How shadow banking fired up China´s stock markets - Sara Hsu

+Sara Hsu 

Shadow banking seemed for a short while on the decline, but the industry is back in force, writes financial analyst Sara Hsu in the Diplomat. The recent rally of China´s stock markets was caused by shadow banking.

Sara Hsu:

Shadow banking experienced declines last year, as fewer funds were channeled to the property market via trust and wealth management products. Some of the funds that entered the shadow banking industry in search of yield were reoriented to the climbing stock market and recently, perhaps ironically, channeled to the stock market through shadow banking products. Fewer funds went into trust and entrusted loans during mid-year 2014, but this trend reversed in December 2014 as the shadow banking industry took advantage of the stock surge by promoting assets that included both stocks and more shadowy products such as trust and entrusted loans. 

A recent crackdown on margin regulation has also served to induce investors to use wealth management products to purchase stocks through shadow banking channels. Although margin trading rose through 2014, the China Securities Regulatory Commission (CSRC) on January 16 reiterated that the minimum account threshold for opening an account (to be potentially used in margin trading) was 500,000 RMB ($80,000). In addition, the CSRC banned Citic Securities, Haitong Securities, and Guotai Junan Securities from opening new margin accounts for three months. Funds have increasingly been transferred to the stock market via umbrella trusts, which use both wealth management product proceeds and private investors’ funds. Private investors can make a profit on such assets as long as the stock market rallies. 

In China’s relatively shallow financial markets, increasingly sophisticated investors have eagerly sought higher returns. The shadow banking sector provided such returns through mid-2014, lost its luster through November 2014 as the stock market rose, and rebounded in December 2014 in tandem with a stock market surge. 

The bull market for stocks reveals that investors continue to hunt for yield, and equally importantly, that investors have a positive market outlook. This perspective reflects statements made by the leadership that the economic slowdown is not a product of declining prowess, but of restructuring toward a more advanced economy. It indicates belief in the ability of the leadership to restart the economy going forward. Although some analysts have viewed the stock rally as a byproduct of irrational investors, recent research by Ya, Ma and He (2014) has shown that China’s stock market increasingly reflects fundamentals and is not as driven by herding activity as in the past. 

While the stock upswing reflects positive investor sentiments, regulators are wary of overleveraging in the stock market as they have been in the shadow banking market. Excessive undertaking of debt for investment purposes led to high leverage for margin trading, thus inciting the recent crackdown. Stop-loss positions for stock investment via wealth management products may exacerbate a stock downturn when it occurs. Continued monitoring by authorities will help to curb the worst practices and control the feeding frenzy in China’s stock markets as bullish investors pour funds into this “new” old financial channel.

More in the Diplomat Sara Hsu is a speaker at the China Speakers Bureau. Do you need her at your meeting or conference? Do get in touch or fill in our speakers´ request form. Are you looking for more financial experts at the China Speakers Bureau? Do check out this list.  

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Now China needs an audit regulator - Paul Gillis

+Paul Gillis 

The Chinese Securities Regulatory Commission (CSRC) will in 2015 drastically change the way how IPO´s take place in China. The government will step back, leaving decision making to the market. To facilitate that change, China needs an audit regulator, writes accounting professor Paul Gillis at his weblog.

Paul Gillis:

As regulators step back, it is critical that other institutional players, particularly auditors, lawyers, and investment bankers step up. They will become the prin-cipal gatekeepers to the market. Without increased professionalism by these players, the Chinese stock markets could become increasingly dangerous for investors. Too many auditors have been willing to sign off on numbers that magically meet CSRC IPO requirements. The Big Four are not major players in the domestic IPO market, which is dominated by local firms. Although some large local firms have emerged, they do not dominate the local stock markets like the Big Four dom-inate most markets around the world. Hopefully, investors will start paying more attention to the audit firms selected by Chinese concerns, and that will lead to larger, higher quality accounting firms dominating the market. 

The CSRC has promised to tighten post-IPO supervision and to punish those who violate the rules. That is laudable, but the devil will be in the details. For the auditors, I suggest that China put in place an independent audit regulator that would be eligible to join the International Forum of Independent Audit Regulators (IFIAR), a group that now includes regulators in 51 jurisdictions.Hong Kong is currently deciding on necessary reforms that would allow it to join IFIAR. An independent audit regulator with the funding to do its job and the willingness to take on recalcitrant accounting firms is now the global standard for securities markets.

More at the ChinaAccountingBlog.

Paul Gillis is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers´ request form.

Are you looking for more experts in managing your China risks at the China Speakers Bureau. Check out this list. 

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How to end the auditing wars - Paul Gillis

+Paul Gillis 

The ongoing stand-off between securities regulators in China and the US keeps auditing firms hostage and might eventually lead to the delisting of Chinese companies at US stock exchanges. Beida accounting professor Paul Gillis tries to map out a way out of the maze in Forensic Asia.(pdf)

Paul Gillis:

A slew of frauds at US-listed Chinese companies have highlighted flaws in the attempts of US regulators to provide, what they believe is, adequate investor protection. The US Securities and Exchange Commission (SEC) demands the audits of all US-listed companies meet the standards established by the US Public Company Accounting Oversight Board (PCAOB). Unfortunately, Chinese-based auditors are unable to release their audit working papers to US regulators without breaching Chinese law. As such, complying with US regulations could land Chinese auditors in Chinese jails and failure to comply could land them in US jails. 

