Beijing To Crooked Brokers: Watch Out

A tough new law aims to clean up China's notorious markets

After years of fighting bureaucratic turf battles, the China Securities Regulatory Commission, the country's stock market watchdog, has finally grown some teeth. Starting on July 1, it will be able to stomp on rampant insider trading, tighten listing requirements, and slap big fines and even prison terms on crooked brokers, company officials, and stock promoters. "The overall goal is to create a fair, efficient, and orderly market," says Liu Hong, 35, the commission's U.S.-educated general counsel.

The cleanup of China's disreputable markets is long overdue. The dramatic October collapse of the $3.6 billion Guangdong International Trust & Investment Corp. set alarms ringing in Beijing about the dangers from China's freewheeling stock markets. "If they don't correct the problems now, it could lead to social instability," warns Jim Lam, chief representative at ABN Amro Asia's Shanghai office.

Such worries finally broke a six-year logjam: At the end of December, China enacted a law to enhance the commission's powers. In the uncertainty that prevailed before the law's passage, the daily combined trading volume on the Shanghai and Shenzhen exchanges slumped to a yearly low around $600 million in late December. And the law has been raising a storm of protest in China's fledgling financial industry ever since. "The law is too strict," complains an official at brokerage Beijing Securities Co. "It gives securities companies no way to survive."

There will be plenty of carnage. By some estimates, as few as 15 brokerage houses will be allowed to offer a full range of underwriting, proprietary trading, and trading for their clients after July, compared with 325 now. New rules will all but ban state enterprises and banks from trading, while security houses with less than $60 million in capital will be limited to executing customer orders.

One thing that won't change in a hurry, though, is the two-tier system that restricts foreigners to buying B-shares, which are denominated in foreign currency. But in the longer run, even foreigners stand to gain from more liquid and less corrupt markets.

Financial information flows should get a lot richer, too. Companies will be required to report promptly--and to publish in designated newspapers--news about problems such as losses or debt-servicing difficulties, along with any major management and ownership changes.

CRONYISM. The law will also implement a new line of defense against fraud. The commission is charged with creating a new securities-issuance board. Composed of a small number of commission employees together with some outside professionals, it will vet companies that are seeking a listing. The idea is to put a stop to the local cronyism that now dominates such decisions. "We should see better companies being listed," says ABN Amro's Lam.

In any event, China's estimated 30 million domestic investors should be much better protected against future rip-offs. New rules will ban brokerages from using clients' funds for trading on their own account. And when investors sustain losses through negligence or fraud, they will have more chance of recovering lost cash. Stock markets, settlement agencies, and trading houses will, for the first time, be compelled to set up compensation funds. In addition, investors will be able to sue dodgy trading houses in civil courts.

In coming months, the commission faces the huge task of systematizing a hodgepodge of more than 250 existing securities regulations to fit with the new law. The resultant uncertainty is causing a lack of liquidity in China's stock markets right now. But whatever the short-term impact of the reforms, a modern China needs an efficient and honest securities market. It's imperative to attract money from foreign and domestic investors alike.

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