Functional transition of the Chinese capital market
Giving full play to the pivotal role of the capital market is conducive to achieving common prosperity for all. Photo: TUCHONG
The Central Financial Work Conference held in October 2023 has explicitly proposed optimizing the financing structure and giving full play to the pivotal role of the capital market. As the modern financial system moves away from traditional intermediation, there is a gradual shift in its function from mainly financing towards a more balanced approach that encompasses both financing and wealth management. Consequently, the significance of capital markets has been steadily increasing. A comprehensive understanding of the fundamental principles driving the growth of China’s capital markets holds great significance for improving its overall functionality.
Financial disintermediation refers to the phenomenon where economic activities no longer rely on financial intermediaries for fund financing, but instead establish a direct connection between fund providers and fund demanders.
The process of enterprises obtaining funds directly represents financial disintermediation, which has driven structural changes in finance and has facilitated the emergence and development of capital markets. As the capital market continues to evolve, the scale and variety of financial assets are becoming increasingly diverse, leading to a growing demand for financial product trading. Throughout the process of disintermediation, the functionality of capital markets gradually improves, shifting the financial function from a primary focus on financing to a balanced emphasis on both financing and wealth management, ultimately transitioning towards a primary focus on wealth management. The result is the disintermediation and marketization of financial transactions.
The reciprocal promotion between technological innovation and capital markets not only creates a circular effect within a country or region, but also generates a radiating effect worldwide through international trade and capital flows.
The strategic location choice of financial institutions can result in a strong agglomeration effect, which not only improves financial service quality, but also attracts the inflow of international capital. This, in turn, will drive industrial progress in the country or region. Therefore, industrial progress not only plays a core role in the country’s economic rise and sustained economic dominance, but is also closely related to the shifting of international financial centers. With the support of capital markets, technological innovation has been widely applied and promoted, which in turn has promoted the prosperity of the capital markets.
Although it is impossible to know which new technologies and industries will emerge in the future, it can be assumed that: firstly, technological progress will drive the upgrading of industries, which will inevitably lead to the continuous replacement of old enterprises with new enterprises pursued by capital markets; secondly, the emergence and development of new technologies such as block chain, crypto-currency, and virtual reality are shaping new industries and asset forms, and the adaptation and application of new technologies in the capital markets will inevitably promote the self-innovation of relevant theories and practices.
From financing to investment market
Capital markets are not typically designed to provide convenience for corporate financing, but rather to provide investors with assets with growth potential. While capital markets play a financing role, they should also provide reasonable returns and fulfill wealth management functions. Only with equitable returns can financing be sustained. Therefore, in order to improve the market function of Chinese capital markets, it is necessary to dive deep into institutional design and facilitate the transition from a market primarily focused on financing to one focused on investment.
To restore the investment and wealth management functions of capital markets, it is necessary to design and reform from three levels: firstly, on the asset supply side, it is necessary to continuously inject high-quality assets with growth potential into the market. Secondly, on the demand side of assets or the supply side of funds, it is necessary to achieve a dynamic balance between the speed of asset supply and the demand for funds. Thirdly, on the trading side, efforts are needed to enhance investor enthusiasm from the dimensions of transaction benefits, convenience, and transaction costs. Among them, the asset supply side is the most important, followed by the demand side, with the trading side ranking last.
From the level of asset supply, the current priority lies in improving the system for reducing stakes in listed companies, rather than suspending initial public offerings (IPOs) and the issuance of new shares.
The asset demand level does not fall within the scope of reform. Both individual and institutional investors make investment decisions based on risks and returns.
The current reform of China’s capital markets will have a profound impact on their future, but it may take a relatively long time to take effect.
In the long run, Chinese capital markets must complete functional transformation, and functional transformation must be completed first at the institutional level.
Wu Xiaoqiu is a professor from the China Capital Market Research Institute at Renmin University of China. Fang Minghao is a research fellow from the Shanghai Institute of International Finance and Economics at Shanghai University of Finance and Economics.