Wei-Guo Zhang, CSRC

1. Wei-Guo Zhang, CSRC How Governance / Accounting Research Are Linked to Regulatory Policies

2. Topic • Performance of Listed Companies • Endeavor to solve non-tradable share issue • Usefulness of key financial figures • Convergence of accounting standards • Unique features of transitional emerging market

3. I. Performance of Listed Companies

4. Performance of Listed Companies • As one of the important elements in the whole reform endeavor over past two decades, Chinese government has been putting enormous efforts to simulate efficiency of, and improve governance of, SOEs by restructuring them into joint stock companies, and then getting them listed in domestic or oversees markets. • One good example is that SINOPEC has become the largest company in Asia (over Toyota) in term of market capitalization since it was listed in Hong Kong a few years ago.

5. Performance of Listed Companies • At the same time, private economy has got significant growth over past two decades as a result of economic reform and open door policy. Its contribution to GDP, fiscal income, accumulation of private wealth, employment, etc, is well recognized. • The growing importance of private economy is also stressed by current Constitution amended several years ago by the National Congress and other government regulations or policies.

6. Performance of Listed Companies • Although most of the Chinese companies listed in and outside mainland China are formerly SOEs, more and more privately owned companies have listed in either domestic or oversees markets in the past several years. • In middle last year, a Small and Medium Sized Enterprises Board was opened in Shengzheng Stock Exchange mainly for private companies.

7. Performance of Listed Companies • Researches on the performance of public v private companies show mixed results, that is some empirical studies prove that decrease in government ownership will improve the performance of listed companies, while other studies do not. • On the other hand, either in mainland or Hong Kong market seam more interested in large scale SOEs rather than small and medium sized private companies.

8. Performance of Listed Companies • Researches need to be done on the reasons for such preference: • Monopolistic control of resources; • Better supervision of various government agencies over state control listed companies through : • appointment of senior management; • Involvement in strategic decision making; • Emphasize on traditional philosophy among management and workers to work for the whole society, and to persuade collective benefits rather than greed for personal interests. • Severe punishment on corruption and other misconducts.

9. Performance of Listed Companies • Greed by private owners for immediate expansion of personal or family wealth by jeopardizing the interest of listed firms and minority shareholders through illegal ways or other malpractices. • Lack of competence of private owners to manage fast growing and diversified firms in such a short term.

10. II. Endeavor to solve non-tradable share issue

11. Endeavor to solve non-tradable share issue • China’s capital market is experiencing the most important transitional period in its history. The focal point is to solve so called non-tradable share issue. • There is no restriction on tradability of any shares based on Company Law, Securities Law and other laws and regulations. However, the promoters’ shares owned by the state and other entities or individuals have been classified as non-tradable for various reasons since the beginning of the capital market in China in early 1990s. • By the end of last year, 64% of shares of listed companies are earmarked as non-tradable. Among these non-tradable shares, 74% are owned by the state.

12. Endeavor to solve non-tradable share issue • The non-tradable shares issue has become the most thorny institutional issue in China’ capital market and cause lots of negative impacts on the development of the market: • The pricing mechanism of the whole market is distorted; • Investor expectation over the future of the market is always uncertain; • There is not same interest basis among different group of shareholders. That is, interests of non-tradable share owners can not be realized through share transfer in stock exchanges. As a result, while individual investors pay great attention to share price movement, the non-tradable shareholders do not. • It become rather difficult to further promote reform of SOEs; • It become the key obstacle to further integrate local markets with matured markets, and to diversify the products in the market.

13. Endeavor to solve non-tradable share issue • In 2001, government tried to solve this issue by selling state owned shared and injecting the receipts into social security fund. • However, the pilot test was suspended shortly due to the wide gap between the experiment plan and the market expectation. • Since then, the market has experienced downslide for four years, and the market capitalization has shrank around 50% even though the whole economy is still on the fast growth track, and key microeconomic indicators are performed very well.

14. Endeavor to solve non-tradable share issue • To further promote the healthy development of the market, the government firmly decided early last year to solve this issue, and laid down the basic principles as follows: • To conform with the law of market economy； • To ensure healthy and steady development of the market; • To keep as a priority to protect the interest of public shareholders.

15. Endeavor to solve non-tradable share issue • Under the approval from the State Council, the CSRC started the campaign to solve the non-tradable share issue. • Basically, the holders of non-tradable shares have to pay a consideration to the holders of tradable shares to get tradable statute for their shareholding. The level of consideration will be determined through negotiation between the two group of shareholders. • The first batch of pilot test finished in June, and the second batch will be finished next month. • We believe that as soon as the issue is solve in the near future, the market will enter into a period of fast growth.

16. Endeavor to solve non-tradable share issue • This campaign creates lots of research issues as follows: • What are the main determinants of the considerations paid by non-tradable shareholders to tradable shareholders? • How do the capital structure, involvement of institutional investors and other factors impact on the result of negotiation? • Are past and forecasted ROE, EPS and other measures the main determinants of the considerations? • Will the problems related to non-tradable share issues be solved, and the performance of companies and the whole market be improved?

