VZCZCXRO6424
RR RUEHCN RUEHGH
DE RUEHGH #0478/01 2120305
ZNR UUUUU ZZH
R 310305Z JUL 07
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 6092
INFO RUEHBJ/AMEMBASSY BEIJING 1305
RUEHCN/AMCONSUL CHENGDU 0801
RUEHGZ/AMCONSUL GUANGZHOU 0781
RUEHHK/AMCONSUL HONG KONG 0919
RUEHSH/AMCONSUL SHENYANG 0803
RUEHIN/AIT TAIPEI 0640
RUEHUL/AMEMBASSY SEOUL 0087
RUEHGP/AMEMBASSY SINGAPORE 0062
RUEHKO/AMEMBASSY TOKYO 0166
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RHEHAAA/NSC WASHINGTON DC
RUEHGH/AMCONSUL SHANGHAI 6534

UNCLAS SECTION 01 OF 03 SHANGHAI 000478 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EAP/CM AND EEB 
STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON/SCHINDLER; SAN 
FRANCISCO FRB FOR CURRAN; NEW YORK FRB FOR CLARK/CRYSTAL/MOSELEY 
CEA FOR BLOCK 
STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/ALTBACH/READE 
USDOC FOR ITA/MAC DAS KASOFF, MELCHER AND MCQUEEN 
TREASURY FOR ADAMS, AND OASIA - DOHNER/BAKER/CUSHMAN 
TREASURY FOR WRIGHT AND AMB HOLMER 
TREASURY FOR FDIC/BAIR, GRUENBERG, VILLARREAL AND CARNS 
NSC FOR WILDER AND TONG 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV CH
SUBJECT: SHANGHAI STOCK MARKET: UNCOMFORTABLY GOOD 
 
REF: A. SHANGHAI 25 
 
     ¶B. SHANGHAI 370 
     ¶C. SHANGHAI 133 
     ¶D. SHANGHAI 332 
     ¶E. SHANGHAI 251 
 
(U) This cable is sensitive but unclassified and for official 
use only.  Not for distribution outside of USG channels or via 
the internet. 
 
¶1. (SBU) Summary: According to Shanghai Stock Exchange (SSE) 
Executive Vice President James Liu, Shanghai's stock market is 
"on a rocket" with 60 percent gains so far in 2007.  Huge 
numbers of new retail investors who most likely lack an 
understanding of the risks inherent in the market have been 
overwhelming China's stock brokerage firms.  Price to earnings 
(P/E) ratios are high and profits for most listed companies have 
been inflated by earnings the companies have made investing in 
the market.  This creates the possibility for an even heavier 
crash should it come.  Financial service sector companies 
account for almost 80 percent of the SSE's market capitalization 
while retail traders account for almost 90 percent of all 
trades.  Given the non-convertibility of the renminbi (RMB), 
China's stock markets are insulated from other global stock 
markets.  When to launch the China Financial Futures Exchange's 
first product (a stock market futures fund) has become a 
political question that must be decided at the State Council 
level.  End Summary. 
 
¶2. (SBU) Federal Deposit Insurance Corporation (FDIC) Chairman 
Sheila Bair met with Shanghai Stock Exchange (SSE) Executive 
Vice President James Liu during her July 26-27 visit to 
Shanghai.  Chairman Bair was joined by FDIC Vice Chairman Martin 
Gruenberg, FDIC Director of International Affairs Fred Carns and 
FDIC Chief of Staff Jesse Villarreal.  Chairman Bair's other 
meetings will be reported septel. 
 
-------------------- 
"We Are On A Rocket" 
-------------------- 
 
¶3. (SBU) SSE Liu told Chairman Bair that in the past 18 months 
the SSE had been "on a rocket" with share values "skyrocketing" 
up 61 percent since the beginning of 2007.  Average daily 
trading volume has been roughly 20 billion USD per day, he said. 
 (Note: The SSE Composite Index climbed 130 percent during the 
last six months of 2006.  Ref A). 
 
¶4. (SBU) Liu said "business has been very good," and while the 
SSE "felt very good about the enormous gains," the nature of 
these gains was causing immense discomfort for both the stock 
exchange's management and Chinese government officials.  The 
main cause of concern for the SSE was the market's very high 
trading volume and the "unprecedented" numbers of new and 
inexperienced retail traders jumping into the market.  Liu was 
concerned that China's brokerage firms did not have the 
"capability to handle this type of trading and were not prepared 
to deal with the numbers of new investors.  (Note: More than 
350,000 new trading accounts were opened in June 2007, alone. 
There are more than 100 million open stock trading accounts. 
Ref B.)  According to Liu, there was no way that brokerage firms 
could "know their customers" or educate them about the risks. 
 
-------------------- 
Unsuitable Investors 
-------------------- 
 
¶5. (SBU) Liu noted that while China has regulations mandating 
that brokerage firms question the "suitability" of customers 
opening trading accounts, these were not being applied. 
 
