China's Capital Markets at the Birth of a New Era
an interview with Winston W. Ma of J.P. Morgan Investment Banking Division
Araceli Almazàn | UC Davis School of Law
Kris Huishan Lin
Posted Monday, May 1, 2006
6 U.C. Davis Bus. L.J. 19 (2006)

Winston Wenyan Ma, CFA and Esq., is currently a Vice President at a major multinational investment bank based in New York, where he is a member of an investment banking structuring and solution team across equity, fixed income, M & A and rating advisories. With bar admissions in both China and New York, he worked as a corporate lawyer at Freshfields' Shanghai Office and Davis Polk & Wardwell's New York office until 2001. In the spring semester of 2000, Mr. Ma was an international visiting professor at the University of Richmond Law School, teaching a course on China's Corporations and Securities Laws.

In addition to Investing in China: New Opportunities in a Transforming Stock Market (2006), he frequently publishes articles on financial innovation matters in industry magazines. He has spoken in a number of global conferences on structured products, convertible bonds, and emerging markets securitization in New York, London, and China. He has been quoted in Bloomberg News, the Wall Street Journal, and Euromoney magazine as a China investments expert and was recently interviewed by Chinese Business News in Shanghai, China on China's current stock market and corporate governance reform.

Mr. Ma has a MBA degree from the University of Michigan, Ross Business School and a Master of Comparative Jurisprudence (MCJ) from the New York University, School of Law, where he was a Hauser Global Scholar. Before that, he graduated with a Bachelor of Science (B.Sc.) and a Bachelor of Law (LL.B) degree from Fudan University Materials Science Department and School of Law respectively in Shanghai, China.

Additional information on Mr. Ma can be found at

The views and opinions expressed in this article are solely those of the author and not necessarily the views and opinions of JPMorgan Chase & Co or any of its divisions or affiliates. This article is for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of any financial instrument.


Prior to April 2005, companies listed on the Chinese stock market were characterized by a split-share structure featuring one-third freely traded public stocks and two-thirds non-tradable state owned shares. These non-tradable state shares were largely responsible for serious corporate governance issues as well as the infrequency of mergers and acquisitions. However, in April 2005, the China Securities Regulatory Commission (CSRC) issued a new plan for state share reform. This reform plan essentially aimed to make all non-tradable state shares become tradable on the market.

As a result of the reforms, the Chinese stock market has assumed a radically different landscape. According to the latest report in March 2006, hundreds of China's listed companies, with an aggregated market share of more than half of the total capitalization of China's domestic stock markets, have carried out their plans to circulate non-tradable state shares. This report signaled that the reform had quantitatively passed the midway point.

Today, we have with us Mr. Winston Ma, the author of the new book: Investing in China: New Opportunities in a Transforming Stock Market and a Vice President at the Investment Banking Division of J.P. Morgan Securities in New York. Mr. Winston Ma will speak to us regarding the impact of this revolutionary reform. Mr. Ma is also one of a few native Chinese investment bankers and capital markets attorneys who has worked in both the United States and China.

Q: What pushed China to launch the state share reform plan?

A: The state share reform is definitely a top priority in China. It's the biggest reform ever in China's stock market history, and it is critical in this process because the state share reform relates to the fundamental feature of China's stock market - that is, the majority equity ownership of the listed companies is in the hands of the state or the state-controlled institutions. Generally, as you just mentioned, about two-thirds of the total share of a listed company consists of state owned shares. Therefore, only about one-third of the shares of the listed company is freely tradable in China's public stock market. This phenomenon is typically referred to as the segregated equity ownership issue. This segregated ownership equity issue is probably the single most important feature for China's stock market, and it is the important reason for the market slump during the past several years. By 2005, the market lost about half of its value from its peak in 2001, and the stock market tanked below the psychologically important level of 1000 points. Long story short, we can certainly say the segregated ownership phenomena is the key structural factor that kept the China stock market weak for many years. The weak stock market led China finally to launch the state share reform plan in the middle of last year.

Q: Why does China put share structure reform as its top priority as compared to issues like corporate governance, corporate transparency and accounting principles?

