Since the first Brokerage Innovation Conference last year, SZSE has been promoting market reform and innovation. I would like to focus on some of our experience in participating in market innovation and development over the past years.
First of all, Chinese capital market shoulders heavy responsibilities and urgent task in serving transition of real economy.
The task of accelerating economic transition and upgrading in China is urgent, as reflected in the situation of our listed companies. According to the annual reports and statistics, the structural changes of listed companies and the cultivation of core competitiveness are still insufficient. Among the S&P 500 constituents, traditional industries and finance that are sensitive to economic cycle account for only 25.6% of the market value. Technology and consumer sectors account for 58.4%, and their earnings are almost independent from the economic cycle. In contrast, listed companies in China are traditional industries-oriented, and the development of high-tech, modern services and consumer sectors lag behind. By the end of 2011, in A-share markets of Shanghai and Shenzhen, listed companies in economic cycle-sensitive industries numbered 1316, accounted for 53.2% of A-share companies and their market value accounted for 52.6%. Such industries include finance, real estate, petrochemicals, electronics, metal products, machinery and equipment. The earnings of these companies fluctuate severely with the economic cycle. Over the past 10 years, the S&P 500 non-financial enterprises maintained an ROE around 18-25%. The ROE of listed companies in Chinareached its highest point of 14.7% in 2007. Last year, the number was only 12.5% (8.6% in Shenzhen), and it was 9.3% (8.4% in Shenzhen) for non-financial enterprises. Listed companies are outstanding representatives of Chinese enterprises. The issues such as unreasonable industrial structure and lack of core competitiveness might be more prominent in real economy.
As a result, lot of work remains to be done to meet the actual demands of enterprises and enable the capital market to better serve the real economy. Firstly, we shall accelerate mergers and acquisitions by listed companies to enhance competitiveness. Secondly, we shall improve the quality potential issuers, extend the coverage of capital market significantly, improve the market screening capability and expand access to capital market for different types of enterprises and projects. We shall not let the growth enterprises and projects fall down in front of the threshold of capital market. This requires a range of innovation in institutional arrangement, financial products and platforms. Over the past year, the industry has done a lot of innovative work in serving the real economy, such as establishment of the OTC market, increasing input in mergers and acquisitions, launching SME private bonds, and developing equity pledge financing business. However, there is still a long way to go and still more efforts are required before demands of real economy are met.
Secondly, innovation in capital market will inevitably face more risks and challenges and it requires particular attention to current situation.
Fostering new industries and innovative enterprises involves trials and errors. NASDAQ is a model market serving high-tech and emerging industries. During its development of over 40 years, it fostered leading enterprises such as Apple and Microsoft, but it experienced radical rises and falls as well. In early 1985, NASDAQ had 4097 listed companies, and 11,820 companies got listed from 1985 to 2008. Over the same period, the total number of delisted companies was 12,965, exceeding that of companies getting listed. During this period of time, a huge OTC market (OTCBB and Pink Sheets) retained nearly ten thousand listed companies, becoming an incubator and a pipeline for NASDAQ. Around the dotcom bubble burst in 2000, the NASDAQ Composite Index fell from more than 5400 to over 1200. Even Microsoft and Apple experienced sharp stock price fluctuations where the highest prices were 660 and 510 times higher than their lowest prices respectively. On the one hand, it requires failure tolerance. On the other hand, it brings severe test to securities companies on risk control capability.
The Chinese economy is in its transition period in terms of growth speed, development model and institutional arrangements. Various contradictions, imbalances, discordance and lack of sustainability become increasingly prominent. Innovation will definitely encounter risks and we are facing more risks and uncertainties under current circumstances. Macro-level and enterprise-level risks will transmit into investment banking, asset management and other business areas. If we take into account competitive pressure both inside and outside the industry and weak risk control, innovation is a real challenge and its associated risk deserves more attention. If major problems ever occur, market confidence will be lost and client trust will be ruined. Furthermore, such scenarios will significantly narrow the development space of securities companies, may negatively affect market reforms and innovation and ruin the opportunity for development in the industry again, which would be tantamount to a collective degeneration of the whole industry.