SHANGHAI 00000478  002 OF 003 
 
 
Brokerage firms were hiring staff at unprecedented levels in an 
attempt to keep up with demand.  These new hires were 
inexperienced, overwhelmed and unable to adequately judge a new 
investor's suitability to sustain risk.  Most of these new 
investors were entering the market in order to make the same 
gains they have heard about from friends and neighbors.  "Only 
in a country like China would we see such a phenomenon, and we 
will see it for a long time to come since there are lots of 
people left who have never traded," said Liu. 
 
¶6. (SBU) Liu said that this wave of new investors into China's 
stock market boom differed from those in the United States who 
began investing during the Dot.Com boom.  U.S. investors at 
least had access to some information about companies from 
"reading the Wall Street Journal" or watching business shows on 
television.  Chinese investors, especially these new ones, were 
not doing any research at all.  According to Liu, they were 
basing their stock picks based on which companies their friends 
were buying. 
 
--------------------------- 
P/E Ratios Also Problematic 
--------------------------- 
 
¶7. (SBU) Price/Earning (P/E) ratios were also a major concern. 
Liu estimated that companies listed on the SSE currently 
averaged P/E ratio between 35 and 45, though this was lower than 
previous highs of 75.  Most problematic for Liu was the fact 
that "the majority of listed companies are themselves investing 
in the stock market."  This meant that their profits were tied 
to the overall health of their investments in the market and 
created a "double-jeopardy" situation.  If the market continued 
to rise, their P/E ratios would continue to look healthy; if the 
market "tumbled, then this would further cause the market to go 
down," he said. 
 
--------------------------------------- 
"The Shanghai Financial Stock Exchange" 
--------------------------------------- 
 
¶8. (SBU) In terms of market capitalization, the SSE has become 
increasingly dominated by financial service sector companies. 
With the listings of the Bank of China, China Construction Bank, 
the Industrial and Commercial Bank of China (ICBC), insurance 
companies and brokerage companies, over the past year, 80 
percent of SSE was now made up of financial services sector 
companies.  "We are now the Shanghai Financial Stock Exchange 
and dependent on the performance of the financial sector," said 
Liu.  "This is bad," he said, "ICBC alone represents almost 15 
percent of the entire market." 
 
¶9. (SBU) Liu speculated that over time the dynamics of the 
market would even out and become more balanced.  He noted that 
the future listing of China Mobile, a telecommunication company, 
would be a good thing for the market. 
 
--------------------------------------------- --- 
China's Markets: "Not Affected By Outside World" 
--------------------------------------------- --- 
 
¶10. (SBU) Liu did not believe that China's stock markets would 
be impacted by gains or losses in the U.S. equities markets. 
While there was "some correlation" with the Hong Kong stock 
exchange, Chinese investors were largely unable to move money 
out of China and therefore forced to keep their money in Chinese 
stocks.  He "did not believe for one single minute" that the 
February 2007 correction (Ref C) was related to declines on 
other international stock markets.  Given the non-convertibility 
of the Chinese Yuan, "though we might affect the outside world, 
 
SHANGHAI 00000478  003 OF 003 
 
 
the outside world does not affect us." 
 
---------------------------------- 
Retail Trades: 90 Percent of Total 
---------------------------------- 
 
¶11. According to Liu, retail traders account for 90 percent of 
all trades on the Shanghai exchange.  (Note: This figure 
measures mutual funds as "retail traders."  End note.)  At their 
peak, institutional traders such as insurance and pension funds 
accounted for as much as 30 percent of market share and 40 
percent of trade volume.  With the entry of so many new retail 
investors, however, institutional influence on the market has 
declined markedly.  Recently, 97 percent of USD 30 billion in a 
single day's trade was done by retail investors, said Liu.  This 
has had the effect that institutional investors and fund 
managers no longer looked at a company's fundamentals; they now 
followed what the retail investors were doing.  This was "a 
tremendously bad situation," he added. Ref D. 
 
--------------------------------------------- ---------- 
Financial Futures: Waiting for the Trigger to Be Pulled 
--------------------------------------------- ---------- 
 
¶12. (SBU) In response to a question about the long-expected 
launch of the stock index futures product by the China Financial 
Futures Exchange (CFFEX) (Ref E), Liu expressed some 
exasperation at the delays.  According to Liu, CFFEX had been 
ready to launch its first product for some time, and, from a 
business point of view the stock index futures product should 
have been launched "a long time ago."  But the timing of the 
launch had become a political issue.  "The head of CFFEX can't 
pull the trigger, the China Securities Regulatory Commission 
(CSRC) can't pull the trigger, no one can pull the trigger. 
Only the top can pull the trigger, he said."  From his 
perspective, since the decision to launch had become entangled 
with politics, it would be "some time" before it would take 
place. 
 
¶13. (U) This report has been cleared by the FDIC delegation. 
SCHUCHAT