17. III. Usefulness of key financial figures

18. Usefulness of key financial figures • The regulatory system and organizational structure in China’s capital market are similar to that in the US. • Like SEC in the US, CSRC is empowered many regulatory functions, including review and approval of fund raising, review, investigate and give administrative sanctions to listed companies, accounting firms, and other intermediaries, as well as responsible personnel. • While fulfilling its regulatory functions, CSRC relies significantly on key financial figures of listed companies and other entities in the market, base on related laws and regulations.

19. Usefulness of key financial figures • For example: based on current Company Law, to issue new shares, a company must satisfy the following conditions: • the company has been continuously profitable for the last three years and is able to pay dividends to its shareholders; • the company is not found to have false records in financial accounting documents in the last three years; • and the forecast rate of profit of the company can reach the interest rate of the bank deposit for the same period of time. • The Law also stipulates that shares of a companies will be de-listed if the companies experienced losses for three consecutive years.

20. Usefulness of key financial figures • Hence, CSRC put lots of resources on checking the accuracy of the related financial figures in its review and enforcement process. • Many companies and intermediaries are sanctioned by CSRC for false disclosure. • The following tables display the efforts exerted by CSRC.

21. CPA Firms Sanctioned by CSRC

22. CPAs sanctioned by CSRC

23. Listed Firms and their Directors and Senior Managers Sanctioned by CSRC

24. Usefulness of key financial figures • These efforts should be praised if we considered that the size of the market in China is only 5-8% of that in the US. • In addition, CSRC has promulgated series of disclosure rules as follows based on its regulatory experiences:

25. Usefulness of key financial figures • Nevertheless, CSRC feel it difficult to prevent more and more sophisticated manipulation techniques. • Questions for researches: • How should CSRC get rid of this difficult situation, especially when institutional investors, public media, and civil action can not play significant roles?

26. IV. Convergence of accounting standards

27. Convergence of accounting standards • As we all know, US GAAP was recognized as the highest quality accounting standard for many years • However, it was criticized for so called rule-based nature after Enron and other financial scandals. • Although, the report by SEC and FASB emphasized that the US GAAP is still the highest standard in the world, the US has decided to harmonized its standards with the IFRS by implementing two stage convergence project with IASB. • All of the listed companies in EU will prepare their consolidated FSs based on the IFRS.

28. Convergence of accounting standards • Japan also started its convergence project with IASB in Summer last year. • In addition, several dozens of countries have claimed either to fully implement the IFRS or set their own standards based on the IFRS. • China has exerted great efforts to harmonized its accounting standards with internationally accepted accounting standards in the past two decades, and has declared to continue this effort in the coming years.

29. Convergence of accounting standards • At the same time, the IASB has encouraged China to speed this process and promised to offer any assistance if necessary because it will be a great achievement for the IASB to have China do to so. • While deciding its convergence strategy, China attaches great importance to the following issues: • When will the US finish its convergence process? • Whether the major countries like the US, UK, Japan, will stop setting their own standards? • When will the US and other major markets accept financial reports of foreign issuers based on the IFRS and its equivalents without reconciliation or any other additional disclosure.

30. Convergence of accounting standards • How will the IASB deal with country specific issues? • How will the principle based and fair value oriented IFRS be interpreted and implemented strictly and consistently among countries claiming to implement or adopt the IFRS. • Will implementation of principle based and fair value oriented IFRS cause any difficulty to perform control or steward function of accounting system?

31. Convergence of accounting standards • Comparative researches are instructive on the following issues: • Differences and similarities of accounting standards adopted by different countries; • Actual implementation of accounting standards among different countries; • Suitability of the IFRS and any other standards to different countries; • Management behavior and market reaction during the transitional period of accounting standards: • The impact of regulatory regime on choice or design, and actual implementation of accounting standards among different countries; • Impacts of implementation of the IFRS on world wild capital flow.

32. V. Unique features of transitional emerging market

33. Unique features of transitional emerging market • Most of the empirical researches up to now are based on the economic theories and methodologies which are wildly used in the US and other matured markets. • These studies may have some fundamental problems because there are lots of unique features in China as a fast growing and transitional economy, which may significantly differ from that in the matured markets. • Features forging from over two thousands history • Political and regulatory tradition relying on bureaucratic and administrative control, rather than communal and contractual control; • Strong sense of family and state benefits rather than individual benefits; • Strong sense of ‘Guanxi’ or nepotism; • Profound equalitarian culture.

34. Unique features of transitional emerging market • Features from centrally planned economy • Government ownership in some industries and in listed companies are still very high; • Strategic decision of business enterprises are still influenced by related government agencies; • Price and volume of economic inputs and outputs are still effected by government policies or plans; • Government policy making and regulatory decision are still not transparent enough. • Features from fast economic growth and reform • Scale and scope of business entities are expanding very quickly; • Organizational structures of business entities are changing rapidly; • Related law, rules and standards, as well as regulatory process are also changing rapidly.

35. Unique features of transitional emerging market • Implications to researchers: • Giving necessary and enough consideration to unique features under Chins’s social economic environment. • Exerting great efforts on exploring and concluding theories and methodologies based on profound social economic conditions in China. • Doing thorough studies on institutional changes, which may informative to the society and instructive to future studies; • Using more case and field studies, which may get result closer to reality and acceptable to practitioners and government policy markers, and accumulate knowledge for further and more sophisticated researches.

36. Thank You! WWW.CSRC.GOV.CN Zhangwg@csrc.gov.cn