The Shanghai Stock Exchange - a History and Overview - Case Study Example

The Shanghai Stock Exchange: A History and Overview Memo of Transmittal Date: To: From: Subject: The Shanghai Stock Exchange: A History and Overview ________________________________________________________________________ The following report is designed to give a history and an overview of the Shanghai Stock Exchange in order to establish its place in the global economy. In creating this report, revelations have come to light on how this exchange functions within the world of finance. As China becomes a more important part of the global economy, it is vital to understand the way in which entrance into the financial world has been accomplished. This report will discuss the future of the market and the way in which foreign investors should approach participation. The current state of the market is still under heavy regulation and limitations that are imposed by the Chinese government, but the economic needs of the country, combined with global influences will undoubtedly require the market to become more open to foreign investment in the future. Table of Contents Executive Summary………………………………......................................................4 Introduction………………………………...................................................................5 The Origins…………………………............................................................................5 Mid Twentieth Century……………………………….................................................6 The Shanghai Stock Exchange………………………………......................................7 Recommendations……………………………….........................................................8 Conclusions………………………………...................................................................9 List of References………………………………........................................................11 Executive Summary The following report gives a brief outline of the Shanghai Stock Exchange. The report includes a brief history of the development of the exchange and the way in which the communist government has impacted the economic health of China. With a market that is opened on a very limited basis to foreign investors, control of the economic trading is still maintained under Chinese control. However, in the past three decades, the concept of capitalism and the creation of an entrepreneurial spirit has changed the way in which the Chinese economy has developed. Without this development, the technological level of services and industry would have remained backward and the economic stagnation would have meant that China would not have withstood the lack of forward financial movement. The economic revolution that opened the country to participating in a world economy increased the importance of China as a global presence. As the market continues to reflect this growth, the influence that the Chinese will have on the world economy will warrant attention in order for foreign investors to benefit from this expansion. The Shanghai Stock Exchange: A History and Overview Introduction The Shanghai Stock Exchange is one of three stock exchanges that currently operate out of the People’s Republic of China. The Shenzhen Stock Exchange and the Hong Kong Stock Exchange also operate in China. The Shanghai Stock Exchange is not yet an open market with the Chinese government restricting the use of foreign investors by maintaining tight control over capital accounts. According to China Daily, “A shares are restricted to domestic investors, while B shares are open to all investors. . .As of December 2004, the SSE has recorded over 37.87 million investors and 837 companies listed on it” (China, 2007). As a thriving exchange, the Shanghai Stock Exchange has developed into a vital presence on the financial landscape and must be considered with due diligence when examining the health of the global economy. The Origins When the origins of what would become the Shanghai Stock Exchange were begun, the market was owned primarily by foreign investors. Modern financial markets were developed in China beginning in the late 19th century which resulted in the forming of the Shanghai Stock and Commodities Exchange in 1920. The exchange opened with 100,000 shares available in common stock. “The Shanghai Stock and Commodities Exchange issued detailed regulations covering stock exchange, brokers, reserve funds, exchange receipts, commissions, business transactions, and legal duties if disputes arose” (Ji 2003, p. 136). In addition to operating in regard to stocks, six commodities were listed for on the company exchange. Cotton, cotton yarn, textile, gold and silver, food and oil, and leather “were handled either as merchandise or on a futures market”(Ji 2003, p. 136). As the modern financial development of China was underway, interest from foreign investors created a gateway into the East under the draw of a thriving and profitable exchange. By 1932, ”40 percent of the seats on the exchange were held by the Sephardic Jews”(Malkiel 2008, p. 101). However, the Shanghai Stock and Commodities Exchange would have a short life. By the time of the Great Depression and with Japan making regular attacks into China, the local exchanges would not survive. However, in Shanghai the exchange would continue to trade until the Japanese finally took over the city on December 8, 1941. The Mid - Twentieth Century The Shanghai Stock Exchange would reopen in 1946, but not much business would be transacted. When the communists took over China in 1949, the government would close the market and trade would be considered against the new from of ideology that was politically embraced. “Such an entity was a capitalist institution that was inconsistent with the Marxist ideology of the Mao revolutionary government” (Malkiel 2008, p. 102). The way in which survival was achieved would not be from the aspect of a trade based economy. The concept that money could be earned by anything other than from work was against the new way. “Neither private ownership, nor the receipt of earnings from capitol rather than from labor, could be tolerated by the Peoples Republic of China” (Malkiel 2008, p 102). Because of this ideology, the markets and the concept of stocks and commodities would not be used within the country for more than 40 years. The Shanghai Stock Exchange After decades of remaining closed to the