1.1 Preliminaries
Securities markets consist of those markets through which people with capital to invest are matched to those who require it for productive purposes. This occurs through the creation and sale of financial instruments in the primary market, and the creation of liquidity through resale in the secondary market.
In most countries, securities markets are subject to a separate (or additional) regulatory regime from other markets, for the obvious reason that a claim over an intangible asset, such as a share in a company, cannot be assessed in the same way as, say, goods or land. So the law responds by imposing special requirements on the various entities (issuers, intermediaries, market operators, and traders) involved in securities markets.
In particular, modern securities regulation is generally an attempt to apply three broad doctrines in response to what are seen as impediments to the effective functioning of the relevant markets. These three principles, each of which is subject to degrees of contention by lawyers, regulatory theorists, and economists of various persuasions, are:
- 1.Protection of investors, market efficiency, and systematic stability.
- 2.These are most likely to be achieved where market participants act with āintegrityā and there is adequate disclosure so that participants are able to make informed market judgements.
- 3.Integrity and adequate disclosure can only be obtained through regulatory intervention, for reasons of market failure.
āIntegrity ā can be a slippery term. It is used here to denote honesty and compliance with a set of market rules that are universally known and consistently applied.
The triple goals of the first doctrine have been expressly identified by the International Organization of Securities Commissions (IOSCO) as the three key objectives of securities regulation.1 The IOSCO is a multinational forum for standard setting and co-operation between national securities regulators. Its published views represent the consensus of over 100 regulatory agencies which between them regulate almost all of the worldās significant securities markets. The China Securities Regulatory Commission (CSRC) is a board-level member.
The IOSCO sets 38 āprinciplesā of securities regulation that have to be implemented under the relevant regulatory framework in order to achieve the three objectives stated above.2 These principles, which include requirements that issuers should make full, accurate, and timely disclosure of financial information material for investors to make informed decisions, both expressly and implicitly endorse the third doctrine listed above.
The second doctrine explains the dual emphasis of conduct regulation and mandatory disclosure that occurs in modern securities regulation (and which is evident in the IOSCO principles). While it is generally accepted that for markets to function efficiently the second doctrine must be satisfied, there is less agreement on how this is best achieved. There is ongoing debate about whether regulation is necessary to achieve it, or whether it is better achieved through market forces or private law. (The IOSCOās existence and that of its member regulatory bodies is obviously predicated on acceptance of the need for regulation.) But among those who agree with the view that regulation is necessary there is debate about the form and extent of that regulation (and here the IOSCO principles are notably non-prescriptive). There are, for example, not only choices between legislation enacted by representative bodies or delegated to the executive; standards, policies, and rules promulgated by regulatory agencies; and self-regulation, but also between the appropriate type, scope, and detail of regulation.
Welfare economics considers that regulation is required because of market failure where there is a monopoly or potential for abuse of market power, or where there is information asymmetry between buyers and sellers, or where what is being traded are āpublic goodsā, or where there are externalities affecting third parties that are not reflected in market prices. The majority view is that the last three of these are prevalent in securities markets.3 For instance, information asymmetries exist between issuers and investors, and information and public confidence in securities markets are āpublic goodsā which benefit all investors (and the public at large) but for which no individual investor has incentive to pay. Misallocation of resources creates externalities in the form of reduced economic growth or a reduction in private wealth that places demands on public welfare resources. Regulation is commonly justified as the most efficient response to these kinds of market failure. This generalized and largely theoretical discussion may suggest that all that is required is to create a regulatory body with the appropriate powers and to set it loose on the market to apply the nostrums. But regulation of financial markets does not, in practice, just consist of the application of mechanical rules by duly created and empowered institutions. It is tied to national social, political, economic, and cultural circumstances. The success of a regulatory system depends on how well it fits with the nationalās existing institutions and circumstances.4
Well-developed and efficient securities markets are important elements of national economic development. In many cases regulation is about the orderly creation of such markets given a particular national historical context. Chinaās securities markets did not arise spontaneously but as a result of a conscious exercise of government policy. In attempting to understand securities market regulation in China, attention must be given to the origin and evolution of the markets and, among other matters, to the development of the concept of the āsocialist market economy ā, to the institutional order of Chinaās de facto federalism (its regionalism), to the extent of āstate capitalism ā, and to the recent politico-economic history of China. Only by understanding these factors is it possible to understand idiosyncratic features such as the āNational Team ā (discussed in more detail in Sect. 1.4), a collection of state-owned or -controlled securities companies which normally act in their own interests as commercial entities in the markets, but which stand ready, under the direction of the government to intervene in the markets in the face of systemic instability.
Perhaps the two most striking features of securities markets in the Peopleās Republic of China (PRC) is, first, that they simply did not exist before the 1990s and second, their startling rate of growth since then. By 2008 market capitalization had reached USD 2 billion, and by 2015 it had grown to USD 7.932 billion.5 By the end of 2015, there were 2827 companies listed on the Shanghai and Shenzhen stock exchanges.6 At that time, in terms of market capitalization , the Shanghai Stock Exchange and Shenzhen Stock Exchange ranked respectively as the fourth and fifth largest exchanges globally.7 The novelty of the exchanges and their rate of growth clearly pose regulatory challenges, not least in respect of the volume of inexperienced retail and institutional investors entering the markets.
The introduction of securities exchanges in China was a matter of the government yielding to economic necessity. Under Deng ās āopen-up policyā , the governmentās share of revenues declined as enterprises were permitted to retain more of their profits.8 Financing the budget deficit through the issue of bonds was a solution.9 Also, after the Tiananmen Square protests in 1989, the Group of 7 Nations (G7) imposed economic sanctions on China,10 and foreign investment in the country dropped sharply.11 China needed capital to pursue its agenda of economic growth, and the governmentās recourse was to raise it from the public by establishing the Shanghai and Shenzhen securities markets .12
Beginning in 1992 all State-Owned Enterprises (SOEs) went through a reform process, which involved their corporatization, and in many cases their listing on the stock exchanges. While, in most cases, the central or regional governments or their instrumentalities retained majority control, this process provided SOEs with a means of re-capitalization. As late a...