Preferable outcomes

By+lan+Xinzhen

Issuing preferred stocks to raise funds—a financing method commonly used in developed markets—is to be introduced into the Chinese market. The China Securities Regulatory Commission （CSRC） on March 21 issued rules for a pilot program on preferred stocks， allowing three types of companies to publicly issue preferred stocks： Shanghai Stock Exchanges 50 index members （the largest by market capitalization）， companies planning to acquire other listed companies by issuing preferred stocks for payment， and companies buying back common stocks that plan to decrease their registered capital by issuing preferred stocks as payment.

Since the reform and opening-up policy was introduced in 1978， China has adopted many market-oriented economic changes by learning from international practices， especially those in developed countries， such as modern corporate governance systems and establishment of a capital market. Now it is preferred stocks turn.

A report by China Securities Co. Ltd. says the pilot program of preferred stocks in the Chinese market can offer a new financing tool for bluechip shares. It can both effectively alleviate the financing pressure on these companies and help improve their corporate governance structures， hence providing an alternative pattern for the reform of state-owned enterprises， especially financial enterprises. In the meantime， issuing preferred stocks can also strengthen the power of industrial leaders in the banking and insurance industries， being conducive to accelerating reorganization and the boosting of restructuring in these industries.

According to the report， after consideration of some indices， such as ownership concentration， dividend yield ratio and company evaluation， the conclusion can be drawn that blue chip shares in the banking， power， transport， construction， coal and real estate industries may be the first to issue preferred stocks.

Investors advice

Besides learning from international practices， policymakers listened to the voice of investors in the domestic market. This is a big step in progress toward the improvement of Chinas capital market. Previously， many policies of the CSRC， such as those concerning issuance of new stocks as well as margin trading and short selling， were often denounced by market investors. It was said at the time that the CSRC had not listened to investors when formulating these policies.

But this time， the CSRC began collecting opinions from the market from last December onward. In the final draft of the rules， the biggest change made was the provision prohibiting listed companies from issuing preferred stocks that can be converted to common stocks.endprint

According to a press release by the CSRC on March 21， the commission received 429 statements of opinions on the convertible preferred stocks， 427 of which came from individual investors. They held that if preferred stocks are allowed to be converted into common stocks， the interests of common stock holders will be diluted and common stock prices in the secondary market will drop. Therefore investors suggest preferred stocks be prohibited from being converted into common stocks.

Choice of timing

Allowing issuance of preferred stocks is a major task for， and target of， both the reform and development of the Chinese capital market， but it has come unexpectedly soon. The overall process only took three months for the CSRC， from collecting public opinions in December 2013 to releasing the rules in March. It has been developed at a faster rate than all previous policies regarding the capital market.

“This may be because of the sluggish economy. The top leadership hopes preferred stocks can stimulate the capital market，” said Wang yong， a macroeconomic analyst with China Securities Co. Ltd.

According to him， based on previous experience， the market expected that the pilot program of preferred stocks might be launched in the second half of this year. However， since 2014， Chinas stock market has remained in the doldrums because Chinas economic performance has failed to meet expectations and the domestic financial system is facing capital pressure.

Chinas economic performance in the first quarter was not optimistic， with many economic indices， such as industrial added value， fixed assets investment and foreign trade， being lower than expected. For this reason， major investment banks have lowered their forecast on Chinas economic growth this year. For example， Bank of America Merrill Lynch lowered its China economic forecast from 7.6 percent to 7.2 percent， and UBS reduced its forecast from 7.8 percent to 7.5 percent.

The capital chains of some domestic enterprises have been broken. In March， a real estate developer called Xingrun in Zhejiang Province， home to a large number of private enterprises， went bankrupt after they were unable to repay the $400 million bank loans. A photovoltaic panel manufacturer Chaori Solar Energy Science and Technology Co. Ltd. in Shanghai also reported Chinas first corporate bond default in early March.

“Against this backdrop， the sooner the supervising authority launches the pilot program for preferred stocks， the earlier enterprises and the market can be stimulated，” Wang continued.endprint

The CSRC also says issuing preferred stocks will help enterprises obtain capitals more conveniently， thus reducing the capital pressure on enterprises in their business operations.

Positive effect

The market has warmly welcomed the rules on preferred stocks. On the day the rules were announced， stock prices of listed banks posted huge gains. The market estimates that listed banks may be the first to issue preferred stocks because many of the listed banks are among Shanghai Stock Exchanges 50 index members. For fast expansion of credit and because of stricter capital requirements imposed by the supervising authority， these banks urgently need more capital.

The performance of blue chips is also the subject of great anticipation in the market. Li Daxiao， head of the research institute of yingda Securities Co. Ltd.， said in his Weibo， a Twitterlike micro-blog， that the program of preferred stocks will be conducive to resuming the financing function of blue-chip shares and increasing their vigor.

Almost all securities companies had a positive view on the CSRCs new rules. A report from China Merchants Securities Co. Ltd. said the pi- lot program of preferred stocks will help deepen the joint stock reform of Chinese companies， boost development of the capital market and significantly influence the stock-issuing companies， investors and the capital market.

According to the report， to stock-issuing companies， preferred stocks will provide a more flexible tool of direct financing. Leaving the control rights of capital structure unchanged， issuing preferred stocks can raise the proportion of direct financing， supplement capital， reduce the overall debt ratio and optimize corporate financial structures. In the meantime， preferred stocks can serve as a payment method for mergers and acquisitions， hence broadening the source of capital and facilitating mergers and acquisitions， in addition to accelerating industrial reorganization.

For investors， preferred stocks will provide a new investment channel， especially in longterm investment funds such as social security and insurance funds. With fixed dividend rates， preferred stocks can provide stable investment returns. Since preferred stocks take priority over common stocks in the payment of dividends and upon liquidation， investing in preferred stocks can reduce investment risks， encouraging investors willingness to directly invest in companies.

To the capital market， preferred stocks are conducive to enriching the varieties of securities and boosting stable development of the market overall. Preferred stocks have a combination of features including some of the properties of both an equity and a debt instrument， therefore they can fill in the gap in a varieties of securities in China， which will guarantee the interests of holders of common stocks， improve the corporate governance structure and boost steady and sound development of the capital market.

A report from Guodu Securities Co. Ltd. says the pilot program of preferred stocks will also help investors make better use of the capital stock. One of the major decisions made by the Chinese Government in its financial reform is to better employ capital stock.endprint