China's Answer to a Year of Market Turmoil: a Super-Regulator

  • Existing regulatory framework seen ill-adapted to realities
  • Stock-market rout prompted calls in government for revamp

China’s government is expected to unveil plans for a financial super-regulator as early as this year, according to people familiar with the matter, as concerns grow about the best way to ensure market stability and maintain investor confidence.

The most-discussed proposal would see the banking, securities and insurance regulators merged into one entity, while the People’s Bank of China would get more power over the economy, said the people, who asked not to be identified because the talks are private. Discussions over creating a single body to handle the work now divided between three agencies has set regulators against one another, with each lobbying to stay relevant after the changes, the people said.

Over the past year, China’s leadership has sought to adopt a more open financial system as it wrestles with slowing economic growth. Setbacks such as last summer’s $5 trillion stock sell-off, a series of financial scandals and January’s aborted introduction of stock market circuit breakers have increased the pressure on regulators. The yuan, meanwhile, is on its longest run of declines since December.

QuickTake China's Pain Points

Fragmented System

“This should have been done a long time ago,” said Hu Xingdou, an economics professor at the Beijing Institute of Technology. “Under a fragmented system, each regulator is going its own way. There’s a lack of coordination and sharing of data, it’s bureaucratic and there’s a lot of overlap.”

China’s fractured regulatory framework has led to different standards, capital requirements and entry thresholds for similar businesses operated by different institutions. Internet finance is a prime example. Rules issued in July said the central bank will supervise online payments, while the China Banking Regulatory Commission oversees Internet lending, trusts and consumer finance. The securities regulator was told to handle equity crowd-funding and online fund sales.

Competition among regulators has also led to weak supervision and a territorial mindset, according to Wu Xiaoling, a former deputy governor of the PBOC who has advocated for a "decisive" coordination mechanism to stabilize the financial system.

Alternative Plans

The leadership is considering other options. One would create a super-regulator that would oversee the China Securities Regulatory Commission, CBRC and China Insurance Regulatory Commission. A third option would combine the three commissions with the PBOC. The new plans could be in place as early as this year, according to the people, though the process may take another few years.

The State Council, China’s cabinet led by Premier Li Keqiang, will oversee the forming of the new regulatory body, the people said. Suggestions may be put forward when the country’s legislature, the National People’s Congress begins its annual two-week session March 5.

Li has faulted regulators’ reaction to the market turmoil, saying at a State Council meeting on Feb. 15 that they didn’t respond actively enough and drawing attention to what he called management problems.

China’s government changed its supervision framework once already this year. In January, it created a department under the State Council’s general office tasked with coordinating between financial and economic regulators and gathering data from local offices, a person familiar with the matter said at the time.

Major Surgery

Frank Song, a finance professor at the University of Hong Kong, said a merger of the regulators would be “major surgery” to the financial system. He said that without a well-thought-out plan, such a drastic adjustment might trigger an even larger crisis that could harm the economy.

“Rushing out this policy before the pros and cons are fully considered might cause more disturbances in the market,” Song said. Given the slowing economy and the recent devaluation of the yuan, “the timing is not good,” Song said.

While proposals to combine the financial regulators have come up over the past few years, the debate intensified in the wake of last summer’s stock-market rout.

Regulators’ handling of the decline drew criticism and laid bare their lack of coordination, prompting calls from within the government to revamp the existing framework. Two multi-billion dollar financial scandals last year, involving a metals exchange and a peer-to-peer lending platform, further shook confidence.

Regulators have been accused of both overreacting and not moving swiftly enough. After the summer’s stock losses, the government temporarily suspended initial public offerings, banned major shareholders from cutting stakes, engineered state purchases of stocks and changed futures trading rules.

A stock-market circuit breaker, introduced to prevent future dramatic declines, was scrapped after four days. Earlier this month, Xiao Gang, the CSRC chairman who’d been criticized for his handling of recent events, was replaced by Liu Shiyu, the former head of Agricultural Bank of China Ltd.

PBOC Claims

Amid the lobbying efforts by different agencies, officials linked with the PBOC have gone public pressing for the central bank to take on enhanced powers.

The PBOC should take charge of monetary policy as well as supervision of the financial industry, Bu Yongxiang, a researcher at the central bank, wrote in Caixin magazine on Feb 23. China’s fractured regulatory system is the “root cause” behind the recent turmoil, Bu wrote.

The suggestion echoed that of Wu, the former PBOC deputy governor. She led a study that blamed splintered regulation for the rise in unofficial lending, such as money provided by trust companies, online platforms and underground lenders, which inflated the stock market bubble and amplified subsequent declines.

Zhang Yuanzhong, a Beijing-based lawyer specializing in securities litigation, said he supported the idea of centralized financial regulation. He cautioned that a combined agency may be too powerful and could overwhelm market participants.

“How to strike the right balance in terms of how power should be allocated between the super-regulator and the market will put the wisdom of China’s decision makers to the test,” he said.

— With assistance by Keith Zhai, Aipeng Soo, and Steven Yang

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