It surprised many when Guo Shuqing, chairman of the China Securities Regulatory Commission (CSRC), stated recently that the country's securities regulator should take more responsibility for the drops seen at mainland markets over the past two years. According to Guo, the volatile conditions at local boards are abnormal and more financial reforms are needed to create a healthier market.
It is rare for Chinese officials to admit fault or speak openly about their obligations, so Guo's remarks could be a sign that big changes for the equity market are indeed afoot. In the meantime however, Guo's comments beg an important question: how responsible should regulators be for the performance of the stock market?
First of all, it is unrealistic to hold the CSRC accountable for all of the ups and downs at the mainland exchanges. The adjustments seen on a daily basis are highly chaotic and influenced by a variety of unpredictable factors, including the inflow or outflow of capital, investor sentiment and developments in other segments of the world financial market. The most the CSRC can do day-to-day is warn investors about the speculative risks they face within the market - regulators cannot tell investors when or what they should buy and sell.
But if we look at the long-term performance of the mainland equity market, it is clear the CSRC can do more. In a healthy financial market, aggregate gains and losses over time will conform with the trends visible within the broader economy. In other words, if China's macro economy is doing poorly, eventually the downturn will weigh on equities as well and there is little the CSRC can do about it.
Yet, if the markets' performance is at odds with the direction of the economy, this is a sign that loopholes exist in the financial system and regulators should take action. Actually, such is likely the situation now in China. Since 2001, after the country joined the World Trade Organization (WTO), its economy took off and the local market flooded with cash. However, the A-share market tumbled for five straight years between 2001 and 2006. In more recent years, even though China's economy has grown by about 7.5 percent annually, its stock markets are still floundering.
Due to a host of systemic problems, investor confidence regarding the companies trading on mainland exchanges is very weak - even though many of their price-earnings (PE) ratios show their shares are undervalued - and most trading activity in the domestic market is little more than shortsighted speculation.
The CSRC should take responsibility for improving the climate at the market and focus on reforms which compel listed firms to improve their management abilities.