Four steps to creating a multi-layered capital market

The Chinese government has attached great importance to the expansion of direct financing, the reduction of the corporate asset-liability ratio and the improvement of economic growth. For example, the Third Plenary Session of the Fourteenth Communist Party of China (CPC) Committee decided in 1993 to expand the ratio of direct financing. In 1997, the Fifteenth CPC National Committee report pointed out the importance of multi-channel capital raising in building up funds for stateowned enterprises. And in 2007, the Seventeenth CPC National Committee report again proposed the need to increase the percentage of direct financing.

Possible monetary policy malfunction

Regarding the corporate asset-liability ratio, because of the lack of capital, corporations tend to have an intense demand for credit. This can be a problem, as when there is a need for tightening monetary supply from the macroeconomic point of view, companies that totally rely on credit would find it hard to maintain their businesses. Therefore, with an underdeveloped capital market and a high corporate asset-liability ratio, the central bank's monetary policy could malfunction.

Data disparity

Because of missing data in the national statistics system, the Chinese government's proposals have not always achieved the expected results. A gap between the registered capital and actual capital of China's state-owned and collectively owned enterprises was revealed in the statistical yearbook issued by the country's Industrial and Commercial Bureau. This has resulted in the absence of concrete data for the net assets held by industrial and commercial enterprises. Unfortunately, China's National Bureau of Statistics (NBS) does not have comprehensive data. It is therefore not feasible to test if the amount of capital and direct financing has improved. According to the data, the quantity of loans increased by more than 20% from 1992 to 2012, whereas the registered capital of all kinds of companies increased by about 18%, as reflected by the statistics from the Industrial and Commercial Bureau.

The fact that capital raising grows more slowly than credit leads to the increase in companies' asset-liability ratios, which builds up financial risk, blocks the implementation of monetary policies and puts pressure on the banks.

Social capital statistics needed

Therefore, a social capital statistics system needs to be established as soon as possible to facilitate the creation of a more substantial capital market. The government - through the NBS and the Industrial and Commercial Bureau, for example - is responsible for leading the data collection of companies' asset and liabilities and analysing the data included in the Fifth Economic Census of China, to establish a capital statistics system centred on companies' assets.

A clear demonstration of the channels, direction and returns involved in the transformation from social capital to corporate capital funding is favourable to expanding direct financing and developing the capital market. A clear development expectation for the multi-layered capital market would provide the dynamics and pressure to push forward reforms.

The NBS has obtained statistics from all kinds of corporate assets, setting a solid foundation for gathering more detailed data. Universities should participate in the study of raising and the market allocation of social capital. In China, capital allocation is the most important issue. Lending without knowing the capital amount can only be detrimental to economic development.

Steps to a multi-layered market

To achieve a multi-layered capital market, important steps need to be taken.

First, more work needs to be done to implement initial public offering (IPO) reform and strengthen the supervision of public companies. The loose structure of the debt market requires oversight and approval before debt is issued. Public companies need approval from the China Securities Regulatory Commission (CSRC), while private companies need to be approved by the National Development and Reform Commission (NDRC) and the People's Bank of China (PBOC).

Renminbi internationalisation

It is impossible to fulfil real renminbi internationalisation without a fully fledged debt market. The PBOC has quoted the total amount of social financing needed to develop a multi-layered capital market. The first variable is loans, which have fallen by 30% in the decade to 2013, according to PBOC statistics. The second factor is direct financing, including capital financing, debt financing, entrusted loans, trust loans and bond issues. In addition to the stock market and debt market, it is important to develop private equity and over-the-counter profit-sharing equity trading to form a multi-layered capital market.

Second, more institutional investors are needed. The development of the capital market largely relies on institutions and the public. Existing commercial insurers hold 9 trillion yuan of assets, with the urban workers' pension insurance holding 3.3 trillion yuan. The National Social Security Fund has reached 1.3 trillion yuan. The Third Plenary Session of the eleventh CPC National Committee decided to inject state-owned assets of as much as 30 trillion yuan into the social security system. So it is important to strengthen the participation of institutional investors, including those from overseas.

Third, improving the bond industry. Financial institutions comprise commercial banks (which cover currency, lending, buying and selling) and investment banks (which manage capital and property). Data from the Securities Association of China shows that, at the end of 2013, there were only 115 investment banks and bond companies in China, with total assets of 2.1 trillion yuan and average revenue of only 1.4 billion yuan. The biggest - CITIC Securities - is around one-sixth the size of US financial institution Morgan Stanley. It is necessary to restructure large security companies and attract foreign investment banks.

At present, the overseas (including Hong Kong) banking industry's assets - which reached 2% after the country joined the World Trade Organization (WTO) - comprise 1.8% of the industry's total assets. Foreign capital stock makes up 3% of the revenue of China's securities industry and overseas capital in the insurance industry is about 4%. The proportion of the banking, securities and insurance industries in the market are 2%, 3% and 4% respectively, as China continued to remain cautious to opening up after joining the WTO, at the time of the Asian financial crisis.

Within the past decade, China's financial reform has equipped it with more competitiveness, and it is therefore more able to attract overseas securities companies. For instance, China's WTO agreement restricted securities companies' foreign stock capital to no more than one-third of their total capital, which was raised to 49%. But this still poses challenges for overseas securities companies.