Abstract: Five developments have ushered in a golden period for China’s capital market. First, a series of fundamental reform measures such as the registration-based IPO system have been introduced. Second, the robust and resilient fundamentals of the Chinese economy, its strong recovery momentum and huge potential, as well as China’s super-large market provide fertile soil for high-quality listed companies. Third, the moderately loose monetary policy has provided necessary liquidity. Fourth, enhanced rule of law is conducive to the long-term prosperity of the capital market. Fifth, adjustments in regulatory policies will help guide long-term capital into the market. Entering the new era, China needs to raise the proportion of equity financing in its capital market and encourage long-term investment.
The development of China's capital market has entered a golden period. For a long time, China has a relatively simple financial structure that is dominated by indirect financing through banks, with the direct financing sector remaining underdeveloped and ill-fitted to the needs of the real economy. Compared with the United States, China’s capital market has a stock-to-bond ratio of 80/20. Such a structure can hardly meet the requirements of high-quality economic development. Entering a new era, China needs to accelerate its efforts to increase the share of equity investment.
I. Five developments have ushered in a “golden period” for China's capital market.
First, the introduction of a series of fundamental reforms in capital market.
A series of measures such as the introduction of the Science and Technology Innovation Board and the registration-based IPO system have lowered the financing costs and provided better capital support for the development of core technologies and innovative companies with high growth potential, reflecting the decisive role of market in resource allocation.
Regulators no longer take on the job of the market to endorse the credit of listed companies, which helps clarify the positioning of the function of the market. Particularly, by improving information disclosure, efficient financing and reasonable risk pricing could be provided for uncertain production factors like innovative technologies, which is conducive to optimizing supply efficiency and fundamentally addressing the severe distortion of the pricing mechanism due to supply and demand imbalance.
Before, rather than investing in high-value firms, speculative trading in shell, small-cap, IPO and special treatment shares prevailed in the market. By implementing reform measures, funds can be directed to China’s strategic and priority sectors and to enterprises with the potential of long-term growth, and thereby help cultivate value investment in the market.
The registration-based IPO system has accelerated the survival of the fittest. After the monetary policy gradually returns to normal, the driving factor of the equity market will shift from valuation to the performance of firms. The number of listed companies will increase, fundamental analysis will become more difficult, and the daily fluctuation in the price will be bigger, indicating that the capital market will be more suitable for institutional investors who have the capability in in-depth research and long-term valuation.
Second, the robust and resilient fundamentals of the Chinese economy, its huge potential and strong recovery momentum, as well as its super-large market, which have provided the fertile soil for high-quality listed companies. Without high-quality companies, even a good system will not work.
Third, the moderately loose monetary policy has provided necessary liquidity for the capital market. This does not mean liquidity flooding; instead, it means that the development of the market will be limited without necessary liquidity condition.
Fourth, enhanced rule of law. This involves continuously strengthening institutional arrangement, cracking down on illegal activities such as market manipulation, fraudulent issuance, insider trading, and profit-channeling, maintaining an open, fair and just market order, and giving zero tolerance for illegal and criminal activities.
Such regulatory principles as strengthening institutional arrangement, reducing government intervention and giving zero tolerance for illegal activities are similar to those for insurance funds: relax restrictions on the market access of front-end products (reducing government intervention) while putting in place back-end control (strengthening institutional arrangement).
First, lowering entry threshold and broadening direct financing channels do not indicate zero management requirements, nor should there be no boundary in encouraging and supporting innovation. Support for innovation that can hardly be translated into productivity, without clear cross-sectoral innovation model and not in line with the orientation of national governance and strategic development should be strictly restricted.
Second, no matter how strict the institutional arrangement and enforcement is, no one can guarantee that only high-quality, well-managed firms will enter the market, neither can we know whether the value, performance and behavior of these firms will not deteriorate over time. The implication of “zero tolerance” is meant to heavily punish non-compliant or fraudulent behaviors as a warning to others, so as to prevent the whole system from being infected by a few cancerous firms.
The regulatory emphasis on “zero tolerance” can give an exceptional boost to market confidence and trust and ensure the prosperity of capital market in the long term.
Actively repairing the ecosystem of the capital market and establishing a virtuous cycle for the competition of listed companies by perfecting delisting standards will help promote the “metabolism” and “self-evolution” of the capital market and create a mechanism which facilitates both entry and exit and preserves qualified companies while eliminating unqualified ones.
China has the largest number of and most active individual investors in the world. In the past, due to low violation costs and opaque information in the capital market, there was a lack of protection for investors, especially small and medium-sized investors. The mandatory co-investment rule in the Science and Technology Innovation Board mainly aims to encourage the sponsor institutions to ensure the quality and reasonable pricing of the IPOs so as to protect the interest of individual investors. A sound market ecosystem has also helped attract international funds.
