How QFII Influence Chinese Stock Market Liberalization?

Compare with Taiwans Experience

by

Chan Oi Yee , Iris MA Finance and Investment 2008

Abstract QFII (Qualified Foreign Institutional Investors) announced in November, 2002 and formally implemented in 1st of December, 2002. It is the initial stock market liberalization policy adopted by Chinese authorizes after the accession of WTO. Stock market liberalization is a decision to allow foreign investors to purchase domestic share. In this dissertation, the major improvements on Chinese QFIIs entry criteria and investment quota are recommended from the Taiwans QFII experience. Taiwans QFII is a good example for comparison on Chinese QFII scheme because Taiwans QFII is the most successful among other emerging counties such as India and Korea. The stock market behaviour of Taiwans QFII implementation is similar to Chinas QFII implementation where both and China have high PE ratio and contain large proportion individual investors at the QFII implementation period. This dissertation is an even study on market reaction around the implementation of QFII. The author find there is no significant abnormal returns in the whole market within the short-term period, 3 months after implementation; negative abnormal returns followed the implementation. Also, there are no significant abnormal returns in the long-term period. These insignificant results implied that investors were taken a wait-and-see attitude and lack of confidence on stock market liberalization. Moreover, the findings is partly comply with the prediction of international asset pricing models , it suggested the scheme may not help much in reducing the cost of equity capital and risk premium of Chinese companies. Finally the long term impact of QFII scheme to difference aspects of Chinese securities market, such as advance investment strategy, listed companies information disclosure standards improvement, the conflict between domestic and foreign banks and the future developments of Chinese liberalization policies are declares in this dissertation as well.

Acknowledgement This dissertation could not have been written without Ms. Thomas Kristie who not only serves as my supervisor but also encouraged and challenged me throughout my academic program. She guided my through the dissertation process, never accepting less than my best efforts. I thank her devoutly. I am also grateful for the support of my parents and of my friends, Cheryl Ha , Jacqueline Leung , Sue Yin Wong and Stephanie Wong

Table of Contents Abstract ... Acknowledgement . Table of Contents .. Table of Abbreviations .. List of Table 1. Introduction 1.1 Background . 1.2 Objective . 1.3 Methodology ... 1.4 Structure .. 2. Literature Review 2.1 Introduction . 2.2 Definition of Emerging stock market 2.3 Definition of Stock Market Liberalization 2.4 Brief concept of International Asset Pricing Model (IAPM) .. 2.5 Short term impact Market Behaviour . 2.6 Long term Impact ... 2.6.1 long term stability and stock market performance ... 2.6.2 Emerging market development .. 2.7 Potential Risk of Liberalization . 2.8 Summary . 3. Background of Chinese Stock Market 3.1 Introduction ..... 3.2 Chinas recent development . 3.3 Brief History of Chinese Stock market 3.4 Capital Control Closed Capital . 3.5 Type of Share . 3.5.1 Non Circulating shares 3.5.2 Circulating Share .. 3.6 Type of market 3.6.1 Primary Market .. 3.6.2 Secondary Market 3.7 Problem of the Stock Market . 2 3 4 7 8

11 12 13 15

18 19 21 22 24 27 27 30 31 33

35 35 37 38 39 40 41 42 43 43 44

3.8 Regulatory Framework ..... 3.9 China Stock Market liberalization 3.10 Summary ... 4. China's QFII scheme and Comparison with Taiwan's QFII scheme 4.1 Introduction . 4.2 QFII definition . 4.3 QFII Application and Operation procedures .. 4.4 Characteristic of QFII . 4.4.1 Avoid market fluctuation .. 4.4.2 Scope of QFII 4.4.3 Investment Sectors Control . 4.4.4 Foreign Exchange Control .. 4.5 Limitation and Risk of QFII regulation 4.5.1 Limitation on QFII investors 4.5.2 Limitation on QFII operation 4.5.3 Lack of regulation on information disclosure 4.5.4 Weakness on QFIIs shareholding control 4.5.5 Centralize of approval process ... 4.6 Reason of choosing Taiwans QFII as example 4.7 Brief history of Taiwans QFII ... 4.8 Comparison of QFII regulation between China and Taiwan . 4.9 The effect of Taiwans QFII scheme 4.9.1 Simulate Investors Confidence ... 4.9.2 Increase proportion of institutional investors in Taiwans stock market . 4.9.3 Enhance the conductivity with international market 4.10 Possible improvement of QFII regulations by looking in Taiwan s QFII development ... 4.10.1 Relaxation on entry criteria ... 4.10.2 Relaxation on capital liquidity ... 4.11 Summary ... 5. Short term Impact - Empirical Research 5.1 Introduction ... 5.2 Theoretical framework ..

47 49 51

53 53 54 57 57 58 58 59 61 61 62 65 65 66 67 69 72 78 78 78 78 79 79 79 80

82 82

5.3 Data and Methodology .. 5.4 Empirical result and finding .. 5.4.1 Descriptive analysis 5.4.2 Regression Analysis .. 5.5 Research limitation 5.6 Summary . 6. Long term Impact 6.1 Introduction . 6.2 Investment strategy ... 6.3 Local stock market . 6.4 Local listed companies . 6.5 Local banking industry .. 6.6 Future development on financial policy .. 6.7 Summary . 7. Conclusion .. Reference . Appendix Appendix 1 -- Provisional Measures on Administration of Domestic Securities Investments of Qualified Foreign Institutional Investors (QFII) Appendix 2a -- China's Stock Index in US$ Appendix 2b Taiwan's Stock Index in US$ Appendix 3 Full Result from SPSS Appendix 4 Full Result from Sata

83 89 89 92 93 97

99 99 104 106 108 109 105 113 116

Table of Abbreviations AAR ADRs CAR CEPA CRSC FDI FII GDP GNP HSBC IAPM IFC IPO Moftec MOC MSCI NBS NPLs PBC PE ratio QDII QFII RMB SAFE SCSPC SHA SHB SZA SZB SHSE SZSE TAIEX TWSE WTO Average Abnormal Return American Depositary Receipts Cumulative Abnormal Return Closer Economic Partnership Arrangement Securities Regulatory Commission Foreign Direct Investment Foreign Institution Investors Gross Domestic Product Gross National Product The Hongkong and Shanghai Banking Corporation Limited International Asset Pricing Model International Finance Corporation Initial Offerings Ministry of Foreign Trade and Economic Co-operation Ministry of Commerce Morgan Stanley Capital International National Bureau of Statistics Non-Performing Loans Peoples Bank of China Price Earning Ratio Qualified Domestic Institutional Investors Qualified Foreign Institutional Investors Renminbi State Administration of Foreign Exchange State Council Securities Policy Committee Shanghai A-share Shanghai B-share Shenzhen A-share Shenzhen B-share Shanghai Stock Exchange Shenzhen Stock Exchange Taiwan Capitalization Weighted Stock Index Taiwan Stock Exchange World trade Organization

List of Table Table Table 2.2.1 History of FDI growth ... Table 3.4.1 Top ten global trading nations Table 3.5.1.1 Capital Structure of Listed Firms Table 4.5.2.1 List of Custodian Bank . Table 4.7.1 Taiwans QFII History .. Table 4.8.1 Detail of Taiwans Investment Qualification Evolvement ... Table 4.8.2 QFII Regulation Comparison Between Taiwan and China . Table 5.4.1 Description of stock market indices monthly return for four event periods (%) Table 5.4.2 Result for Panel and Linear Regression (%) Table 5.5.1 Correlations between A-share market and B-share Market Table 6.1.1 Current QFII Status .. Table 6.2.2 Top 10 Shares purchased by QFII in 2007 .. Diagram Diagram 3.8.1The Structure of CSRC ... Diagram 4.1 QFII application and operation procedures Diagram 4.6.1 Comparison of PE ration in Major Stock Market 48 56 67 20 39 41 64 70 73

75

90 93 95 100 104

Chart Chart 4.1 Taiwan's Investors Distribution 1991 71

Chart 4.2 Taiwan's Investors Distribution 2001 Chart 4.3 China's Investors Distribution 2003 .. Chart 4.3 China's Investors Distribution 2003 ..

71 72 72

Chapter 1 Introduction

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1.1 Background In year 1979, the open policy was introduced in China which derived upon the restricted trade and inwards investment policy. It became a crucial element of the new foreign invest policy, for example the Joint Venture Law 1979 and the four Special Economic Zones (SEZs), Shenzhen , Zhuhai, Shantou and Xiamen were establish. In 1984, the Joint Venture regulations were declared and the foreign investment started to growth rapidly in the following years, 1985-1987. In later year 1992, Mr. Deng Xiaoping recalled the importance of open-door policy and the Peoples Congress of China formally replaced the planned economy by a market economy in 1993. Since the economic reform started in 1978, the economic was growth rapidly; the average economic growth rate was calculated at 9.6 percent from 1978 to 2004 (Li et al., 2007).

On December 11, 2001 China formally became a member of WTO. It is an historical turning point which brings Chinas economy into harmony with the world. Although a WTO membership is important for the integration with world economy, it brings many vital opportunities and also challenges.

For such a long period, Chinese authorities cut tariffs, liberalizes its trade, security investment and even some domestic sectors to foreign participation, which push Chinese regulated economy more further to a market economy. Since China joined WTO, hundred of laws and regulations were revised for coping with the WTO policies. To be fully integrated into world economy, all of these changes are essential for a countrys economy. The significant economy growths in China were mainly gained from the comparative advantages in capital and labor-intensive sectors, where enable resources reallocated and

11

created more work opportunities.

However, there are still long ways to go before enjoining the positive effects which bring from WTO accession. While integrating into global economic system, many challenges accompany by the underdeveloped and

inexperience of Chinas traditional financial sector. On December 11, 2006, five years after WTO accession, foreigner-owned banks can freely manage renminbi (RMB) banking business as domestic banks do (Ma, 2007). Transformation of governments functions is the greatest challenge in government sector. As WTO requires their members governments to be fair, transparent and marketable, Chinese government has realized the necessary to speed up the reformation in different sectors and develop an optimistic legal, policy and financial environment.

1.2 Objective It is a popular research topic, how stock market liberalization impacts emerging stock market, in both short term and long term. Such empirical researches were usually examine on a group on emerging countries, however, lack of them focused on only one country, especially Chinas QFII and the impacts on its stock market. It possibly is an interest area to work on; therefore the gap could be filled up by providing a deep analysis on QFII regulation and the influence of QFIIs implementation in Chinese stock market.

However, QFII has already implemented for quite a long period, nearly 6 years, but it is still putting efforts on fully open up the Chinese stock market. Therefore the major objective of this dissertation is to capture the temporary influences of
12

QFII on stock market occur around the implementation period and the validity of the prediction of IAPM will also examine throughout the study. Chen & Yus (2004) paper, the first paper worked on the announcement of QFII policy impact to Chinese stock market, is modified by taking a longer observation period and the implementation date is used instead of announcement date.

Before RMB can feely convert, the only way to achieve the expectation of Chinese authorizes - attract more foreign investment by adopting QFII scheme, is to improve the corporate governance of local domestic listed companies. Traditionally Chinese domestic investors are lack of advance investment technique therefore, example of foreign professional investors can use for educating local investors. For the result, the potential long term influences of QFII on China domestic listed company, investor and banking industry are also the objective in this study. In order to achieve detail recommendations, experience of Taiwan will use for judging the current QFIIs status in China, the limitations, potential development and long-term impact will be declared in this way.

1.3 Methodology Methodology is not only a method of analysis empirical findings , it is a section including research design , explaining how the research undertake, data collection methods and analysis technique and specify the methods of achieving research objective. In this research, both qualitative and quantitative research methods are adopted and case study is used for detail explanation.

According to Saunders et al. (2000) a research approach can either deductive

13

or inductive. Inductive approach refers to build a theory through gathering and analyzing a group of data while deductive approach is to develop and test an existing theory or hypothesis by creating a new research strategy. It implies that, deductive approach is mostly the same as quantitative approach and inductive approach is similar to qualitative approach. Punch (1998) realized that quantitative research is a method to present facts by pooling and analysis a large group of data. On the other hand, qualitative research is basically targeted on empirical research analysis, the data can be taken in many forms and usually present in non-numerical form. Also Ghauri et al. (1995) suggested that qualitative research is usually rational, explorative and institutive. Therefore, analysis previous researchers experience is treated as an important part in the whole research.

Secondary data, which described as inductive approach, are used throughout the research. China financial market data are used to evaluate the performance of QFII and Taiwan QFIIs experience is used for identifying the improvement aspects of Chinas QFII regulation and listed companies information transparency.

In order to achieve a high quality research, a good research strategy is essential. A clear objective should keep in mind when answering each research questions (Saunders et al., 2000). Research strategy can also take in any form of experiment, survey, case study, ground theory, ethnography, action research, cross-sectional and longitudinal studies, and exploratory, descriptive and explanatory studies.

14

When a holistic and in-depth investigation is needed, case study is suggested to be the best methodology (Feagin, Orum & Sjoberg, 1991). Case study is a method to analyze the phenomenon by selecting a few examples and examine the characteristics from those examples or cases. The most suitable case that can choose to study must bethe relatability of a case is more important that its gernealisability by Bassey (1981). It implied that the best case to study must have some direct relevance with the original case, just like the Chinas QFII scheme and Taiwans QFII scheme, where both of them have a similar stock market structure and performance.

1.4 Structure In Chapter 2, literature review will be used to define each key terms, emerging market, stock market liberalization and international asset pricing model. Moreover, the short-term and long-term impacts of stock market liberalization will be specified and conclude with the potential risk of stock market liberalization.

In Chapter 3, a broad view on Chinese stock market history and its current position will be described in detail. Besides that, the type of share currently trade in Chinese stock market, type of markets and the regulatory framework will also mention.

In Chapter 4, apart form the broad view of Chinas QFII scheme and Taiwans QFII scheme, comparison of these two QFII schemes will be given. Recommendations on Chinas QFII scheme which learn from Taiwans QFII scheme will make as well.
15

In Chapter 5, it is the empirical experiment part, the theoretical framework research strategy will demonstrate first and following with the experiment of short term impacts of QFII onto stock market where secondary data of Chinese stock market index and Taiwans stock market index are used for examination.

In Chapter 6, long term impacts of QFII in different of aspects the Chinese economy will be described. Influences on investment strategy, stock market, and listed company will be involved. The future developments of Chinese stock market are also recommended.

16

Chapter 2 Literature Review

17

2.1Introduction Qualified Foreign Institution Investors (QFII) is a milestone in Chinese stock market liberalization history. It enhances the opening process of local stock market (A share market) to the rest of the world. The adoption of QFII is aiming that more investment from foreigners will be attracted and Chinese stock market will liberalize finally. Due to the new policy, more investments are attracted and more challenges of foreign capital inflow and outflow are following by. Summarize the empirical studies of previous researchers the impacts of liberalization can be described into two types, short term and long term. Apart from the final result of stock market liberalization on market, the experience of how it contributions on emerging stock markets are more relate to this research study.

This chapter will start with the definitions of emerging stock market and stock market liberalization and follow the brief idea of standard International Asset Pricing Model (IAPM). After demonstrated the definitions of those key terms, past literatures will use to explore the short term impact and long term impact. In short term impact, will mainly study on the short term market behavior and the stock market volatility at initial liberalization. With regard to long term effect, past empirical researches are divided into how liberalization influences emerging stock market stability and how it affects the development of emerging market. The contributions and limitations of all literatures will be pointed out through this research study. Finally this chapter will conclude with the potential risks of stock market liberalization.

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2.2 Definition of Emerging stock market According to International Finance Corporation (IFC) emerging stock market is the stock markets consist in the developing countries where they are low or middle income economies (Kim & Singal 2000). Moreno (2007) listed a range

of emerging stock markets such as Indonesia, Korea, Philippines, Thailand, Chain, Czech Republic, Mexico and etc. An emerging stock market usually exists in an emerging economy. As Dara (2000) said to measure the development status of a country, gross national product (GNP) are used to measure the level of income traditionally. Generally, there are common criteria exist among emerging stock markets. If a stock market belongs to emerging, this market should have begun a process to change such as growing size, turnover and sophistication. IFC, a member of the World Bank Group who publishes monthly Emerging Stock Market indexed has tracked a list of emerging markets that are particular interest to international investors, so do Morgan Stanley Capital International (MSCI). Besides the measurement mentioned above, IFC also guided that an emerging stock market should be in term of five characteristics, which are growth, changes (economics, financial and political), investability, size and liquidity.

Because of the relative small of Chinas capital market to the whole economy and the potential of fast growing, which make Chinas stock market classify as emerging. As Chinese market liquidity are increasing which allows the market earning more potential , on the other hand , the range of companies quoted are widened and the corporate sector becomes more relied upon equity financing. Moreover, foreign investors have shown more interests of the investment opportunities in China (where the rate of foreign direct investment (FDI)
19

increasing year by year). According to the Ministry of Foreign Trade and Economic Co-operation (Moftec), until June of 2008 there are 14544 FDI firm in China , reduce 22.15% compare with the same time of last year. The actual FDI reached to US$ 523.88 hundred million, in the first half of 2008, rise nearly 50% from last year.

Table 2.2.1 History of FDI growth

Source : Beamish (1993)

Regarding to the majority of emerging markets think liberalization is an essential policy decision to attract more foreign investment funds. Hence, the following section will focus on emerging stock markets performance and behaviour which occurs at the initial market liberalization.

20

2.3 Definition of Stock Market Liberalization As the importance of liberalization therefore definition will be demonstrate first. Stock market liberalization is specifying from a more general policy reform called Capital account liberalization. There are several meanings regarding Capital account liberalization. A general definition given by Biem and Calomitis (2001) it is a package of reforms that include global opening up and the creation of governance infrastructure such as sound law and regulation governing trading , and reliable systems of accounting information and control (Bekaert et al., 2005). Henry (2000b) narrowed definition to removing restrictions on international capital flows.

Henry (2000) also gave another definition on stock market liberalization, he thought it is a decision that made by a countrys government to allow foreigners to purchase share in that countrys stock market. It is a political decision designed to attract foreigners investments in domestic stock market. Extensively it is also treated as a study on economic, financial growth and development. Thus stock market liberalization is not just a political decision; it is an indicator on macroeconomic factors which may influence financial growth and development.

Moreover, study of Kim & Singal (1993) used an increase in issuance of share capital and stock voting open to foreigners as a detail classification for stock market liberalization. Similar to the first introduced by Henry (2000), Jayasuriya (2002) specified the stock market liberalization definition narrowly. The data is available for the identifiable ease dates. If any one of the following occurs, an official policy announcement, establishment of a country fund, or an increase
21

in the IFCs Investability Index of at least 10 percent1 then this month will be counted as the market opening date. Hence, the date of liberalization is directly captures at the official policy announcement while the others alternative are indirectly capture the opening date.

Chinas QFII scheme is the first phenomena which made by Chinese government allowing the foreign investors to purchase A share in China domestic share market. The introduction of QFII scheme is really a strong evidence of Chinese stock market liberalization. Moreover, Henry (2000) suggested that standard international asset pricing model (IAPM) can be used for predicting the implication of stock market liberalization. The brief idea of will explain in the next section.

