Wednesday, April 1, 2009

Five Years Holding Period, Is it Fair?

China Banking Regulatory Commission (CBRC)'s chairman, Liu Mingkang announced that rules will change for foreign invesors who invest in Chinese commercial banks.

Remember the blockbuster IPOs of Chinese state-owned banks? Bank of China, China Construction Bank, China Industry and Commerce Bank all had their IPO a few years ago when the market was good. Many foreign investors bought shares of those banks, riding the wave of the bull market. When they bought into those shares, they agreed to holding those investment/shares for a period of three (3) years before they could sell because the CBRC required such a lock-up period.

The market situation has changed dramatically in recent months. Many of those foreign investors that bought shares in Chinese banks found themselves in urgent need of liquidity due to the severe finanical crisis worldwide. For example, according to reports, Bank of America sold its shares in the China Construction Bank; Royal Bank of Scotland got rid of its shares in the Bank of China. Foreign investors in Chinese banks' stocks also sold their shares for speculation purposes, based on the same report.

To combat the above phenomena, the CBRC has announced that the rules of the game shall change--the lock-up period for foreigner investors in Chinese banks' stocks will be lengthened from three (3) years to five (5) years.

It appears that this rule change is not meant to be retroactive, and it is effective only against future "strategic investors" in Chinese banks' shares.

The change from three years to five years seems arbitrary. Why would a five-year lock up period be more effective in reducing speculation on the part of foreign investors? I don't know if the CBRC made its rule/policy change based on solid research or just a a matter of course. Chinese government appears in many instances to like the number "five" in its macro-level planning. I sure hope the former is the case.

The change further illustrates the difficulties that foreign investors face in China in terms of uncertainties in the Chinese legal environment. When foreigners just got used to the three- year holding period for their investments in Chinese banks, suddenly, the Chinese government decided that a longer holding period is more desirable from a regulatory standpoint. For any reasonable investor, the question to pose is--what is prevent the CBRC from modifying the holding period in the furture again?

It is understandable for the Chinese government to make policy changes in accordance with circumstances and the country's corresponding regulatory needs. However, any policy changes must be based on sound reasoning by balancing the needs of investors and those of the public/nation at large. Without a balanced approach to adjustments in policy changes, China will be in actuality doing itself a disservice in creating unnecessary uncertainty in its capital markets.

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