Chapter 7
The Shanghai Securities Market

1. History

2. The Variety of Securities

3. Listed Companies

4. Investors

5. The Trading and Clearing System

6. The SSE Index

7. Market Outlook

1. History

The Shanghai securities market is the offspring of China’s economic reform. Over the past 20 years, it has rapidly developed from being a small regional market into a large national market. The development of the Shanghai securities market since the reform and opening-up of China can be divided into three periods.

Exploration and Startup (1981–1990)

The issue of treasury bills was resumed in 1981, restarting China’s securities market. In 1984, a few enterprises in Shanghai, Beijing, and Shenzhen began to issue stocks and corporate bonds, and the variety of securities had gradually increased. In 1988, the treasury market was established along with a securities market consisting of a primary and secondary market.

Comprehensive Development (1991–2003)

By the end of 1990, the Shanghai and Shenzhen Stock Exchanges had been established with the consent of the State Council, and the securities market went into official operation. During this period, the Shanghai securities market experienced a rapid expansion, rising from original scattered regional stock markets to a centralized national stock market. Its trading varieties also expanded from the singular treasury bonds and stocks to include corporate bonds, financial bonds, funds, convertible bonds, warrants, and asset-backed securities. Many new technologies, such as centralized bidding transactions and paperless issue and trading, were successively put into use. A series of laws were promulgated successively, such as Company Law, Securities Law, and Law on Securities Investment Funds. A nationwide securities regulatory system was basically established, featuring the administrative regulation of the China Securities Regulator Commission (CSRC) and the industrial self-discipline and regulation of the Securities Association of China, and the Shanghai and Shenzhen Stock Exchanges.

Further Development (2004–Present)

Since 2004, the securities market has observed the principles of “being open, fair, and just,” followed the guidelines of “governance by law, supervision, self-discipline, and standardization,” and tried to implement a concerted development with the national economy. The securities market aims to establish an efficient and transparent capital market with a reasonable structure, complete mechanisms, proper functions, and safe operation

2. The Variety of Securities

The securities listed at SSE can be divided into four categories: stocks, bonds, funds, and warrants. When SSE opened in December 1990, there were only 30 securities listed, including eight A shares and 17 treasury bonds. By the end of 2005, there were 1,031 securities traded in the market, including 827 A shares, 54 B shares, 120 bonds, 26 funds, and four warrants.

2.1 The Stock Market

The securities can be divided into Share A and Share B. Share A is only available for domestic investors and QFII to subscribe to and trade, while Share B is only for domestic and foreign investors to subscribe to and trade in U.S. dollars. In 1990, the first eight A shares were listed, then the first B share listed in 1992. With the listing of a large number of state-owned enterprises, high-quality private enterprises, and the three types of venture enterprises, the function of Shanghai securities market as the national economic barometer began to materialize. As of 2005, there were 827 A shares and 54 B shares listed in the market, and the total market value of shares in SSE reached RMB 2,309.61 billion, with a negotiable capitalization of RMB 675.461 billion. The proportion of negotiable capitalization to the total market value was 29.2%.

2.2 The Bonds Market

Bonds include treasury bonds, corporate bonds, and convertible corporate bonds. The treasury bonds market of SSE is the most vibrant in China. The government securities repurchase that was put forward in 1993 brought the mortgage function of treasury bonds into play. By the end of 2005, SSE had 120 varieties of bonds in total, including 43 treasury bonds, with a deposited bond balance of RMB 344.8 billion. It also had 47 corporate bonds, with a deposited bond balance of RMB 30.0 billion, and 18 convertible bonds, with a deposited bond balance of RMB 16.7 billion, plus three repurchase bonds. The aggregate deposited bond balance was close to RMB 391.7 billion.

SSE has actively supported the development of the asset securitization business, and provided the circulation platform for asset securitization varieties via the block trading system. On September 6, 2005, the first asset securitization product in the history of China, Unicom CDMA, began circulation in SSE, creating a new

development space for SSE. The full name of the asset securitization plan of Unicom is China Unicom CDMA Network Rental Income Plan. The funds raised reached RMB 1.6 billion.