Thirdly, in order to do better in risk prevention in the process of innovation, we must rely on market players and lay due emphasis on the work in three areas.
The regulators and the securities industry have attached great importance to risk prevention during the process of innovation, carried out many explorations and accumulated valuable experiences in the past year. To solve the problem, we should continue to promote market-oriented reforms and fully rely on market players. Thus we can stimulate the vitality of the market and at the same time prevent market risks. In terms of risk prevention, three items requires our due attention.
First we should enhance practice standards and internal control mechanisms of securities companies. The transition of the real economy has raised higher requirements for the capital market. The key for risk prevention is whether securities companies can enhance their brokerage practices and cultivate their internal control culture. Securities companies shoulder great responsibilities and should have the awareness of seizing and treasuring opportunities.
At present, despite the high enthusiasm, securities companies should focus on fundamental mechanisms and products, build their basic strengths in due diligence inspection and internal control, forge their advantages in basic products, and cultivate their own clients and products. Only quality services can win the trust of clients and make securities companies fully perform their function as “bridging two parties” intermediaries. As the IPO financial special inspection indicates, there is still space for improvement in due diligence inspections. The establishment of the new National SME share transfer system and the OTC market as well as the innovation of new products will be more dependent on the quality of securities companies’ due diligence inspection which is the reference for market players to assess risks.
The internal control of securities companies is the frontier for risk prevention. The internal control mechanism involves the perfection of institutional systems and also the cultivation of corporate culture. We must keep up with the rapid development of innovative businesses.
Second we should strengthen self-regulation. In the supervisory framework consisting of self-regulatory, administrative and judicial measures, self-regulation can adapt to market change fastest and thus it reduces supervision cost. Strengthening self-regulation also serves as the premise of reducing administrative interference and unleashing market vitality. Without effective self-regulatory mechanism, introduction of rigid administrative supervision would be necessary, and the space for market innovation will be compressed.
The IPO reform carried out last year proves that the Investment Banking Committee of Securities Association can better play role in extended dimensions, promoting the reform in supervision over sponsor institutions and price inquiry agencies.
In the future, we are faced with heavier pressure for industry supervision over product innovations. Self-regulation can utilize the professional resources, form timely industry standards and make flexible adjustments and thus win time for follow-up administrative supervision and open new space for innovations with the precondition of risk prevention.
Third, we must investor suitability management. Securities companies know investors best. The strengthening of suitability management enables us to achieve a reasonable allocation of risks among different types of investors, and this serves as the micro-foundation for the capital market to effectively resolve the real-economy shocks. Investor suitability management is also a safeguard ex ante for regulating client behavior and maintaining market order, which is particularly important for market and product innovations. The problems exposed in the bond market recently also remind us that client management for intermediaries should not be neglected.
While financial innovation offers more choices and convenience for investors and issuers, it also makes the transfer of benefits easier and more subtle. In order to win social acceptance and reach a sustainable development, innovations must stick to the basic requirement of compliance with laws and regulations.
Since last year, innovative businesses have experienced fast development. Securities companies should understand the prospects for innovation and the far-reaching impact to their business model and revenue restructuring. Securities companies should make determination to give up short-term benefits for the long-term goal, pay more attention to the suitability management, and build a safeguard mechanism for innovation development.
At present, China has entered a critical period for deepening reforms and restructuring its development model. Securities industry is also in a key period of innovation and development. We should be aware that it is not easy to cultivate innovative businesses. From the external perspective, the improvement of laws and regulations, supervisory methods and trading systems is needed; from the internal perspective, securities companies need to do better in organizational structure, incentive mechanism, R&D capability building, technology system, client base, sales network, risk control and human resources cultivation. Thus we should never haste in such a process. Instead, we should start from seemingly trivial matters, establish a good reputation for the securities industry and reinforce market confidence. With the high-level attention of securities companies and the joint efforts from relevant parties, we can make breakthroughs in industry innovation and thus enables the capital market to play its due role in the economic and social transition.