2.4 Brief concept of International Asset Pricing Model (IAPM) Standard International Asset Pricing Model is meaning the equity premium embedded in its aggregate valuation will be proportional to the variance of countrys aggregate cash flows if an emerging countrys stock market is completely segmented form the rest of the world (Henry, 2000b). Once liberalization takes place in the emerging stock market and until it is fully integrated, the equity premium and covariance of countrys aggregate cash flow with those of a world portfolio are proportionally linked. If the foreign ownership of an emerging market is restricted and partly segmented, like QFII in China, then the equilibrium of the emerging markets valuation will incorporate with the equity premium and may lie in somewhere between
1

The Investability Index is constructed as the ratio of the market capitalization of stocks that

foreigners can legally hold to total market capitalization

22

autarky and fully integrated premium (Bekaert and Harvey, 2000). They also showed a possible reduce on equity premium that subscribed to an emerging stock market when the local price of risk (the variance) exceeds the global price of risk (the covariance). Holding constant future cash flows, the decrease will cause a permanent fall in the total equity capital cost and the aggregate equity price index will affect as well. In Chen & Yu (2004) working paper they described this effect by the following way:

E[RM] = rf+ T Var(RM)

(1)

Where E[RM] is the expected rate of return on the aggregate domestic stock market before liberalization, rf demonstrate the domestic risk- free rate ,T is the price of risk and Var(RM) is the variance of the market return. Therefore the difference between E[RM] and rf ( E[RM] - rf ) is the aggregate risk premium. Replacing the terms in formal (1), the expect rate of return on the market after liberalization, E[R.M], should be given.

E[R.M] = rwf+ MW (E(RW)- rwf)

(2)

Here rwf is representing the world risk free rate, MW is the beta of the domestic stock market with the world stock market and E(RW) show the expected return on the world equity market.

Furthermore, if the capital markets are completely opened then the world risk free rate rwf will become the relevant interest rate. When substitute E(RW) in formal 1 , the equation will become E[Rw] = rwf+ T Var(Rw). Therefore,
23

substitute into formal 2, the new equation will be look like this

E[R.M] = rwf+ MW (rwf+ T Var(RM) - rwf) = rwf+ TMW Var(RM) = rwf+ T Cov(Rw, RM)

(3)

And the equation of the difference between before and after market liberalization ( E[R.M] - E[RM] ) can be written in the following ,

E[RM] = E[R.M] - E[RM] = ( rwf - rf )+ T { Cov(Rw, RM) - Var(RM)} (4)

If

rwf < rf and Cov(Rw, RM) < Var(RM) , thus the E[RM] will be small than 0 ,

which implied that stock market liberalization reduces the equity capital cost of the liberalization country.

2.5 Short term impact Market Behavior Concerning the linkage of stock market liberalization and stock return, Kim & Singal (2000) found out critical evidence on the valuation of initial stock market liberalization. From their empirical result, suggested that stock returns increase immediately after market opening without a concomitant increase in volatility. However, they did not control the confounding event during the sample period and the decrease of stock return follow by.

Henrys (2000) study improved Kim and Singals (2000) research by using 12 emerging countries data. The empirical result gave out an average abnormal
24

return of 4.7 percent per month in which the liberalization in a countrys stock markets initial implementation that experienced the real dollar terms within 8 months window in stock markets.

After controlling of co-movements with world stock markets liberalization, economic policy reform and macroeconomic fundamentals, the result in a deduction of abnormal return happened (only 3.3 percent per month over the same horizon) is still statistically significant. In addition, Henry concluded that even employing a smaller range of months, including five months, two months or even the implementation month only for estimation, all windows are still in conjunction with the statistically significant stock price revaluation. Moreover, his findings consisted with a fundamental prediction of the standard International Asset Pricing Model (IAPM).

After Henry (2000) had presented the first empirical research on how stock market liberalization influenced the equity prices in the emerging market, a relative large amount of studies also have been pointed out many challenges in this field. For example, Henry (2000b) also stated that the stock market liberalization raise up the private investment rate right after it had adopted for three years. Bekaert and Harvey (2000) thought the abnormal return may increase or decrease in the post-liberalization period but it might also be affected by the model specification. In contrast, Kim & Singal (2000) concluded the stock returns were actually fell in one year after the liberalization. Errunza (2001) also concluded that the concern of destabilizing influence of the foreign participation is largely unwarranted. However the data used in these studies were prior to the financial crisis in 1997 (Wang, 2007).
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In the study of Dvorak (2001), he did research on the correlation between local and world return as well as the impact of foreign trading with the short term volatility. He found out the foreign trading did not impact the volatility in the developed countries under the controlling of total volume in the local markets, but it dose impact the volatility in the emerging market. Moreover, Bae et al. (2002) has shown that stocks with higher investability index (i.e. more accessible to foreign investors) have higher return volatility in emerging markets (Wang, 2007).

However, the researches mention above are all observing a yield of emerging countries rather than a single country or region. Base on the cross countries analysis, the inside country factors will be ignored. Therefore, it is hard to define how a stock market opening influences the market performance and the reaction of foreign investors, such as China.

Because of the similar investors structure and the price earning ratio of Taiwan and China stock markets at the implementation moment of QFII (TWSE , SZSE and SHSE web site2), Taiwan QFIIs experience choose as an example for the comparison, and more details about two markets will be discussed in later chapter. Here, an individual study from Li (2001) will be employed to justify short term market behavior in an emerging market. In this studied, Li focused on the Taiwans experience of market opening and analyzed the stock market data one year before and after the opening event (QFII).He identified there was no significant change in the stock mean returns while volatility is
2

TWSE Taiwan Stock Exchange SZSE Shenzhen Stock Exchange SHZE Shanghai Stock Exchange 26

notably reduced three months after opening Taiwan stock market. If applied this result to China, the volatility should be reduced and the stock return will be constant during implementation of QFII.

2.6 Long term Impact 2.6.1 long term stability and stock market performance Since the second oil price shock in 1979, the paradigm of liberalization became more impressive and widely spread. Its influx foreign capital led to increased volatility in these emerging markets. In opposite to other academics researches which showed little evidence to support claims of increased volatility in those volatile market, Dara (2000) argued that emerging market are always volatile. Risk can be widely spread through opening the emerging stock markets and the volatility also can be eliminated by the presence of foreign investors. Aside from the foreign investors, local investors also play an important role in determining the emerging market volatility and the level of asset price (Bae et al, 2002). Nevertheless, Richards (1996) found out there is an insignificant linkage between liberalization and increased volatility. He estimated the volatility from two periods, 1972 to 1992 and 1992 to 1995 (foreign institutional investors played a significant role in emerging markets). Monthly data were collected from nine markets while weekly data were gathered from 16 markets started at the end of 1988 until the end of September 1995. Finally, he concluded that the volatilities were not much different between periods and there was little evidence indicated the volatility would rise in both short and long term return while large scale foreign investments became a major player in these markets.

27

Actually volatility does not rise in emerging market, but people usually think stock market liberalize will cause volatility increase, the reason is here. Levine & Zervos (1998a,b), they are the first to ask whether stock markets are key to economic growth . In this study, the measure of stock market liquidity, size, volatility and integration with world capital markets were used to test whether correlated with the current and future rate of economic growth, capital accumulation, productivity improvements, and saving rates, the data of 47 countries from 1976 to 1993 were used. The testing result indicated that

there is a positive and significant relation between stock market liquidity and long term growth, where a small and liquid market will usually have high turnover and small value traded. Additionally, this finding implied importance of the liquidity of stock market tends to be risen following the liberalization of international capital control.

In order to test further the studies from both Dara (2000) and Richards (1996), Kim & Singal (2000) chose 20 countries as sample from the IFCs (1996) emerging markets database, which is similar in other studies. They exposed the stock markets opening do increases the stock price while no positive changes in stock return volatility. Stock price increase may also indicate the demand for domestic securities raise and oblique the domestic firms can access foreign capital at lower cost. However, greater volatility may reduce investors interest in holding stocks as higher risk premium may face, consequently, the cost of capital will either higher or lower than investment. Since policy makers impossibly to react the unexpected market forces without considering economy, therefore, guidance on growth control is essential. Kim

& Singal (2000) revealed that there is no upward pressure on inflation will
28

affect the efficiency gains and the inflation rates, on average, will fall after stock market liberalization. An appreciate exchange rate may help the country to retain its competitive position in the global marketplace, especially for the export- orientated economies countries. The government in such countries may always need to worry about the inadequate on investment opportunities for absorbing massive inflow of money. Hence, too much capital inflow will cause inflation.

On the other hand Dara (2000) mentioned that the first time of an industrial countries portfolio mangers invest in emerging market, they may react to expose more comparatively volatile in the market other than increase volatility in such market. The 1994 Mexican currency crisis and the East Asian financial turmoil both raise the interests of many academics and politicians to look into the desirability of free flow of capital for emerging economies where Chile and China were successfully restrained on capital flows. Even popular economists such as Joseph Stiglitz of the World Bank and Panl Krugman of MIT have championed capital control as a way of coping with financial crisis (Kim & Singal, 2000). Hence made people link financial turmoil, crises and increase volatility together. Moreover, these assumptions of financial turmoil also the increase of volatility and foreign investors are lack of evidence to support, because financial crisis may not is the result of volatility increase.

Additionally, the movement of hot money, it is an important and difficult issue need to be concern. Hot money is the international flow of funds which highly sensitive to the changes of interest rate, expectation of future economic growth and returns on securities held (Hu, 2004). Even a small shock to the economy
29

will cause a serious volatilization on inflow of funds and consequently destabilize the domestic economy.

2.6.2 Emerging market development Other than the liberalization impacts on market stabilize, there are many liberalization researches focused on the economy and policy development in an emerging market. As mention in Dara (2000) there are several benefits an emerging economy can gain from the increase of foreign investors after opening stock market. The major advantage is the raise of investment opportunities for foreign investments. Also the financial instrument and the other equity market developments can be enhanced as well (Levine & Zervos, 1998a). In doing so, the cost of investment can maintain at a relatively low level and the economic growth is facilitated too. In Henry (2000) paper, the researcher selected a sample of 11 developing countries and liberalized their stock markets ; 9 out of 11 experienced a growth in private investment after the first year liberalization. In the second and third years after liberalization 10 and 8 countries respectively experienced a higher growth rate of private investment. This example do make a strong evidence on capital account liberalization has no effect on investment.

Allocate capital more efficiency is another crucial consideration. Kim & Singal (2000) pointed out that accountability management and shareholder rights, which allowed the investors to stay away from dangerous of expropriating wealth by other investors; therefore it is treasured by the foreign institutional investors. In order to achieve this more transparency on list companies information associate with more complete disclosure rules are required.
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Because of the convincing and satisfactory response to those requirements, listed companies information and corporate governance are improved, the risk of holding stock reduced and lower the cost of capital. Meanwhile Dara (2000) concluded in most emerging markets, there are significant restrictions to the information distribution and less information disclosure apply to companies with a greater time lag than those in well-developed markets. As mention in other research, Dara (2000) suggested efficient stock market development must accompany by liberalization of financial sector and it is also important to follow prudent macroeconomic policies.

Besides the impacts on the domestic economy, development of financial markets can also be seen as a risk diversification. A global diversification enables better resource allocation and fewer international risks need to bear with. As well as the integration of stock market and global diversification taken place, more advantages on steady-state welfare can be retained. In addition, Frenkel & Menkoff (2004) suggested by limited the types of financial products, information asymmetry between local and other foreign institutional investors, the integrated of emerging and international financial markets will results more and new diversify opportunities.

2.7 Potential Risk of Liberalization Although there is strong evidence on liberalization will benefit the emerging market, several legitimate concerns about the rapid market growth and potential risk need to be considered. First, the widen degree of market development and liquidity will result as volatility increase, trading frequency increase and new information will reflect in price more quickly. Thus, the
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excessive price volatility in some stock markets is required to separate from the real economies. Also the potential risk of bubbles economies, it is common in developing countries where the stock prices rise sharply in the emerging markets. Financial liberalization often lead financial crisis (Daniel & Jones ,2007).The example of Russia financial crisis, at the beginning of 1990s its price-earning ratios of listed stocks rise rapidly on several emerging market and followed a sharp drop in the late 1990s.

Because of the strong inflow of capital so the supporting services, such as the improvements and reforms of bank system, are required. Providing more

credit to market participants can encourage the foreign investors trading and attendant settlements. Consequently, excessive risks might impose when the effort to develop stock market is less- than- adequate market infrastructure (Dara, 2000). Finally, private capital flows to emerging market economies could damage the sustainability of these markets, which may lead unbalance country performance, slowing down the financial reform, and diminish influence of multilateral institutions and injudicious lending. Thus the continue expansion of capital flows and relatively huge scale can weaken external competitiveness and put pressure on monetary policy. Financial instable creates uncertainty that can seriously damage market efficiency and lead a significant economic destabilize.

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2.8 Summary Recalling to the experience of emerging market, both benefits and risks exist at the same time within the stock market opening process. The opening policy is seemed to be two-edged sword; it is not just influence foreigners only. Even it shows the opportunities of attracting foreign capital for financial economic growth but it also hasten the development of equity market. Enlargement in equity market will result as more liquid, more internationally integrated. While increasing the efficiency of the market prices, the market size, variety of market participants and information transparency can both improve and expand. Because of the protection requirements on account management from foreign institutional investor, risk of holding stock and even the cost of capital are able to reduce. Moreover, the sustainability of emerging market may be damaged by the introduction of private investment, which may lead uneven country performance as well. As a result, strong and continue capital inflow will possibly weaken the external competitiveness and put pressure on monetary policy.

The impacts of QFII may not fully demonstrate through the literature review but the liberalization experienced in emerging stock markets is still valuable and remarkable for Chinese authorizes. Also, these empirical findings may be useful in predicting the QFIIs performance in stock market and Chinese stock market future developments.

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Chapter 3 Background of Chinese Stock Market

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3.1 Introduction Accession of WTO is an important event in the Chinese history. It causes a rapid growth in Chinas economy and authorities reforms. All of these changes lead the opening of Chinese stock market to a further step. In this chapter development of Chinese stock market before QFII implemented will be drafted. Besides the history of Chinese stock market, its background such as, type of shares, market, and the regulatory framework will present in this section. Before the QFII implemented - the first policy on Chinese stock market liberalization to foreigners, there are lack of successful stock market opening policies in the past. Therefore, the history of Chinese stock markets development and liberalization process is necessary to explain the appearance of QFII scheme.

3.2 Chinas recent development In December 2001, after years of negotiations, China finally became one of the World trade Organization (WTO) members. In order to match the WTO agreement, many reforms were taken place, especially the increase in Chinese export efficiency and the widely open of its economy to foreign competitions. When its export and economy become more efficient and mature, China may disadvantage more on low cost labors losing. Aside of the changes mentioned, financial sector is another seriously influenced. Since the Chinese market opened to rest of the world, greater accession of foreign banks and insurance companies gained into Chinese market, which including the securities, fund management and also joint ventures companies. Whilst the more accession of foreign institutions, the lower entry thresholds for foreign venture capitalists will be (Suen , 2002).
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According to Burke (1999), there is a crucial advantage expose from the Chinas WTO accession which is the Chinese financial services opened to foreign investment. However, state-owned banks dominated majority of financial sector by holding large amount of non-performing loans (NPLs). When the financial sectors become more mature, the requirements on investment brokerages, risk assessor, invest advisers and other intermediary services providers will expect to strengthen.

Chinas economy continues opening up since the joined of WTO in 2001. According to the latest figure from the National Bureau of Statistics (NBS), the first quarter gross domestic product (GDP) of 2008, is 6149.1 billion RMB and there is a 10.6 percent growth at the same period of last year3. Hu (2004) mentioned an important reason that lead foreign exchange reserves increase and massive capital inflow into country. He indicated that Chinas spectacular growth performance and its status as world factory is main reason of exchange reserve and capital inflow raise. According to statistics issued by the Peoples Bank of China, Chinas official foreign exchange reserves amounted to 1528.249 billion US dollars by the end of 2007. Now China is ranked as the 3rd largest exporter and importer. In the first four months of 2008, the total imports and exports amounted 7912.6 billion US dollar and reach a 24.4 percent of growth compare with same period in 2007. Chinas foreign trade has been growing at a much faster rate then the world trade on average for over two decades. Market opening and economic growth has made China target more on foreign direct investment.

Gross Domestic Product (GDP) (First Quarter,2008) From http://www.stats.gov.cn 36

3.3 Brief History of Chinese Stock market Chinese securities trading emerged in Shanghai in 1984 and four years later 1988, there are four professional securities trading corporation formed in order to help business to issue their bond and/or shares. In the early 1990s the over-the-counter exchange systems: the STAQS and the National Electronic Trading System were established.

Nowadays, there are two stock exchanges in mainland China which located at Shanghai and Shenzhen. The Shanghai Securities Exchange (SHSE) was formally opened on 19th December 1990, at the end of 1994 there were 168 companies approved to listed in SHSE which is much more than in 1991, just only 8 companies (Green , 2004). Also on 3rd of July 1991, another stock exchange, Shenzhen Securities Exchange (SZSE), was formally opened. This exchange allows issuing B-shares to attract foreign funds enter China, the number of stocks listed increase quickly from only 19 at the end of 1991 to 138 by September 1994 (Green, 2004). By the end of 2007, 1,550 companies were listed in Shanghai and Shenzhen stock exchanges, with a combined market value of RMB 32.71 trillion and accounting for 140 percent of the country's GDP (Zhang, 2008).

However these two stock exchanges took a difference role within the stock market. Shanghai stock exchanges are mainly dominated by large state-owned enterprises as well as it is monitored closely by Chinese government, therefore, the stock performance in this stock exchange are usually treated as an indicator of Chinese domestic economy. In contrast, most of the manufacturing and export companies which have a close relationship
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with Hong Kong, are listing on Shenzhen stock exchange (Green, 2004). It makes Shenzhen stock exchange relatively more international base than Shanghai stock exchange.

3.4 Capital Control Closed Capital In order to measure the economic openness, Hu (2004) suggested using trade/GDP or FDI/GDP as indicator which are the same as in China Statistical Year Book 2003. Hu (2004) also found out that China ranks one of the most open among the worlds large economies. However, the openness of capital account is incompatible with that of economy.

Because of the huge capital inflows and foreign exchange reserve, which give big pressure on the countrys exchange rate regime Therefore, in July of 2005, the Peoples Bank of China, the nations central bank, announced that RMB no longer peg to US dollar and re-peg to a basket of currencies. Meanwhile, the exchange rate for US dollar to RMB reduced by 0.17 to 8.11; which means, RMB immediate appreciates 2.1 percent against US dollars (Lenard, 2005). Within the top ten global trading nations table (table 3.4.1), it is obvious showed that China is the only one who still has capital control , maintained widespread restrictions over the movement of cross-border capital. Under the Chinas closed capital account, the restrictions on inward portfolio investment are very tight.

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Table 3.4.1 Top ten global trading nations

Source: Hu (2004)

Even through China has eliminated most restriction on inward foreign direct investment, there are still have wide-ranging controls over portfolio investment such as equities, bonds, bank loans, currencies, commodities and derivative instruments. In order to deal with the obvious incompatible between Chinas closed capital account and a higher degree of country economic opening, QFII scheme established. It allows the foreign investors to invest in the domestic listed, denominated by local currency stock, such A-shares, corporate bonds, exchange trade funds and other securities. The adoption of QFII is an early step to match the openness of capital account with the economy, relaxing the capital control.

