The "Concept of Scientific Development" in finance (3)

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26 Jun 2008

The "Concept of Scientific Development" in finance (3)

A financial system based on the "people first" principle should ensure that the interests of domestic investors are properly addressed.

The applicability of the "Concept of Scientific Development" to the financial development in China is multi-dimensional. Last week I focussed on the strategic level. This week I would like to focus on the policy-making. We all know that, with a very high savings rate, there is a strong demand on the Mainland for a wider spectrum of financial products that suits the different risk appetites of investors. The "people first"(以人為本)principle requires considerable attention to satisfying this demand. This is also in the interest of achieving "sustainable development"(可持續發展). When investors are given an opportunity to achieve a higher and more stable rate of return for their money through investing in financial products of their own choice, there is less need for them to self insure. The high national savings rate (and the level of gross domestic fixed-capital formation as a percentage of GDP) will therefore come down, reducing the chance of over investment in the economy, and increasing the chance of more balanced and sustainable growth.

To satisfy different investment appetites and provide sources of funding for those in need of funds for their economic activities, there is a need to develop the domestic capital markets, including the listing of shares by companies that satisfy the listing rules designed to protect investors. If the investment demand is strong enough, there is a case for allowing the listing of foreign companies or the "importing" of financial products through various means. In a jurisdiction with no exchange controls and with free flow of capital, the market can work out itself what financial products are imported and how, for example through the listing of foreign companies, the trading of derivative products of shares traded on overseas exchanges (domestic policies in these overseas jurisdictions permitting) or the outflow of domestic savings to overseas markets. With exchange controls, however, there are important policy decisions to make and, in the case of the Mainland, there is scope for applying the "Concept of Scientific Development".

Bearing in mind the "people first" principle, the importing of financial products should be organised in a way that ensures the demand for investment products by Mainland investors is properly addressed: they should not be asked to pay prices significantly different from those at which the products in question are traded overseas. There are valid reasons explaining the price premium of A shares over the corresponding H shares, for example that the investor base and risk perception in the two markets are different. But in the long run, there should be arrangements to ensure that Mainland investors do not pay prices much higher than those foreign investors would have to pay for the same shares in the secondary market.

There seems to be an opportunity to "import" financial products on the Mainland. At the conclusion of the Fourth China-US Strategic Economic Dialogue last week, it was announced that China is preparing to allow qualified foreign companies to list on its stock exchanges through issuing shares or depository receipts. This should help address the demand of Mainland investors for investment opportunities, and it is to be hoped that the relevant detailed rules will be consistent with the "people first" principle in ensuring domestic investors pay a fair price.

If there were no exchange controls, the market would quickly achieve price equality of the same instrument listed on the Mainland and overseas because investors would buy in the market where the shares are cheaper and sell in the one where the shares are more expensive. With exchange controls, however, there is a need to establish a mechanism to help narrow the price gap, consistent with the core principle of the "Concept of Scientific Development". One way of doing so is to allow convertibility between the same instruments dual-listed on the Mainland and in overseas markets.

The argument goes further. The "Concept of Scientific Development" also emphasises "sustainable development in a comprehensive and co-ordinated manner"(全面協調可持續發展) and "balanced development" between economic growth and social welfare(統籌兼顧). If, for the time being, conditions do not allow the market to play these important roles in view of the continuing exchange controls on the Mainland, these emphases should be the guiding principles for formulating the enabling policies. Bringing foreign instruments to the Mainland market with an appropriate price-equalising mechanism through the Hong Kong platform will fulfil the objective of helping to create the "mutually assisting, complementary and interactive"(互助、互補、互動)relationship between the two financial systems on the Mainland and in Hong Kong that the Premier has prescribed for us and, most importantly, help realise the "Concept of Scientific Development" in the financial development of China.

Joseph Yam
26 June 2008

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