In order for overseas auditing firms to audit US-listed companies, they must submit to an inspection by the PCAOB to ensure they are following US standards. Chinese regulators have been reluctant to offer joint inspections as they believe this is a breach of national sovereignty and have pushed for the equivalent of the audit oversight systems in third countries, similar to the agreement China has struck with the EU. Unfortunately, the PCAOB has little statutory authority to offer this. 

The China Securities Regulatory Commission (CSRC) may well cede to some form of joint inspections between Chinese and US regulators but on the condition that only they will be allowed to administer punishment to wayward Chinese auditors. However, approval from the Ministry of Finance is questionable given the issue of “face”.

And Gillis - at the end of high detailed article - cautions, as the situation is still developing:

The biggest risk is to China. If Chinese entrepreneurs are unable to obtain access to capital, indigenous innovation may suffer, and China’s long-term competitiveness may be affected. Chinese stock exchanges are not ready to replace U.S. markets for entrepreneurial companies. The CSRC recently announced it was liberalizing rules for Chinese companies to list overseas, motivated in part by a huge backlog of pending IPOs in China. 

The only scenario that resolves the situation without kicking Chinese companies off of U.S. stock exchanges is where the United States and China reach a diplomatic solution. From the U.S. perspective, the PCAOB and the SEC have likely put their best offer on the table. Both regulators are bound to follow U.S. laws, which generally require them to regulate auditors as they have proposed. A law change seems unlikely, given it would propose a lower standard for Chinese companies than that imposed on other companies, including American companies. James Doty has pointed out that the Supreme Court case that upheld the constitutionality of the PCAOB established that the PCAOB is in a reporting line to the President, but it is unlikely, and perhaps not legally possible, for the President to settle the dispute in another fashion. 

Investors should watch this situation closely. The market is likely to move significantly if the issue is either resolved or the likelihood of deregistration and delisting increases.Much more in the ChinaAccountingBlog.(pdf)

Paul Gillis is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers´request form.
Are you interested in more financial experts at the China Speakers Bureau? Do have a look at this recent list. 

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Raising the standard of Chinese law firms - Paul Gillis

Paul Gillis

The China Securities Regulatory Commission (CSRC) has fined three Chinese law firms for their shoddy legal work in IPO´s. A positive development in trying to raise the standard of Chinese law firms, writes professor Paul Gillis at his China Accounting Blog. "It´s about time." 

Paul Gillis:

The IPOs in question were all on China’s stock exchanges, and accordingly come under the regulatory authority of the CSRC. It is about time that the CSRC has taken action to raise the standards of legal practice on listed companies. The first crackdown on the accounting profession took place in 1997 and it was brutal. A quarter of Chinese CPAs faced discipline or eviction from the profession in the 1997 rectification. The legal profession is overdue for rectification. 

The CSRC’s jurisdiction does not extend to overseas listed Chinese companies. Overseas listed Chinese companies of any meaningful size tend to use well-known international law firms. But these international law firms are not allowed to opine on matters of Chinese law, so local firms are used for this purpose. 

Some local firms are well known for their willingness to issue clean opinions on variable interest entity (VIE) structures even in the face of considerable doubt as to whether the agreements that underpin these structures are enforceable. Many Chinese lawyers do not believe these agreements are enforceable, but those lawyers are not engaged to issue opinions on VIEs. The SEC has been tough on companies using the VIE structure, but is not in a position to challenge Chinese lawyers on matters of Chinese law. The CSRC does have that power, but it lacks jurisdiction over these companies. That is one of the things that the Singapore Solution can fix.

More at the China Accounting Blog.

Paul Gillis is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers´request form.

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The Singapore solution for China´s stock woes - Paul Gillis

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Getting listed is notorious difficult for Chinese companies, because getting permissions in mainland China is tough. But there is hope, writes professor Paul Gillis in the Wall Street Journal, as regulators in China and Singapore recently signed an agreement to let private companies list directly. Now such an agreement is needed between China and the US.

Paul Gillis:

The problem is that so many Chinese companies are forced to list overseas because it is still so difficult to win permission to issue shares on the mainland. That makes the deals a lose-lose for investors everywhere. Chinese citizens can’t buy offshore shares be- cause of the mainland’s capital controls. Meanwhile,foreign investors technically don’t buy the company, either.To circumvent foreign-ownership restrictions, Chinese firms use the so-called variable-interest entity (VIE) structure. With the VIE structure, offshore shell companies have contractual claims to the revenues from, but no actual ownership of, the Chinese firms. 

Fortunately,a solution is finally coming into sight, from an unexpected quarter: Singapore. The China Securities Regulatory Commission (CSRC) in November reached an agreement with Singaporean authorities to allow Chinese companies to list directly in the Lion City without first setting up an offshore holding company. If this becomes atemplatefor other jurisdictions—and aseed of further reforms in China—investors everywherestand to benefit.

More in the Wall Street Journal

Paul Gillis is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers´request form.

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