3.5 Type of Share Until now, the regulatory framework has been set up nationwide automated trading system and professional terms are formed in security market. However the market is still not consummate and partially illiquid. There is only about
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one-third of total shares were allowed to circulate and the rest of shares are non-circulating share, meaning those share cannot be traded on market freely. Even so the circulated share can be categorized into different type according to investor, issuer and currency.

3.5.1 Non Circulating shares Government Owned share, these are the shares directly owned by government and it occupies the largest amount of total stock, 46% at the end of 2001, in its capacity as sponsor of IPOs. (Naughton, 2007) Sponsor legal persons, they usually are stated owned corporations, the parents of the listed firms, in some cases, they are holding companies established to manage government shares. These two types of share are making up with a direct and indirect government control.

Private Placement of Legal Person Share, the ownership of this share type reflects the continuing interest of firms that listing sponsored in the first place. However, this type of share cannot be sold on the market, they can be only transferred through private placements, by the end of 2005, 5.3% of total share was traded in this way. Worker Share, it takes over a small proportion of non-negotiable shares and they were issued to workers within the companies, but these shares have now virtually disappeared. (Naughton, 2007)

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Table 3.5.1.1 Capital Structure of Listed Firms Percent of Total Shares 2001 I. Non Circulating Shares IA. Sponsors Shares Government-owned Sponsor Legal Person IB. Private Placement of Legal Person Shares IC. Worker Shares II. Circulating Share A- Shares B- Shares H- Shares 65.3 59.8 46.2 12.7 4.7 0.5 34.7 25.3 3.1 6.4 Source: Naughton, 2007 p. 470 2005 61.8 53.4 5.3 0.1 38.2 29.9 2.9 5.4

3.5.2 Circulating Share Circulating shares are the share traded in segmented market. A-Shares, which are the primary share type traded. It is the share that available only to Chinese citizens so it is denominated in Chinese currency. B-Shares, are denominated in foreign currency and were originally reserved for foreign investors, however, Chinese citizen may able to hold them now as well. H-Shares are shares listed by Chinese companies on Hong Kong Stock Exchange and N-Shares (American Depositary Receipts ADRs) are shares issued by Chinese companies and trade on New York Stock Exchange. In August 2005, 117 firms have issued H-shares and all but two were listed on the

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Hong Kong Stock Exchange, excepted two were listed in Singapore only. Moreover, 17 of H-shares companies have joint listing in New York or London. (Ma, 1996, Naughton, 2007). Red Chips are shares of the Chinese

enterprise but listed in Hong Kong Stock Exchange, the Chinese institutions or enterprises normally withhold the largest quantity of shares in those red chip companies. These shares are traded in Hong Kong but derive most of their profit from business in mainland China (HSBC web site)

Chinese policies markers want to collect Chinese household saving but also tap into foreign capital without exposing themselves to the possibility of destabilizing capital flow. Therefore A-shares are usually priced higher than B-shares and/or H-shares, intend to limit the investment options available to Chinese households (Chan , 2001). Because of the market inefficiencies, B-shares market does not expanded as rapidly as A-shares market. B-shares market is appearing less liquidity and inactive than A-shares market (Naughton, 2007). Nonetheless, Red Chips are more attractive to foreign investors than B-shares because it offers foreign investors more disclosure of Chinese companies through a more transparent lens of Hong Kong stock market (Chan , 2001).

3.6 Type of market Similar to other stock markets around the world, Chinese stock markets also consist of primary market, which allow companies to issue their initial offering (IPOs), and the secondary market where shareholders can trade their stocks.

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3.6.1 Primary Market Chinese companies can initially issue their shares by either internal offering or public offering. Internal offering share which is similar to the Private Placement of Legal Person Share, meaning a firm can sell its stocks only to its own employees with a discount. Same as private placement of legal person share, internal offering shares are not able to trade in any secondary market as well. Approvals from firms supervisory industrial bureau, and other government agencies, including China Securities Regulatory Commission (CSRC), State Council Securities Policy Committee (SCSPC) and the Peoples Bank of China (PBC) etc must be needed for issuing internal shares. Moreover, the annual stock issuance plans are jointly established by those departments. Every providence will be given a quota and conclude the finial decision base on firms qualification, stock market condition and new government policies (Green, 2004).

3.6.2 Secondary Market Chinese Secondary Market contains investors, market marker, organized exchange and various brokerage firms etc. In China, security investors can be divided into two main types, most of the investors are individual investors and institutional investors just consist of a small amount. Individual investors can be divided into two types, general investors and prestigious investors. The difference between general and prestigious investor is that, prestigious investor can directly access to a network computer4, at least RMB 100 000 capital stock and a monthly fee paid to brokerage firm are required (Ma 1996,

The network computer offers current market information from SHSE and SZSE. It is a software that perform technical analysis of the stock price movement. 43

Green, 2004).

Nowadays brokerage firms are taking an important status in Chinese stock market. Shares can only trade through brokerage firms therefore every investor needs to hold an account with brokerages firms. Ahead of any stock transaction, brokerage firm need to get hold of the corresponding stock certificate. At the present time, transactions are replaced by networked computers which allow direct connection to the broker from respective brokerage firm in stock exchange (SZSE & SHZE web site). Therefore, it is difficult to see any completed transaction by transferring the physical copy of stock certificate now.

Moreover, the Chinese stock exchange is following four operational principles: electronic trading, central settlement, no physical exchange of certificates and automatic transfer. For example, in SHSE, potential sellers can only trade on stock market after share certificates deposited. Thereafter, member of stock exchange, like a brokerage firm, can ask price on its computer and wait the potential buyers to agree with (bid price equal ask price), then trade will take place. Also the deposited certificates will be checked and ownership will transfer automatically. Even this system is complicate but it minimizes paperwork and speed up the transactions (SZSE & SHSE web site)

3.7 Problem of the Stock Market As Wang (2004) argument there are still many problems appear in Chinese stock market because the lack of advanced regulatory experience under an immature economy. Firstly, there are too many share types which confusing
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investors, except the well-know A-shares and B-shares, there are several additional share types available to foreigner, such as H-shares, N-shares, Red chips, Blue chips, and these entire shares are denominated in free exchangeable currency.

The development of Chinese stock market causes problems on the institutional investors development. Institutional investors, such as mutual funds, pension funds and insurance companies. They are the shareholders usually large in size and interest in monitoring enterprise performance. Institutional investors are also serving as patient owners with long-term interest in improving corporate governance and performance (Gleave & Kazer, 2007 and Naughton, 2007). Since the disclosure standard of China is far behind than those mature markets, the interests of institutional investors may be reduced. In additional the market is highly inefficient so the traded companies only have to provide limit information. As a result, it becomes a vicious circle.

Moreover, the Chinese stock market is thin, meaning that the supply of desirable shares is quite limited (Gleave & Kazer 2007 and Naughton, 2007).

The market contains many small-cap stocks instead of occupied by big blue-chip companies. Also most of those blue-chips are only listed on oversea exchanges which mean those blue-chips are not tradable to Chinese residents. Because the underdeveloped of Chinese retail investors and institutional investors as well as the limit share types available for Chinese citizen to invest. Hence, shares price are pushed up and lead Chinese stock market to a bubble market.

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Until 2001 Chinese disclosure and regulation standards were extremely poor which cause liquidity problems. From that time outwards information disclosure standards were improved. Nowadays, the corporate reports must be post on internet and competitive business press transparency is also improved. Regardless of these improvements, the disclosure standards and information reliability are still far behind the standard of developed economy market. (Naughton, 2007). Also the regulatory system was put focus on protecting

the right of government as the owner of the companies, in another word, the protections on minority shareholders are weak. Because of the limitations given on companies information and shareholder control, the Chinese stock market is simply affected by the change in government policy (Chen, 2003).

Furthermore, the IPOs are strictly regulated and the market is the low contestability of control in China. Since Chinese government is one of the sponsors of the IPOs and the government owned nearly two-third of the total shares (Chen, 2003, Naughton, 2007). Also the state owned and legal person shares are not able to trade in secondary markets, obviously the non-transferability of state share disallows the government to sell its shares and reinvest in other firm. On account of the ownership system is dominated by government, sometimes stock market listings have only led on to privatization, in which legal- person shares have been placed with private investors.

Finally, the two stock exchanges in China have a similar size and performing virtually same function on every aspect. The market structure is contradicting to the global trend of combining multi exchange into one single stock exchange.
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Thus, the special stock market features result as a remarkable impact on foreigners contribution to Chinese stock markets.

3.8 Regulatory Framework In China, State Council Securities Policy Committee (SCSPC) and the China Securities Regulatory Commission (CSRC) are responsible on regulating the stock market. They were established and began to intervene in the market in 1992. Because of the establishment it allows the Chinese authorities to develop stock market more actively. Besides that the measures improvements allow the supervision and regulation of stock market become more complete. Nowadays the regulatory framework has been set up and the Shanghai Stock Exchange, Shenzhen Stock Exchange, regional offices and the Securities Association of China are all under CSRCs supervision.

Since December 29, 1998 the Securities Law passed, it impacted the development of Chinese stock market seriously. After the passing of Securities Law, a series of policy regulatory and progress on regulating investor, listed companies and government behaviors were established by the Chinese authorities. At the peak time 2000, there were 1086 listed companies with a market capitalization of RMB 4800 billion approached 50 percent of GDP. However, four year later the total capitalization had fallen to 23 percent of GDP (Naughton 2007). By the end of 2007, there are 1530 listed companies in two stock exchanges and its market capitalization surpassed 50 percent of GDP. (SZSE and SHSE factbook, 2007)

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Diagram 3.8.1The Structure of CSRC

Department and Offices Regional Offices CSRC Shenzhen Stock Market Shanghai Stock Market

The Securities Association of China

Source www.szse.com.cn, Zhang(2001)

The current Security Law5 was at the 6th meeting of the Standing Committee of the Ninth National Peoples Congress on December 29, 1998. Nowadays, security law is important on maintaining and promotion the development of Chinese securities market, however, the law is insufficient in some aspects because the provisions are too general. Moreover, the law did not take the update situation into account, such as the possible securities industry challenges face after the accession of WTO.

Full Security Law http://www.csrc.gov.cn/n575458/n4001948/n4002075/n4002315/4059170.html

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3.9 China Stock Market liberalization In the early 1990, the establishment of B-shares market is the initial opening of Chinese stock market; it was dominated by foreign currency and available exclusively to foreigners. Since 2001 Chinese citizens were permitted to own or trade in B-shares, similar to other shares which are dominated in RMB. Opening of B-shares created two windows for Chinese capital markets; B-shares market is treated as a channel to help the small amount of Chinese State Owned Enterprises to reserve limited foreign currency ; reveal to foreign investors how did the Chinese authorizes solve the opening problems of stock market and economy , is account as another windows (Chao, 2003). Through years development in B-shares market, there are still lack of listed companies in the market and does not contribute much to the whole market capitalization. Hence, the choices of stock available to foreign investors are absolutely limited. Thus, it is a subject to argue that stock market liberalization is to opening B-shares market to its domestic investors because the policy does not create new avenue to foreign investors (Chen & Yu, 2004).

Other than B-shares, some Chinese companies will list their share in other oversea security market, aimed to gain more investment funds from foreigners, for example, the H-shares, N-share, L-shares and S-shares. Hence, H-shares are the share offered by Chinese companies and listed on Hong Kong Stock Exchange. As this share type can be trade by Hong Kong local investors and other international investors, these shares are promised to trade in Hong Kong dollars but denominate in RMB. N-shares are share issued on New York stock exchange and they are subscribed in US dollar and denominated in RMB. However many N-shares are not trade directly on stock exchange, they are
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issued by the ways of ADRs (American Depository Receipts). L-shares and S-shares are shares offered on London Stock Exchange and Singapore Stock Exchange respectively. (Green, 2004 ). However, those types of shares are the process of Chinese stock market liberalization; they are just another way for stock listing and trade.

Only consider as a real liberalization, an emerging country should open its domestic market to foreign institutional investors and complete opening finally. Many Chinese economists such as Jiao (2003) used Taiwan QFII as reference to predict the impact of Chinese QFII scheme. In1991 Taiwan was formally attempt the qualified foreign institutional investor (QFII) scheme, through the scheme qualified investors permitted to buy and trade Taiwan listed securities directly. After three main reformations over the 10 years implementation and development, Taiwan stock market achieves the expected result under QFIIs contributions and finally liberalizes its capital market.

In contrast, CSRC and Peoples Bank of China (PBC), the two regulators on Chinas financial markets, jointly established the Chinas QFII regulation and system in a decree titled, Provisional Measures on Administration of Domestic Securities Investment of Qualified Foreign Institutional Investors (QFII), in November 2002. It notified the first step of liberalization where foreign institutional investors can directly enter into Chinese stock markets.

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3.10 Summary Regarding to the accession of WTO, Chinese economy grow rapidly and its stock market show its talent to be the top in the world. However, due to the immature Chinese stock market, many problems are still questioning the direction of its markets to be fully liberalized. Therefore to achieve better result, Chinese authorizes need to put more effort on improvements in every aspects. In next chapter current status of QFII will be examine in detail and follow with a comparison of Taiwans QFII scheme.

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Chapter 4 China's QFII scheme and Comparison with Taiwan's QFII scheme

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4.1 Introduction Since the entering of World Trade Organization in 2001, QFII was initially launched in China on November 5, 2002. The Provisional Measures on Administration of Domestic Securities Investments of Qualified Foreign Institutional Investors (QFII) was issued by the Chinese Securities Regulatory Commission (CSRC) on September 11, 2006. The QFII regulation is absolutely a successful policy which initially allows foreign investors to invest and trade A-shares in Chinese history. The following chapter will discuss the basic concept of QFII regulations and recommend the future developments depending on Taiwans QFII experience.

4.2 QFII definition QFII, Qualified Foreign Institutional Investment, it is a kind of transitional policy especially designed for emerging market. Such scheme is usually used to overcome the restrictions of exchange freely, and closed-end capital policies to foreign investors. As a result, attract more foreign investments and open the capital markets gradually are the main objectives of such scheme. Emerging markets such as South Korea, India, Brazil and China Taiwan province and etc, used this scheme for market liberalization. After adopted such scheme from early 1990s in those emerging countries, stock market liberalization is accelerated in a relatively safe environment and its effectiveness was being proved (Chen, 2006). Therefore in the case of China, QFII is the ideal choice for attracting more foreign portfolio investments to enter Chinese market until renminbi (RMB) became freely convertible.

In China, a QFII is referring to a foreign fund management company, a foreign

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insurance company, a foreign securities company or other asset management companies that have been approved by the CSRC to invest in China securities markets and obtained a quota from the China State Administration of Foreign Exchange (SAFE) to remit foreign exchange into China to make securities investment. As China has constantly restricted foreign exchange control, such scheme is used to enhance the entry of foreign capital and companies into Chinese securities market. Because of the QFIIs activities and qualifications are strictly regulated, the potential interruptions cause by massive capital inflow can be minimized as well.

Besides of the main objectives - promotion of convertible capital account, Chinese authorizes want to improve the corporate governance in the market. Introduction of QFII enable traditional domestic listed companies to learn more advance management techniques from foreign professional investors, in which, encouraged domestic listed companies to repackage themselves for attracting more new investments from foreign qualified institutional investors (Li et al., 2007). In stead of benefit to domestic listed companies, domestic individual investors can also improve their risk management knowledge, investment strategy from the introduction of QFIIs.

4.3 QFII Application and Operation procedures In order to apply for QFII status, a foreign investor / candidate must assign a domestic bank or a foreign banks branch located in China to act as a custodian. The custodian need to submit all application documents, including the application forms, the most recent 3 years audited financial reports, statement on sources of funds etc, to both CSRC and SAFE on behalf of the
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foreign candidate. After the application documents are completed and sent to CSRC and SAFE, decision on the application will be made within 15 working days. In order to encourage medium and long-term investments, preference will be given to the institutions managing closed-end Chinese funds subject to the requirements of pension funds, insurance funds and mutual funds with good investment records in other markets. As soon as the foreign candidate has been approved by CSRC and become a QFII, then the candidate will receive a Securities Investment Licences from CSRC. The QFII applicant can then apply the investment quota from SAFE. This quota is the maximum amount of the foreign exchange that a QFII allows to remit in Chinese securities markets. Therefore, the total investments for QFII in Chinese securities market must not exceed this quota. Nowadays, SAFE has established the minimum investment quota of US$ 5 billion at least and raises the maximum from US$8 billion to US$ 30 billion (Gave, 2007).

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Diagram 4.1 QFII application and operation procedures

Prepare to invest in China s share market

Cannot Invest
Qualified as QFII ?

Hand in application document to CSRC

Appoint one or two domestically registered broker to conduct trading in the exchange

Open a special RMB account at an

Qualified as QFII

approved custodian bank

Custodian bank opens a security account

Apply investment quota form SAFE

for QFII

Exchange foreign currency into RMB QFIIs broker opens a special security account for QFII

Obtain investment quota

Invest in China domestic security markets

Become QFII

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4.4 Characteristic of QFII 4.4.1 Avoid market fluctuation When opening the stock market in developing countries, there are two ways to raise foreign funds, one is indirect way and the other one is raise funds directly. The indirect way mean that the foreign funds are raised by issuing the beneficiary certificates or shareholding certificates to oversea investors and then such fund will be used for investing local security market. Hence indirect way represent the domestic stock market is opened to foreign investment funds which target the same stock market which one country. It is the method chose at the beginning of Taiwans QFII adopted (Lu, 2004). In contrast, Chinas QFII skipped this step and used a direct way. This direct way of investment allows the foreign institutional investors to operate the dealing system of Chinese securities market and compete with local investors. The reason why China used direct way is because the scale of its security market and foreign reserves are far forward then Taiwan and Korean (Xu & Qu, 2003, Lu, 2004). Under such circumstances foreign investors allow acting independently, however, market go larger and mature, the more difficult to coordinate the investors in the market and transaction activities may suffer from global economic situation.

Because of the massive capital flow follow by the introduction of QFII, high quality capital inflow control must be established, such as strong capital inflow control and complete perfect monitoring measures. Unfortunately, the stock price will be affected and volatilize by the world market easier, due to the stock market opening. Therefore the quota set in the QFII regulations limited the capital inflow and minimize the capital fluctuation.
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4.4.2 Scope of QFII The range of qualified institution investors quoted in Chinas QFII is much wider than Taiwan. At the early stage of Taiwans QFII, it just allowed the fund management institutions, insurance companies and bank to join only, alternatively, the securities company and other assets management companies were forbidden. According to the Provisional Measures on Administration of Domestic Securities Investments of Qualified Foreign Institutional Investors (QFII) , the qualified institution investors include overseas fund management institutions , insurance companies , securities and other assets management institutions which have been approved by China Securities Regulatory Commission (CSRC), those institutions mentioned are nearly all the investment institutions inside China . And the examination on qualification are more strict ,for example, the qualified institutions must not have less than US$10 billion assets management in the most recent account year ( Wang, 2008 ,Lu, 2004 & appendix 1 ).

