Contributor: History is like a mirror —a review of Chinese governance on the financial market.
Again on May 21, 2021, a report stemming from China’s 51st meeting of the Central Financial and Economic Affairs Commission led by the organization’s director, Liu He, discussed cryptocurrency mining in the country. Liu He is also the vice-premier of the State Council of the People’s Republic of China and the Political Bureau of the CPC Central Committee. The statement said it is necessary to “crackdown on Bitcoin mining and trading behaviour, and resolutely prevent the transmission of individual risks to the social field.”
The impact of this incident is still uncertain, but it is possible that all public mining activities in China will be banned, and exchanges may face severe blows.
An Overview of the Governance
If one gives a quick scan around the whole globe, China (here means Mainland China) is probably one of the regions with the most conservative regulatory attitudes towards crypto assets.
Since then, the government has been keeping a close eye on crypto asset-related activities. It has shut down numerous blockchain-related news accounts on the WeChat social app and banned hotels in the main cities from hosting events promoting cryptocurrencies.
In November and December 2019, some exchanges’ offices, like BISS exchange, were forced to close, and staff members were arrested. According to the People’s Bank of China (PBoC) Financial Stability Report (2019), it stated that the 173 Chinese virtual-currency trading and token issuing platforms had all halted operations.
Some may find it confusing, with the governments’ attitudes varying so much, but it is understandable concerning the past chaos in the Chinese financial market histories.
History Is Like a Mirror
Those not from mainland China may be unfamiliar with the history of the Chinese security market. There were some occasions of chaos and lawlessnes, paid with high cost, due to the immaturity of the market itself as well as the regulations and investors, from which, one may get a clue why the authorities are so sensitive about everything concerning public fundraising and open trading.
The Chinese capital market is quite young, with only 30 years of development, yet it has achieved quite some accomplishments. But in the process of development, there were a number of occasions that would not be easily forgotten by the regulators and investors. Financial problems could go politicized quite rapidly.
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1. The Event of 810
In the early 1990s, a new type of voucher called “stock subscription certificates”, which gave investors the right to purchase stocks at the predetermined price, became popular in China. On May 21, 1990, the Shanghai Stock Exchange released the price limit of listed shares, which led to a sharp rise of 105% in a day. Subsequently, the stock index soared for two days in a row. More and more people began to believe that Chinese stocks can make people rich overnight.
On Aug. 10, 1992, the Shenzhen “1992 stock subscription certificate” was registered for the fourth round. 5 million subscription forms for drawing lots were planned to be issued in advance, and each person could get one with his /her ID card. In the morning of the 9th, there were over 1.2 million citizens from all parts of China queuing along for more than ten hours. Tens of millions of bundles of ID cards were sent to Shenzhen by express mail, and there are over 3 billion in deposits and remittances in Shenzhen banks.
Within half a day, all the lottery forms were sold out, and the order began to collapse in people’s doubts, due to the exposure of sales corruption among the crowds. Tens of thousands of citizens who failed to buy the lottery tables put up anti-corruption and justice slogans, and formed a siege on Shenzhen municipal government and people’s Bank of China, which led to the “the event of 810.”
2. The Event of 327 Treasury Bond Futures
In the early 1990s, it was difficult to issue treasury bonds, and people were reluctant to purchase. The state decided to introduce the derivatives to make the market more liquid and flexible. In December 1992, it launched 12 kinds of futures contracts on the Shanghai Stock Exchange. The so-called “327” is the code name of a treasury bond futures contract, which corresponds to the issuance of three-year treasury bonds due in June 1995, with a total amount of 24 billion yuan.
At that time, the Ministry of Finance gave national debt value maintenance subsidies due to China’s high inflation. The uncertainty of the subsidy rate provided space for speculation of the futures. A large number of institutional investors have jumped from the stock market into the bond market. The focus of confrontation between the long and short sides was around the prediction of the maturity price of the “327” Treasury bond, which was largely affected by the uncertainty of the subsidy rate and the market interest rate at that time.