Meanwhile, in order to increase the variety of fixed income securities, SSE prepared the Asian bond ETF. The Executives’ Meeting of East Asia and Pacific Central Banks (EMEAP) set up the Asian Bond Fund. This organization consists of the central banks and financial service authorities from 11 members, including the People’s Bank of China. The Asian Bond Fund is made up of the Pan-Asia Bond Index Fund and eight single market index funds. The China Bond Index Fund is one of the eight, and it mainly invests in China’s RMB bonds market. In May 2005, EMEAP injected US$2 billion into the Asian Bond Fund, US$0.12 billion of which was invested in the China bond index fund. The China bond index fund primarily adopted the ETF products to invest in treasury bonds. It will be listed in SSE for public investors to subscribe to.

2.3 Fund

By the end of 2005, there were 25 close-end funds and one ETF traded on SSE. The ETF has all the features of an index fund, including index duplication, passive management, low cost, as well as the characteristics of open-end funds and close-end funds. Meanwhile, it also optimizes ordinary open-end funds and close-end funds. Compared with ordinary open-end funds, ETF fulfills the subscription and redemption via stocks instead of cash; and compared with ordinary close-end funds, ETF may eliminate the discount and premium problems in the secondary market.

SSE launched the first ETF in mainland China, SSE 50ETF, in February 2005, to deepen the blue-chip investment and value concept, construct the stock pricing base market, and increase the number of institutional investors. SSE 50 ETF has been widely recognized by the industry since its launch, and it won the Best Product Innovation Awards by Asia Asset Management on March 1, 2005. Also, in April 2005, it won the Asia-Pacific Best Product Innovation Award in the 2005 Global ETF Awards.

2.4 Warrants

Warrant is a special contract in which the issuer promises to sell (or purchase) a certain amount of specific assets at some agreed price, on or before a certain date in the future. The warrant holder pays a certain sum to the issuer, which constitutes the price of the warrant. There are two types of warrant. First, the warrant issued by issuers of underlying stocks (such as the listed company) is called corporate-issued warrant, Second, the warrant issued by a third party, such as the securities trader other than the issuer of underlying stocks, is called the derivative warrant. On August 22, 2005, SSE successfully put forward the first Baosteel Warrant. By the end of December 2005, there were four warrants trading in the market.

3. Listed Companies

3.1 Overview of Listed Companies

Over a long period of time, SSE has set the establishment of a blue-chip stock market as its developmental goal, aiming to become an investment arena where both domestic and overseas investors can share the fruits of China’s economic growth. The sustained economic growth has already cultivated large amounts of excellent Chinese enterprises, many of which have already been listed in SSE. These companies include not only large state-owned enterprises with outstanding performance, such as Sinopec, Bao Steel, and China

Unicom, but also fast-growing private enterprises and foreign-funded enterprises. Propelled by the further development of China’s economy, some outstanding listed companies will grow into world-class multinationals, which will, in turn, enable the Shanghai securities market to become a world-class blue-chip market. By the end of December 2005, 834 companies were listed in SSE, with total market value of RMB 2,309.6 billion, among which the negotiable market capitalization was RMB 675.5 billion.

3.2 Industrial Distribution of Listed Companies

About 65% of all the listed companies in SSE are industrial enterprises, 16% comprehensive enterprises, 10% utilities enterprises, 7% commercial enterprises, and 2% real estate companies.

3.3 Regional Distribution of Listed Companies at SSE

In terms of regional distribution, most listed companies in SSE are from developed coastal areas, 17.39% of which are local enterprises in Shanghai, while 7.55% and 7.31% come from the adjacent Jiangsu and Zhejiang Provinces respectively.

3.4 Ownership Structure and Split-Share Reform of Listed Companies

Share split has been a historical problem since the establishment of the Shanghai securities market. Over a long period of time, when the companies were listed at SSE, some of their shares were negotiable while the other shares were not. This has resulted in a coexistence of tradable and non-tradable shares in such companies’ ownership structures. The differentiation between the tradable and non-tradable shares leads to the interest divarication among shareholders, and distorts the pricing mechanism of the capital market, as well as restricts the standardization of the listed companies and the capital market. With a view to changing this situation, under the guidance of the CSRC, SSE started the split-share reform in May 2005 to unify the tradable and non-tradable shares of listed companies through a reasonable plan.

The split-share reform proceeded smoothly. As of February 27, 2006, a total of 365 SSE-listed companies have completed or are engaging in the split-share reform, accounting for 44.68% of all listed companies and 52.53% of total market value. The accomplishment of the reform has created a new situation for the long-term healthy development of SSE. The governance structure of listed companies will be significantly improved, the price discovery function of the market and the function of market disciplining behaviors of the listed companies will recover soon, and the investor confidence will be further enhanced.