A: I think these are all very important problems. However, for these problems you just mentioned - corporate governance, transparency and accounting principles and you can probably add shareholder protections - these issues, to a great extent, are created by the segregated equity ownership structure in a listed company. Let's take corporate governance, for example. When the state owns two-thirds of a listed company that means there's no visible owner that holds the controlling interests of that company because the state is simply a notional controlling owner. So, it is very hard to imagine that the state would be able to supervise corporate actions accordingly and effectively. As a result, it's hard to imagine how corporate governance standards would be implemented successfully before the segregated equity ownership structure issues are solved. So, I think China is taking the right actions by focusing on the shared structure reform as its top priority and its reforms in the stock market at this moment. In a nutshell, they are trying to focus on the fundamental issues.

Q: How does the share merger between the state and individual shareholders work? And what is most crucial issue to a successful share-merger plan?

A: First of all, I would like to point out that the share merger is more of a share transformation because the reform essentially involves turning the formerly non-tradable shares into tradable shares. In terms of how this is carried out, it's more like a negotiation between the public shareholders who hold the tradable shares in the public market and the state shareholders who hold the non-tradable shares by themselves. It is a negotiation because through this state share reform, the non-tradable shares will eventually turn into tradable shares. This is a new trading privilege that the non-tradable shareholders are going to get.

Public shareholders are naturally going to be concerned that the new supply of shares into the public trading market puts pressure on the stock price. As a result, for the companies involved in the state share reform, the typical process is at the high-level, the non-tradable shareholders need to give "consideration" to the public shareholders to use as consideration to get the trading rights. The consideration is typically in the form of new shares, and in some cases, people have been using very innovative instruments such as warrants. Essentially, it's a negotiation and the non-tradable controlling shareholders would come up with a specific plan. For example, in order for my shares to flow (to be tradable), each public shareholder will receive a certain number of shares, or a number of warrants, or certain cash as consideration. The public shareholders will decide at the shareholder meetings whether they considered it a fair consideration, whether they should accept it. So, it is very much a market-based negotiation process.

Q: Given that this is a negotiation between the public and state shareholders, does this process seem to allow a lot of room for innovation?

A: That's precisely right. I think the Regulatory Commission is encouraging the process to be carried out in any form that the shareholders have agreed to. In a sense, it's not really an administrative process where the government tells the company what to do. Rather, it's a discussion between different classes of shareholders. The Commission is a different government branch that really encourages the shareholders to come up with really innovative solutions to this crucial issue.

With regard to the question on what the most important factor in a successful state share reform would be, the most critical part is to manage the process when the formally non-tradable shares are eventually introduced into the market post-reform. The state share reform is also frequently referred to as the "full floatation reform," which is a manifestation of the essence of this reform from a trading perspective. After this reform, some formally non-tradable shares, the shares not formally in the trading market, will eventually be able to be traded in the public market. In the near term when the reform is accomplished, many formally non-tradable shares will become tradable and those shares will eventually be introduced into the market creating some short-term oversupply. How to manage this process will be critical for the final success of this reform.

Q: What changes will this share reform bring to the existing Qualified Foreign Institutional Investors (QFII) system?

A: Since this reform will bring non-tradable shares into the public tradable shares, I think the QFII system will eventually become more important post-reform. As everyone knows, the QFII system essentially gives qualified foreign institutional investors the access to China's public stock market, which is generally referred to as the A-share market. The state share reform is essentially going to turn many formerly state owner-shares into A-shares. Thus, the A-share market will become more critical in going forward for foreign investors to tap the China market.

Q: If there will be more tradable shares in the A-share market for the foreign investors to participate in, how would the Chinese government handle the impact on these foreign investments?

A: In general, this increase of foreign equity ownership has been a major trend in China's securities market reform in the past several years. You should look at the QFII system in the context of institutionalizing the market. Again, if we go back to this segregated equity ownership structure issue, the essence of that issue is that two-thirds of the shares are in the state's hands and only one-third in the public investors' hands. From the investor's perspective, there's little power for them to enforce corporate governance in the best practices.