4.4.3 Investment Sectors Control Chinas QFII offers qualified institution investors and local security investment fund quite large freedom especially on investment scope, share types and the shareholding scale etc. Usually foreign investors may want to takeover listed companies by purchasing majority stocks of the corresponding listed companies in secondary market. In order to avoid the risks of important

sectors in the country may be takeover by foreign investors, restrictions such as identifying some non-invest sectors for foreign investors and set the maximum shares which foreign investors can hold are essential. Hence, the provisional measure mentioned that except B-shares, A-shares, Government
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bonds, Convertible bonds, Corporate bonds and other financial instruments are permitted to invest in (Zhang & Zheng, 2003, Lu, 2004 and appendix 1). Also there are some areas prohibit to invest, such as, state safety sector, secret recipe of Chinese traditional medicine, fundamental telecommunication and futures industry etc. All permitted, restricted and prohibited industries sectors for foreign investment are outlined in Foreign Investment Industry Guidelines6.

Chinas QFII provisional measure clearly stated that the share held by each QFII in one listed company cannot exceed 10 percent of total outstanding share of that company and total share held by all QFII in one listed company should not exceed 20 percent of total outstanding of the company. Compare with Taiwan, it limited all foreign investment in one listed company a maximum 10 percent at the beginning of regulation set up (Zhang & Zheng, 2003, Lu, 2004 and appendix 1).

4.4.4 Foreign Exchange Control When a country opens their stock market to foreigners, the certain foreign currency has to exchange to local currency for purchasing local stocks. The foreign investors need to sell and buy the local currency to transfer profit and capital in and out of the country. Therefore the capital inflow and outflow will affect drastically to the countrys foreign market. As a result, restrictions on capital flowing are essential. Looking at the establishment of Taiwan QFII, it

For details of those industries, refer to Catalogue for the Guidance of Foreign Investment Industries (Amended in 2007) http://www.fdi.gov.cn/pub/FDI_EN/Laws/law_en_info.jsp?docid=87372

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also took restrictions on capital flowing. It required the foreign capital must be remittance within three months after approved and in the fowling three months capital cannot be repatriated. Moreover the gain from investments can be counted and remittance once a year. Compare to Taiwan, the restrictions in China are more conscientious. The principal and interests can be repatriated three years after its remittance of the principals. The amount of each batch of principal repatriation should not exceed 20% of the total principals, and the interval between two repatriations should not be shorter than one month (Zhang & Zheng, 2003, Lu 2004 and appendix 1). These restrictions are undoubtedly control the risks cause by international flowing capital and the dangers of larger scale maliciously capital withdraw can avoid, so long term investments from QFII are also encouraged.

Nowadays, foreign exchange restrictions has relaxed more than before but RMB is still not able to convert freely especially on the foreign currency capital account. Conversely, there are some argument on the free convertibility of RMB is necessary for A-shares market opening. Freely convert of RMB

allows large amount of foreign capital enter Chinese market, also, the incentive for foreigners to keep RMB in cash can remove as well. Many securities markets in other countries, such as India, Brazil , Korea and Taiwan etc, were also opened to foreign investments without freely convert their currency in before hand. Thus, from the other counties experiences implied that non-convertibility of RMB (Mundell ,2002 ,Chu,2007) should not influence the Chinese stock markets liberalization.

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4.5 Limitation and Risk of QFII regulation Undoubtedly, the introduction of QFII pushes the development of Chinese foreign investment legal framework to another advance situation. The sophistication investment process, confidence of the domestic individual investors in China and the quality of the domestic investment professionals, they are the factors which determine the quality of the QFII policy. In the following section limitations of QFII regulations will be discussed.

4.5.1 Limitation on QFII investors In the article 2, the qualified investors definite as those oversea fund management institutions , insurance companies , securities companies and other assets management institutions which are approved by China Securities Regulatory Commission (CSRC) and assigned investment quota by State Administration of Foreign Exchange (SAFE). Except the three types of institutions are clearly stated, the qualification of other institutions are definite vaguely in article 6. In this article, it just mentioned the requirements on financial, credit status and other aspects only. Thus, it dose not give a clear legal instruction on whether other institutions like government investment institutions and unit trust institutions are qualify as QFII. These confusions inside provisional measure implying that there are inadequacies compare to the formal legislations (Wang, 2006, Wu, 2008). While Chinese government wants to attract more mid- and long- term foreign investments, the high qualification standards, asset holding requirements and the experienced operation history , all of these limitations may block out many worthy and interested foreign investors from Chinese security market.

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4.5.2 Limitation on QFII operation Nowadays, the provisional measures restricted the qualified foreign investors to choose their custodian bank. The investors can only choose one domestic custodian bank to carry on their capital management. Until now there are only 13 custodian banks (Table 4.5.2.1)7 can do the capital custody.

Being with the lack of freedom on choosing suitable a custodian bank, the QFII cannot compare the service of each bank. In order to enjoy better service, the transaction cost of switching back will increases as well. Hence, if a QFII chose a wrong bank at the beginning, then it can just endure to the poor service provided by that bank. As a result QFII needs to bear larger risk while their accounts are completely management by one custodian bank (Hu , 2008). Furthermore, as mentioned in part 4.4.4 the capital can be repatriated 3 months after it entry Chinese market. In which risk of maliciously withdraw of capital can be prevent but also limit the liquidity of QFIIs investment on global level.

According to the analysis made by Hu (2008), he judged that QFIIs are longer acting as long term and worthy investors. Because he categories QFII into two types, sell side and buy side. The buy side QFIIs will usually use their investment quotas for self-trading or set up a Chinese fund which is management by themselves or other trustees. In contrast, the sell side QFIls, which include UBS, Deutsche Bank, Merrill Lynch, Nomura Securities and etc. They will retain some quotas for self-investment and lend most of their

http://www.csrc.gov.cn/n575458/n4001948/n4002030/10801331.html

62

investment quotas to other investment institutions, in order to gain commission from it. Regarding to the globalize trend, invest in China, appreciation of RMB and the bull market of A-shares, many foreign investors want to entry Chinese market. Until now the investment quotas are still limited therefore renting the QFIIs quotas will give a huge amount and risk-less profit to those sell side QFIIs. Furthermore, Hu (2008) and Pettis (2003) also stated that those who rent the quotas are not long term investors, they are the investors who targeting for short term profit only and their investment funds are counted as hot money. Consequently, market stability will be easily damaged by the hot money effect. If there is a downturn happen, those hot money investors will be the first one who escapes the market. The present securities market is volatilized where there is a large group of hot money investors containing inside the market.

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Table 4.5.2.1 List of Custodian Bank Name of the Custodian No. Bank 1 Industrial and Commercial Beijing Bank of China Limited 2 3 4 Agricultural Bank of China Beijing Bank of China Limited China Construction Bank Beijing Corporation 5 Bank of Communications Shanghai Co., Ltd. 6 7 8 Hua Xia Bank Co., Limited Beijing China Everbright Bank China Merchants Bank Shenzhen Co., Limited 9 10 CITIC Industrial Bank China Minsheng Banking Beijing Corp., Ltd. 11 12 Industrial Bank Co., Ltd. Shanghai Pudong Development Bank Co., Ltd. 13 Bank of Beijing Co., Ltd. Beijing 3-Jun-08 Shanghai 10-Sep-03 Fujian 25-Apr-05 9-Jul-04 Beijing 18-Aug-04 6-Nov-02 Beijing 23-Feb-05 23-Oct-02 3-Jul-98 18-Mar-98 Beijing 29-May-98 7-Jul-98 24-Feb-98 Registration approved date Place of Qualification

Source : www.crsc.gov.cn

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4.5.3 Lack of regulation on information disclosure There is still lack of information disclosure regulations, especially on QFIIs investment aspect. The information such as, proportion of share that QFII held and the companies invested can only view on the CSRCs quarterly report and unfortunately only the top ten share-holdings will be shown. In contrast to Taiwan, they required all foreign capital flowing to be shown on stock exchange everyday. Because the size of foreign capital is relatively large, this policy can avoid any illegal investments happen and better supervision on QFIIs investment behaviors can be provided by administration departments. (Ji, 2007) As a result, general investors can access the QFIIs investment decision more easily. The comparison of Taiwans information disclosure system and Chinese one, Chinas information disclosure system of QFII is definitely far behind and incomplete.

4.5.4 Weakness on QFIIs shareholding control As declared in provisional measures the maximum investment of 10 percent in a single company and maximum 20 percent of combined shareholding of all QFII in a single company (Wang, 2006). This regulation is seem to be efficiently control the listed company takeover by foreigners, but it is just a limitation the scale of A-shares investment in secondary market only .

In fact, there are still many ways authorize foreign investors to gain shareholding in listed companies. For example the Notice on State-owned Legal Person Share Transfer to Foreign Trader made by CSRC and Ministry

65

of Finance (MOF) on November, 2002 8 , and Measures for Strategic Investment by Foreign Investors upon Listed Companies9 jointly made by CSRC , SAFE, Ministry of Commerce (MOC), State Administration For Industry & Commerce and State Administration of Taxation in December , 2005, both of them allow the foreigners to buy and own different kinds of shares legally and relatively easier than through QFII. Even though foreigners cannot own majority shares through QFII scheme, foreign investors still have other opportunities to gain shareholding of domestic listed companies (Hu, 2008).

4.5.5 Centralize of approval process Throughout the QFII measures, approvals are required for every single aspect in the application and operation. The government agencies are required for the QFIIs qualification and receiving of investment license, obtaining investment quota from SAFE. Moreover, the set up of special RMB account for QFIIs investment, the choosing of custodian banks and even the capital repatriation are all restricted by central government. While the foreign investors getting approves from the governing authorizes, such as SAFE & CSRC, the more uncertainties foreign investors may face where those authorizes have absolute right on adjusting the qualitative standards and rejecting the foreign investors

For Detial of the Notice on State-owned Legal Person Share Transfer to Foreign Trader http://news.sina.com.cn/c/2002-11-04/1253794928.html Full Measures for Strategic Investment by Foreign Investors upon Listed Companies http://www.for68.com/new/2007%5C1%5Cwa23822943441221700218816-0.htm
9

66

4.6 Reasons of choosing Taiwans QFII as example Taiwans QFII experience gave China a good opportunity to learn from. Its stock market has a longer history than Chinas one, it was established in 1961. In the early of 1990, individual investors were the majority player in the market, nearly 96.6%, which is quite similar to Chinas stock markets nearly 99% are individual investors. At the moment of QFII launched, 1991 & 2002 respectively, Taiwans stock market PE ratio is about 32.05 while there is an average 30 from the two stock markets in China. However, these PE ratios are already much higher than other advanced markets, for example in 1991, the PE of London Stock Exchange and New York Stock Exchange was just 14.2 and 15.08 respectively. Moreover, as Taiwans QFII was abolished in 2003 therefore it is worthy to use as an example to investigate for improvement of Chinas QFII regulation (Lin & Chen, 2006).

Diagram 4.6.1 Comparison of PE ration in Major Stock Market

Source: Lin & Chen , 2006

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Apart from the obvious similarity of high PE ratio and market structure between Taiwans and Chinese stock market during the period of QFII implemented, there are some minor reasons which make Taiwan to be a good example to compare with. Emerging market like India and Korea, both adopted similar

liberalization policies as QFII. For India, its government launched a Foreign Institution Investors (FII) scheme in 1992. The qualification criteria and investment choice, shareholding proportion are both similar to Taiwans QFII scheme. Indias FII a allows investors who are professional , good reputation and approved by the Reserve Bank of India - Indias Central Bank and the primary and secondary stock market , including share, bonds, unit trust and etc are open to foreigners. The shareholding is basically same as Taiwans QFII which limited to 10 percent for one FII and 20 percent for all FIIs (Cai2002). While Taiwans QFII is already fully liberalization its stock market, India is sill implementing FII (Indian Reserve Bank web site). Base on the smaller degree of Indias market liberalizes than Taiwans, therefore, Taiwans the successful liberalization experience is a better example.

For Korea, the process of introduce QFII scheme is similar to Taiwan as well. At the beginning of QFII introduce, Korea launched two international unit trust investment funds, which used to attract the foreign investment fund to investment in Korea market and this scheme lasted for 11 years (Lu, 2004). As mention in chapter 4.4.1, Chinese QFII skipped this step in attract foreign investment directly because of greater foreign reserves and securities market scale. Even the introduction process Taiwan and Korea are different with China, the liberalization process of Taiwan much ahead of India and the similarities of Chinese stock market structure and PE ratio which market Taiwan be the best
68

example for comparison with China.

4.7 Brief History of Taiwans QFII Taiwan was formally introduced QFII scheme in 2nd of January, 1991, and it has experienced three important stages during its development process. The first stage in February, 1995, the limitation on all QFIIs total quota was cancelled by government and nearly 3 years later , December 2000, the restriction on individual QFIIs and all QFIIs shareholding in one listed company were deregulated. The final stage was happened almost the same time as China launched its QFII scheme - Taiwans market abolished the QFII scheme. The abolishment implied that the capital market is fully opened up and shaped; also the capital inflow and outflow of QFII are free to proceed in whole stock market (Cai2002).

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Table 4.7.1 Taiwans QFII History

All QFII Share Holding in One Company Individual QFII Share Holding in One Company ALL QFII Allowed Individual QFII Quota (US$ Million) Allowed Quota (US$ Million)

Jan-91 Jan-93 Aug-93 Nov-93 Apr-94 Feb-95 Jul-95 Sep-95 Dec-95 Mar-96 Nov-96 Dec-96 Jan-98 Mar-99 Nov-99 Oct-00 Nov-00

10%

5%

250

0.5~5 10

500 20 750 No Quota Limit 12% 15% 6% 7.50% 40 20% 25% 10% 60 30% 50% 15% 50% 120 150 200
Except special industry , deregulate individual QFII

Dec-00
and all QFIIs shareholding in one company

Nov-01 Jul-03

300
Abolish QFII scheme, foreign capital free to flow in Taiwan's Security Market

Source :www. tse.com.tw

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When Taiwans QFII implemented, the main investors were from Asia countries. The main reason is that Asian investors were more familiar with Taiwans market than other foreign investors; also the barrier of entry market was relatively lower than China at that moment. Therefore small and new investors were willing to entry, until the market became mature and more liberalize European and US institutional investors joined in the market.

Chart 4.1 Taiwan's Investors Distribution 1991

6%

12%

48%

34%

US

Europe

Asia

Other

Chart 4.2 Taiwan's Investors Distribution 2001 4% 43%

11%

43%

US

Europe

Asia

Other

Source: www.twse.com.tw

In contrast, even the Chinese government has set high entry qualification for QFIIs, US and European investors are still the main investors in Chinas market. From the statistical data showed that American and Asian investors

71

are increasing since the stock market liberalized (Chat 4.3 & 4.4).

Chart 4.3China's Investors Distribution 2003

18% 36%

46%

US

Europe

Asia

Chart 4.4 China's Investors Distribution 2005

26% 42%

32% US Europe Asia

Source: www.sse.com.cn and www.szse.com.cn

4.8 Comparison of QFII regulation between China and Taiwan On behalf of the evolvement of investment quota and shareholding which mentioned in the above section and table, there are three more aspects need to be outlined. First aspect is the relaxation on Taiwan investors qualifying criteria, the security asset under its management reduce to at least US$ 200 million from US$300 and US$500 million on banks and insurance companies respectively, for fund management institution, the total investment fund managed required at least US$ 500 million at the beginning and reduced to at

72

least US$ 200 million in 2001(Cai, 2002). The table 4.8.1 below will give a more detail on how investment qualifications evolve.

Table 4.8.1 Detail of Taiwans Investment Qualification Evolvement Bank Insurance Company Fund Management

Institution The Total Years operating in Total security asset Years of setting Total investment fund managed (US$ million)

World security Rank of total asset (top_) Jan 1991 1993 Aug 1995 May 2001 none 2 1000 1000 3 3 500 3 asset

managed insurance managed up (US$ million) business (US$ million)

10

5 3

5 3

3 3

3 3

Source : Zhang & Zheng , 2003

At the beginning of Taiwans QFII scheme carried out, it limited the capital inflow and outflow. Similar to Chinas QFII regulations, it required the principal of QFII to be remitted within 3 months after qualification approved and the

73

principal cannot repatriate 3 months after. Moreover Taiwans QFII limited the times of capital inflow and outflow, it cannot exceed four times a year. In 1996, the restriction on repatriation of principal and profit gained were abolished and to more further, there is an allowance to report to foreign exchange department when remitting capital less than US$50 million. When the investors need to repatriate their capital, they must exchange through the Central Bank of the Republic of China (Taiwan) and charge 20% on interest and dividend tax. Until 2001, the time limitation on principal remits release to maximum two years (Zhang & Zheng, 2003).

The last aspect is talking about the investment choice. In January 1991, the governing departments required the QFII use 10 percent of their remitted principal to set up a fixed saving account and in 1992, it just needs to use that 10 percent to invest currency market within 90 days. However, in 1995 the quota of currency market investment increases to 30 percent. On the other hand futures market is also allowed to trade since 1998, convertible bonds and other financial instruments are permitted in 2001(Zhang & Zheng , 2003).

In table 4.8.2 will compare the QFII regulation between Taiwan and China in detail.

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Qualified Investors

Table 4.8.2 QFII Regulation Comparison Between Taiwan and China China Taiwan (1991) Taiwan (Current) Commercial Banks Commercial Banks Foreign Institutional Investors 1) Total asset in last financial 1) Total asset in last financial 1) Commercial Bank year ranked within the top 100 year ranked within the top 500 2) "Asset in securities" under its 2) "Asset in securities" under its 2) Fund Management Company management to be no less than management to be no less than US$ 10 billion US$ 2500 million 3) Insurance Company 4) Securities Bank Fund Management Company Fund Management Company 1) Operating for more than 5 1) Operating for more than 5 5) Mutual Funds years in fund management years in fund management 2) Asset under its management in 2) Asset under its management in the last financial years should at the last financial years should at least US$ 10 billion least US$ 500 million No requirement on the assets and years of operation Insurance Company Insurance Company 1) Operating for more than 30 1) Operating for more than 10 2) Paid in capital should no less 2) Securities assets under its than US$ 1 billion management in the last financial year should not less than US$ 3) Securities assets under its management in the last financial year should not less than US$ 10 Securities Company 1) Operating for more than 30 2) Paid in capital should no less than US$ 1 billion 75

China Taiwan (1991) 3) Securities assets under its management in the last financial year should not less than US$ 10 Investment Quota Individual: between US$ 50 million and US$ 30 billion Individual: between US$ 0.5 million and US$ 50 million Total : 250 million Remit its principal within 4 months after obtained certificate

Taiwan (Current)

No restriction for QFII Us$ 50 million for non-QFII No restriction

Principal Injection

Remit its principal within 3 months after obtained certificate

Principal Repatriation

3 years lock up period of principal 3 years lock up period for all for closed-end fund management QFIIs companies ; after 3 years, QFII required to apply with the SAFE to repatriate its principals by stages and by patched no more than 20% of total principals for one single stage and no less than one month interval between 2 stages 1 year lock up period for other QFIIs; after 1 year 20% of their principal can be repatriate at each stage and no less than 3 months interval between 2 stages

No restriction

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Profit repatriation

China Once a year

Taiwan (1991) No more than 4 times a year

Taiwan (Current) Anytime as all tax paid

Shareholding percentage No more than 10% of one single listed company's outstanding share cannot hold by each QFII All QFIIs together cannot hold in total more than 20% of one single listed company outstanding Allowable investment activates

No more than 5% of one single 100% except for mining industry , listed company's outstanding public sector and electric industry share cannot hold by each QFII All QFIIs together cannot hold in total more than 10% of one single listed company outstanding 1) All stocks listed in Taiwan Stock Exchange 2) Government Bonds 3)Convertible Bonds and corporate bonds 4) Derivatives - options and futures Total investment on options and futures cannot exceed 30% of total principal remitted into Taiwan

1) A shares (excluding B shares) 1) All stocks listed in Taiwan Stock Exchange 2) Government bonds 2) Government Bonds 3) Convertible bonds and 3) Corporate Bonds corporate bonds 4) Other financial instruments as permitted by CSRC

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4.9 The effect of Taiwans QFII scheme Adoption of QFII in Taiwans securities market which enhances its liberalization and progress of globalization, discussion of each effect will be follow:

4.9.1 Simulate Investors Confidence In general people think QFII are experienced and professional investors therefore their investments are usually treated as an indicator of the most potential shares. The over-trading of QFIIs in Taiwans shares which increase confidence of domestic investors to invest in Taiwans stock market. On behalf of the financial crisis in 1997 and bull market in 2000 (Zhang & Zheng , 2003, Lin & Chen , 2006), most of the QFIIs persevered long term on their investments and retained the capital inside Taiwan, thus, stabilized the Taiwans stock market.

