The country also needs to consider allowing two domestic exchanges to set up trading terminals abroad to facilitate overseas investments in yuan-backed securities, the research arm of the Shanghai Stock Exchange said in a report.

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"China mainland stock markets are troubled with low liquidity, which could fan speculation and manipulation as well as increasing investors' trading costs," said Liu Ti, the Shanghai bourse's chief of research.

"To solve the problem, we should first act to optimize the market structure."

Regulators also have to continue to urge institutional participation and step up the pace to lure overseas investors to enter domestic markets, the report said.

Although the advice of the exchange's research unit doesn't represent regulatory rules, it usually indicates the direction the bourse is planning to move.

The mainland's benchmark stock gauge has more than doubled from an eight-year low set last year as listings of blue chips lured back investors.

The Shanghai Composite Index breached the 2,000 level on Monday for the first time in more than five years. The barometer was up one percent yesterday to close at 2,037.55.

"Allowing foreign listings will give overseas firms a tool to raise capital for local expansion and offer Chinese investors access to quality companies," said Wu Zhiguo, a Guohai Securities Co analyst.

"But I expect that won't be realized in the short term and won't come until most of mainland's biggest companies list shares here."

HSBC Holdings Plc, Europe's biggest lender, has said it would like to list on China's mainland by 2010 if given regulatory approval.

China's mainland must also strive to develop its financial-derivative markets which tend to feature stock-index futures and options, single-stock futures and options as well as covered warrants, the report said.

Government support should be given to large enterprises to go public to deepen the market base and weed out manipulation and price rigging, it said.

Regulators are expected to assign separate trading arrangements to different sectors and allow daily unlimited trading in shares of some companies, according to the report.

The mainland doesn't allow investors to sell stocks on the same day they buy the shares.

Mainland markets should also embrace margin trading and short-selling systems, the report said.

China's mainland is on track to introduce a margin-trading regime, which lets brokers fund investors' stock purchase, by the year end.

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