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Implications of Recent Financial Regulatory Changes in China

03-22

Recent changes in the Chinese financial regulatory framework have aroused wide attention domestically and overseas. First, the registration-based IPO rules have formally sailed out in the Chinese domestic stock market since February 2022. As of March 13, 2023, eleven companies have gone public on the Shanghai and Shenzhen Stock Exchange Main Board under the new registration-based IPO rules. The A-share market responded to this news peacefully. On the other hand, the recently concluded China's annual NPC meeting approved the formation of a national financial regulatory administration, which will replace the existing China Banking and Insurance Regulatory Commission and consolidate financial regulation except securities regulation under this new governmental institution.

The two major changes in Chinese financial regulation move toward regulatory efficiency and emphasize the role of capital markets in the future of the Chinese economy. For market transactions in general, the cost of transactions goes up with more governmental intervention in the markets, as more rent-seeking activities could happen in a more robust governmental intervention mode. Therefore, consolidating financial regulatory power into one national financial regulatory administration would lower the transaction and compliance costs of the entities in the Chinese financial market. Notably, while lowering the cost of transaction and compliance, maintaining adequate disclosure is also essential for investor decision-making. An intricate balance needs to be achieved between the two-regulatory efficiency and adequate investor informing.

With pressure from financial regulatory reforms, the tangible assets underlying financial assets-business entities would have to move to meet the regulatory changes. Beyond the regime of financial regulation, corporate law takes over. It is also expected that the corporate governance level of Chinese companies would improve with the corresponding financial regulatory reforms. The rule of law in the Chinese business sectors and foreign investment climate would become more capital-friendly and economically efficient.

Despite all those growing pains, since the first two stocks traded in the Industrial and Commercial Bank of China in 1986, the Chinese securities markets have taken a significant leap in the past thirty years. Measured by market capitalization, China has grown from nowhere to the second-largest stock market, ranking only behind the U.S. market.

That being said, according to the recently released 2022 Chinese Family Wealth Investigation Report, financial investment is still a small fraction of Chinese families' wealth compared to real estate holdings, far below the level of the United States. Except for large institutional investors like pension funds, ordinary Chinese investors invest in the stock market with more of a gambling mind but less of a long-term retirement plan. The low percentage of financial investment in overall Chinese families' wealth has hindered the development of the Chinese capital markets in the past few years. With the development of Chinese capital markets gaining an unprecedented level of recognition ever in Chinese history, it is hoped that more residents in China would increase the ratio of financial investments in their wealth portfolio.

While the U.S. system is built upon a preexisting foundation of private ordering, its bipartisan political system magnifies interest groups' lobbying and confrontation in the U.S. policy-making process. With one ruling party and the lack of a private sector till the 1980s in her economy, the Chinese regulatory system has largely emerged through mandate. Its regulatory reforms are also more swift and efficient. It would be anticipated that the financial regulatory reforms would also entail economic structural changes in China.

By combating corruption in all sectors in the past decade, the Chinese government effectively reduced the disparity of wealth among different social classes and achieved a more equitable distribution of social wealth in accordance with the CPC goals. Hopefully, the heightened importance of developing Chinese financial markets could also bring about more equitable social wealth redistribution per the CPC goal in the next few years.

Lastly, despite the current political tension between the U.S. and China, we are walking into a more interdependent and converging future of the financial markets and possibly regulatory standards. For example, in August 2022, the Public Company Accounting Oversight Board (PCAOB), the China Securities Regulatory Commission (CSRC), and the Ministry of Finance of the PRC (MOF) entered into a written agreement, granting the PCAOB access to inspect and investigate audit firms in China for the first time in history.

Given the lagged effect of regulation, international financial regulation cooperation can only prevent or solve some issues that arise from the financial markets. However, international financial regulation cooperation should enrich a mutual understanding of international regulatory differences and foster mutual economic exchange and development. It should also inform public policy and guide the development of the financial market. Despite the clouds cast by the trade war or cold war, international capital flows will not stop across the Pacific Ocean. (by Qin Xia )

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