4.9.2 Increase proportion of institutional investors in Taiwans stock market At the time of QFII implement 96.9 percent were individual investors and the rest were the institutional investors. Within the 10 years of QFIIs implementation in Taiwan, individual investors reduced to 84.4 percent and the institutional investors increased to 15.6 percent which is four times more than 10 years ago. Since the power of foreign institutional investors has been dramatically expanded, their investment has gained a long term development (Zhang & Zheng , 2003).

4.9.3 Enhance the conductivity with international market As mention in Zhang & Zheng (2003) paper, during the early stage of QFII
78

implementation, 1991 to 1995, the conductivity between Taiwans stock market and New York stock market and London stock market were relatively small. In the later stage, 1996 to 1991, the conductivity has increased. In 2001, the conductivity coefficient of Taiwan and New York stock market has increased to 0.682 and 0.785 in London stock market. The conductivity coefficient implied that Taiwans stock market is more easily affect by New York and London stock market. As there are linkages between different markets which allows its securities to become more globalize.

4.10 Possible improvement of QFII regulations by looking in Taiwan s QFII development 4.10.1 Relaxation on entry criteria

In other emerging countries such as Hong Kong, Singapore, Korea and etc, as they are familiar with the progress of QFII, understand more and the good prospect of Chinese market so encourage the interest to invest in. However the entry barriers are very high in China, the restriction of asset scale, operation years and world ranking, block out the potential investors. From the experience of Taiwans QFII, China should relax on its qualification criteria, besides that, it can put more focus on asset status and investment concern, of course, choose the best among candidates.

4.10.2

Relaxation on capital liquidity

In order to prevent the impact of QFIIs malicious withdraw of their capital, restrictions are made on capital inflow and outflow, and however it reduces the liquidity of QFIIs capital. Thus, it may block out some investors who wish to benefit from capital liquidity. Therefore, China should follow Taiwans fund
79

management criteria, gradually release more on capital flowing and charge a reasonable interest and dividend tax on capital repatriate.

4.11 Summary Although the QFII scheme was successfully implemented in China, there are still many which can learn from Taiwans successful experience. Base on the experience of Taiwan successfully liberalized its market to foreigners in 2003, Chinese authorizes should able to recognize there are still a lot for Chinese securities markets to be improved and finally liberalized. Chinese authorizes should put more efforts on entry barriers relaxations, capital liquidity and etc.

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Chapter 5 Short term Impact - Empirical Research

81

5.1 Introduction In this chapter, research by Kim & Singal (2000) and Bekaert & Harvey (200) will use for evaluate the short term impact of QFII. These researches are basically focused on the relationship between stock market liberalization and stock market return on emerging market. While analysis the short term influences of QFII scheme, suitable adjustments can possibly draw by policy makers. Moreover, the research will be finished by observing the market behaviors during the event, implementation of QFII scheme. The event study method will be used for dividing the examination period.

5.2 Theoretical framework According to Henry (2000b) if the stock market of an emerging country is completely segmented from the rest of the world, the equity premium in the standard International Asset Pricing Model will proportional to the variance of the countrys aggregate cash flows. Once liberalization takes place and stock markets become fully integrated, the equity premiums will proportional to the covariance instead of variance of countrys aggregate cash flows. However, if the market is not completely segment because of some foreign ownership restriction, like QFII in China, the equilibrium valuation will incorporate with equity premium and it will lie somewhere in between autarky and fully integrated premium. Bekaert and Harvey (2000) found out that the local price of risk (the variance) exceed the global price of risk (the covariance). Consequently liberalize a fully or mildly segmented emerging market the equity premium is expected to fall. Taking constant expected future cash flows, the deduction of equity premium will lead a permanent fall in the cumulative cost of equity capital and cumulative equity price index revaluation, as the research of
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Chen and Yu (2004) described in Chapter 2.4.

5.3 Data and Methodology Event study is used as a standard methodology to evaluate the reaction of share price. It is a measure of the quantitative impact of an event on the value of a firm (Curthbertson & Nitzche, 2004). Since it requires a measure of abnormal share price movement, event study can be used as evidence in legal cases of insider dealing. Under an efficient market, the influence of the event will be reflected on the future cash flow very quickly. Then speedily compounded in the stock price, thus, there should be no abnormal returns in the post-event period. (Curthbertson & Nitzche, 2004)

In order to construct an event study, following the ideas of Curthbertson & Nitzche (2004) and Barnesa & Ma (2002), the event, event window, estimation window, estimation model and investigation window need to be determined. The event as implied by the name it is what the investigators wish to study, and it is the good or bad news that potentially influence the share price. Event window is the period that the event happens. Narrowly definite, it is the occurring period that the event is publicly announced. Usually the next days share price will affect since the event announced and on behalf of the time difference in different media, therefore three days after the event announced is treated as event window. Estimation window is the data which are used for estimating the parameters. In the event study, the abnormal return which occurs around and during the event window must be investigated. Moreover, investigation window is an extension of the event window (Bamesa & Ma, 2002).
83

Abnormal return occurring in different period, will give different outcome. When it occurring in an interval before the event window means there has been trading on inside information or the market has contain the predictable information in the event. If the abnormal return happen after the event window implies whether the market reactions is overreact or under-react the event announced (Bamesa & Ma, 2002). because of

Once all windows are

determined, normal outcome can be figure out during the event window in the absence of event. Moreover estimation of aggregate abnormal return will be given by difference the actual and predicted return during the event window, and statistically test the return is different from zero will follow by.

As event study is suggested to be the most suitable methods to examine the market reaction and the returns expose from specific event. However QFII is not a initial stock market liberalization policy to China, there are similar liberalization policies established before. Hence, event study can still use for suggest the market reactions. Meanwhile, traditional event study is employed to test whether any abnormal return exist in pre-event period, post-event period and after-event period. Apart from testing a single market, the same method will use on Taiwans QFII as well. Difference is expected to draw out from the comparison of Chinas and Taiwans experiments.

For China, Shanghai A-share Index and Shenzhen A-share Index are taken to represent the A-share market in both exchanges. The same token, Shanghai B-share Index and Shenzhen B-share Index represent the both B-share market. Similar for Taiwan, Taiwan Capitalization Weighted Stock Index is used to represent Taiwan stock market. Monthly closing prices are taken from
84

DataStream and Taiwan Stock Exchange. Since the indices are in different currency, the exchange rates are taken from Bloomberg financial information provider. It is noted that RMB is virtually pegged at 6.85 with US dollar and New Taiwan dollar is pegged at 31.4 with US dollar during the study period. Moreover, Hong Kong dollar is fixed at 7.8 with US dollar which converted all indices into US dollar.

Since there is not significant impact of QFII found in Chen & Yu paper (2004) by adopting one year before and after the event, monthly data of three years before t-2 (day -35) and after t2 (day 36) QFIIs implementation are being chosen for this experiment. The event window t0 (day 0) of China and Taiwan are set to be 1 December 2002 and 1 January 1991 respectively. The reason why chose the implement date instead on announcement date is because the security price may not react immediately right after the new policy announcement. That means, implementation date should be more match to the definition of event window, where announcement date and implementation date are different. The estimation window, marked as before event period is taken from month -35 to -3. Investigation window which are pre-event period, post-event period and after-event period, they are from (-2, 0), (1, 3) and (4, 36) respectively.

Implementation

t-2

t-1

t0

t1

t2

Source: Errunza & Miller (2000)

85

The before-event period is the period outline the comparison basis for analysis on other event window behavior. The pre-event period is measuring how markets behave a short period before the event occurs. As Errunza & Miller (2000) suggested most of the reactions to liberalization happen during this period because they think information is being leakage prior before official announcement. Under the concept of standard international asset pricing model, liberalization will cause market revaluation and rise in index. Meanwhile, the first three months after implementation are taken as post-event period. Generally, there is a linkage between market behavior in pre-event and post-event period. Similar to Errunza & Miller (2000) and Henry (2000b) also point out that no evidence to examine the stock revaluation after implement stock market liberalization policy; they both thought majority simulations to stock market happened prior to policy announcement. In contrast to Henry (2000b), Kim & Singal (2000) and Bekaert & Harvery (2000) argued that there are reactions happen in post-event period, after the liberalization. The rest of months excluded from those three periods are count into after-event period, in which, long term market perception are measured. As Chen & Yu (2004) said, liberalization can reduce the cost of capital and equity risk premium therefore positive price reaction and slow down volatility might follow of the QFII implementation. They also point out that, when markets are more segmented, more underperformance the market will be; because underperformance is the reflection of market segmentation level.

Subsequently, estimation window need to build as follow: let Ri,t be the return on month t, where i is the indices used for experiment , Shanghai A-share (SHA), Shanghai B-share (SHB), Shenzhen A-share (SZA) , Shenzhen
86

B-share (SZB) and Taiwan Capitalization Weighted Stock Index (TAIEX). Hence Ri,t will be denotes as RSHA,t , RSHB,t , RSZA,t , RSZB,t and RTAIEX,t . Return of each share index is found by the following equation (Chen & Yu ,2004 and Chen et al ,2006 ) :

Ri,t = ln Pi,t ln Pi,t-1

Where Pi,t is the price level of market index i on month t. The cumulative abnormal return (CAR) can be found by in term of AAR , it is the average abnormal return (Wu,2008).

Since panel data allow pooling the series and cross-sectional data, accordingly, panel regression is employed to found out the aggregate market (SHA, SHB, SZA & SZB) reactions to QFII implementation.

Ri,t = i +1PREit+2POSTit + 3AFTERit +it (5)

Because there is just one index (TAIEX) in Taiwan market therefore linear regression will use in such case. Nevertheless, the equation conduct for panel

87

regression and linear regression are the same.

RTAIEX,t = TAIEX +1PRETAIEX,t +2POST TAIEX,t + 3AFTER TAIEX,t +iTAIEX,t (5a)

Moreover, linear regression will apply to examine the reaction of each market to the implementation. The equation 5 can be rewritten as

Shanghai A-share Index: RSHA,t = SHA +1PRE SHA ,t+2POST SHA , + 3AFTER SHA ,t +SHA ,t (5b)

Shanghai B-share Index: RSHB,t = SHB +1PRE SHB,t+2POST SHB,t + 3AFTER SHB,t +SHB,t (5c)

Shenzhen A-share Index: RSZA,t = SZA+1PRE SZA,t+2POST SZA,t + 3AFTER SZA,t +SZA,t (5d)

Shenzhen B-share Index: RSZB,t = SZB+1PRESZB,t+2POSTSZB,t + 3AFTERSZB,t +SZB,t (5e)

The I is the market- specific dummies. PREit , POSTit and AFTERit are the independent dummy variables. PREit is the dummy variable which take 1 in (-2,0) among the five indices and other is marked as 0. POSTit and AFTERit are marked similarly, but (1, 3) and (4, 36) are mark as 1 respectively and all other period are taken as 0. Thus, parameters 1, 2 and 3 measure the average monthly abnormal return in the pre-event, post-event and after-event periods
88

respectively. The abnormal returns are relative to the monthly average return within estimate period (-35,-3). In addition, price of month -36 are requested for finding the return on month -35.

In the stock market is subscribed as the standard international asset pricing model, then 2 will be positive because of market revaluation while 3 is negative (cost of equity capital reduced). Also if 1 is positive which implied there is information leakage prior of QFII announcement, otherwise1 is statistically insignificant. If information leakage leads to serious insider trading, then1 will be significantly larger than 2 and may even render2 negative (Chen & Yu 2004).

5.4 Empirical result and finding 5.4.1 Descriptive analysis The following table (5.4.1) summarized the means and standard derivations for each stock index in corresponding period.

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Table 5.4.1 Description of stock market indices monthly return for four event periods (%)
Mean Before -event Shanghai A-Share Index Shanghai B-Share Index Shenzhen A-share Index Shenzhen B-share Index Taiwan Capitalization Weighted Stock Index 0.0033 -0.1006 0.1177 0.0024 0.15 0.209 0.77 0.082 0.0324 -0.0796 0.02624 -0.0019 0.169 0.06 0.075 0.076 0.0036 -0.0716 0.02974 -0.0152 0.069 0.031 0.0571 0.063 0.0415 -0.0928 0.0324 -0.0221 0.132 0.041 0.071 0.073 0.0038 Pre -event -0.059 Post -event 0.0296 After -event -event Standard Derivation Before Pre -event 0.018 Post -event 0.064 After -event 0.054

-0.0099 0.064

The means of pre-event show an obvious downturn occurred before the implementation of QFII in stock market, where the all five indices have a negative value. From the result of Chen and Yu (2004)10, it might able to suggest the stock market suffer a downturn before QFII implement and the downturn may last for more than one month. The performances of all indices in pre-event periods are even worse then in before-event period. In addition, the signification changes in all indices may suggest that investors actively react to

10

The pre-event stock return for 20 trading day in Chen & Yu (2004) are : Shanghai A-share index -0.011 , Shanghai B-share index -0.029 , Shenzhen A-share index -0.0231 and Shenzhen B-share index -0.366

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the QFII implementation and looking forward the market liberalization.

After the implementation of QFII, post-event period, for a quarter of year the mean index return obvious increase and most of them exceed the corresponding ones in pre-event period. Moreover, the mean index return reduce back to negative again in after-event period, except Taiwans one but a deduction is taken place. Hence the highest level on stock indices return implied that the markets were a bit overacted during the first launch of this new scheme. Also the following decrease made the effect of QFII seem to be temporary brought the market back to a better level for only three months. Moreover, the standard deviations of all five indices in post-event period are all less than the corresponding ones in pre-event period, which illustrated a slow down on the stock market volatility and showed QFII has just brought a short-term positive impact to the stock markets.

Furthermore, there are significant different between A-shares of both Shanghai stock exchange and Shenzhen stock exchange in before-event period and post-event period while underperformance in B-shares markets. The phenomena of outstanding performance in A-shares could result form the actions of switching investment from B-shares market to A-shares market by foreign investors. At the same time , the index returns percentage in after-event period are much less than corresponding in before-event period, and tell there is a small volatility in after-event period. Hence, command that to some extent QFII stabilize the stock market in relatively long term.

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5.4.2 Regression Analysis Panel and linear regression are adopted to exemplify further the cumulative impact of QFII on the whole security market and individual impact on specify share index market. The result is summarized in table 5.4.2.

Consistent with IAPM, the coefficient of PRE (1) should be telling the reaction of investors to the information leakage before QFII announced. However, this study is aim to found out how market react around the implementation period therefore, information leakage and insider trading are not the objective in this study. Although investors reaction on information leakage is not the main focus, the pre-event period contained the moment of QFII announce. Hopefully, by looking at the coefficient of PRE can get some idea on the reaction of investors at the announcement period. The values of 1 are -0.094 % for the whole Chinese market and -0.042% in Taiwans one. The negative values of 1 are statistically comparatively significant, in which, suggests there is slightly negative response of investors to the announcement of new market liberalization policy. It might be the result of investors unconfident to the QFIIs effectiveness and they cannot clearly predict the future of accelerating market liberalization. With regard to the individual market, only Shanghai B-share market showed some negative responses to market liberalization with a significant coefficient.

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Table 5.4.2 Result for Panel and Linear Regression (%)

Panel Regression China (Aggregate) China (aggregate) TAEIX SHA SHB SZA SZB PRE (1) POST (2) AFTER (3) R2 No. of Observation -0.042 0.0006 -0.03 0.032 284 0.097 0.114 -0.001 0.057 71 -0.063 0.026 -0.014 0.062 71 -0.134 -0.075 -0.009 0.026 -0.064 -0.019 0.118 0.072 71 71 0.018 0.003 0.004 0.042 0.004 0.032 -0.112 -0.006 -0.034 0.04 71 TAEIX SHA SHB SZA SZB Linear Regression

Panel Regression : Ri,t = i +1PREit+2POSTit + 3AFTERit +it Linear Regression : RTAIEX,t = TAIEX +1PRETAIEX,t +2POST TAIEX,t + 3AFTER TAIEX,t +iTAIEX,t RSHA,t = SHA +1PRE SHA ,t+2POST SHA , + 3AFTER SHA ,t +SHA ,t RSHB,t = SHB +1PRE SHB,t+2POST SHB,t + 3AFTER SHB,t +SHB,t RSZA,t = SZA+1PRE SZA,t+2POST SZA,t + 3AFTER SZA,t +SZA,t RSZB,t = SZB+1PRESZB,t+2POSTSZB,t + 3AFTERSZB,t +SZB,t TAIEX: Taiwan Capitalization Weighted Stock Index market dummy variable SHA : Shanghai A Share Index market dummy variable SHB: Shanghai B Share Index market dummy variable SZA: Shenzhen A Share Index market dummy variable SZB: Shenzhen B Share Index market dummy variable

IAPM also mention that if there is market revaluation and reduce cost of equity capital then2 will be positive while3 is negative. Form the table 5.4.2 even the values do comply with IAPM but they are insignificant. As the small values which imply there is just a little investor react upon QFII implementation and

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most of them adopt a wait-and-see attitude. However, the individual share index markets show a better result. For example the Shanghai A share and Shenzhen A share market and Taiwan stock market , all of them have shown some significant responses to QFII within the three months right after implementation , where they have a positive 2 and negative 3. Similar to the result in Chapter 5.4.1, it also showed there is signification volatility in A-shares market within three markets. From the two results can possibly conclude that the investors take action by switching investment on B-shares to A-shares market within three months after implement. For Taiwan, cause only one share index is taken to represent Taiwans stock market, so it might able to suggest that domestic investors were appreciate to invest after a wait-and-see period. Similar for foreign investors, they might withdraw their investment in other countries and reinvest in Taiwan market after wait-and-see for few months.

