An American Investor's View
of the
Chinese Stock Markets

Dean LeBaron
June 18-19, 1993

prepared for the

SHENZHEN INTERNATIONAL "B" SHARE SEMINAR

Shenzhen, P.R. China

I was invited to speak at this historic seminar, but, at the time, I was unable to be present in Shenzhen. The hosts asked if I would prepare a paper that could be presented in lieu of my speech. This is it. Attendees at the seminar included, primarily, brokers and other investment professionals working in the securities markets in Shenzhen and Shanghai.

* * *

I am very sorry I cannot be with you today in Shenzhen, but in my spirit, every day, I am participating in the "B" share markets in Shenzhen and Shanghai. It is a great honor to be asked to present to you my view of the stock markets in China. I have become deeply interested in China, for both personal and financial reasons, since my first visit to China over 12 years ago. I have had some experience with newly-developing stock markets in countries that have functioned as command economies, and my firm has been instrumental in gaining access for foreign investors to invest in the stock markets of the closed economies of Brazil and India.
Competition For Capital

Capital is competitive worldwide. There is a free market for capital, and projects and stock markets in China, for example, must compete for that capital on a worldwide basis - not just against other Chinese enterprises or other Chinese provinces, but against alternate investments in every country of the world.
At any given time, my firm might hold investments in five hundred different enterprises around the world, and we evaluate each of those enterprises and investment prospects against each other. Companies and stock exchanges in China, and particularly the Chinese Government, must have a worldwide perspective.
New capital will be required in order to maintain or perhaps even increase the rate of growth in the Chinese economy which has taken place over the past few years and which is expected for the next five-year plan.
Is The Chinese Government Committed To The Success Of The "B" Share Markets?

Foreign investors are not confident that the Chinese Government supports the B share markets. We see many companies listing in Hong Kong and elsewhere, including New York, completely avoiding the B share markets within China. We are left with the impression that the B share markets will be left without a parent. I doubt this is true, but support from the very top levels must be conveyed.
The incidents last year in Shenzhen, that caused great concern to many people in China and around the world, indicate that capital is available and that the demand for investments in China's stock markets exceeds the supply. When there is an imbalance in supply and demand, there are two things that can be done. Demand can be reduced . . . that is usually unwise in a fully-functioning economy. In the socialist market economy of China, I would argue it is better to increase the supply.
One Market - One Class Of Shares

Foreign investors like things that are the same, not different from what they are accustomed to. They would prefer to see the B share and the A share markets consolidated. I see no reason to keep them separate. The apparent discount of B shares to A shares is the result, in large part, of fluctuations in the value of the currency and other uncertainties of currency conversion. Sun Hung Kai recently reported the drop in Shanghai's swap market exchange rate from about RMB 8 to the U.S. dollar to about RMB 10, and that it may drop further. This will cause a further drop in B share prices.
One could establish a single market for a single class of shares of Chinese companies, limiting (if necessary) the percentage ownership by foreign investors. Currency should be treated as a separate issue - which it is. The value of a company and its stock should be the same whether the stock is owned by a Chinese or a non-Chinese investor.
Cooperative Efforts

The central government and the local exchanges should encourage foreign investors to participate in corporate governance in the Chinese companies in which they invest. China would like to have more contact with the West - institutional shareholders could be one of the best sources of experience with successful investment practices. It would not cost anything, and the shareholders would feel as though they are part of the economic development of China, rather than merely watching from the outside. The markets would gain the commitment of experienced foreign investors to help make the markets work.
Under the auspices of the central government, representatives of the stock exchanges in Shenzhen and Shanghai could together, as one team, make major presentations in major financial centers around the world.
The stock exchanges should work together with the Chinese brokers in providing information on stocks and acting as an information source. Familiarity with the Chinese stocks in the B share markets would greatly help to improve confidence and, therefore, improve turnover and prices.
Honesty

Perhaps the most important objective is to promote honesty - it is extremely important that investors are confident that everyone will be treated fairly in accessing the investment opportunities that are available. Stock markets must have transparency, with complete and accurate disclosure of financial information. There must be rules and regulations and openness about who is trading; who is buying; and who is selling. The promotion of honesty is one of the key functions of developed stock markets around the world. Transactions do not take place behind closed doors. Typically they are in the open, to be seen and monitored by everyone.
There are often problems with stock markets, and some of those problems occurred in Shenzhen. Problems have also occurred in the United States at various times. The problems are worldwide, and the fact they occur publicly is, in my view, an advantage and not a disadvantage.
In my view, the stock market will do more to promote honesty than almost anything else. In late 1992, the Securities Supervisory Board was established to regulate China's securities markets. It is an important step directed toward enhancing honesty in China's new markets.
Investment In Joint Ventures

Joint ventures that have international partners should be encouraged to issue shares to the public, including both Chinese and non-Chinese investors. The managers of these joint ventures would be familiar with international accounting and management techniques, and that would further promote confidence, particularly among foreign investors. It is not that these techniques are necessarily better than their purely Chinese equivalents, but they would be familiar to foreign investors and would be more in accordance with internationally-recognized standards.
Global Computer Linkages

Exchanges in China should be linked by computer as they are in a number of countries like the U.S., Switzerland, India, and others. Trades can be initiated on one exchange and executed on another.
One of my Chinese friends tells me the stock market is widely regarded as a high tech industry in China. That should not be the case. Rather, the stock market should be a very efficient user of the tools of the high tech industry. With a small computer chip the size of my watch, stock markets will work very well. On a silicon substrate, you can have a fully functioning stock market, handling of all its transactions in a fully open and transparent way.
Markets can operate twenty-four hours a day, by machine, by satellite and with computer link-ups from one market to another, inside and outside of China, thereby reducing destructive competition among Shanghai, Shenzhen, Hong Kong, or wherever.
The Future

It will take time for the regulatory framework governing the markets to fully develop and for Chinese enterprises to become sufficiently profitable to become eligible for listing, whether in China or in New York. One of the fastest ways to learn will be to seek the cooperation of those who have expertise in international markets.
Like most emerging markets, the infant stock markets in China have been quite volatile, due to an imperfect legislative framework, a shortage of skilled professionals, and so on. But we are encouraged by the commitment expressed by the Chinese Government and also that Vice Premier Zhu Rongji personally chairs the Securities Supervisory Board.
Opportunities in China are unique, the size of China is unique, and the pace of activity that I have seen in the last 12 years is unique. China has the opportunity to experience tremendous growth in its stock markets, greater, perhaps, than in the case of my country, the United States. For instance, it is reported by some that the growth in Shenzhen, during each of the last 12 years, has been 45%. The U.S. stock market is fully advanced and will not experience that same degree of absolute growth.
Regardless of the current difficulties of its stock markets, if China is able to maintain the pace of its economic growth, the future of the Chinese stock markets is exceedingly bright.

- Dean LeBaron, Chairman Batterymarch Financial Management