Aug. 26 (Bloomberg) -- China may let investors sell bonds that can be swapped for shares to deter equity sales and support the nation's stock market, the world's worst performer this year.

The China Securities Regulatory Commission is studying exchangeable bonds as part of a package of measures to restrict sales of shares in state-owned companies, said a Beijing-based official of the regulator who declined to be identified before a proposal is made public.

The plan would enable state shareholders to raise funds without selling stocks on the market, limiting supply as trading restrictions end on more than $1 trillion of government holdings. A cut in trading taxes and curbs on initial share sales failed to halt a 56 percent slump in the benchmark index this year.

``This measure will help ease the pressure placed on the market by state-owned shares,'' said Victor Wang, a Hong Kong- based analyst at UBS AG. ``Investors' sentiment is quite low and the government has been trying to bolster market confidence by limiting massive share sales.''

As much as 8.7 trillion yuan ($1.3 trillion) of government holdings become tradable through 2010, according to local data provider Wind, an overhang that's weighing on investors just as inflation and a slowing economy threaten to undermine earnings growth.

China Shares

China's benchmark CSI 300 Index soared 7.9 percent on Aug. 20, its biggest gain since April, on speculation the government would announce plans to support a market that has lost $2 trillion in value this year. The index gained 162 percent last year, the world's best performer. It declined 2.9 percent to 2,331.53 at the 3 p.m. close today.

China shares trading the U.S. gained, sending the Bank of New York Mellon China ADR Index up 0.5 percent as of 1:25 p.m. in New York. American depositary receipts of China Life Insurance Co., the nation's biggest insurer, climbed 4.1 percent to $55 as of 1:28 p.m. in New York. China Southern Airlines Co. ADRs added 3 percent to $15.91.

Lockup restrictions are set to expire on shares accounting for more than half the combined $2.29 trillion capitalization of the Shanghai and Shenzhen markets. The overhang is the legacy of a 2005 government-led shakeup that converted non-tradable shares into common stock that can be bought and sold on exchanges.

Share Transfers

Under the commission's plan, shareholders wanting to sell after lockups expire would have to transfer their stakes to a third party such as a clearing house, according to the official. They would then be allowed to sell bonds to investors that could be swapped for the shares later.

The commission doesn't have a timetable for the plan, the official said. The rules haven't been completed and it's unclear if the bonds can be traded before they are turned into common stock, the person said.

The measures being considered will include more transparent information disclosure when holders of state-owned companies' shares place sales through block trades, and working with the state-asset supervision agency to monitor transfer of those shares, according to the official.

The securities watchdog said on Aug. 15 it may use brokerages as intermediaries to sell state-owned companies' shares instead of placing them directly on the secondary market, to ease pressure on share prices.

State-Owned

In April, the Beijing-based commission brought in rules to limit the amount of state-owned stock that can enter the market. Shareholders selling more than 1 percent of a company's shares within a month must do so through block trades, which require a buyer to be lined up beforehand, and don't go through an exchange. The finance ministry cut the tax on share trading to 0.1 percent, from 0.3 percent, in the same month.

The CSRC was also delaying the issuance of written approval documents, the final regulatory stage, to companies preparing IPOs to arrest the stock market's decline, two people familiar with the matter said earlier this month.

The CSI 300 has tumbled this year on concern that central bank's efforts to tame inflation, which reached a 12-year high in February, and weakening economic growth will hurt earnings. China's economy grew 10.1 percent in the three months through June, slowing for a fourth quarter.

The index rose more than sevenfold between July 2005 and October, driven partly by the success of the government's plan for non-tradable shares.

The ownership shakeup ended a four-year bear market and paved the way for share sales by PetroChina Co., Industrial & Commercial Bank of China and China Construction Bank Corp. Companies raised $63 billion selling stock in China in 2007, more than the previous six years combined.

The government was forced to abandon the sale of state holdings in 1999 and again in 2001 after investors grew panicky about a glut of shares landing in the market.

The 21st Century Business Herald reported the exchangeable bonds plan earlier, citing unidentified people close to the regulator.

To contact the reporter on this story: Zhao Yidi in Beijing at at yzhao7@bloomberg.net

Last Updated: August 26, 2008 13:33 EDT