Efforts are underway in China to improve systemic risk controls in the country’s capital markets. These efforts are significant and could impact both the way companies raise capital to grow and how the government funds development projects. 

Speaking in early September during the 7th General Assembly of the Shanghai Stock Exchange (SSE), Liu Shiyu, Chairman of the China Securities Regulatory Commission (CSRC) pointed out that a strict and comprehensive regulatory environment is key to limit systemic risk. The CSRC was created in 2003 and operates under the supervision of the People’s Bank of China. Liu was appointed in February with a mandate to reform the country’s capital markets. 

For China, strengthening risk controls in capital markets is a priority, particularly as these markets are a key source of funding for the infrastructure and capital projects that the country needs to ensure ongoing and steady economic growth. 

There has been some discussion of a restructuring of the country’s regulatory bodies, perhaps bringing the CSRC together with peer agencies like the China Banking Regulatory Commission and the China Insurance Regulatory Commission but, for the time being, no announcement has been made. 

China’s capital markets continue to grow and investors are lining up to play a larger role but regulators have to deal with increasingly rapid flows of capital and technology, quick changes in business structures and the growth of credit that some fear adds to the hidden risk in the system. 

A series of proposed reforms announced earlier this year would strengthen China’s capital markets and, perhaps, equalize access across the country. 

“For a long time, China’s capital market, whether IPO or refinancing, strictly used an approval system. The long-term control of resource mismatch and allocation is inefficient and is the biggest problem in China’s current capital market. Therefore, at this stage, China’s capital markets are undoubtedly undergoing a major reform through the implementation of new systems,” says Guangshui Yang, partner with FenXun Partners, a law firm in Shanghai’s free trade zone. 

IMPROVING ACCESS 

One proposal would allow Chinese companies from poor regions to get to markets faster, bypassing long waiting list of 836 companies (as of early September) looking to issue initial public offerings (IPOs) in Shanghai or Shenzhen faster. Other policies would boost access for regions with great potential. 

“At this stage, China’s capital markets iare credit-based; prices are subject to the government’s regulation of the financial system. The reform will prompt China to gradually change to a capital market-based financial system. Chinese enterprises will have more indirect financing, which will help China to enter the era of diversified business prosperity,” says Yang. 

“According to our observation, China’s securities market will continue to open,” says Yingfei Yang, counsel at FenXun Partners. “It is the strategic goal of China’s securities market reform to push forward the market-oriented reform and internationalization strategy of China’s securities market by 2020. This is the foundation of China’s financial system, especially the securities market, as a new international center.” 

The reforms are not only significant but also extensive, reaching less developed regions such as Northeast China as well. 

“For sure, there is a lot of room for future growth in the capital markets in Northeast China,” says Chi Rida, founding partner of Jilin Gongcheng Law Firm and vice-president of the All China Lawyers Association. “The capital markets here in Northeast China are developing rapidly and capital is always necessary for development.” 

“The central government is constantly rolling out new policies that will drive business and investment in the northeastern region. These policies will help expand the capital markets.”

SPECTACULAR GROWTH 

The growth in some markets has been spectacular. 

Equities markets, for example, have grown by leaps and bounds over the past few years.. China’s stock exchanges had a market capitalization of 23.04 trillion yuan ($3.4 trillion) in 2012 and that more than doubled to 53.13 tril¬lion yuan by 2015. By early September of this year, companies had raised 50 billion yuan in Shanghai IPOs and another 27.35 billion yuan in Shenzhen, according to Dealogic, compared to 63.36 billion yuan raised in Hong Kong. 

Law firms, both domestic and international, are looking to tap into both the growth and the changes. In September, for example, international firm Allen & Overy added two partners, Lina Lee and Jonathan Hsui, to its capital markets operations in Hong Kong. 

“We are seeing increasing demand from Chinese corporates for equity capital markets legal advice as they continue to expand into global markets,” says the firm’s global corporate co-head Richard Brown. 

Jerry Peng, an analyst with Macquarie Research, believes capital markets could be affected by efforts to tighten credit. 

“Credit tightening now looms as the major risk for China equities,” he said in September. 

China’s asset markets have grown into behemoths that attract international investors looking for a wide range of asset quality. China bond markets, for example, are growing and are generally seen as safe with very few defaults, says Vishnu Varathan, a senior economist at Mizuho Bank. 

Companies in almost every sector of the economy are looking to tap China’s capital markets to expand. One visible case in point is health care, where capital market reforms are combining with reforms and growth to the health care system to provide myriad opportunities for growth. 