Therefore, one focus of the Chinese government is to increase the institutional investor base in China's stock market, which would foster corporate governance. During the past several years, there have been rules consistently introducing or opening up access to China's domestic institutional investors. For example, the government is allowing commercial banks and insurance companies to invest in the equity market as a way to build up the institutional investor base. In this QFII context, the punch line is that the launch of this QFII system is also part of that institutionalization of the market. I think that in going forward, China will keep emphasizing the importance of the QFII system and will keep encouraging foreign equity ownership for China's stock market.

Q: What about the overseas listings of those Chinese companies, will they decrease because of the state share reform?

A: That's a very complex question but I think in the short term it's very clear; because of the state share reform, the Chinese government has decided to shut down the IPO market domestically. As a result, in the short-term, most of the new listings are happening in overseas markets, like the Hong Kong market for example. On the other hand, I think a post-reform domestic market should become a more viable alternative for Chinese companies to tap corporate financing alternatives.

Q: In the long-term, will the domestic market be a healthier market to raise capital?

A: I'm rather optimistic on that. In a post-reform setting, with a better equity structure, it will be much easier to implement a modern corporate governance system with modern corporate standards, such as minority shareholder protections. I would think that post-reform, the domestic stock market will become a much more investor-oriented market, and it will be more useful to the domestic companies when they try to tap capital domestically.

Q: Do you anticipate that these reforms will lead to a loosening of the limitations of foreign ownership in Chinese companies and joint ventures?

A: In the past several years, the general legal and regulatory reforms have been going in that direction, i.e. the continued loosening of limitations of foreign ownership. In the A-share market, the tradable share market side, the QFII system was basically implemented in 2002 to open up foreign ownership in the public tradable share market. Then on the non-tradable share side, a series of mergers and acquisitions (M & A) rules were implemented from 2002 to 2004. That new M & A framework has opened up foreign ownership in listed companies through acquiring non-tradable shares via private negotiations. So looking at the QFII system and the new M & A framework together, you can certainly see China is upgrading its legal framework on both sides of the equity structure of the listed companies to facilitate increased foreign ownership in listed companies.

Q: Apart from the state share reform plan, what other regulatory measures has China adopted to attract more foreign participation in its stock and capital markets?

A: There is one new rule that is not related to state share reform itself but related to a consequence of the state share reform. As I mentioned, the QFII system is intended to give qualified institutional investors the access to public Asian markets and the M & A legal framework is meant to enable people, including individual foreign investors, to acquire non-tradable shares. State share reform will have a subtle yet important impact on the M & A framework. Traditionally, if a foreign investor was not big enough to be a QFII, it could always take non-tradable shares through the M & A route. Under state share reform, however, many of those non-tradable shares are eventually going to disappear. They will become the public share equivalent, and for many investors who are not QFII, all of a sudden it looks like they are losing that access.

So the interesting development this year is the new rule, the Administrative Measure for Strategic Investment in Listed Companies by Foreign Investors, issued in January that allows foreign strategic investors to purchase specific interests in listed companies after such companies carry out their state share reform. In the post state share reform period, this new rule will keep the smaller foreign investors in the market by allowing them to purchase shares on the A-share market as strategic investors, even though they are not QFIIs. Eventually that group of investors should have the same access to China's companies just as before.

Q: In 1999, China passed its first securities laws. In 2005, numerous amendments were made to the securities laws. What are the main features of these laws?

A: It's really interesting to look at the development of the securities laws. China didn't have any securities laws until 1999, as you mentioned. In the seven years following 1999, however, there were massive demands for more securities laws in connection with the rapid progress and structural transformation of the market during those years. As a result, when it was officially amended in 2005, 50% of the original 1999 securities law was changed.

Also, from a minority shareholder perspective, because of the segregated shareholder ownership issues, the public investors are by definition minority shareholders. To that end, the increase of minority shareholder protections is a truly important feature.

