China Stock Market Dysfunctional Amid IPO Halt, Neoh Says

China’s equity market has become “dysfunctional” after the regulator halted share sales and investors shifted to wealth-management products, said Anthony Neoh, a former government adviser who helped the nation open up to foreign money managers a decade ago.

Smaller companies are losing access to capital as the China Securities Regulatory Commission extends a more than nine-month halt on initial public offerings and government-controlled banks focus on lending to state-owned enterprises, said Neoh, who helped start the Qualified Foreign Institutional Investor program as the CSRC’s chief adviser from 1999 to 2004. Many investors assume wealth-management products are guaranteed by the government, creating “tremendous moral hazard,” Neoh said.

The Shanghai Composite Index tumbled 42 percent in the four years to yesterday, the worst performance worldwide after Greece’s ASE Index. Investors have liquidated about 2.7 million stock accounts since June 2011 and about 116 million are empty or frozen, regulatory data show. More than 700 companies are waiting to raise funds, according to data compiled by Bloomberg.

“We now have a dysfunctional stock market,” Neoh, who is now part of the CSRC’s international advisory body and a visiting professor at the National University of Singapore, said in an interview in Shanghai on July 30. “The stock market has been starved for funds.”

New Lending

The Shanghai Composite gained 1.8 percent to 2,029.07 at today’s close. The measure doubled in 10 months through August 2009 as the government poured $652 billion of stimulus into roads, railways and housing, has lost $749 billion in market value the past four years. The gauge dropped 12 percent this year as Premier Li Keqiang signaled tolerance for slower growth to shift the economy away from investment-led stimulus. The government is targeting expansion of 7.5 percent this year, which would be the slowest since 1990.

The economy is decelerating as the Communist Party reins in an unprecedented $1.6 trillion lending boom in 2009 that helped send home prices to all-time highs and left local governments with record liabilities. New yuan bank lending was $1.3 trillion in 2012, according to the People’s Bank of China.

Chinese stocks will eventually rally as the economy grows at a faster pace than most major countries and regulators increase oversight of stock sales, Mark Mobius, who oversees about $53 billion as the executive chairman of Templeton Emerging Markets Group, said in a July 29 interview in Bangkok.

“The IPO situation will get better in the sense that the quality of new issues coming into the Chinese market will improve,” Mobius said.

Ponzi Scheme

Wealth-management products, which CSRC Chairman Xiao Gang likened to a Ponzi scheme in an October commentary, have lured investors because they typically provide rates of return higher than savings deposits, which are set at 3 percent annually.

The value of the products, which invest in everything from money markets to stocks and local-government loans, surged eightfold since 2009 to 8.2 trillion yuan ($1.3 trillion) at the end of March, according to government data.

While they look like time deposits to investors, about 70 percent of them don’t have their principal guaranteed by banks, according to data from the China Banking Regulatory Commission, which requires banks to register all WMPs they sell. About half invest in riskier areas including stocks, derivatives and loans to local governments and property developers, the CBRC said.

“We don’t have a set of standards that are uniform for trust companies, insurers and wealth-management firms,” said Neoh, who was chairman of Hong Kong’s Securities and Futures Commission from 1995 to 1998. “The implicit understanding is that if something goes wrong, the government will come in and protect them.”

Chief Adviser

Calls to the CSRC and CBRC’s press offices weren’t answered today. The offices haven’t responded to faxed requests late yesterday seeking comment.

A qualified lawyer, Neoh was invited to become the CSRC’s chief adviser by former Premier Zhu Rongji and helped develop the legal framework for the listing of mainland enterprises in Hong Kong, according to a profile on the website of the Association of Chartered Certified Accountants. He was in Shanghai this week to speak at a finance and banking forum held by the National University of Singapore’s business school.

Neoh oversaw the creation of the QFII program that grants international institutions access to Chinese securities. Some 229 foreign firms have been approved to invest $43.46 billion in yuan-denominated stocks and bonds, CSRC data show.

China needs to improve its oversight of capital flows after $2.7 trillion in unexplained funds moved overseas in the past decade, Neoh said, citing November data from Integrity International. Those funds fueled property bubbles in cities such as Hong Kong instead of being invested in domestic assets, he said.

“Public policies we have been pursuing have created conflicts with each other which meant one particular sector has been disregarded,” Neoh said. “It’s actually not because of a lack of reforms. There have been a lot of reforms. It’s because of mismatches between a lot of these reforms.”