On behalf of the definition of IAPM, the coefficient 3 for AFTER is telling whether any reduction on capital cost take place. As state in the table 5.4.2 3 for aggregate is -0.03% and it is statistically significant. It proved there is decrease in capital cost happen after three months of implement. However, this phenomenon does not work in the case of Taiwan, as well as in other individual share market of China. For such insignificant values, it might be the result of underestimation caused by stock market down-turning. In general, QFII can still bring long term reduction on cost of equity capital.

To summarizes the result, before the QFII implementation investors feel unconfident to enter market and adopt wait-and-see attitude. Within the three months right after the implementation, investors reaction actively and switch
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the investment in B-share market to A-share market. However, this is just a short term positive impact to the market and it return to the original level at the fourth months after QFII implementation. It is not just happened in China, it also happened in Taiwan.

5.5 Research limitation Under the highly correlation between each A-shares and B-shares markets (Table 5.5.1) so the panel regression should not just depend on the share indices return in different period only. In order to overcome the underestimation and provide better examination in panel regression, macroeconomic factor variables should be taking into account as well. For example the opened B-shares market to domestic investors and the accession of World Trade Organization, all these events and any other policy announcements might influence Chinese stock market during implementation of QFII scheme.

Table 5.5.1 Correlations between A-share market and B-share market SHA SHA SHB SZA SZB 1 0.59768 0.97276 0.52804 1 0.59192 0.86949 1 0.51121 1 SHB SZA SZA

Furthermore, the incorporative of Taiwans and Chinas results might due to the different economy background and share market structure of two countries. In which the time period taken for experiment are totally different, therefore the economy status in two countries should be totally different. As the economy
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cycle of two countries are difference which might influence the interest of investors as well. Moreover, the different on the QFII entry criteria, a relatively lower entry barrier in Taiwan might attract more foreign investments, thus, an outstanding performance occurred in the post-event period. Besides that, the market structure between Taiwan and China are totally different. Since only one stock market in Taiwan, Chinese share markets are segmented into A-shares and B-shares and there is lack of financial instruments in the markets. Meanwhile all stocks in the market are tradable in Taiwan and only one-third of shares are allowed trading in China. Consequently, therefore interests of foreign investors to invest in China may reduce.

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5.6 Summary The event study methods has used to examine the short term impacts of QFII on Chinese stock markets and Taiwan stock market and linear and panel regression are adopted on monthly stock market return on January 1, 2000 to December 1, 2005 and February 1, 1988 to January 1, 1994 respectively. For Chinese A-shares and B-shares market index are taken independently and the prediction of IAPM were shown in the empirical results, a limit reduction in cost of equity capital might result in the future. Considering the short term impacts are not as obvious as IAPM prediction, and the evidence prove that volatility was reduce before and after the QFII implemented, these suggested that QFII could stabilize the stock market in a long term. Conversely, most of the investors are taken a wait-and-see altitude on how QFII benefit stock market liberalization. As to examine more accurate experiment, macroeconomic factors around the study period should consider as much as possible. Even thought, it is a useful experiment for policy markers to understand how QFII influence stock market in short term.

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Chapter 6 Long term Impact

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6.1 Introduction Definitely the entries of qualified foreign institutional investors widen the source of capital which original dominate by Chinese companies. The scale of institutional investors is enlarged as well. However comparing to the total market capitalization, the proportion investment of QFII is still relative small. As the result, no obvious short term impacts of QFII to the whole market. Hence, to cope with the new financial policy, different market participants react differently QFII implementation. At the beginning of this chapter, the changes of investment strategy on either domestic individual or institutional investors will be given. Afterward, the influences of QFII to stock market, listed companied, local security company and banking system will be clarified. Finally, the future improvements of liberalization policy will be predicted.

6.2 investment strategy Until 1st of September, 2008, there are 59 QFII investors and investment quota of US dollar 30 billion were granted by Chinas State Council. There was nearly a US dollar 9.995 billion has been used up and allocated to 49 QFII at early 2007. In these investors, there are commercial bank, investment bank, asset management firms, securities institution and other private foundation etc.

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Table 6.1.1 Current QFII Status Investment Quota No. QFII Name Qualified Date (US$ million) 1 UBS AG 2 Nomura Securities co. Ltd Morgan Securities & Co. 3 International Limited 4 Citigroup Global Markets Limited 5 Goldman, Sachs & Co 6 Deutsche Bank Aktiengesellschaft The Hongkong and Shanghai 7 Banking Corporation Limited 8 ING Bank N. V. 9 JP Morgan Chase Bank Credit Suisse (Hong Kong) 10 Limited Standard Chartered Bank 11 (Hongkong) limited 12 Nikko Asset Management Co. Ltd. 13 Merrill Lynch International 14 Hang Seng Bank 15 Daiwa Securities SMBC Co. Ltd. Lehman Brothers International 16 (Europe) 7/6/2004 200 12/11/2003 4/30/2004 5/10/2004 5/10/2004 450 300 100 50 12/11/2003 75 10/24/2003 5 9/10/2003 9/30/2003 350 150 8/4/2003 400 6/5/2003 7/4/2003 7/30/2003 550 300 400 6/5/2003 400 5/23/2003 5/23/2003 800 350

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17 Bill & Melinda Gate Foundation INVESCO Asset Management 18 Limited 19 ABN AMRO Bank N.V. 20 Societe Generale 21 Templeton Asset Management 22 Barclays Bank PLC 23 Dresdner Bank Aktiengesellschaft 24 Fortis Bank SA/NV 25 BNP Paribas 26 Power Corporation of Canada 27 CALYONS.A. Goldman, Sachs Asset 28 Management International Martin Currie Investment 29 Management Government of Singapore 30 Investment Corporation Pte Ltd. 31 AIG Global Investment Corp Temasek Fullerton Alpha 32 Investment Pte. Ltd 33 JF Asset Management Limited 34 The Dai-ichi Mutual Life Company 35 DBS Bank Ltd.

7/19/2004

8/4/2004 9/2/2004 9/2/2004 9/14/2004 9/15/2004 9/27/2004 9/29/2004 9/29/2004 10/15/2004 10/15/2004 5/9/2005

250 175 50 75 75 500 200 50 75 200

10/25/2005

120

10/25/2005

100

11/14/2005

50

11/15/2005

100

12/28/2005 12/28/2005 2/13/2006

150 100 100

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36 AMP Capital Investors Limited 37 The Bank of Nova Scotia KBC Financial Products UK 38 limited La Compagnie Financierr Edmond 39 de Rothschild Banque 40 Yale University Morgan Stanley Investment 41 Management Inc. Prudential Asset Management 42 (Hong Kong) Limited 43 Stanford University GE Asset Management 44 Incorporated 45 United Overseas Bank Limited Schroder investment 46 Management Limited HSBC Investments (Hong Kong) 47 Limited 48 Shinko Securities Co. Ltd. UBS Global Asset Management 49 (Singapore) Ltd Sunitomo Mitsui Asset 50 Management Company Limited 51 Norges Bank

4/10/2006 4/10/2006 4/10/2006

200 150 100

4/10/2006 4/14/2006 7/7/2006

100 50 200

7/7/2006 8/5/2006 8/5/2006

200 50 200

8/5/2006

50

8/29/2006

200

9/5/2006

200

9/5/2006

50

9/25/2006

200

9/25/2006

200

10/24/2006

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52 Pictet Asset Management Limited The Trustees of Columbia 53 University in the City of New York Prudential Asset Management 54 Co., Ltd. Robeco Institutional Asset 55 Management B.V. State Street Global Advisors Asia 56 Limited Platinum Investment Company 57 Limited 58 KBC Asset Management N.V. Mirae Asset Investment 59 Management Co., Ltd.

10/25/2006

3/12/2008

4/7/2008

5/5/2008

3/16/2008

6/2/2008

6/2/2008

7/25/2008 Source: www.crsc.gov.cn

Recalling to the shareholding of QFIIs and categorise by industry, most of their investments are in industry of machinery and equipment product,

transportation, mental, mining, information technology and real estate.

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Table 6.2.2 Top 10 Shares purchased by QFII in 2007 GuangDong Midea Electric Appliances Machinery, Equipment, Meter Co.,Ltd. (000527) Changsha Zoomlion Heavy Industry Science And Technology Development Co.,Ltd. (000157) Gree Electric Appliances,Inc.of Zhuhai (000650) China State Shipbuilding Co., Ltd. (600150)

Guangzhou Baiyun International Airport Transport, Storage Company Ltd. (600004)

Mining

Datong Coal Industry Co., Ltd. (601001)

Real Estate

Shanghai Shimao Co.,Ltd (600823)

Guangdong Golden Horse Tourism Group Information, Technology Stock Co.,Ltd. (000602)

Metal, Nonmetallic Mineral Product

JiaoZuo WanFang Aluminum Manufacturing Co.,Ltd. (000612)

Source: CRSC and SAFE

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QFIIs usually are the top leaders in the global markets; all of them possess advanced investment techniques and capital asset management experience. The entry of professional and experienced foreign investors cause an inevitably change to Chinese investors traditional behavior( Li , Zhang & Mao2008 ). In a long term view investment strategy of domestic investors should improve as well, where foreign investors are acting as a model for Chinese investors to learn from. For example the UBS AG has declared that four common criteria in their investments, 1, a large market capitalization and market volume, 2, high quality corporate governance, 3, continuity of profit growth, and 4, the top in the corresponding industry. Under the high reputation of QFIIs investment are always treating as a guide for Chinese inexperienced investors to follow by. (Xu2007)

The characteristics of preferred industry and stocks of QFIIs investment intention are clearly drafted. Their requirements on list companies corporate governance, information transparency and etc., are not only a direction for Chinese investors investment, they can also indicate the possible internal improvements in listed companies.

6.3 Local stock market For a long history, majority of Chinese security markets were occupied by medium and small individual investors and most of them were holding a faith of gambling, therefore, the more gambling investors inside the market, the more destabilize, volatile the market will be. As the introduce of institutional investors , which are more rational and looking for more long term investment, therefore more institutional investors enter the market, should be possibly
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stabilize the market. Compare to those developed countries, UK and Japan, institutional investors hold about 75% and 50% respectively of the total security market, there is just only 30% in China. In order to stabilize the Chinese security market, more institutional investors should be attracted. (Wang, 2006, Zhu, 2008). In addition, the entry of professional foreign investors will allow the domestic investors to learn from. Hopefully, the investment strategy, operational level and asset management technique of Chinese securities agencies can be improved. As a result a win-win situation for both institutional investors and individual investors can be achieved.

Aside from the structure of securities market reforms, the completeness of financial instruments development and regulations of securities market are also enhanced in long term. Under the current QFII regulation derivative, hedging instruments are still allowed to trade. In order to create more opportunities and benefit the foreign investors themselves, they are willing to bring their experience and innovation on financial instruments to China. As the experienced foreign investors joined the Chinese market, they may requests many adjustments and improvements on the basic regulations of Chinese security market, which will encourage the development of the security market policy. Since the energetic development and completeness of financial instrument and regulation are enhanced, in which they also improve the competitive of Chinese security market (Huang, 2007 ).

6.4 Local listed companies Basically the QFIIs impacts on local listed companies can be categories into three dimensions, the structure of shareholding and information disclosure. As
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mentioned above, the increases of institutional investors, it will lead a reformation of listed companies shareholding structure. Originally majority share of listed companies were hold by individual investor, after QFII implemented, shareholding by institutional investors become heavier. It result that institutional investors become more important to listed companies and it implies more insider information, such as shareholding structure and any other bad news of listed companies, will be request as well. Due to the poor information disclosure system, insider information will be prior and monopolized by to those strong local investors and cause serious inside trading (Chen & Wang, 2007,Deng, 2007)

Under a poor information disclosure environment, implementation of QFII can help to solve this problem. As Young and McGuinness (2001) argument, financial analysts are important in establishing a relationship between share price and managerial behavior. Before embarking in strategic investment, institutional investment will require a clear and quality research. Regarding to the expectation of listed companies, more investments introduce from QFIIs , listed companies will respect more to financial analysts.

Moreover, QFII influence the degree of voluntary disclosure of additional information (Chen & Wang, 2007,Deng, 2007). It is a common feature for many firm unilaterally report additional relevant information over and above the basic requirement, such as company future development, to gain

competitiveness. As Ferguson et al. (2002) indicated that PRC companies listed on the Mainland exchanges voluntarily disclose little Meanwhile, the QFII provisional measures require foreign investors to hold their stocks for a
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long period and more risks need to take into account. In order to reduce the degree of asymmetric information between outsider and senior management level of listed companies, more comprehensive disclosure are essential. Besides that, the level of transparency is an important issue that QFIIs will consider before invest. As Ferguson and McGuinness (2004) declare as some firms adopt more transparent, proactive disclosure practices, others will be forced to follow suit or risk being perceived as lemon in the overall capital market.

6.5 Local banking industry Due to the provisional measures of QFII, only one in-country custodian bank can assign to each QFII, which employed the investment quota for domestic security investment. Therefore the custodian, securities broker, is the only one can QFIIs directly get help and contract with. Base on the huge benefits of QFIIs investments, those unqualified agencies to development their custodian and brokerage business with QFIIs such as, domestic security dealers and banks, will be simulated to performance better. Except improving the status of custodian bank inside China, QFII can also raise the realization of domestic bank in world-wide market. Many years ago, Chinese banks have already developed a good relationship with many foreign institutions. Taking advantages on this linkage Chinese banks can clarify the foreign investors more easily, and provide the most suitable consultant services, as a result, enable a custodian bank to pool more QFII customers. Therefore, the more Chinese banks understand the foreign institutional investors, the more easily for them to provide suitable service. Finally, reputation of domestic banks will be raised as well (Zheng & Wang 2007).
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Nevertheless, there may be a conflict between domestic and foreign capital bank. Although foreign capital banks benefit on communication, prefect asset management, securities custodial and settlement of assets services, traditional market of domestic banks may be damaged. Fortunately, domestic banks also bring up unexpected results in the market as well. First, close relationship built between domestic banks and many local enterprises, individual and institutional investors and even government. The close relationship of implied a strong interactions are developed in between. In 2006, the RMB market was opened to foreign capital banks. Thereafter, the inexperience of foreign capital bank in such currency market which lead a turn down in the competition. Conversely, the highly experienced domestic banks can easily survive from the competition, and gain more advantages on QFIIs investment ahead foreign capital bank. On the other hand, corporation with large securities institutions allow domestic banks to provide better services for QFIIs investments. In aid of the better services, the entry barriers for other banks will rise correspondingly and the domestic banks can gain more priority on adjusting barriers (Zheng & Wang 2007).

6.6 Future development on financial policy In order to fulfill the stock market liberalization, both permission of foreign capital inflow to domestic stock market and deregulation of domestic capital to oversea markets are required. Since 2001 China became a member of the WTO and following the launched of Closer Economic Partnership Arrangement (CEPA), which increased the number of foreign direct investment to set up their business in China (Lam & Ng, 2004). Under this reason the economic of China growth much faster and the foreign exchange reserve becomes bigger.
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According to globalize experience, when there is a long term balance of trade then it must need to ease up the offshore investment of business and resident progressively, otherwise, the store up of the foreign exchange reserve will cause the problems of currency appreciation and the stress of inflation.

Qualified Domestic Institutional Investor (QDII) which is derived from CEPA, it allows the Chinese investors to invest overseas security market through the qualified financial institution. However, individual investors have limited right to manage their own investment. Liberalize more of Chinese stock market, individual offshore securities investment scheme was implemented in late 2007. This scheme is just allowing the resident in few specific places to trade securities in Hong Kong Stock Exchange freely. Although the scheme just lasted for 3 months, it gave a big shock to Hang Seng Index (the indicator for the Hong Kong Stock Market) and Hong Kong Stock Market. At the meantime, the date of re-implementation is still not yet known. However, the suddenly halt of this scheme implied quite a lot of problems for the Chinese stock market and its economics. As it is an essential step for stock market opening , recalling to Mr. Wen Jiabao, the Premier of the State Council of the People's Republic of China, this scheme need to be considered more deeply before it can adopted again. A synopsis of Individual Offshore Security Scheme is given here as it is not the focus of this dissertation.

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6.7 Summary The entries of professional and experienced foreign institutional investor bring dramatically impacts to Chinese stock markets. The introduction of professional investment institutions, asset management techniques improve the techniques and confidence of traditional domestic investors. Introduction of QFII widens the source of capital and causes changes in stock market structure changed as well. Beside the influences on investors, voluntary information disclosure and corporate governance are also improved. As the information transparency increased, the competitiveness of Chinese stock markets is also enlarged. Due to the opening of Chinese market, the powerful background of China domestic banks shows advantages in the competition with foreign capital banks. The more advance contributions from domestic banks supply to QFIIs, the more empowerments of Chinese banking industry around the world. Finally, the store up of foreign exchanges reserve which speed up the stock market liberalization as well.

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Chapter 7 Conclusion

112

7. Conclusion The accession of WTO and the rapid economic growth of China declared its ability to make its stock market to be one of the best in the world. The Chinese authorizes show their efforts on matching stock market improvement and liberalization to the rapid growth on whole economy by established vary policies and measures. The introduction of QFII is really a milestone on

Chinese stock market liberalization history. It is the first time in the history China opens up its domestic securities markets directly to foreign investors.

This dissertation studies on the contributions and conflicts happened in other emerging stock markets liberalization as well as the influence on such liberalization policy in Chinas stock market. An event study evaluates the short term impacts on Chinese stock market which bring from QFII launched. Market reactions around the implementation periods are investigated and the consistency of the situation in China with predictions of IAPM is being tested.

From the empirical findings, short-term impacts of QFII on Chinese stock market and Taiwan stock market are partly comply with the prediction of IPAM and may not lead to the expectation of cost of equity capital deduction and risk premium in the future. Even though the figure of impact is not as significant as IAPM prediction, there is evidence of volatility reduced during the period of post-event and after-event. It implied that QFII implementation can stabilize the stock market in long term. However, the insignificant result of the QFII implementation may due to the rigid of current provisional measures and the investment limitations. It may also the result of investors were fear to the future of stock market after liberalization policy implemented.
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The long term impacts are basically the recommendations which learn from successful implementation of QFII in other emerging markets, for example Taiwan, its QFII was abolished in 2003 and it had finally open up Taiwan stock market. From the experience of Taiwans QFII scheme, Chinese authorizes should consider improve in such aspect, establish better information disclosure standards, and relax the qualification criteria of QFII entry, the proportion of QFII shareholding. As to attract more foreign investment fund, listed companies are encouraged to repackage themselves. However, the traditional domestic investors are lack of professional investment knowledge, the introduction of QFII can help in education local investors as well. Due to the success of QFII, QDII are implemented and it opens the Chinese securities market to a wider angle. Finally, to be fully liberalized the Chinese stock market the scheme of individual offshore securities investment must re-implemented even it was abolished now.

Therefore, the total effects of QFII scheme onto the stock market liberalization are worthy to examine. As the regulations relax more the QFIIs investment should become more active and significant.

