Lang Xianping Explains Why Financial Market Reforms Won't Lift the Market

This week Lang Xianping discusses China's latest financial reforms as relates to the financial markets, specifically the stock and futures markets. He shows that contrary to the popular assumption that increased foreign investment will boost the market, history shows that at best there will be no effect or a negative one depending on how the futures market reform plays out.

At 8:00 he shows the various global stock markets and how they have performed relative to August 2007: India has done the best, up 67.21%, Germany is up 28.76%, the U.S. is up 22.92%.

8:51 China...down 60% from the peak and no recovery. Now there is a bold experiment, strong medicine: introduce foreign investors to lift the market. Will this work? Lang Xianping says he has no forecast, he doesn't forecast stock or real estate markets....but he can give some evidence. We can look at what happened in other areas that introduced similar policies.

9:40 First look at Taiwan. He has a chart of the Taiwanese stock market (top in blue) with the proportion of foreign ownership below. Foreign ownership has rise from 12% up to 33% recently. He says this doesn't mean the foreign ownership boosted the market: foreigners bought into the market because the stock market went higher.

10:40 Next is Thailand, which reformed in 1988. Foreign ownership went from 15% to 60% as Thailand's stock market boomed. In 1997, the Asian crisis hit and foreigners sold out. Recently foreign ownership was 33%. So he says, around 30%, foreign ownership may not affect the market, based on it having apparently no effect on Thailand or Taiwan.

12:20 Next is Korea, with opened up its stock market in 1998. At that time the South Korean market was doing very well. Foreign ownership climbed to 40% by 2004, but since then has fallen to 32%.

13:00 So we can learn two important things. First, foreigners do not come in to help you lift the stock market, rather foreigners come in once the market is doing well. Second, thirty-something percent is a magic number. Foreign ownership in China will also not exceed this level.

Now, with the market this rotten, are foreigners going to come and trade Chinese stocks? Will they suddenly show up and invest lots of money? They have to trust the market, have to give them a guarantee. Only if they think they can make money will they enter the market.

14:00 We've reformed the stock market for many years, several big problems haven't been fixed. For example, class actions (none). So many fraudulent companies, why can't they be delisted? Misappropriation of funds, solved or not? Preferred stock? IPO process, has it been improved? If you have no way to protect domestic investors, then you cannot protect foreign investors. How can you expect them to come to China? So first we must complete the basic work, not place this hope on foreign investors. If we first protect our domestic investors, foreign investors receive the benefit as well, then maybe they will come invest. Otherwise you are trying to catch fish in the trees.

15:00 Aside from the stock market, the new reforms will allow foreigners to trade futures, especially financial futures. Financial futures are more than 80% of the market. Now here's a really interesting statistic. Are you preparing to open the market today or 10 years from now? Look at this chart: Taiwan, Hong Kong, South Korea and Japan. The blue bar is the preparation time for opening the market, in years. Taiwan was the longest, at 13 years. Japan the shortest at 0 years. Taiwan needed a long time because they wanted to deeply interact with foreign markets. After understanding the rules of the game, decide on sound regulations. So it took more than 10 years. Hong Kong took less time. South Korea opened its futures market in 1997, and only took 2 years to prepare. Japan didn't even wait, just opened the market. Can you guess the result? The longer they took to open the futures market, the smaller the volatility in the stock market. And less time spent preparing, the volatility is extremely high. ou know why? Because you don't have sound regulatory policies.

16:40 In 2003, South Korea's futures market volume stood at 42% of global volume. Equity futtures stood at 74% of global volume. This small of a country has such a large share of the global market, why? Because the market volatility is too large. There are no regulatory controls for this type of volatility.

17:10 Japan in 1998 opens up. What's the result? January 1990 Japan's stock market collapses. Goldman Sachs used Nikkei futures to bet on collapse. In the end, they won. Japan's stock market tumbled 63%. Japanese people suffered losses of 50%. Volatility was too great.

17:40 If you allow foreigners into the futures market, what do you think the result will be? If you want a stable situation, you need a long time, do a lot of preparation, to have low volatility. So if you are wondering why the stock market hasn't gone up much after the announcement of the reforms, you can see there are a lot of problems.

Question time and a discussion follows.