By Maria Trombly | Securities Industry News | October 31, 2005

The biggest problem facing China's stock market today is the fact that two-thirds of all shares are locked up in government hands. "If two-thirds of the shares cannot be circulated, then there is no pressure on the management," said Thomas Liu, professor of finance at Shanghai's Jiao Tong University. "They're not afraid of being run out."
China's Minsheng Banking Corp., the first bank to join the share-conversion program, says that it has received government approval to convert its state interest to publicly tradable shares.

As a result, the long arm of the state stifles even publicly listed companies and they do not operate according to market principles, said Liu. This creates corporate governance problems and explains why China's stock market has been declining for four consecutive years, even as the economy has been booming.

Under new reforms, state-owned shares will be converted to publicly tradable shares in a three-year, phased process (Securities Industry News, May 9). China's Minsheng Banking Corp., the first bank to join the share-conversion program, says that it has received government approval to convert its state interest to publicly tradable shares.

Minsheng, China's second-largest domestically listed lender, plans to also list on the Hong Kong Stock Exchange next year. "We received approval from the China Banking Regulatory Commission on Oct. 12 to go ahead with the plan," the bank said in a statement.

Existing shareholders must approve the conversion plan. Since any sell-off of state-owned shares could lower stock prices, Minsheng sweetened the deal: Existing shareholders will get three additional shares for every ten they currently hold.

Several other firms are also planning share conversions, including Three Gorges Dam operator Yangtze Electric Power Co. and steel mill Baoshan Iron & Steel Co. Both plan to offer compensation to existing shareholders.

The government announced a trial share-conversion program for 46 companies last spring, then extended it to all listed companies in August after most of the first set of companies received shareholder approval for their conversion. Now, over 100 additional companies have prepared plans to sell off state-owned shares.

Unfortunately for foreign investors, holders of B shares and H shares aren't likely to be compensated in the reform process. Only the approval of A-share holders is required to get approval for a conversion, according to a China Securities Regulatory Commission ruling in September.

There have been previous attempts to reform China's share-ownership structure, said Fraser Howie, co-author of "Privatizing China: The Stock Markets and Their Role in Corporate Reform." Each attempt was abandoned within six months, he said.

This time, the government will not change its mind, said Liu. "This is the only way to recover the confidence of the investing public," he said.

There are also plans afoot to merge A shares--bought by local investors and qualified foreign institutional investors--and B shares, which are denominated in dollars and sold to foreigners. For example, Shanghai Forever Co., one of China's largest bicycle manufacturers, plans to buy back and cancel its B shares as soon as it finishes converting non-tradable shares into public shares.

"China's foreign-currency stock bourses have finished their tasks, and the country needs a unified equity market," Chen Rong, chairman of Shanghai Zhonglu Group Co., which owns 54 percent of Forever, told the government-owned Shanghai Daily newspaper. "We expect regulatory support for our move quickly."