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Wu, X.C. (2008) , QFII (Discuss the QFIIs influence on Chinese Securities Market), Jin Ka Gong Cheng, Vol.12, No.5, pp. 66 Wu,2008 Merger Activities and Stock Market Valuation in China http://www.nber.org/books_in_progress/ease18/wu2-27-08.pdf Access on 10th August, 2008 Xu, G.Q. & Qu, W.B. (2003), QFII (Define the QFII regulation), Economic Tribune, No.5, pp.16-17 Xu, X.Y. (2007), QFII (Empirical research on QFIIs Investment Strategy and Reaction), ZheJiang Finace, No.8, pp.43-44 Yong M.N and McGuniess (2001), The missing link: Why stock markets have been ineffective in Chinese SOE reform, Business Horizons, Vol. 44, No. 4, pp. 55-62 Zhai, C. R. (2006) , QFII (Discuss the Influence of QFII on Financial Safety), Journal of ShanDong Institute of Trade Unions Administration Cadres, Vol.12, No. 5, pp. 116 ZHANG R. (2008), Taking stock Business Weekly http://www.chinadaily.com.cn/bw/2008-03/24/content_6559339.htm Access on 10th August, 2008 Zhang, W.G. (2003), QFII (The design of QFII regulation) , South China Financial Research, Vol.18, No.1, pp.78-79 Zhang, Y.B. & Zheng, J. (2003), QFII SystemTaiwan's Experiences and Their Enlightenment to the Mainland, Journal of Hunan Business College, Vol. 10, No. 10, pp.58-60 Zhang. Y (2001) The Chinas Stock Market after Entry of the WTO http://www.harvardchina.org/conference/conf2001/conferenceSummary/Finan cial/speech(zhangyujun).ppt Access on 7th September, 2008

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Zheng, M. H. & Wang, G. Z. (2007), QFII (The Influence of QFII on domestic Banking Industry), Journal for Party and Administrative Cadres, No. 1, pp.13-14 Zhu, L.B. (2008), QF (The motivation of QFII enlargement and its influence on Chinese securities market), The Border Economy and Culture, No. 5, pp.25-26

WebSite: Bloomberg: www.bloomberg.com Chinese Securities Regulatory Commission : www.crsc.gov.cn China State Administration of Foreign Exchange: www.safe.gov.cn HSBC glossary: http://www.hsbc.com.hk/1/2/chinese/hk/investments/glossary#Q Morgan Stanley Capital International: www.msci.com Ministry of Foreign Trade and Economic Co-operation: www.mofcom.gov.cn Shanghai Stock Exchange: www.sse.com.cn Shenzhen Stock Exchange: www.szse.com.cn Taiwan Stock Exchange: www.tse.com.tw Indian Reserve Bank: http://www.rbi.org.in/home.aspx

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Appendix

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Appendix 1 Provisional Measures on Administration of Domestic Securities Investments of Qualified Foreign Institutional Investors (QFII) China Securities Regulatory Commission People's Bank of China Decree No. 12 The "Provisional Measures on Administration of Domestic Securities Investments of Qualified Foreign Institutional Investors (QFII)", which will come into effect from 1 December 2002, is hereby promulgated.

Chapter 1. General Provisions Article 1. Based upon China's relevant laws and administrative regulations, this Regulation was promulgated for the purpose of governing Qualified Foreign Institutional Investors' investments in China's securities market and promoting developments of China's securities market.

Article 2. Qualified Foreign Institutional Investors (hereinafter referred to as "QFII" which can be a single or a plural, as the case may be) are defined in this Regulation as overseas fund management institutions, insurance companies, securities companies and other assets management institutions which have been approved by China Securities Regulatory Commission (hereinafter referred to as "CSRC") to invest in China's securities market and granted investment quota by State Administration of Foreign Exchange (hereinafter referred to as "SAFE").

Article 3. QFII should mandate domestic commercial banks as custodians and domestic securities companies as brokers for their domestic securities trading.

Article 4. QFII should comply with laws, regulations and other relevant rules in China. Article 5. CSRC and SAFE shall, in accordance with the laws, supervise and

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govern the securities investing activities undertaken by QFII within the jurisdiction of China.

Chapter 2. Qualifications, Criteria and Approval Procedures

Article 6. A QFII applicant should fall within the following criteria: (1) The applicant should be in sound financial and credit status, should meet the requirements set by CSRC on assets size and other factors; and its risk control indicators should meet the requirements set by laws and securities authorities under its home jurisdiction; (2) Employees of the applicant should meet the requirements on professional qualifications set by its home country/region; (3) The applicant should have sound management structure and internal control system, should conduct business in accordance with the relevant regulations and should not have received any substantial penalties by regulators in its home country/region over the last three years prior to application; (4) The home country/region of the applicant should have sound legal and regulatory system, and its securities regulator has signed Memorandum of Understanding with CSRC and has maintained an efficient regulatory and co-operative relationship; (5) Other criteria as stipulated by CSRC based on prudent regulatory principles.

Article 7. The criteria of assets scale and other factors as referred to in the aforesaid article are: For fund management institutions: Having operated fund business for over 5 years with the most recent accounting year managing assets of not less than US$10 billion; For insurance companies: Having operated insurance business for over 30 years with paid-in capital of not less than US$1 billion and managing securities assets of not less than US$10 billion in the most recent accounting year; For securities companies: Having operated securities business for over 30 years with paid-in capital of not less than US$1 billion and managing securities assets of

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not less than US$10 billion in the most recent accounting year; For commercial banks: Ranking among the top 100 of the world in the total assets for the most recent accounting year and managing securities assets of not less than US$10 billion. CSRC may adjust the aforesaid requirements subject to the developments of securities market.

Article 8. To apply for QFII qualification and investment quota, an applicant should submit the following documents to CSRC and SAFE respectively through its custodian: 1. Application Forms (including basic information on the applicant, investment quota applied for and investment plan, etc.); 2. Documents to verify that the applicant meets requirements set in Article 6; 3. Draft Custody Agreement signed with its expected custodian; 4. Audited financial reports for the most recent 3 years; 5. Statement on sources of the funds, and Letter of Undertaking promising not to withdraw funds during the approved period; 6. Letter of authorisation by the applicant; 7. Other documents as required by CSRC and SAFE. All the aforesaid documents, if written in languages other than Chinese, must be accompanied by their Chinese translations or Chinese extracts.

Article 9. The CSRC shall, within 15 working days from the date the full set of application documents are received, determine whether to grant approval or not. Securities Investment Licences will be issued to those applicants whose applications have been approved whereas written notices will be given to those applicants whose applications have been rejected.

Article 10. Applicants shall apply to the SAFE through their custodians for investment quotas after obtaining the Securities Investment Licences. SAFE shall, within 15 working days from the date full set of application documents are received, determine whether to grant approval or not. Applicants whose applications have been approved will be notified in writing their permitted investment quotas and Foreign Exchange Registration Certificates will be issued. Written notices will be given to those applicants

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whose applications have been rejected. The Securities Investment Licence will automatically become void if an applicant is unable to obtain the Foreign Exchange Registration Certificate within one year after the Securities Investment Licence is granted.

Article 11. In order to encourage medium and long-term investments, preference will be given to the institutions managing closed-end Chinese funds subject to the requirements of Article 6 or pension funds, insurance funds and mutual funds with good investment records in other markets.

Chapter 3. Custody, Registration and Settlement

Article 12. A custodian should meet the following requirements: (1) Has a specific fund custody department; (2) With paid-in capital of no less than RMB 8 billion; (3) Has sufficient professionals who are familiar with custody business; (4) Can manage the entire assets of the fund safely; (5) Has qualifications to conduct foreign exchange and RMB business; (6) No material breach of foreign exchange regulations for the recent three years. Domestic branches of foreign-invested commercial banks with more than three years of continual operation are eligible to apply for the custodian qualification. Their paid-in capital eligibility shall be based on their overseas headquarters' capital.

Article 13. Approvals from CSRC, People's Bank of China (hereinafter referred to as "PBOC") and SAFE are required for custodian status.

Article 14. Domestic commercial banks should submit the following documents to CSRC, PBOC and SAFE to apply for custodian status: 1. Application Forms; 2. Copy of its financial business licence; 3. Management system in relation to its custody business; 4. Documents verifying that it has efficient information and technology system; 5. Other documents as required by CSRC, PBOC and SAFE.
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CSRC, together with PBOC and SAFE, will review application documents and decide whether to approve the applications or not.

Article 15. A custodian shall perform the following duties: 1. Safekeeping all the assets that QFII put under its custody; 2. Conducting all QFII related foreign exchange settlement, sales, receipt, payment and RMB settlement businesses; 3. Supervising investment activities of QFII, and reporting to CSRC and SAFE in case QFII investment orders are found to have violated laws or regulations; 4. Reporting to SAFE about foreign exchange remittance and repatriation of QFII, in two working days after QFII remits/repatriates its principal/proceeds ; 5. Reporting to CSRC and SAFE about the status of QFII's RMB special account, in five working days after the end of each month; 6. Compiling an annual financial report on QFII's domestic securities investment activities in the previous year and sending it to CSRC and SAFE in three months after the end of each accounting year; 7. Keep the records and other related materials on QFII's fund remittance, repatriation, conversion, receipt and payment for no less than 15 years; 8. Other responsibilities as defined by CSRC, PBOC and SAFE based on prudent supervision principles.

Article 16. A custodian should strictly separate its own assets from those under its custody. A custodian should set up different accounts for different QFII, and manage those accounts separately. Each QFII can only mandate one custodian.

Article 17. QFII should mandate its custodian to apply for a securities account on its behalf with securities registration and settlement institution. When applying for a securities account on behalf of the QFII, a custodian should bring the QFII' mandate and its Securities Investment Licence and other valid documents, and file with CSRC the relevant situation within five working days after opening a securities account. QFII should mandate its custodian to open a RMB settlement account on its behalf with securities registration and settlement institution. The custodian

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shall be responsible for the settlement of QFII's domestic securities investment, and shall file with CSRC and SAFE the relevant situation within five working days after opening a RMB settlement account.

Chapter 4. Investment Operations

Article 18. Subject to the approved investment quota, QFII can invest on the following RMB financial instruments: 1. Shares listed in China's stock exchanges (excluding B shares); 2. Treasuries listed in China's stock exchanges; 3. Convertible bonds and enterprise bonds listed in China's stock exchanges; 4. Other financial instruments as approved by CSRC.

Article 19. QFII may mandate domestically registered securities companies to manage their domestic securities investments. Each QFII can only mandate one investment institution.

Article 20. For domestic securities investments, QFII should observe the following requirements: 1. Shares held by each QFII in one listed company should not exceed 10% of total outstanding shares of the company; 2. Total shares held by all QFII in one listed company should not exceed 20% of total outstanding shares of the company. CSRC may adjust the above percentages based on the developments of securities market.

Article 21. QFII's domestic securities investment activities should comply with the requirements as set out in the Guidance for Foreign Investments in Various Industries. Article 22. Securities firms should preserve the trading and transaction records of QFII for at least 15 years.

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Chapter 5. Fund Management

Article 23. Upon the approval of SAFE, a QFII should open a RMB special account with its custodian. Within five working days after the opening of the RMB special account, the custodian should report to CSRC and SAFE for filing. Article 24. Revenue articles in the RMB special account shall include: settlement of funds (foreign exchange funds from overseas, and accumulated settlement of foreign exchange should not exceed the approved investment quota), proceeds from the disposal of securities, cash dividends, interests from current deposits and bonds. Expense articles in the RMB special account shall include: cost of purchasing securities (including stamp tax and commission charges), domestic custodian fee and management fee, and payment for purchasing foreign exchange (to be used to repatriate principals and proceeds). The capital of special RMB account shall not be used for money lending or guarantee.

Article 25. Within three months after receiving Securities Investment Licence from CSRC, QFII should remit principals from outside into China and directly transfer them into RMB special accounts after full settlement of foreign exchange. The currency of the principals from QFII should be exchangeable currency approved by SAFE and the amount of the principal should not exceed the approved quota. If QFII has not fully remitted the principals within three months after receiving Foreign Exchange Registration Certificate, the actual amount remitted will be deemed as the approved quota; thereafter the difference between approved quota and the actual amount shall not be remitted inward prior to the obtaining of a newly approved investment quota.

Article 26. In the case that a QFII is a closed-end Chinese fund management company, it can mandate its custodian, with the submission of required documents to SAFE to apply for purchase of foreign exchange for the repatriation of principals by stages and by batches three years after its remittance of the principals. The amount of each batch of principal repatriation

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should not exceed 20% of the total principals, and the interval between two repatriations should not be shorter than one month. Other types of QFII can mandate their custodians, with the submission of required documents, to apply to SAFE to repatriate the principals by stages and by batches one years after their remittance of the principals. The amount of each batch of principal repatriation should not exceed 20% of the total principals, and the interval between two repatriations should not be shorter than three months. The overseas receivers of the above-mentioned repatriation should be the QFII themselves.

Article 27. QFII whose principal of approved investment quota is remitted to China for less than one year but over three months, after the submission of transfer application form & transfer contract and upon approval of CSRC and SAFE, may transfer the approved investment quota to other QFII or other applicants who have fulfilled the requirements of Article 6. After getting Securities Investment Licence from CSRC and investment quota from SAFE, the transferee can remit the difference as its principals if the value of the transferred assets is lower than the investment quota approved by SAFE.

Article 28. If QFII intends to remit principals inwards again after it partially or fully repatriates its principals, it should re-apply for investment quota.

Article 29. If QFII needs to purchase foreign exchange to repatriate their post-tax profits of the previous accounting year which have been audited by Chinese CPA, the QFII should mandate its custodian to apply to SAFE fifteen days prior to repatriation, together with the following documents: 1. Repatriation Application Form; 2. Financial reports of the accounting year in which the profits are generated; 3. Auditor's report issued by Chinese CPA; 4. Profits distribution resolutions or other effective legal documents; 5. Tax payment certificates; 6. Other documents as required by SAFE. The overseas receivers of the above-mentioned repatriation should be the QFII themselves. Article 30. SAFE may adjust the timeframe required for QFII to repatriate its

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principal and proceeds, subject to the needs of China's foreign exchange balance.

Chapter 6. Regulatory Issues

Article 31. CSRC and SAFE should annually review QFII's Securities Investment Licence and Foreign Exchange Registration Certificate.

Article 32. CSRC, PBOC and SAFE may require QFII, custodians, securities companies, stock exchanges, and securities registration and settlement institutions to provide information on QFII's domestic investment activities, and may conduct on-site inspections if necessary.

Article 33. Stock exchanges and securities registration and settlement institutions may enact new operation rules or revise previous operation rules on QFII's domestic securities investments, the implementation of which will be effective upon approval of the CSRC.

Article 34. In the event of any of the followings, QFII should file with CSRC, PBOC and SAFE in five working days: 1. Change of custodians; 2. Change of legal representatives; 3. Change of controlling shareholders; 4. Adjustment of registered capital; 5. Litigations and other material events; 6. Being imposed substantial penalties overseas; 7. Other circumstances as stipulated by CSRC and SAFE.

Article 35. In the event of any of the followings, QFII should re-apply for its Securities Investment Licence: 1. Change of business name; 2. Acquired by or merged with other institution(s);

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3. Other circumstances as stipulated by CSRC and SAFE.

Article 36. In the event of any of the followings, QFII should surrender its Securities Investment Licence and Foreign Exchange Registration Certificate to CSRC and SAFE respectively: 1. Having repatriated all its principals; 2. Having transferred its investment quota; 3. Dispersion of authorised entities, entering into bankruptcy procedures, or assets being taken over by receivers; 4. Other circumstances as stipulated by CSRC and SAFE. If QFII fail to pass the annual review on Securities Investment Licences and Foreign Exchange Registration Certificates, as mentioned in Article 31, the Licences/Certificates will automatically be invalid. And the QFII should return these Licences/Certificates as required by the aforesaid Article.

Article 37. In accordance with their respective authorities, CSRC, PBOC and SAFE will give warnings or penalties to QFII, custodians and securities companies, etc. who violate this Regulation. The same breach, however, should not be subject to two administrative penalties or more.

Chapter 7. Supplementary Provisions

Article 38. This Regulation is also applicable to institutional investors from Hong Kong Special Administrative Region, Macao Special Administrative Region and Taiwan Region, who conduct securities investment businesses in Mainland China.

Article 39. This Regulation will come into effect from 1 December 2002.

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Appendix 2a China's Stock Index in US$*

SHA Year 12/1/1999 1/1/2000 2/1/2000 3/1/2000 4/1/2000 5/1/2000 6/1/2000 7/1/2000 8/1/2000 9/1/2000 10/1/2000 11/1/2000 12/1/2000 1/1/2001 2/1/2001 3/1/2001 4/1/2001 5/1/2001 6/1/2001 7/1/2001 8/1/2001 9/1/2001 10/1/2001 11/1/2001 12/1/2001 1/1/2002 2/1/2002 3/1/2002 4/1/2002 5/1/2002 6/1/2002 7/1/2002 8/1/2002 9/1/2002 Date -36 -35 -34 -33 -32 -31 -30 -29 -28 -27 -26 -25 -24 -23 -22 -21 -20 -19 -18 -17 -16 -15 -14 -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 SHA 224.3924 211.8140 238.0188 263.6265 279.5507 285.0443 294.8582 293.7156 314.1038 309.5323 295.6210 305.7326 321.8296 319.8404 318.7926 302.4601 324.8773 323.0657 336.6493 335.2804 302.9306 276.9632 269.0587 259.9545 268.0759 249.8382 225.9220 228.5826 244.7113 254.1394 225.8466 261.1662 251.6587 254.0945 -0.0577 0.1166 0.1022 0.0587 0.0195 0.0338 -0.0039 0.0671 -0.0147 -0.0460 0.0336 0.0513 -0.0062 -0.0033 -0.0526 0.0715 -0.0056 0.0412 -0.0041 -0.1015 -0.0896 -0.0290 -0.0344 0.0308 -0.0705 -0.1006 0.0117 0.0682 0.0378 -0.1180 0.1453 -0.0371 0.0096 Return SHB 38.4210 37.9110 40.7170 38.1080 42.4770 43.0970 56.4680 54.8210 61.5490 64.4750 62.1280 70.1550 74.9990 89.5500 85.5650 100.4790 160.1970 181.4700 231.8900 213.3900 168.5890 158.3220 151.5510 157.5120 168.6150 171.5310 143.5040 142.0080 151.8070 145.2760 134.9370 148.5850 150.9170 151.3050 -0.0134 0.0714 -0.0662 0.1085 0.0145 0.2702 -0.0296 0.1158 0.0464 -0.0371 0.1215 0.0668 0.1773 -0.0455 0.1607 0.4665 0.1247 0.2452 -0.0831 -0.2357 -0.0628 -0.0437 0.0386 0.0681 0.0171 -0.1784 -0.0105 0.0667 -0.0440 -0.0738 0.0963 0.0156 0.0026 SHB Return SZA 67.1720 62.9994 73.6767 82.2967 87.6416 89.1132 92.1771 92.7599 98.2275 95.9229 92.6877 95.6330 100.8794 99.5838 98.0801 92.0478 98.9938 97.2281 100.5983 100.1949 90.3897 83.4998 79.0139 75.5536 78.5585 72.8553 64.2875 65.5631 72.1574 74.6983 67.3101 77.2969 74.8715 75.6549 -0.0641 0.1566 0.1106 0.0629 0.0167 0.0338 0.0063 0.0573 -0.0237 -0.0343 0.0313 0.0534 -0.0129 -0.0152 -0.0635 0.0727 -0.0180 0.0341 -0.0040 -0.1030 -0.0793 -0.0552 -0.0448 0.0390 -0.0754 -0.1251 0.0196 0.0958 0.0346 -0.1041 0.1383 -0.0319 0.0104 SZA Return

