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R 050946Z MAY 06
FM AMEMBASSY BEIJING
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UNCLAS SECTION 01 OF 02 BEIJING 008331 
 
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E.O. 12958: N/A 
TAGS: EFIN EINV PGOV CH
SUBJECT:  CHINA SECURITIES REGULATOR TELLS FED VISITORS 
CAPITAL MARKETS MAKING PROGRESS 
 
REF:  BEIJING 07696 
 
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¶1.  (SBU) Summary:  The head of the Research Department at 
the China Securities Regulatory Commission (CSRC) advised a 
group of analysts from the New York Federal Reserve Bank on 
April 17 that China's stock market reform process is moving 
forward, with a new listing process, successful conversion 
of non-tradable shares and more participation by 
institutional investors, including by Qualified Foreign 
Institutional Investors (QFIIs).  The QFII program has been 
especially important in improving governance standards, and 
the Qualified Domestic Institutional (QDII) program is also 
poised to begin.  The official also sees signs of progress 
in the development of a corporate bond market.  While 
securities firms are still weak, introducing foreign 
partners will help bolster their operations.  Overall, he 
believes the markets are much improved and will only become 
stronger.  End summary. 
 
Reforming the Markets 
---------------------- 
 
¶2.  (SBU) On April 17, a delegation of analysts from the 
New York FRB met with Qi Bin, the head of the Research 
Department at CSRC, to discuss recent developments in 
China's capital markets.  Qi began by insisting that the 
CSRC's priority is further liberalization of the capital 
markets.  In that spirit, the CSRC has recently reformed 
the listing process.  Formerly, listings were determined by 
the CSRC alone, but now it is more market-driven, with 
securities firms taking the lead.  He confirmed a recent 
CSRC announcement that listings will resume within a few 
months.  Qi noted that China is both an emerging market and 
a transitional economy and that its stock markets have a 
relatively short history.  Still suffering from poor 
governance and disclosure standards, the markets are 
struggling with many other problems as well, including the 
non-tradable share (NTS) problem.  (Note:  Before the NTS 
reform, two-thirds of the shares of listed companies were 
state-owned and non-tradable.  End note.)  He suggested the 
NTS reform would be finished within a few months. One sign 
of progress in the reform program is the fact that 25 
percent of the market is now in the hands of institutional 
investors.  Although all of the securities firms are 
essentially bankrupt, the Government is trying to bring in 
new incentives like MBOs and stock options.    Thus far, 70 
percent of the NTS reform has been completed.  The goal of 
the CSRC is to stabilize the market and compensating 
tradable shareholders is intended to help achieve that 
goal. 
 
QFII and QDII 
------------- 
 
¶3.  (SBU) Another important contribution to a more stable 
market, according to Qi, was the introduction of the 
Qualified Foreign Institutional Investor (QFII) program. 
Begun in 2002, the program has turned out better than 
expected by improving the market standard and changing the 
market philosophy.  The QFII program has required companies 
to improve disclosure and governance.  There are currently 
39 QFIIs to which US$6 billion of the potential US$10 billion 
quota has been granted.  As for the Qualified Domestic 
Institutional Investor (QDII) program, Qi stressed that 
the Chinese Government must be "very careful" to ensure 
that it leads to an improvement in China's financial 
system.  Noting that a series of new policy announcements 
had just come out on the QDII program (see ref), Qi said 
the Social Security Fund and certain insurance companies 
had already been allowed to begin investing overseas. 
Retail investors will also be allowed to invest in overseas 
markets later this year. 
 
Conditions for Bond Market 
-------------------------- 
 
¶4.  (SBU) Commenting on the bond market, Qi said there are 
a number of government organizations involved in the 
supervision process, chiefly CSRC, the People's Bank of 
 
BEIJING 00008331  002 OF 002 
 
 
China, Ministry of Finance and National Development and 
Reform Commission.  Qi said he sees the explosion in the 
short-term market as a positive development, but the 
opening of the bond market has been too slow. 
Acknowledging there is a lot of pent-up demand by companies 
to raise money in the bond market, Qi was not sure when 
longer-term bonds would be allowed.  Qi agreed that 
credible rating agencies are important for the bond market, 
and noted that Moody's just signed an agreement to enter a 
joint venture with the Cheng Xin credit rating agency.  He 
also noted that Morningstar has a wholly-owned mutual fund 
rating agency in Shenzhen.  In Qi's view, the prerequisites 
for a bond market are:  quality credit ratings, investor 
education, good financial institutions and a proper legal 
environment. 
 
Securities Firm Problems 
------------------------ 
 
¶5.  (SBU) Regarding securities firms, Qi noted that barring 
them from operating asset management accounts for clients 
was an important improvement.  Another important step will 
be making them more competitive by introducing foreign 
partners.  At present, foreign investors are restricted to 
49 percent of an asset management company and 33 percent of 
a securities firm.  Qi said progress in reforming the 
markets and allowing more foreign participation depends on 
the strength of the market.  The stronger the market, the 
faster reform will move. 
 
¶6.  (SBU) Qi said he is most worried about the prospect 
that the market will remain too small and will crash.  He 
regards the markets as already too far behind China's 
economic development.  Although there has been a lot of 
negativity about the markets over the past five years, he 
believes the market is now more disciplined.  The worst 
firms have already been driven out of the market and there 
is now a possibility of good value investments.  Although 
the market has dropped 50 percent, 120 firms have actually 
tripled in value.  The market was once all speculation but 
the situation is now changing. 
 
¶7.  (U) This report has been cleared by the New York FRB 
delegation. 
 
SEDNEY