Finally I would also mention that the newer securities laws reflect the government's approach to encourage financial innovation. Many places in the securities laws are loosening up the traditional restrictions in many practices. Now, when the old securities laws were enacted in 1999, many Asian countries were suffering from the Asian financial crisis. Since China was very much a separate system, it was protected. In that context, the enactment of the securities law was more concerned with administrative protection and stability rather than market innovation. Now, seven years later, the market has developed and the securities firms and investors are getting more sophisticated and mature. Therefore, it is not very surprisingly that the new securities laws have loosened up many of the former restrictions to allow future financial innovations. For example, the new securities laws have removed the restrictions of share landing, which opens the door for security firms and exchanges in the future to introduce the short selling of stocks.

Q: Based on your experience as a member of an investment banking solution team on equity, fixed income, M & A, and ratings, and as a United States capital markets attorney, what is your opinion of China's state share reform plan.?

A: I think it's quite remarkable that the state share reform is being carried out mainly by the market, by market practice, and by market actions instead of through administrative orders. It is very encouraging progress for China's stock market as it transforms from a market under a state dominated economy into a market economy.

Q: Do you think there will be some high-end securities litigation connected with these reforms?

A: It's hard to tell. The litigation culture is still in a developing mode in China. But given the new securities laws that have included so many new amendments which have authorized and empowered minority shareholders and public investors to enforce their rights, I would think that many more investors will be keen at looking at the new securities laws and finding ways to protect their rights in the event of bad corporate governance issues as well as related transactions.

Q: In your new book, Investing in China: New Opportunities in a Transforming Stock Market, which was recently published in mid April, you mentioned that "foreign acquisition of state and legal person shares through Management buy-out and Mergers & Acquisitions are among the emerging investment strategies in China." For those who have not had the chance to read your book, can you tell us what effect the state-owned enterprise privatization will have on management buy-out (MBO) and mergers & acquisitions (M & A)?

A: I think the implications are huge and very complex, but I would just like to mention that the two most important issues are pricing and approval. Both issues are extremely important for foreigners who are trying to understand the particularity of doing business in China. As for pricing, if we are talking about M & A or MBO with non-tradable shares, the fist question one must ask is how to evaluate them because these shares are not traded in the public market. You have to value those shares under a lot of assumptions, and there is no easy comparison to use because their counterparts are tradable shares in the public market. In contrast, these non-tradable can only be transferred through private agreements. Therefore, the pricing aspect for these shares is difficult.

The second issue is approval. By nature, many of these non-tradable shares are owned by the state or state-controlled institutions, so in order to transfer those interests to domestic investors- domestic companies or foreign investors, you would always have to go through complex approvals because state-owned assets are involved. Also, when the transactions are related to state-owned assets, the public will immediately focus on whether there is any "loss of state-owned assets." To transfer and to acquire state-owned assets, it typically involves a very complex approval process and a lot of negotiation with the different government branches.

Q: Can you give us a recent example of a notable M & A deal involving a company listed on the Chinese stock market?

A: Despite all the complexities we have discussed, we have seen very exciting progressions in the M & A and MBO market in China recently. I think the most notable example was the acquisition of a state-owned company by the Carlyle Group, a major U.S. private equity fund. Last year, the Carlyle group closed an unprecedented transaction where it acquired the majority equity ownership of a state-owned company. That had never been done. For the first time, a foreign private equity fund was able to acquire the controlling interest of a state-owned company. Even though the market has its own difficulties such as the state-owned assets and all the complexities around it in particular, there is very encouraging progress in the market. This progress is making people believe that we will see a boom of those transactions in China very soon.

Q: Do you have any related thoughts on these reforms that weren't addressed by my previous questions?

A: I would make a quick note related to your opening remark. You mentioned that by March of this year, the reform has reached in the aggregate capitalization worth more than 50% of the total listed companies. From that perspective, the reform has been carried out very smoothly. I think that it will be very interesting to observe the reforms once it is accomplished in terms of the market will behave after the reform. As we know, the segregated equity ownership structure has bothered the market for so many years. It will be very interesting to see whether the trading behavior or the investment sentiment will have a very dramatic difference in the short-term once the reforms are complete.