According to Fitch Ratings, the international rating agency, says that China's reform of the share structure of listed companies ("listcos") will improve the liquidity in domestic stock markets. This reform is also a significant step towards improving Chinese listcos' corporate governance.

Fitch says that the split share structure has been a major encumbrance upon development of the Chinese stock market. Currently, non-tradable shares - mostly held by state shareholders - account for roughly two thirds of domestic listcos' total shares, with only one third traded on two domestic exchanges.

This split shareholding structure has substantially distorted the pricing mechanism in the domestic stock market and added uncertainty to investors' expectations. The dominance of state shareholders in listcos has also led to problematic corporate governance practices, significant related-party transactions and, at times, marginalisation of individual shareholders' interests.

Although the share structure reform has no direct impact on the companies' credit profile and creditors' interests, Fitch views the reform as a positive development as it will increase China's stock market liquidity and provide greater scope for tradable shareholders to negotiate with non-tradable shareholders and protect their legal rights, including through more effective corporate governance and operational management.

In an attempt to address the above problems, the Chinese stock market regulator announced in May 2005 a trial reform of the split share structure for four domestic listcos. The regulator also approved a decision for an additional 42 listcos, including some of China's biggest and best-known corporate names, to participate in the reform in June 2005.

The regulator's general guidelines of the reform include the following: (1) non-tradable shareholders should compensate tradable shareholders as the precondition of floating their shares on stock exchanges; (2) non-tradable shares will be locked-up for 12 months after the individual company's reform scheme takes effect and non-tradable shareholders cannot sell more than 5% of their stakes within another 12 months; and (3) the companies should obtain the approval of reform schemes from at least two thirds of tradable shareholders before implementation.

Fitch notes however that the major non-tradable shareholders will likely continue to exert substantial influence on the listcos' management in the short term.

Fitch warns that there are still some risks and uncertainties associated with the implementation process of share structure reform. Firstly, the sluggish Chinese stock market will continue facing downward pressure as the immense amount of non-tradable shares get floated, though this will be moderated by the restrictions on non-tradable shareholders' selling shares in the "lock-up" period. The share compensation obtained by tradable shareholders will also be a concern for increasing share supply.

Secondly, the upcoming guideline on share structure reform of state-controlled companies, issued by China's state-owned assets watchdog the State-owned Assets Supervision and Administration Commission ("SASAC"), may exert substantial influence over the reform schemes of state-controlled listcos. The SASAC has expressed concerns about maintaining the state shareholders' majority shareholding position in some listcos within key sectors even after the implementation of the reform.

Thirdly, many listcos may suffer in equity financing if the stock market continues softening; as a result the listcos may shift their focus to debt financing under more stringent terms. As many Chinese companies obtained bank loans via pledging their listed investments, the banks may require the borrowers to pledge more assets to compensate the decline in value of the original collateral.

Fitch also estimates that the listcos may face the pressure of raising cash dividends from major tradable shareholders especially mutual funds and other institutional investors over the long term, which could cause listcos' cash outlays to increase.

By People's Daily Online