3.5 The Top 50 Listed Companies

By the end of 2005, the total market value of the top 50 listed companies had reached RMB 1,203.13 billion, down 4.07% compared to the value of 2004, accounting for 52.09% of the total market value of all listed companies at SSE. Sinopec. listed in 2001, maintained its lead position.

4. Investors

The Shanghai securities market enjoys a unique investor base. The number of individual investors is huge. Institutional investors have developed rapidly, while foreign investors are the new powers with tremendous potential.

4.1 Active Individual Investors

SSE has always worked hard to attract individual investors since its establishment. The rapid growth of China’s economy has greatly increased the income of Chinese residents, and paved the way for individual investors to invest in SSE. As of December 31, 2005, SSE had 37,479,173 accounts, among which, 212,826 were held by institutional investors and 37,266,347 by individual investors.

4.2 Participation of Institutional Investors

In recent years, the entrance of social security fund, insurance fund, and enterprise annuity, as well as other pension funds, into the market has initially balanced the structure of institutional investors in the Shanghai securities market. In 2005, the CSRC, together with the CIRC and the Ministry of Labor and Social Security, took active measures to encourage the entrance of social security fund and insurance fund into the market steadily, and speed up the process of enterprise annuity entering the market. The national social security fund has actively participated in investments in the stock market since its establishment, and its amount of investment has grown year after year, making it a major investor.

The insurance funds have also become a main investor in the securities market. By the end of 2005, insurance funds entering the market indirectly reached RMB 106 billion, an increase of 57% compared to the previous year, while the funds directly investing in the securities market went up to RMB 13.57 billion. In recent years, the scale of the insurance industry entering the market indirectly via securities investment fund has expanded rapidly. Compared to 2004, the total amount of insurance funds investing in funds and equity funds has increased greatly, accounting for 22.79% of the fund market. Insurance institutions have become the most important institutional investor in the securities investment fund market, playing an important role in developing the funds, stabilizing the capital market, and maintaining the market confidence.

4.3 The Increasingly Mature Securities Investment Fund

In recent years, the sustained development of the securities investment fund has further expanded the investment scope and sales channel of the funds. Statistical data shows that, as of December 31, 2005, there were 218 securities investment funds active in the market, with a total net value of RMB 469.11 billion and total fund shares of 471.48 billion.

On July 14, 2005, SSE launched the fund distribution platform named SSE LOF, which was a new network consisting of all members of SSE qualified for offering and specializing in the acquisition (subscription) and redemption of open-end funds. An investor can conduct the acquisition (subscription) and redemption of open-end fund at the business office of any SSE member with the qualification of fund offering, as long as he/she holds a SSE shareholder code card (SSE common stock account) or the Shanghai securities investment fund account with China Securities Depository and Clearing Corporation Limited. The subscription and redemption of open-end funds via the SSE LOF Distribution System is the same as the over-the-counter system, both of which are based on the net value.

4.4 Sustained Development of Qualified Foreign Institutional Investors (QFII)

Along with China’s entry into the WTO, the Shanghai securities market has accelerated its opening-up to foreign investors. By virtue of the QFII system, more and more investors from foreign mature markets are participating in SSE. By the end of 2005, QFII had approved 32 qualified foreign institutional investors, with approved investments denominated in foreign currencies worth US$5.495 billion. By the end of October 2005, QFII held securities assets worth RMB 28.5 billion, accounting for 90% of the total assets, which included stocks valued at 16.9 billion or 53% of the total assets as well as funds of 4.4 billion or 14% of the total assets. The sustained development of QFII has not only enhanced the international influence of SSE and boosted market confidence, but also promoted the development of China’s capital market.

5. The Trading and Clearing System

5.1 The Trading System

The trading days of SSE is from Monday to Friday each week. In the morning session, 9:15 to 9:25 is the competitive bidding time, while 9:30 to 11:30 is the continuous bidding time. During the afternoon session, 13:00 to 15:00 is the continuous bidding time and 15:00 to 15:30 is declaration acceptance time for block trade. The market is closed on Saturday, Sunday, and days as proclaimed by SSE.

