A variety of government policies and policy-related events can influence the operation of China‘s stock market. In terms of different policy objectives, all the stock market-related regulatory policies can be broadly categorized into two classes. One class focuses on creating a fair and transparent environment for all market participants and the other aims at maintaining a desirable overall level of securities‘ prices, which is believed to be conducive to maintain a stable, healthy development of the stock market.
In practice, regardless of the type of target the regulatory policy aims at, from the perspective of stock investors, there are six major types of policy event in stock markets that are likely to give rise to market uncertainty or investment risk. These policy events can be summarized as: regulations and laws; system reformation; regulatory activities; administrative intervention; official comments; and adjustments of economic policies.
3.2.1 Regulations and laws
Regulations and laws concerning stock markets are the fundamental rules and principles for investors as well as listed companies to abide by when participating in the market that are formulated to create and maintain a fair and transparent market for all market participants.
The regulations and laws in China‘s security markets have been gradually released and enforced step by step since it is still a developing capital market with a history of fewer than 30 years. For example, the fundamental legal document the ―Securities Law of The People’s Republic of China‖ was implemented in December 1998 but its enforcement started around eight years later than the foundation of the Shanghai Stock Exchange (SSE, founded in and operated from December 1990).
3.2.2 System reformation
System reformation concerning the stock market includes the introduction of new trading rules, changes in current regulations and regulatory authorities (He, 2009). It is not uncommon to see reform of the regulatory system conducted from time to time in China‘s stock market. In practice, there are some major issues, such as state-owned shares and no- tradable shares in the history of the stock market‘s development in China because the initial objective of the foundation of the capital market mainly focused on providing low-cost financing for state-owned enterprises rather than improving the efficiency of the financial market (Wang et al., 2012). For instance, in the beginning, state-owned shares were untradeable to ensure control of state-owned enterprises by the central government; this rule goes against the requirements for operating listed companies in terms of the structure of modern corporate governance and, as a result, reform occurred in June 2001 to enable state- owned shares to be tradable (He, 2009).
3.2.3 Regulatory activities
To safeguard the efficient, transparent operation of the stock market, three main kinds of regulatory measures (economic, legal and administrative) under special circumstances, were explored by authorities to supervise the behaviour of investors and investment intermediaries as well as the offering and trading of securities (Wang et al., 2012). In China, stock market violations, such as market manipulation, false information disclosure, customer fraud and insider trading, are still quite common thus the regulatory actions need to be taken frequently to maintain a healthy, orderly market environment. As a result, apart from daily regulation, some special actions are taken by regulatory officials to deal with such potential problems that could be seriously detrimental to the stable development of the stock market. For example, the ‗Special enforcement action of CSRC in 2015‘ engaged in by regulatory authorities mainly
concentrated on fighting against stock market violations related to insider trading, market manipulation and financial fraud for IPOs21.
3.2.4 Administrative intervention
In developed stock markets, it is unusual to find any direct interference by the government in stock market affairs but, in China, under some special circumstances, there is an increasing tendency that the regulatory authorities prefer to stabilize volatile fluctuations of the stock market by virtue of active administrative intervention instead of other market-oriented measures (Wang et al., 2012). Consequently, it gradually became a main reason that the Chinese government has been criticized for making a policy-driven stock market. In practice, official market intervention in China‘s stock market is believed to more likely trigger big market volatility rather than stabilizing it. In June-July 2015, Chinese regulators limited short selling under a threat of arrest and encouraged state-owned brokers to buy shares by providing liquidity to stabilize the turbulent stock market; the regulatory authorities asked the major securities companies to stop selling stock when the Shanghai Composite Index (SHCI) was below 450022.
