Regulatory Capture and the Chinese Stock Market

November 30, 2015 8:00 am Last Updated: December 3, 2015 7:39 am

The Chinese leadership’s recent attempt to save China’s stock market, after its extraordinary meltdown this summer, failed. While key officials of China’s securities industry are being investigated, the big question is whether corruption and insider trading in China’s stock market will really disappear.

China’s securities industry, and the capital in it, is highly dependent on connections to people in the right places of power. Will the anti-graft campaign carried out by Party leader Xi Jinping and his deputy Wang Qishan undo the relationship between power and capital?

The Regulators and the Regulated

Interest groups—individuals, families, and firms that help one another out—have formed around China’s stock market. Except for stock investors, the Chinese Securities Regulatory Commission (CSRC), intermediaries, listed companies, various professional media, and stock analysts are all in cahoots with one another, which has lead to symbiotic relationships and deep conflicts of interest.

For instance, from 1996 to March 2011, a total of 58 former CSRC officials joined brokerage and fund management at senior positions, either the vice president level or elsewhere in the senior management team, according to National Financial News.

The May 16 article said that it’s an open secret in the industry that good connections with the CSRC and related departments are closely related to the success of a project. When listed companies choose a brokerage firm, their main criteria is the strength of the firm’s connections with the CSRC. Most of the top 10 brokerage firms in 2010 had former officials who had just left CSRC.

Gray Areas

CSRC officials joining securities firms easily leads to insider trading. Due to an intentional gray area in the law, officials in the CSRC system often join brokerage firms, fund management companies, and trust companies after working at CSRC for several years.

In 2000, the CSRC issued personnel guidelines for senior positions, but there were still no clearly defined limits regarding the relationship between the regulator and the regulated. This omission was not caused by low levels of legislation; the regulations had very detailed provisions as to the qualification requirements of independent directors of listed companies. Commentators at the time noted that the huge contrast between the two positions was “quite interesting.”

The CSRC Staff Code of Conduct published in 2009 still did not have adequate provisions regarding the period before a regulatory agency official may join a regulated company.

This “forever-cat-and-mouse-friends” relationship makes insider trading a common practice in China’s stock market, and it is rarely punished.

The Difficulty of Supervision

Recently, Communist Party agencies have started removing the limitation of CSRC officials joining regulated companies.

In 2014, CSRC issued a rule that, beginning 2015, officials leaving CSRC must observe a strict three-year period before joining regulated companies. This new regulation led to many officials leaving CSRC and joining the regulated companies earlier than planned.

The implementation of this waiting period is to “learn from the United States.” However, it is difficult for China to solve corruption even when copying U.S. law. The U.S. government observes a separation of powers, but in China the Communist Party dominates everything. Insider trading and nepotistic dealings are inevitable. As long as there is no change to the one-party monopoly on power, the breeding ground for corruption remains the same, and, as the Chinese saying goes, the trees growing in that soil will be the same trees.

This is an abridged translation of He Qinglian’s Nov. 19 article, published on Voice of America Chinese. He Qinglian is a prominent Chinese author and economist. Currently based in the United States, she authored “China’s Pitfalls,” which concerns corruption in China’s economic reform of the 1990s, and “The Fog of Censorship: Media Control in China,” which addresses the manipulation and restriction of the press. She regularly writes on contemporary Chinese social and economic issues.