SSE adopts the collective auction method. The trading of all listed securities goes through the aggregate auction via the mainframe, and is automatically matched according to the principle of price-time priority. The SSE implements the overall designated trading system for the securities transaction. The investor engaging in securities trading in SSE designates a member trading and clearing on his behalf, and signs the designated trading agreement. The investor can only conduct trading by opening his securities account at the seat owned by the member.

SSE launched the block trade business in January 2003. Contrary to price bidding transactions, block trade is conducted through the block trading system platform specially developed by SSE. This helps change the current situation of merely matching transactions and diversify trading mechanisms.

The trading price of securities listed in SSE generally fluctuates in line with the market conditions, allowing competitive bidding. Currently, it implements a 10% price limit to all A shares, B shares, and funds on each trading day (exclusive of the first trading day), and 5% price limit to ST stocks. The declared price of block trade must be determined between the maximum and minimum strike prices concluded within the bidding time. In the event that no security is traded, the closing price is the strike price.

SSE uses the net price to trade listed government bonds. The government bond repurchase adopts two trading modes, namely, pledge and buyout.

Having been upgraded many times, the capacity of the SSE trading system is now leading the world. The mainframe is capable of accepting 29 million trusts, striking 60 million transactions, and completing 16,000 transactions per second.

5.2 Registration and Clearing

The Shanghai branch of the China Securities Depository and Clearing Corporation Limited (DCC) registers and deposits the stocks of companies listed at SSE collectively.

DCC implements a central depository system for all securities listed at SSE. Each securities company is the central depository trustor of listed negotiable securities and the non-tradable securities held by securities investors, while the issuer is the central depository trustor of state-owned shares and legal-person shares. According to the central depository system, DCC is responsible to the depository trustor and the depository trustor to the securities investors deposited. A securities investor must assign a securities enterprise as his/her security depository institution and designated trading organization.

Currently, DCC, according to the principle of security, efficiency, and other criteria, has gradually established a legal person netting system that integrates centralized clearing and classified delivery, implementing a “T+1” delivery system for A Shares. On a trading day, SSE transfers the data of securities transactions to DCC, which summarizes and clears all transactions of the same member on the trading day according to the netting principle, calculates the net amounts of securities or amounts receivable or payable, and completes the clearing process.

On the next trading day (“T+1” day) at 9:00 a.m., it begins the delivery to clear the transfer of funds and securities of each clearing member, so as to make the buyer get the securities and the seller get the funds. The delivery sequence starts first with the delivery of transactions in the secondary market, and then the delivery of the subscription of new shares in the primary market. The delivery is completed by means of recording. The members open securities and fund accounts at DCC for funds delivery. DCC’s computers automatically transfer the securities (funds) from the accounts of the payers to the accounts of the payees according to the clearing results. The members, after completing the delivery with DCC, then conduct the clearing and delivery with investors.

6. The SSE Index

6.1 The SSE Index Series

The index is not only the barometer but also the lifeline of the securities market. Over the past 16 years, from the initial single composite index to the various indexes, SSE has gradually formed a relatively comprehensive index system. This system has become an authoritative statistical index widely used both at home and abroad to evaluate the performance of China’s securities market. The SSE index series includes the Shanghai SSE 180 Index, the Shanghai SSE 50 Index, the Shanghai Composite Index, the A-Share Index, the B-Share Index, the Classified Index, the Bond Index, and the Fund Index, among others. Among these, the Shanghai Composite Index is the earliest compiled index.

The SSE 180 Index is a benchmark index established on the basis of the development situation of China’s securities market, using international experience and compiled using scientific methods. The index reflects the conditions and operations of Shanghai securities market, serving as a performance benchmark for investment and a basis for financial derivatives. The SSE 50 Index pools the 50 largest stocks of good liquidity and a broad representation from the Shanghai securities market to form a constituent index. It comprehensively reflects the complete picture of the most influential leading enterprises in the market, and forms a Chinese blue-chip group. What is more exciting is the Shanghai-Shenzhen 300 Index, a unified index that has been cultivated for as long as seven years.

6.2 The Base Day, Base of Index, and Base Index

Since the SSE 180 Index, released on July 1, 2002, is the extension of the SSE 30 Index released on July 1, 1996, the SSE 180 Index still takes the average negotiable market capitalization from January to March 1996 as the base, with a base index of 1,000 points.

The SSE 50 Index takes December 31, 2003 as its base day, and the adjusted market value of all stocks on that day as the base, and its base index is 1,000 points. It was released on January 2, 2004.