rest of the world, China found itself in a position where they were technologically behind and was in need of improving the way in which the people had access to services and industry. The Law on Chinese-Foreign Joint Ventures that was passed in 1978 allowed for companies to join with Chinese industry and bring the technologies that were lacking into the country while allowing for a stronger export business to be developed (Hertz 1998, p. 99). The economy of China was in trouble at this point and Deng Xiaoping, the leader of the Communist Party of China, worked toward development of this plan in order to elevate the Chinese from the economic crisis, but still maintain a sense of autonomy from Western influence. However, the revolution that Deng would create would be with the goal of transforming the economy from “one that was centrally planned to one that was market-oriented, where individual initiative would be encouraged and rewarded”(Malkiel 2008, p. 103). The creation of the market in China was a slow process. The Shanghai branch of the People’s Bank of China began allowing “public transfers of securities in order to eliminate black market trading”(Malkeil 2008, p. 104). The market would see its first steps toward being established when in 1986 the bank established an over-the-counter service which consisted of phone-banks where trade happened over the phone. Fifteen similar set-ups sprung up within a year and while trading was manipulated and the market was not done with any efficiency, the Shanghai Stock Exchange was on its way into development. The Shanghai Stock Exchange was finally officially reestablished in 1990 with modernized electronic system that is still ahead of the technology used in both Hong Kong and Taiwan (Malkeil 2008, p. 106). “By the end of 1992, the number of listed increased to 38, of which two came from other provinces. The total market capitalization of the 38 stocks was 55.84 billion RMB” (Ma 2004, p. 12). The market would be increased to 759 stocks listed at the Shanghai Stock Exchange with 2536.37 billion RMB in capitalization by 2002 (Ma 2004, p. 12). The exchange has grown well since its recreation and the market has proven to provide the boost that the Chinese government was seeking during its reforms in the late twentieth century. Recommendations Currently, over half of the shares in the Chinese market are “held by the state or by state-controlled agencies and are not actively traded. . . The domestic stock market remains a very small source of financing for the growth of business enterprises”(Malkeil 2008, p. 109). With limitations on the amount of participation that foreign parties are allowed, the current potential for investing is small and with a reserved advantage. However, the involvement that China has had to institute in global economics in order to compete is continually increasing so that eventually participation by foreign investment will be necessary in order to create a continuing expansion for Chinese economic health. The future of the Chinese stock market will be grounded in the growth of the market. The government has instituted regulations that state that “all new issues floated in either Hong Kong or other financial capitals must also be listed in China” (Malkeil 2008, p. 109). While the government is still instituting rules and regulations that keep the market under a tight control, it is probable that in the future the economic issues that drive the market may be more relevant to the fluctuation of the market than on the dictates of the state. Conclusions At present, with the strict rules and regulations that prevent many forms of transactions to take place within the exchange from foreign traders, the Shanghai Stock Exchange should be watched, but not considered as part of a portfolio development. While the market has gained a good deal of control over the manipulation that was experienced during the early years of the current incarnation, it would still show wisdom to watch this growing financial center before investing in the foreign available stocks. The way in which the shares were classified was that A-shares were available only for Chinese investors and B-shares were available only to foreign investors. As the market has changed, the B-shares have been opened to Chinese investors, while the A-shares have remained closed to foreign investors. The B-shares had been designed to come from larger companies, which allowed for these shares to be targeted specifically for foreign investors only. With the current difficulties within Chinese industries in the form of tainted exports (toothpaste poisoned and exported to Panama, canned milk tainted with melamine, and pet food poisoned and responsible for the deaths of several animals in the U.S), it is wise to continue a wait and see attitude when considering investing in Chinese industry. The regulations that produce limits may actually be saving foreign investors from becoming to deeply involved in a country that is experiencing growing pains. With the execution of two of the men involved in the poisoned milk scandal, which cost the lives of six children and made 300,000 others ill (2 Face 2009), the way in which industry is regulated and the way in which issues are then resolved continues the watch and see theory in how to approach the Shanghai Stock Exchange and in considering investing in Chinese industry. List of References “2 face execution over china poison milk scandal”. (2 January 2009). MSNBC. 3 March 2009. Available from http://news.mobile.msn.com/en- s/articles.aspx?aid=28787126&afid=1 Graham, E. M., Oding, N., & Welfens, P. J. J. (2005). Internationalization and economic policy reforms in transition countries. Berlin: Springer. Hertz, E. (1998). The trading crowd: An ethnography of the Shanghai stock market. Cambridge studies in social and cultural anthropology, 108. Cambridge [England]: Cambridge University Press. Ji, Z. (2003). A history of modern Shanghai banking: The rise and decline of China's finance capitalism. Studies on modern China. Armonk, N.Y.: M.E. Sharpe. Ma, S. (2004). The efficiency of China's stock market. The Chinese economy series. Aldershot, Hants, England: Ashgate. Malkiel, B. G., & Taylor, P. A. (2008). From Wall Street to the Great Wall: How investors can profit from China's booming economy. New York: W.W. Norton &. Read More