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Future Financial Reform Should Be Focused on Financial Infrastructure Construction


By Zhang Chenghui, Director-General of the Research Institute for Finance, Development Research Center of the State Council (DRC)

Research Report No 106, 2013(Total 4355)

I. Financial Infrastructure Is the Prerequisite for the Sound Development of the Financial Industry

If categorizing is done in terms of the intensity of factor inputs and the industries are classified as labor-intensive, capital-intensive, technology-intensive and knowledge-intensive, then the financial industry is deemed as a "contract-intensive industry". As a special service sector, the financial industry relates to contractual arrangements being far more intensive and complicated than other industries in production and trading of financial products, which are more vulnerable to "information asymmetry" and "ethical risks". Hence, if sound environments for ensuring the contract implementation are few and far between, risks will increase substantially, thus affecting investors' information and their trading aspirations, even triggering or amassing systemic risks. Functions of the financial infrastructure are all in all for ensuring the correctness and implementation of contracts.

Despite various reasons for financial crises that happened in the past, the backwardness of the financial infrastructure was a common problem. Countries worst hit by the 1997 Asian financial crisis almost all saw problems related with their financial infrastructures. For example, bankruptcy laws of Indonesia, South Korea, Thailand and Russia were not all carried out strictly, leaving creditors' interests unprotected, and malfunctioning enterprises or financial institutions thereby overlooked market constraints and acted willfully. Reasons related to financial infrastructure can still be found for the eruption of the ongoing international financial crisis: on one hand, with the explosive development of the financial derivatives, loopholes appear against consumer protection; on the other hand, the issue of "too big to fail (TBTF)" is quite tangible in developed countries, making ethical risks unavoidable.

II. Three Pillars for the Construction of Financial Infrastructure

The financial infrastructure of a country should include legal environment, information system and market support system as three major pillars.

1. Legal environment is the soul of financial infrastructure

Only with a sound legal environment can relations among various stakeholders be adjusted effectively so as to ensure the normal operation of the market. A sound legal environment involves three basic elements, namely, perfect legal system, effective executive system and reasonable authorization to financial supervision and regulation departments. Firstly, the legal system should be well established and can cover all fields and behaviors related to banking transactions. Meanwhile, the legal system should also keep pace with the times and be adjusted in the right time so as to address the changing economic and social environment. Secondly, a fair, just and efficient financial dispute hearing and arbitration mechanism should be set up under the legal system so as to ensure that laws are implemented to the letter. The highly professionalized banking industry and the complexity of the financial disputes have made it difficult for general judges to make appropriate judgments. As a consequence, the viewpoint of establishing an independent financial dispute judicial organ is being gradually accepted. In practice, pilot courts have been set up in Shanghai, Henan, Beijing and Wenzhou. In January 2012, the International Financial Arbitration Court began to operate in Hague, specializing in offering arbitration services for disputes arising from complicated and contentious financial derivatives and securities. Thirdly, financial supervision and regulation departments should be given necessary authorizations. As fast fund movement, hidden illegal conducts and difficulty in obtaining evidence through investigation feature financial transactions, plus financial investors being relatively scattered, the number of small and medium investors being huge and the class action mechanism being imperfect and incomplete in China, therefore, it is necessary to provide financial supervision and regulation departments with necessary rights to enforce the laws, such as the query rights, calling rights and the right to freeze account. However, these rights must be moderate and reasonable, and such rights cannot be exercised unless misconducts are committed.

2. Use the effective information disclosure and assessment system to address information asymmetry and construct the long-acting constraint and incentive mechanism for borrowers

Foreign experience shows that information disclosure is less demanded when stockholders concentrate relatively and, conversely, high-quality financial information disclosure is needed. It is easy to explain: A small number of big shareholders are far more capable of acquiring and handling information than large numbers of scattered small stockholders. To protect small and medium investors, accurate and timely information disclosure is needed to help them judge investment risks and returns and stabilize future expectations. That is to say, indirect-financing-oriented economies have lesser pressure of disclosing information to the public, while direct-financing-oriented economies are more sensitive to information. At present, China is making efforts to boost the transformation from the investment-driven and scale-centered extensive economic growth pattern to the innovation-driven intensive growth pattern that focuses more on efficiency and benefit. This transformation calls for the acceleration of technical innovation, calls for the major efforts to developing service industries and small and medium-sized enterprises, and calls for accelerated development of the capital market. As a result, investors will demand more disclosure of information in the future.

The accounting system is the first element to bolster the effective information disclosure mechanism. The system is the benchmark base for information disclosure; the second element is the system for information disclosure. For listed companies (including public companies, yet the implementation standard is different from that of listed companies), the active disclosure system is carried out. That is, listed and unlisted public companies take the initiative in disclosing necessary financial and business operation information to the public at given time and with prescribed content. Ensuring the authenticity and accuracy of information disclosed is of vital importance to the system. For unlisted and non-public companies, the passive disclosure system is carried out, namely, information is collected and compiled under the credit reference system, and information on inquiry subjects are provided to those in need of information when necessary conditions are met. The integrity and objectivity of the credit reference system is of vital importance to the system. Third is the rating system. Through the system, the objective and specialized third-party comments are provided to investors to help them improve their expertise and experience. Ensuring the authoritativeness and credibility of the rating agency is of vital importance to the system.

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