To bite, the CSRC needs legal teeth

While the media has been focusing on the reform bonus in recent weeks, a message from Xiao Gang, chairman of China Securities Regulatory Commission, has largely gone unnoticed.

As such, the media may have done a great disservice to their audiences many of whom are known to play the stock market.

Since his appointment in March, Xiao has been leading the charge to address the most glaring shortcomings of the stock market, raising the hopes of many in the beleaguered league of small investors.

In the past several months, Xiao has seemed particularly outspoken about the direction he is pursuing for stock market reform. His latest message was of special significance because it touched on the very heart of the issue. Speaking at the annual conference of Caijing, a business magazine, Xiao reportedly stated that there would be no reform without a sea change in the regulatory fundamentals.

He was quoted as saying that the only option was to adopt a self-regulatory system similar to those that prevail in most international financial markets rather than an approval system that has put too much strain on resources and the capabilities of the Chinese regulatory authorities. In a self-regulatory environment the responsibility and obligation for compliance are placed on the stockbrokers, financial advisers, accountants, listed company executives and other market practitioners.

Instead of examining and approving transactions, the regulator's job is focused mainly on prevention, investigation and prosecution. Like the police, the securities regulator is responsible for enforcement of the securities law and swings into action when a breach of the law is detected.

Even the CSRC has conceded that enforcement is a weak link in the regulatory armor. Employing more qualified investigators, which the CSRC is doing, may help. But the problem goes far beyond that.

Without the power to conduct searches and the authority to subpoena witnesses, there is little the CSRC can do to demand cooperation from the companies or individuals being investigated. It is understood that resistance, sometimes violent, is not uncommon from those under investigation.

Worse, the CSRC does not have the power to prosecute. As it is, CSRC has to refer cases to government prosecutors who may not be as familiar with the securities laws and regulations.

Market self-regulation has proven to be a good idea in some other markets. But the idea can only work if the regulator is fully armed with legal teeth.

In the Hong Kong Special Administrative Region, for instance, insider trading and a list of other stock market misdeeds are criminal offences liable to heavy fines and incarceration when convicted. Tough regulations and vigilant enforcement are seen to have the effect of nurturing a culture of responsibility and integrity among the market practitioners.

The approval system, accompanied by loose regulations and lax enforcement, would encourage practitioners to take chances in a perennial cat-and-mouse game with the regulators, knowing that even if they get caught, the penalties won't be crippling.

As many stock market commentators have suggested, a fundamental change to the market regulatory principle is long overdue.