State Council Restrictions Could Hurt China’s Exchanges

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By Vivian Ni

Dec. 2 – The future outlook of China’s more than 300 commodities and cultural exchanges has been clouded, as the State Council recently vowed to tighten regulations on all of them. Despite seeing strong business growth, many of the exchanges now face being cleared out of the market if they fail to obtain a license from the government.

In an age when investment into securities is becoming less promising due to the government’s tightening monetary policies, investors are eager to find other financial products that will bring them profits – and that is how hundreds of exchanges have sprouted up across China seemingly overnight. A wide range of products are traded on these exchanges: from metals, artwork, agricultural products and medical products, to financial assets, equity and carbon emission rights.

“Decision No. 38
While enthusiastic speculators trading at these exchanges understand well that the possibility of earning massive profits comes together with the risk of significant losses, the arrival of a recent State Council document has turned out to be more devastating than any other types of market fluctuations.

In the “Decision on Clearing Up as Well as Rectifying All Types of Exchanges and Effectively Preventing Financial Risks (guofa [2011] No.38)” issued on November 11, the State Council has emphasized that all kinds of exchanges across China – including equity exchanges, cultural artwork exchanges and commodities exchanges – shall obtain approval from the State Council. An exchange without such approval will not be able to:

  • Issue public offerings by dividing the ownership/value of any individual asset into equal shares
  • Trade shares divided out of the ownership/value of any individual asset
  • Conduct trading though centralized transactions – such as through a call-auction mechanism or a market maker system
  • Allow an investor who has bought/sold an item to buy/sell the same item within five trading days
  • Allow the equity ownership to exceed the size of 200 people

Impact on cultural exchanges
As most of China’s existing exchanges are not properly licensed by the State Council, “Decision No.38” could potentially hit all of them. However, the document is especially heartbreaking for the country’s emerging local cultural exchanges, where the ownership of a piece of expensive artwork is usually divided into a large amount of shares for public offering.

At the Tianjin Cultural Artwork Exchange (TCAE) – reportedly the largest exchange of its kind – 20 pieces of artwork have been issued to investors with a total initial value of RMB433.9 million. With prices of each share hovering around RMB1, it makes it very easy for the equity ownership size to exceed 200 people – the limit specified in “Decision No.38.”

All 20 TCAE stocks dropped by over 4 percent on November 24, the day “Decision No.38” was disclosed. Investors worry that a potential shutdown of the exchange under the tightened regulations could bring them even greater losses.

The development of cultural exchanges is therefore in a dilemma: on one hand, financial markets appreciate such an innovative avenue for cultural and intellectual property right trading, which makes artwork more accessible to regular investors while, on the other hand, the lack of transparency in pricing and statistical releases could potential cause problems big enough to push these cultural exchanges towards facing stricter government inspections.

Boasting some features similar to cultural exchanges, the increasing wine futures exchanges – where the value of a bottle of wine is divided into equal shares – will also likely come under strengthened government scrutiny, some experts say. Investment into expensive Western wine is becoming another type of emerging speculation that has recently attracted mounting interest.

Impact on metal exchanges
This wave of government scrutiny may also reach metal exchanges that are almost everywhere in the country. According to a report by Shanghai Business News, a collection of metal exchanges in China’s Tianjin, Hunan, Zhejiang, Yunnan and Shandong have already been placed on the top of the inspection list.

Weicai Bulk of Precious Metals Exchange based in Hunan Province was among the first batch of metal exchanges that announced a suspension of trading. According to the exchange’s web site, all types of its spot gold trading will be suspended starting at 4:30 a.m. on December 24, and all investors are required to close positions before that time.

The newly-opened Fanya Metal Exchange based in Yunnan Province is also waiting to see if it will pass the government’s scrutiny. The exchange – mainly trading silver, cloud germanium and indium – allows investors to realize unlimited transactions of one item within 24 hours (the T+0 mode), which goes against the T+5 limit stipulated in “Decision No.38.”

While metals – especially gold – are globally appreciated as a hedge against inflation, China’s metal exchange system needs more standardization. The backgrounds of shareholders, high leverage risks, questionable market maker systems and fund management safety have been regarded as major issues that could hurt the interests of investors.

The market opening of another Yunnan-based metal exchange established earlier this year – the Pan Asia Gold Exchange (PAGE) – may also be affected by this sudden regulatory headwind. While two months ago a PAGE official told China Briefing that the exchange was in the process of a “software adjustment” and was expected to start trading “around December,” two days ago the official said the “software adjustment” was still being processed and put no prospective schedule on when trading may begin.

The establishment of the PAGE attracted wide international attention, as global players see it as an important step for China to impact the gold market and gain a say in gold pricing. It was even predicted that the opening of the exchange may trigger a fresh wave of speculative gold buying and selling. However, the arrival of “Decision No.38” could potentially delay such progress.

The coming government scrutiny is generally seen as an active move, but some economists have raised other concerns. They worry a broad range of exchange clear-ups may reduce China’s say in global commodity pricing – some of which is essential for a country in pursuit of large-scale construction and rapid GDP growth.

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China’s Pan Asia Gold Exchange: A New Playing Field for Speculators?

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