China’s healthcare sector is growing rapidly and one reason is the fast-increasing elderly population. According to Frost & Sullivan, there could be 331 million people over the age of 65 in China by 2050. The need for medical care is expected to expand as older Chinese people use more services. 

According to brokerage and investment house CLSA, investors are also looking at the healthcare space and looking to benefit from new policies. The National Development and Reform Commission (NDRC) released “Comments on Promoting Healthcare Service Pricing Reform” in July which could open the door for hospitals to raise service charges by as much as 20 percent in the short term and double then over the next two or three years, admittedly from a low base. 

“So healthcare service and hospitals are kind of the new spotlight in the whole industry. We will see more privatisation in the sector and more private names such as (Phoenix Healthcare Group) and Kangning riding the government’s favourable policy trends for fast M&As (mergers and acquisitions) and expansion,” says Shao. 

The result is a series of deals and efforts to tap China’s capital markets. 

A case in point is the proposed secondary listing of Wenzhou Kangning Hospital, maybe the largest private psychiatric specialty care service provider in China. Kangning is looking to raise 193 million yuan by placing 8.1 million A-shares. 

At least four Chinese hospital groups have issued shares in Hong Kong, including Phoenix, Harmonicare, Wenzhou Kangning and Zhongmei Healthcare, the last in September. 

Earlier this year, for example, Shanghai Fosun Pharmaceutical Group Co. Ltd., chaired by Guo Guangchang, who is dubbed China’s Warren Buffet, announced plans to invest 1 billion yuan in 10 hospitals alongside Taikang Life Insurance Co. Two years ago, China’s leading drug maker purchased US-listed Chindex International Inc., which operates a number of private hospitals in China, from private-equity firm TPG Capital. Shanghai Fosun Pharmaceutical first tapped capital markets in Shanghai and then followed that up with a $510 million IPO in Hong Kong in 2012. Zhong Lun Law Firm advised on the deal, which was a somewhat typical example of a private institutional investor pouring money into state-owned hospitals, which had to be restructure.

PUBLIC-PRIVATE 

The combined opening of the healthcare and capital markets in China is creating new opportunities for private players to grow and be competitive. 

For the government, this is good news as it can help leverage the power of the private sector in the development of the country. 

The use of capital markets in development is one avenue for growth. Another is combining private and public resources through public-private partnership (PPP) models, first used in the infrastructure and public service fields, according to the Circular on Issues Concerning the Promotion and Application of the Public-Private Partnership Model (Circular No. 76). The PPP model can be trickier than straight private investment as it requires some kind of government body to choose and work with investors. The basic framework for it is the Government Procurement Law (revised in 2014). This PPP model is also visible in the healthcare space. 

“The process of selecting investors for healthcare PPP projects is actually the process by which hospitals, as the public institutions making procurements with fiscal funds, select investors that will provide the services,” Liu Ruina, a lawyer with Han Kun Law Offices, noted in a recent report. 

Section 26 of the Government Procurement Law clearly stipulates that “open bidding shall be the main procurement method in government procurement.” 

“However, does this mean that PPP projects must first choose to adopt open bidding? It is better to analyze the question on a case-by-case basis and not to draw a broad conclusion in this regard,” Liu said in the report. “PPP projects can last for decades and involve multiple processes. So, the real question is which stages may involve open bidding? Taking the example of PPP projects in the healthcare sector, there are two stages which may involve bid invitations. The first stage is to select investors. Second is the project implementation stage. This stage mainly relates to new construction projects and hospital renovation projects.” 

According to Liu, “the relationship between concession projects and PPP Projects directly reflects the conflict of the regulations issued by the NDRC and the Ministry of Finance, which has been a long-lasting puzzle to PPP practitioners.” 

Earlier in July, the State Council issued a document titled Opinions on Deepening the Reform of Investment and Financing Systems. In Section 9 of the Opinions, it mentioned that “the government encourages the cooperation of the government and social capital. Various departments of various regions may seek to expand the supply of public goods and services by granting concessions and the government procurement of services in the form of a single project, a combination of projects and contiguous development in the areas of transportation, environmental protection, healthcare, elderly care, etc.” 

“This is the first time the central government has categorized ‘government and social capital cooperation (PPP)’ into two models: concessions and the government procurement of services, which also challenge the expression referenced in Circular No. 76, namely that PPPs are in essence the government’s procurement of services. In order to better coordinate the powers of the two ministries and resolve the conflicts of their respective regulations, it is necessary to promulgate a superior law, the Government and Social Capital Cooperation Law, and its implementing regulations as soon as possible,” noted Liu in the report.