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10/1/2002 11/1/2002 12/1/2002 1/1/2003 2/1/2003 3/1/2003 4/1/2003 5/1/2003 6/1/2003 7/1/2003 8/1/2003 9/1/2003 10/1/2003 11/1/2003 12/1/2003 1/1/2004 2/1/2004 3/1/2004 4/1/2004 5/1/2004 6/1/2004 7/1/2004 8/1/2004 9/1/2004 10/1/2004 11/1/2004 12/1/2004 1/1/2005 2/1/2005 3/1/2005 4/1/2005 5/1/2005 6/1/2005 7/1/2005 8/1/2005 9/1/2005 10/1/2005 11/1/2005

-2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

240.7847 230.2823 212.8981 207.0313 228.6484 232.6652 232.3189 232.2814 240.8266 226.7829 225.6132 221.6722 208.9627 208.0683 218.7343 228.9159 248.2428 258.3640 269.0027 244.1301 241.6943 220.6965 210.1719 202.2582 213.7521 199.9333 204.4652 194.0573 182.1305 199.5985 187.2773 177.4289 159.1108 161.7098 167.0163 181.6608 177.1085 167.1734

-0.0538 -0.0446 -0.0785 -0.0279 0.0993 0.0174 -0.0015 -0.0002 0.0361 -0.0601 -0.0052 -0.0176 -0.0590 -0.0043 0.0500 0.0455 0.0811 0.0400 0.0404 -0.0970 -0.0100 -0.0909 -0.0489 -0.0384 0.0553 -0.0668 0.0224 -0.0522 -0.0634 0.0916 -0.0637 -0.0540 -0.1090 0.0162 0.0323 0.0840 -0.0254 -0.0577

144.5750 129.2810 114.5280 113.5100 127.2740 126.2190 122.7980 118.6140 118.6480 112.2840 111.3330 102.6270 99.1230 112.6590 111.8430 104.9380 116.1020 119.1480 117.9220 107.0240 105.8770 89.6800 89.9430 86.3070 91.9550 80.2420 82.4010 75.6520 72.4160 81.7110 79.8590 75.2630 65.9870 64.0350 59.4210 67.3460 67.6500 59.4130

-0.0455 -0.1118 -0.1212 -0.0089 0.1145 -0.0083 -0.0275 -0.0347 0.0003 -0.0551 -0.0085 -0.0814 -0.0347 0.1280 -0.0073 -0.0637 0.1011 0.0259 -0.0103 -0.0970 -0.0108 -0.1660 0.0029 -0.0413 0.0634 -0.1363 0.0266 -0.0855 -0.0437 0.1208 -0.0229 -0.0593 -0.1315 -0.0300 -0.0748 0.1252 0.0045 -0.1298

71.0904 67.8562 61.0288 59.8066 65.5960 66.7238 65.6731 64.3069 67.8696 62.2041 61.5066 61.0148 57.2214 55.8823 57.4522 57.4025 62.6980 68.2915 70.3234 62.0882 62.0048 55.5261 52.9233 49.9807 53.9613 50.3902 51.6697 47.9520 44.6526 49.4551 46.2514 42.5640 38.4462 37.9471 38.4631 43.0136 42.5202 40.1519

-0.0622 -0.0466 -0.1060 -0.0202 0.0924 0.0170 -0.0159 -0.0210 0.0539 -0.0872 -0.0113 -0.0080 -0.0642 -0.0237 0.0277 -0.0009 0.0882 0.0855 0.0293 -0.1245 -0.0013 -0.1104 -0.0480 -0.0572 0.0766 -0.0685 0.0251 -0.0747 -0.0713 0.1022 -0.0670 -0.0831 -0.1017 -0.0131 0.0135 0.1118 -0.0115 -0.0573

137

12/1/2005

36

168.4933

0.0079

60.8950

0.0246

40.4006

0.0062

* Exchange rate US - RMB 6.8546 20/8/2008 * Exchange rate US - HK 7.81 20/8/2008

138

SZB Year 12/1/1999 1/1/2000 2/1/2000 3/1/2000 4/1/2000 5/1/2000 6/1/2000 7/1/2000 8/1/2000 9/1/2000 10/1/2000 11/1/2000 12/1/2000 1/1/2001 2/1/2001 3/1/2001 4/1/2001 5/1/2001 6/1/2001 7/1/2001 8/1/2001 9/1/2001 10/1/2001 11/1/2001 12/1/2001 1/1/2002 2/1/2002 3/1/2002 4/1/2002 5/1/2002 6/1/2002 7/1/2002 8/1/2002 9/1/2002 10/1/2002 11/1/2002 Date -36 -35 -34 -33 -32 -31 -30 -29 -28 -27 -26 -25 -24 -23 -22 -21 -20 -19 -18 -17 -16 -15 -14 -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 SZB 10.6750 10.8402 11.3165 11.1097 11.9474 11.5305 14.3271 14.3087 14.8557 15.1444 13.7412 14.8859 15.3722 17.6294 17.4487 19.6858 43.3649 48.3184 52.4547 46.4475 36.2962 35.1416 30.9644 32.4891 35.1526 34.0172 27.3618 27.7392 29.5886 29.2800 25.9186 30.1872 31.1731 31.0641 29.6551 25.5650 0.0154 0.0430 -0.0184 0.0727 -0.0355 0.2172 -0.0013 0.0375 0.0192 -0.0972 0.0800 0.0321 0.1370 -0.0103 0.1206 0.7898 0.1082 0.0821 -0.1216 -0.2466 -0.0323 -0.1265 0.0481 0.0788 -0.0328 -0.2177 0.0137 0.0645 -0.0105 -0.1219 0.1525 0.0321 -0.0035 -0.0464 -0.1484 Return

139

12/1/2002 1/1/2003 2/1/2003 3/1/2003 4/1/2003 5/1/2003 6/1/2003 7/1/2003 8/1/2003 9/1/2003 10/1/2003 11/1/2003 12/1/2003 1/1/2004 2/1/2004 3/1/2004 4/1/2004 5/1/2004 6/1/2004 7/1/2004 8/1/2004 9/1/2004 10/1/2004 11/1/2004 12/1/2004 1/1/2005 2/1/2005 3/1/2005 4/1/2005 5/1/2005 6/1/2005 7/1/2005 8/1/2005 9/1/2005 10/1/2005 11/1/2005 12/1/2005

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36

24.4626 23.9408 26.7991 26.4658 26.1351 27.1915 28.9927 27.6184 29.6117 29.3749 29.1273 35.2926 34.9408 34.8333 37.6077 38.3110 38.7211 33.4585 34.7953 32.9052 31.1206 28.0982 31.2343 28.5958 30.6887 28.1439 29.7667 32.7964 33.6131 32.1791 28.7810 27.4890 28.1172 28.7681 28.6232 24.1933 24.8635

-0.0441 -0.0216 0.1128 -0.0125 -0.0126 0.0396 0.0641 -0.0486 0.0697 -0.0080 -0.0085 0.1920 -0.0100 -0.0031 0.0766 0.0185 0.0106 -0.1461 0.0392 -0.0558 -0.0558 -0.1022 0.1058 -0.0883 0.0706 -0.0866 0.0561 0.0969 0.0246 -0.0436 -0.1116 -0.0459 0.0226 0.0229 -0.0051 -0.1681 0.0273 * Exchange rate US - RMB 6.8546 20/8/2008 * Exchange rate US - HK 7.81 20/8/2008

140

Appendix 2b Taiwan's Stock Index in US$*

TAIEX Year 1/1/1988 2/1/1988 3/1/1988 4/1/1988 5/1/1988 6/1/1988 7/1/1988 8/1/1988 9/1/1988 10/1/1988 11/1/1988 12/1/1988 1/1/1989 2/1/1989 3/1/1989 4/1/1989 5/1/1989 6/1/1989 7/1/1989 8/1/1989 9/1/1989 10/1/1989 11/1/1989 12/1/1989 1/1/1990 2/1/1990 3/1/1990 4/1/1990 5/1/1990 6/1/1990 7/1/1990 8/1/1990 9/1/1990 Date -36 -35 -34 -33 -32 -31 -30 -29 -28 -27 -26 -25 -24 -23 -22 -21 -20 -19 -18 -17 -16 -15 -14 -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 TAIEX 2610.8300 3206.3500 3345.9100 3767.7800 4441.5500 4951.3300 5422.0700 7352.1300 8039.0700 6580.9200 6851.9700 5856.6200 5716.9200 6679.8500 7318.0400 7785.2800 8795.4300 9497.4200 8619.4200 9731.6200 10402.7500 10066.9700 10121.3700 8658.4300 10677.5700 11983.4600 11223.1000 9741.5200 7848.0100 6157.2500 5037.6600 4119.7400 3237.5700 0.2055 0.0426 0.1187 0.1645 0.1087 0.0908 0.3045 0.0893 -0.2001 0.0404 -0.1570 -0.0241 0.1557 0.0912 0.0619 0.1220 0.0768 -0.0970 0.1214 0.0667 -0.0328 0.0054 -0.1561 0.2096 0.1154 -0.0656 -0.1416 -0.2161 -0.2426 -0.2007 -0.2012 -0.2410 Return

141

10/1/1990 11/1/1990 12/1/1990 1/1/1991 2/1/1991 3/1/1991 4/1/1991 5/1/1991 6/1/1991 7/1/1991 8/1/1991 9/1/1991 10/1/1991 11/1/1991 12/1/1991 1/1/1992 2/1/1992 3/1/1992 4/1/1992 5/1/1992 6/1/1992 7/1/1992 8/1/1992 9/1/1992 10/1/1992 11/1/1992 12/1/1992 1/1/1993 2/1/1993 3/1/1993 4/1/1993 5/1/1993 6/1/1993 7/1/1993 8/1/1993 9/1/1993 10/1/1993 11/1/1993

-3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34

2912.1600 3966.2200 4399.5800 3938.0600 4643.0700 4781.3900 5605.6600 5993.0000 5869.7800 5259.5600 4779.6400 4669.0800 4541.4500 4448.6900 4438.6600 5023.1900 5031.0100 4908.1900 4529.4000 4476.8500 4588.4600 4234.6100 3918.1200 3632.6900 3666.4300 3615.8600 3633.8400 3274.3000 3845.0500 4597.5800 4655.4600 4450.4200 4196.4100 3990.8400 4032.6500 3862.0900 3970.5100 4251.8000

-0.1059 0.3089 0.1037 -0.1108 0.1647 0.0294 0.1590 0.0668 -0.0208 -0.1098 -0.0957 -0.0234 -0.0277 -0.0206 -0.0023 0.1237 0.0016 -0.0247 -0.0803 -0.0117 0.0246 -0.0803 -0.0777 -0.0756 0.0092 -0.0139 0.0050 -0.1042 0.1607 0.1787 0.0125 -0.0450 -0.0588 -0.0502 0.0104 -0.0432 0.0277 0.0684

142

12/1/1993 1/1/1994

35 36

5089.2000 6057.6200

0.1798 0.1742

* Exchange rate US - RMB 6.8546 20/8/2008 * Exchange rate US - HK 7.81 20/8/2008

143

Appendix 3- Full Result of SPSS Mean and Standard Deviation of Shanghai A-Share Index Return , Shanghai B-Share Index Return, Shenzhen A-Share Index Return, Shenzhen B-Share Index Return and Taiwan Capitalization Weighted Stock Index Return in different period
ReturnSHA ReturnSHB ReturnSZA ReturnSZB ReturnTAIEX * BEFORE

BEFORE 0 Mean N Std.

ReturnSHA -.01053360 39 .055452103 Deviation

ReturnSHB -.02333709 39 .074786975 .04153617 33 .131739771 .00639648 72 .108973241

ReturnSZA -.01608557 39 .063417398 .00360382 33 .069058248 -.00706127 72 .066328896

ReturnSZB -.00570906 39 .077013518 .03236809 33 .168550959 .01174297 72 .127842285

ReturnTAIEX .01878005 39 .099250258 .00330991 33 .150097179 .01168957 72 .124444370

Mean N Std.

.00376697 33 .064047227

Deviation Total Mean N Std. .059548609 Deviation -.00397917 72

ReturnSHA ReturnSHB ReturnSZA ReturnSZB ReturnTAIEX

* PRE

PRE 0 Mean N Std.

ReturnSHA -.00158852 69 .059617629 Deviation

ReturnSHB .01071051 69 .109067830 -.09282611 3 .041252518 .00639648 72 .108973241

ReturnSZA -.00425471 69 .066135001 -.07161207 3 .030831522 -.00706127 72 .066328896

ReturnSZB .01571597 69 .128747515 -.07963615 3 .059568553 .01174297 72 .127842285

ReturnTAIEX .00782400 69 .120457738 .10059771 3 .209886793 .01168957 72 .124444370

Mean N Std.

-.05896424 3 .017527105

Deviation Total Mean N Std. .059548609 Deviation -.00397917 72

144

ReturnSHA ReturnSHB ReturnSZA ReturnSZB ReturnTAIEX

* POST

POST 0 Mean N Std.

ReturnSHA -.00543895 69 .059398935 Deviation

ReturnSHB .00526591 69 .110541535 .03239972 3 .071059400 .00639648 72 .108973241

ReturnSZA -.00866126 69 .066591653 .02973865 3 .057377120 -.00706127 72 .066328896

ReturnSZB .01111284 69 .129958435 .02623597 3 .075087771 .01174297 72 .127842285

ReturnTAIEX .00708058 69 .124418322 .11769620 3 .076557267 .01168957 72 .124444370

Mean N Std.

.02959572 3 .064497618

Deviation Total Mean N Std. .059548609 Deviation -.00397917 72

ReturnSSEA ReturnSSEB ReturnSSZA ReturnSSZB ReturnTW

* AFTER

AFTER 0 Mean N Std.

ReturnSHA .00092832 39 .063596699 Deviation

ReturnSHB .03049780 39 .127581995 -.02208689 33 .073988500 .00639648 72 .108973241

ReturnSZA -.00017165 39 .068740594 -.01520355 33 .063434726 -.00706127 72 .066328896

ReturnSZB .02328067 39 .159109511 -.00189250 33 .076458764 .01174297 72 .127842285

ReturnTAIEX .01959253 39 .152010022 .00234970 33 .082187324 .01168957 72 .124444370

Mean N Std.

-.00977893 33 .054779904

Deviation Total Mean N Std. .059548609 Deviation -.00397917 72

145

Normal Regression Regression of Shanghai A-Share Index

Model Summary

Adjusted R Model 1 a R .248(a) R Square .062 Square .020

Std. Error of the Estimate .058939975

Predictors: (Constant), AFTER, POST, PRE

Coefficients(a)

Unstandardized Coefficients Model 1 (Constant .004 ) PRE POST AFTER -.063 .026 -.014 .036 .036 .015 .010 B Std. Error

Standardized Coefficients Beta t B .367 -.212 .087 -.114 -1.765 .727 -.934 Sig. Std. Error .715 .082 .470 .354

a Dependent Variable: ReturnSHA

146

Regression of Shanghai B-Share Index

Model Summary

Adjusted R Model 1 a R .343(a) R Square .118 Square .079

Std. Error of the Estimate .104603714

Predictors: (Constant), AFTER, POST, PRE

Coefficients(a)

Unstandardized Coefficients Model 1 (Constant .042 ) PRE POST AFTER -.134 -.009 -.064 .063 .063 .026 .018 B Std. Error

Standardized Coefficients Beta t B 2.281 -.248 -.017 -.293 -2.130 -.145 -2.471 Sig. Std. Error .026 .037 .885 .016

a Dependent Variable: ReturnSHB

147

Regression of Shenzhen A-Share Index

Model Summary

Adjusted R Model 1 a R .268(a) R Square .072 Square .031

Std. Error of the Estimate .065289134

Predictors: (Constant), AFTER, POST, PRE

Coefficients(a)

Unstandardized Coefficients Model 1 (Constant .004 ) PRE POST AFTER -.075 .026 -.019 .039 .039 .016 .011 B Std. Error

Standardized Coefficients Beta t B .317 -.228 .079 -.142 -1.910 .664 -1.170 Sig. Std. Error .752 .060 .509 .246

a Dependent Variable: ReturnSZA

148

Regression of Shenzhen B-Share Index

Model Summary

Adjusted R Model 1 a R .199(a) R Square .040 Square -.003

Std. Error of the Estimate .128024868

Predictors: (Constant), AFTER, POST, PRE

Coefficients(a)

Unstandardized Coefficients Model 1 (Constant .032 ) PRE POST AFTER -.112 -.006 -.034 .077 .077 .032 .022 B Std. Error

Standardized Coefficients Beta t B 1.452 -.176 -.010 -.134 -1.451 -.079 -1.087 Sig. Std. Error .151 .151 .937 .281

a Dependent Variable: ReturnSZB

149

Regression of Taiwan Capitalization Weighted Stock Index

Model Summary

Adjusted R Model 1 a R .239(a) R Square .057 Square .015

Std. Error of the Estimate .123485673

Predictors: (Constant), AFTER, POST, PRE

Coefficients(a)

Unstandardized Coefficients Model 1 (Constant .003 ) PRE POST AFTER .097 .114 -.001 .074 .074 .030 .021 B Std. Error

Standardized Coefficients Beta t B .154 .157 .185 -.004 1.306 1.536 -.032 Sig. Std. Error .878 .196 .129 .975

a Dependent Variable: ReturnTAIEX

150

Correlation of Shanghai A-Share Market , B-Share Market and Shenzhen A-Share Market and B-Share Market
Correlations

ReturnSHA ReturnSHA Pearson 1 Correlation Sig. (2-tailed) N ReturnSHB Pearson .598(**) Correlation Sig. (2-tailed) N ReturnSZA Pearson .973(**) Correlation Sig. (2-tailed) N ReturnSZB Pearson .528(**) Correlation Sig. (2-tailed) N .000 72 .000 72 .000 72 72

ReturnSHB .598(**) .000 72 1

ReturnSZA .973(**) .000 72 .592(**) .000

ReturnSZB .528(**) .000 72 .869(**) .000 72 .511(**) .000

72 .592(**) .000 72 .869(**) .000 72

72 1

72 .511(**) .000 72

72 1

72

** Correlation is significant at the 0.01 level (2-tailed).

151

Appendix 4 Full Result of Stata 10 Panel Regression of Chinese Stock Market (aggregate)
. regress return PERdummy POSTdummy AFTERdummy SS .082807922 2.50156017 2.5843681 Coef. -.0421027 .0006083 -.0319652 .0184522 df 3 284 287 MS .027602641 .00880831 .009004767 t -1.90 0.03 -2.67 2.18 P>|t| 0.058 0.978 0.008 0.030 Number of obs = F( 3, 284) Prob > F R-squared Adj R-squared Root MSE = = = = = 288 3.13 0.0260 0.0320 0.0218 .09385

Source Model Residual Total return PERdummy POSTdummy AFTERdummy _cons

Std. Err. .0221598 .0221598 .0119676 .0084624

[95% Conf. Interval] -.0857209 -.04301 -.0555218 .0017952 .0015156 .0442265 -.0084087 .0351092

152