On one hand, Guan Jinsheng, known as the godfather of China’s securities at that time, predicted that the maintenance and discount rate of “327” Treasury bonds should be maintained at the level of 8%. According to this calculation, the bonds will be cashed at 132 yuan. When the market price fluctuated around 147 yuan, Wanguo Securities together with the Liaoning Guofa group, became the main short player.
On the other hand, in 1995, China Economic Development Trust and Investment Corporation (CEDTIC), subordinate to the Ministry of finance, believed that the Ministry of finance would raise the rate of maintenance and discount interest. As a result, CEDTIC became the main force in the long position.
On Feb. 23, 1995, the Ministry of Finance issued a notice that the “327” T-Bond would be cashed at 148.50 yuan, hence the short judgment was completely wrong. Guan Jinsheng took measures to avoid huge losses within the eight minutes of the closing, selling Treasury bond futures through overdraft. All long parties didn’t have time to react and were liquidated. CEDTIC had a huge loss of about 4 billion yuan.
At 10pm on Feb. 23, 1995, after an emergency meeting, the Shanghai Exchange announced that all transactions within the last eight minutes on February 23, 1995, were invalid. Due to this decision, with a loss of 5.6 billion yuan, Wanguo Securities was on the verge of bankruptcy.
On May 19, 1995, Guan Jinsheng was arrested in Hainan for embezzlement. On May 17, 1995, CSRC issued the emergency notice on suspending the national treasury bond futures trading. China’s first financial futures product came to an end.
The event of 327 treasury bond futures had a huge impact on the development of the financial market so that the stock index futures were launched in 2010, and the new Treasury bond futures simulation transactions were launched in 2012. Also, there were constant arguments on who has benefited from insider information in this trading. The loopholes in the exchange market and authorities had led to the closure of the first trial on the futures market.
3. Manipulators, Forgers and Scammers
Counterfeiters and manipulators have always been cancer of China’s financial market since birth, they are never absent in the young market history and keep coming again and again. Reasons for this can be complicated, like incompetent supervision, low breaching penalties, excessive speculative investment expectations, insufficient investor education, etc.
Despite the fact that the Chinese stock market may have the highest entry stepping stones around the globe, due to the down-to-every-little-trivial investigation, dogmatic examination requirements and long waiting lists in the process of IPO, the enormous benefits from the listing entity always grant both the controllers and early investors with great impetus for information manipulation. Multi-million yuan penalties and market entry prohibition are nothing compared to the gains from the listing shares of companies in the market. Small investors, which contribute to over 80% of the market quantities, different from other U.S. and European financial markets, may easily be tricked and manipulated by the deceivable information and suffer losses.
The same tragedies were witnessed many times before and are not likely to be stopped in the near future. In the year 2019 only, over 10 listed companies were identified or suspected to be involved in the falsification of financial statements, among which, Kangmei (600518), Kangdexin (002450) and Furen (600781) were most eye-catching.
Kangmei Pharmaceutical was founded in 1997 and listed in 2001. It had disclosed to maintain double-digit growth of net profit since 2006. In May 2018, its market value hit a peak of 128.336 billion yuan with a wide spread of both individual and institutional shareholders. On April 29, 2019, Kangmei released a notice, in which it admitted to wrongly record cash of 29.944 billion yuan in its books. This notice has caught the market by surprise, especially when this misbehavior happened to one of the ‘good students’. CSRC began to make an investigation and concluded after 8 months that Kangmei inflated cash and bank balances by a shocking amount of 90 billion yuan from 2016 to 2018. Stock prices collapsed and over 300,000 shareholders were suffered. However, the company, the controlling individual, its directors, and the management team were only penalized with several hundreds of thousands of yuan respectively.