Fifth, adjustments in regulatory policies. Favorable policy adjustments by regulators including China Securities Regulatory Commission (CSRC) and China Banking and Insurance Regulatory Commission (CBIRC) would attract more long-term capitals to the Chinese capital market.
At present, the Chinese capital market houses pensions of over 6 trillion yuan, social security funds of over 2 trillion yuan, insurance funds of over 20 trillion yuan, and bank wealth management funds of over 20 trillion yuan. Tapping into this immense pool of funds, the Chinese investor community enjoys enormous potential to elevate the proportion of equity assets in its investment portfolio.
For example, insurance funds in China have mainly been invested in fixed-income assets over a long time. Many of the investments are for short-term speculation purposes, while demands for long-term investments have remained unmet. As the average interest rate goes down and credit risks mount up, it will be harder for insurance investors to strike a proper balance between returns and risks.
Guo Shuqing, Chairman of CBIRC, noted in a number of recent speeches the importance to support insurance companies to step up their investments in the capital market, especially in the stocks of high-quality listed companies, in various ways including direct investments and entrusted investments. According to him, CBIRC will introduce related regulatory policies in the coming period of time, including those on the differentiated regulation of equity investments by insurance companies.
These policies will facilitate the entry of long-term insurance funds in the capital market in pursuit of stable returns over the long run, which could increase the proportion of institutional investors relative to individual investors. These capitals are expected to boost efforts in exploring cross-cycle investment strategies and models, flatten fluctuations in the capital market and fundamentally promote its development.
The application of new accounting standards has further boosted insurance companies’ willingness to invest in high-dividend, low-fluctuation equity assets, and the sound development of the capital market will also create more opportunities for investors with long-term funds.
II. Now is a perfect window period to introduce regulatory policies aimed at boosting investments in the capital market
Regulatory policies should be introduced at the correct timing, or the proper window period. With differentiated regulatory policies in place at present, the maximum proportion of equity investments in total investments of insurance companies with good performances has been raised to as high as 45%, replacing the previous cap of 30%. Why wasn’t the cap elevated earlier? In fact, regulators have been studying various policies options, and increasing the proportion of equity investments for insurance companies has been under consideration before, but they were waiting for a good timing to do this. Previously, the capital market was sluggish and clouded with uncertainties, with insufficient reforms and low investor confidence. Even if the regulators increased the cap, few insurance companies would actually expand their equity investments. Back then, the proportion of direct and entrusted equity and stock investments in total investments across the entire insurance industry was only around 20%, and so the 30% cap had already provided sufficient space for growth. The major problem is still the lack of motivation and willingness among investors.
Then why lift the cap now? Because now is a perfect window period.
First of all, past reform endeavors have forged a safer capital market, which enhanced investors’ trust and confidence.
Second, as more companies enjoy the opportunity to go public, the Chinese capital market sees greater liquidities.
Third, from the perspective of investments in long-term values, more investors are turning to equities with high dividend, high growth potential and low fluctuations over the long run, rather than merely focusing on short-term fluctuations and returns. Equity investments are expected to produce returns much higher than investments in non-standard assets and fixed-income assets. They generate higher yields.
Fourth, from the perspective of balance sheet management, assets and liabilities of insurance companies are increasingly matched.
As the Chinese capital market matures and regulators lend greater policy support, insurance companies are more motivated to step up their investments in the capital market, especially in the stocks of high-quality listed companies. The effect of the policy will gradually come through.
It’s important to form a virtuous circle between capital market reforms and developing long-term capitals. Improvements of the capital market and introduction of more long-term insurance funds are two goals that should be mutually reinforcing.
Chairman Guo Shuqing has also pointed out that China needs to support the development of the third pillar pensions, which, as I understand, can help translate household savings into investments to boost the development of the capital market.
Chinese people love savings. This mentality in itself is by no means wrong. Savings have played an important part in sustaining Chinese households during the pandemic. It is inadvisable to spend every penny earned. Some of the young people today turn to shark loans to support their excessive spending. This is unsustainable, whether for themselves or for the society.
The concept is fine, but the problem lies in the form of savings. Most of the savings in China are placed with banks, but banks’ main function is to extend credits; only a small portion goes into equity investments. Thus, it would be desirable to turn part of the 90 trillion yuan of household savings in China into long-term funds through investments in third-pillar pensions.
On one hand, sustained and stable development of the capital market could produce safer and higher yields for the money that people put aside for their old-age care in a more efficient way. Only with a safe and stable capital market can Chinese people update their investment mentalities and turn to these wealth management vehicles.
On the other hand, driving structural adjustments in household savings with policies and a variety of investment tools would help introduce more funds into the capital market. The positive changes in household savings and in the capital market could be mutually reinforcing to create greater benefits for the country, the market, the businesses and the Chinese people.
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