3.2.5 Official comments
Despite the fact that there is no formal requirement for authorities to perform regulatory duties, official comments often play a very important role in regulating China‘s stock market. There are several ways by which regulators make comments about the current situation or future developments of the stock market, such as officials‘ public speeches, media interviews, review articles on the stock market and official statements. Under the special political atmosphere formed a long time ago, official comments from the People‘s Republic of China have a remarkably significant influence on market participants because stock investors in China are inclined to believe that official comments are very influential in the operation of the stock market (Zhu & Xie, 2011; Wang et al., 2012); some abnormal movements in stock prices are always preceded by the latest published official comments. For example, one comment on the People’s Daily website was believed to trigger massive amounts of investment by individual investors in stocks in April 201523.
21Source: The official website of CSRC: http://www.csrc.gov.cn, 2015-04-24. 22Source: No selling when the SHCI is below 4500, Beijing Morning,2015-07-05. http://www.morningpost.com.cn/2015/0705/794888.shtml .
23 On April 21, 2015, one article on the People’s Daily website made a comment that ‗4000 of Shanghai Composite Index is only a starting point of the current bull market‘, which triggered unprecedented enthusiasm of stock investors and further inflated the stock market bubble.
3.2.6 Adjustment of economic policy
Another category of policy events concerned investors is the adjustment of economic policy including macroeconomic policy, regional development policy as well as industrial policy. Economic policies are aimed at developing the economy rather than promoting the development of the stock markets; but, in practice, news information about changes in economic policy is likely to attract enormous attention of market participants because macroeconomic conditions significantly affect the profitability of listed companies as well as the investment expectations of stock investors. In the past decade, in only a very few cases has the central government of China tried to stabilize the stock market by monetary policy operations, e.g., the recent stock market bailout in the form of an unlimited liquidity injection by the Central Bank of China in June-July 201524.
Table 3.1 Categories of GovernmentPolicy Actions Related to the Stock Market
Categories Description Example
1. Regulations and Laws
The fundamental rules and principles for investors as well as listed companies to follow in the capital market.
‗Securities Law of The PRC‘ 2. System
Reformation
The introduction of new trading rules, changes in current regulations and regulatory authorities.
Reduction of state- owned shares. 3. Regulatory
Activities
Regular supervision of the behaviour or conduct of investors and investment intermediaries as well as the offering and trading of securities.
IPO verification; investigation of insider trading by CSRC. 4. Administrative Intervention
Interference by government to stabilise the stock market under some special circumstances.
The bailout of the stock markets in July 2015.
5. Official Comments
Comments on the current situation or the future development of the stock market, mainly from officials‘ public speeches, media interviews, review articles about the stock market and official statements.
Published interviews of CSRC‘s president in Securities Times.
6. Adjustment of Economic Policy
Changes in economic policies including
macroeconomic policy, regional development policy and industrial policy.
Interest rate changes; national economic development strategy of ‗one band one road‘.
Source: Author‘s summary based on the literature.
Apart from the six types of policy event shown in Table 3.1, some other stock market-related events are also likely to induce uncertainty and result in market volatility, e.g., the appointment of the president of CSRC and the establishment of the Small and Medium-size Enterprise Board by the Shenzhen Stock Exchange. However, in this present study, it is
24 According to the reports in China Business News on 07/09/2015, in June-July 2015, apart from the cutting the interest rate and reserve ratio, the central bank of China also provided liquidity for CSFC (China Securities Finance Corporation, a state-owned securities company) to buy shares in the stock markets. It was severely criticized by some stock market analysts and commentators because shares buying by CSFC with money from
unnecessary to develop a new category because the influence of this kind of event on investors is like the influence from the release of fundamental regulations and laws.
In addition to the policy events summarized above, there are other important events related to stock market volatility, such as political issues, natural disasters and the global financial crisis. This study focuses on investigating the effect of policy risk on the volatility of the Chinese domestic stock market, thus any events unrelated to the domestic regulatory policies (or activities), such as interest rate adjustments in the US and Britain exiting from the EU (Brexit), are not included in the classification in Table 3.1, even though they do have a significant influence on stock market volatility.