China, Explained series: Key Reforms to the Regulatory Governance of Chinese Companies

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As China opens its financial markets to the outside world, understanding the country’s regulatory framework is one challenge for foreign investors.1 Since opening its doors to foreign investments in 1978, China has pushed reforms to create an investment climate friendly for foreigners. We discuss the key milestones made in China to improve corporate governance and establish a regulatory framework for foreign investors.

Shifts to better corporate governance

Developing a credible and effective corporate governance system became an important initiative for China as it began to open its financial borders. Shleifer and Vishny (1997) argued that corporate governance – the alignment of investors’ interests and those of company management – is closely related with a country’s regulatory framework for investors.2 The rationale is that investors (the shareholders, minority interests and creditors) face the risk that returns on their investments will never materialize without legal grounds to penalize controlling shareholders or managers who expropriate them. For the last two decades, China embarked a series reforms to strengthen corporate governance at the state-owned, private and listed companies.

Key Reforms Objective
State-owned enterprise (SOE) reforms SOE privatization to separate ownership from management
Opening of Shanghai and Shenzhen stock exchanges China moves toward capital market reforms
Launch of the Qualified Foreign Institutional Investor (QFII) program; the Renminbi RQFII program Allows licensed foreign investors to invest in China's stock exchanges; allows access to offshore RMB to invest in PRC markets
CSRC tightened listing requirements* To strengthen corporate governance
Launch of the Shanghai/Shenzhen-Hong Kong Stock Connect program Allows foreign and Mainland Chinese investors to trade securities in each other's markets 
Scraps QFII and RQFII quotas Further opening of PRC markets
Launch registration-based IPO system Streamlines listing process; tougher penalties on disclosure violations

*Note: China Securities Regulatory Commission (CSRC) required annual return on equity (ROE) must >10% for each (not just average) of the preceding 3 years. Source: European Finance Association. Review of Finance. Corporate Governance in China: A Survey (July 2020)

The China’s securities regulator, the China Securities Regulatory Commission (CSRC) has taken a huge role in overseeing the nationwide securities market. Since its establishment in 1992, more than 300 laws and directives concerning the securities and futures market have been issued.3 It has the authority to regulate and supervise securities issuers, to investigate, and impose penalties for illegal activities related to securities and futures. CSRC provides the basic framework for information disclosure and transparency of the Chinese securities markets — a key area of concern for investors. These disclosure requirements are described by several levels of government ranging from securities legislation to questioning by CSRC.4 The new securities legislation offers enhanced information disclosure mechanism and added protection for both domestic and foreign investors. It covers guidance on the adoption of a registration-based IPO system for the A-share market and tougher punishments for malpractice and insider trading. In China, Explained series: How to find quality corporate reporting in China?, having a registration-based IPO system is one way to “price out” companies who exhibit poor corporate governance after listing.

Making China accessible to foreign investors

To sustain its remarkable economic growth and compete globally, China introduced the Qualified Foreign Institutional Investor (QFII) and Renminbi (RQFII) schemes in 2002 and 2011 respectively and the Mainland China-Hong Kong Stock Connect channels in 2016 to encourage foreign investment participation. QFII and RQFII quotas will be removed in November 2020 providing greater access to Chinese equities.

Understanding the legal protections available to foreign investor

China has taken significant reforms to build a regulatory foundation for foreign investors seeking to enter its financial markets. To better understand the rights and protections that are available for foreign investors, it is important to differentiate which channels the investor is entering the Chinese market. As described in How to Invest in China, there are numerous ways a foreign investor can access the PRC market. In addition to country legislation, each access channel is subject to its own laws and regulations, and each would require expert legal advisers to assess the applicable PRC laws and investor risks. 

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

When investing in less developed countries, you should be prepared to accept significantly large fluctuations in value.

Investment in certain securities listed in China can involve significant regulatory constraints that may affect liquidity and/or investment performance.



1 Invesco. The China position: Gauging institutional investor confidence
2 John F. Kennedy School of Government Harvard University  Journal of Financial Economics. Investor Protection and Corporate Governance. (2000)
3 University of Southern California. Corporate Governance in China: Recent Developments, Key Problems, and Solutions.
4 China Securities Regulatory Commission. Code of Corporate Governance for Listed Companies in China.