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Liberalization of China's Financial Markets Calls for Effective Market Regulation

by Ketaki Sood, Larta Research Economist

November 11, 2002

China's financial markets have long been only partially open to foreign ownership. However, much of that changed with the announcement last week by the Ministry of Finance, China Securities Regulatory Commission, and State Economic and Trade Commission removing restrictions on selling state-owned shares to foreigners. Allowing foreign ownership of state-owned and legal-person shares, which constitute 70% of the market's $500 billion capitalization, will allow foreign companies to buy into existing companies in China, in addition to starting new projects in the country. By opening up its financial markets, China has established for itself an additional source of foreign capital. Foreign banks and funds with at least $10 billion in assets and approval from the government will be able to buy Class A shares, which are traded in the Shanghai and Shenzhen exchanges. Before the announcement, foreign investors were restricted to buying foreign-currency dominated shares of about 100 companies listed on China's Class B exchanges.

There is, however, skepticism regarding the response towards such financial liberalization. Whether foreign demand for shares will be strong is yet to be seen, as a number of Chinese A-share companies display poor profits and management. There is also a glaring need for the restructuring of China's financial markets, which are underdeveloped, lacking liquidity, and needing corporate governance standards. Poor regulation and dominance by an inefficient state sector has led to false disclosures and share-price scandals in China's markets. Effective market regulation is required to restore investor confidence in the Chinese stock markets; without such regulation, the long-term impact of such financial liberalization will be subdued.