Since its listing in 2010, Kangdexin’s share price had risen nearly tenfold, with a market value of almost 100 billion yuan. It was recognized as a ‘white horse’ stock with high returns on investment. On January 14, 2019, Kangdexin, with over 15 billion yuan deposited in banks on the book, was shockingly unable to pay back its short-term financing bonds with the amount of only 1.5 billion yuan, which caused wide doubts in the market. After 7 months of investigation, CSRC concluded that, from 2015 to 2018, Kangdexin inflated profits amounting to over 11.9 billion yuan. Over 150,000 shareholders were suffered from the fraud. Similarly, the penalties against the companies and other stakeholders were insignificant to the loss.
The high participation of individuals has been a noticeable characteristic of the Chinese Stock Market since its birth in the 1990s. As we discussed before, financial problems could go politicized easily and fast, especially under the pressure of public opinions on the regulating authorities and market infrastructure. The government always keeps a sensitive and high-handed attitude towards these financial activities with wide public participation.
4. Collective Failure of China’s Online Lending Platform
In 2006, the first peer-to-peer lending intermediary platform appeared in mainland China, and it had continuously developed into the largest online lending region in the world. By 2018, China’s P2P industry reached 1.3 trillion yuan, with more than 50 million registered users.
In June 2018, there was a large-scale collapse of P2P platforms, due to reasons like pyramid selling, lack of internal control, term mismatch, embezzlement or total scammers. In July 2018 alone, 221 online lending platforms were closed, and the number of victims was estimated to be more than one million. For example, in July 2018, Li Zhenjun, chairman of the online lending platform “Tourongjia”, was reported with nearly 1.6 billion of the volume money absconded. 13 senior members were detained as suspects.
P2P victims were scheduled to march on Aug. 6, 2018 in Beijing. But some "extreme" measures had been taken by the local government, and there were quite many people intercepted on the way. Still, people who did not need to travel a long distance gathered in the Financial Street in Beijing for the 8:30 March to the CBRC, but they were stopped by the police who had been deployed around, and several leaders were taken away by the police.
The whole industry was facing panic, and it was stretching to a wider range of communities. That is exactly what the government feared most and would always keep social stability as the highest priority.
Something Else Also Matters
Of course, we shall always bear in mind that China still has the largest population and has the highest (maybe one of the highest) individual participation ratio in the financial market around the globe. Old traditions taught the Chinese to save and invest money for sustainable usage rather than consume it overnight, which many still believe at present. Any financial discord may be easily scattered to the wide public and magnified by the spread. The modern Chinese financial market is young, with only 30 years of development, and the governments are still trying to find the best way to supervise the market and educate the public investors with Chinese characteristics. But cautiousness and conservativeness are always what they cherish, to shelter the growth of the "fragile" and "sensitive" market.
When blockchain projects are trying to raise funds from the public and making transactions, it easily goes into the territory of finance, which the government is always keeping close eyes on. Barbarous growth has been lasting for several years and there are vivid metaphors as "sickles" and "leaks" on the relations among exchanges, projects, private investors and the public. Scammers and pyramid schemes are beginning to emerge. Several small so-called exchanges and untrustworthy organizations are trying to raise funds from the public and providing transaction services under the shining cover of blockchain. Scammers are running away with money and wider loss is beginning to emerge into the public as the participation grows.
The Chinese authorities’ regulatory attitudes towards cryptocurrencies and blockchain give little surprise to most of the veterans in the Chinese financial market. The similarity was witnessed many times, e.g., on the equity derivatives market, bond futures, openness to foreign investors, foreign participation in the financial institutions, etc.
Highly regulated and take-your-time, that’s what the Chinese governance seems to deliver to the market on the blockchain. A promising technology as the blockchain is, still one needs to behave and never "cross the line."
This recent ban is not the first and surely it will not be the last. Especially for those who are dealing with direct transactions with fiat RMB, cross-border transactions with large volume, extreme leverages or raising funds from the general public, you need to be very careful.