The SSE Composite Index takes December 19, 1990 as its base day, and the market value of all stocks on that day as the base, and its base index is 100 points. It was released on July 15, 1991.

The SSE A Share Index takes December 19, 1990 as its base day, and the market value of all A shares on that day as the base, and its base index is 100 points. It was released on February 21, 1992.

The SSE B Share Index takes February 21, 1992 as its base day, and the market value of all B shares on that day as the base, and its base index is 100 points. It was released on February 21, 1992.

The SSE industrial index takes April 30, 1993 as its base day, and the market value of shares in corresponding sectors as the base; its base index is the unified 1,358.78 points (the closing point of the SSE Composite Index on April 30, 1993). It was released on June 1, 1993.

The SSE Fund Index takes May 8, 2000 as its base day, and the market value of all securities investment funds on that day as the base; its base index is 100 points. It was released on June 9, 2000.

The SSE Government Bond Index takes December 31 2002, as its base day, and the market value of all constituent government bonds as the base. Its base index is 100 points, and it was released on January 2, 2003.

The corporate bond index takes December 31, 2002, as its base day, and the market value of all constituent corporate bonds on that day as the base, with a base index of 100 points. It was released on June 9, 2003.

7. Market Outlook

The fast growing Chinese economy, stimulated by China’s continuous reform and opening-up, will lay a solid foundation for the development of SSE. Looking ahead, SSE will march from an emerging market to a mature market in terms of market scale, market function, investment tools, quality of listed companies, and internationalization.

From 1978 to 2004, China’s GDP increased from US$143.7 billion to US$1,649.4 billion, representing an annual average growth of 9.4%. Its GDP is expected to reach about US$4,000 billion in 15 years. Shanghai’s securities market will definitely benefit from China’s soaring economy. Currently, China’s financial system, which gives priority to the indirect financing of banks, does not contribute toward eliminating the risks in the banking system and enhancing the risk resilience of Chinese enterprises. In its Eleventh Five-Year Plan, the Chinese government proposed to speed up direct financing, actively develop the capital market, such as stocks and bonds, and steadily develop the futures market. The experience of some

mature capital markets shows that the market value of a country’s primary market generally accounts for 100% of its GDP, whereas the value of SEE only makes up 16%. If this proportion can rise to 100%, SSE will be able to rank among the top six in the world’s securities markets.

Over a long period of time, the existence of large amounts of non-tradable shares in the securities market has made it impossible for the resource allocation to be realized by M & A in the securities market. The functions of the capital market in selecting the superior and eliminating the inferior and allocating resources have not been brought into full play. The split-share reform initiated in 2005 has eliminated the difference between tradable shares and non-tradable shares, and realized the full circulation of shares, paving the way for the M & A development of the securities market.

The reform of state-owned asset management system is also underway. The strategic restructure of the state-owned capital is being conducted. The state-owned capital has gradually exited from the competitive industries. It is foreseeable that after the full circulation in the securities market is realized, the securities market will become an important arena for the restructure of state-owned listed companies and state-owned capital.

Innovation has always been the major driver of SSE. Such innovation over the next five years will find expression mainly in the following aspects. First, financial derivatives will be put forward. Currently, there are no financial derivatives in the Shanghai securities market. In order to provide more diversified investment varieties and risk management tools to investors, the innovation based on stock, index, and derivatives of index products is essential. Second, the market of fixed-income products will be developed. It is an urgent task faced by the current Shanghai securities market to vigorously promote the development of the corporate bonds market, the treasury bonds market, and other fixed-income markets. In the coming five years, the size of the corporate bonds market in Shanghai will be further enlarged, and the securitized asset products will undergo rapid development. Third, the trading mechanism will be perfected. The Shanghai securities market will further perfect the block trade and carry trade; establish the pilot margin trading system, the securities lending system, and the system of market makers; and relax restrictions on the price limits

With the acceleration of economic globalization, especially the further integration of China’s enterprises into the world economy, the pace of the Shanghai securities market bringing itself in line with international conventions will be quickened through international cooperation. In about five to ten years from now, the reform of the RMB exchange rate regime will be deepened, and the liberalization pace of the RMB capital account will speed up. The cross-border bidirectional flow of capital will increase, and the restrictions on QFII will be further relaxed. Offshore companies will be listed at SSE, enabling the latter to become one of the major investment destinations in the world.