Rating agency likes stock trading reform
(China Daily)
Updated: 2005-07-05 06:19

Fitch Ratings, the international rating agency, says that China's planned reform of the share structure of its listed companies will improve liquidity in domestic stock markets. This reform is also a significant step towards improving Chinese firms' corporate governance.

Fitch says that the split-share structure that currently exists - stemming from the government's general policy of maintaining state shareholders' control over companies - has been a major restriction on the development of the Chinese stock market.

Currently, non-tradable shares - mostly held by the State - account for roughly two thirds of listed companies' total shares, with only one third traded on the two domestic exchanges.

This split-shareholding structure has substantially distorted prices on the domestic stock market and added uncertainty to investors' expectations. The dominance of State shareholders has also led to problematic corporate governance practices, and marginalisation of individual shareholders.

In an attempt to address the above problems, the Chinese stock market regulator announced in May that there would be a trial reform of the split-share structure for four domestic listed companies.

The regulator also agreed to allow an additional 42 firms, including some of China's biggest and best-known corporate names, to participate in the reforms in June.

The regulator's general guidelines for the reform included:

Non-tradable shareholders should compensate tradable shareholders as a pre-condition of floating their shares on stock exchanges.

Non-tradable shares will be "locked" for 12 months after the individual company's reform scheme takes effect, and non-tradable shareholders cannot sell more than 5 per cent of their stakes in the following 12 months.

Finally, the companies should obtain the approval of reform schemes from at least two thirds of tradable shareholders before implementation.

Although the share structure reform has no direct impact on the companies' credit profile and creditors' interests, Fitch views the reform as a positive development.

It will increase China's stock market liquidity and provide greater scope for tradable shareholders to negotiate with non-tradable shareholders, and protect their legal rights using more effective corporate governance and management systems.

Fitch notes, however, that the major non-tradable shareholders will likely continue to exert a substantial influence on the firms' management in the short term.

The most popular reform proposal announced by listed companies was that non-tradable shareholders had agreed to transfer a portion of their shares to tradable shareholders free of charge as a pre-condition of floating their shares on the exchanges.

This reform scheme will not change the company's total share volume, but will alter the shareholders' structure, and increase the voting rights of the original tradable shareholders.

As the non-tradable shareholders have assumed an obligation to compensate tradable shareholders, this scheme will not affect the company's cash flow and credit ratios in the near term. However, greater voting rights for tradable shareholders may increase the prospect of higher shareholder returns in the medium-to-longer term.

New instruments, such as warrants, have also been introduced in reform schemes for China Yangtze Power and Baoshan Iron & Steel. Fitch points out that the introduction of warrants into the reform scheme will offer more flexibility for tradable shareholders in making investment decisions.

But it will also bring about new risks and uncertainties for tradable shareholders in exercising their warrants, as they are more complex and obscure in terms of the actual compensation offered.

Although most companies participating in the trial proposed to compensate tradable shareholders with shares, medical company Jilin Aodong Medicine Industry Group Co announced it would reduce the volume of its non-tradable shares at the rate of 1 non-tradable share for every 0.6074 tradable share before floatation.

But Fitch also warns that there are still some risks and uncertainties associated with the implementation process of share structure reform.

Close