The big falls on the mainland's stock market occurred hand in hand with the referendum held in Greece on the sovereign debt crisis. Together, the two incidents have had a big impact on global financial markets. However, whether there is a causal link has yet to be proved. Both the Shanghai and Shenzhen Stock Exchange have experienced several crashes since they were founded in the late 1990s. The benchmark Shanghai Composite Index even fell by more than 70 percent from 2007 to 2008. The drastic 30 percent drop during recent trading, in reality, can be seen as the refraction of deepened reform achieved in the mainland securities market. For it was after the global financial crisis in 2008 that the central government started to accelerate reforms and expand the scope of opening-up the securities market by implementing a series of measures.

The securities margin trading mechanism implemented on March 1, 2010 was regarded as one essential step in the reform process, after which the Shanghai-Shenzhen 300 Stock Index Futures was officially listed on the China Financial Futures Exchange the following month. This marked the beginning of stock index futures trading on the mainland. As for the measures to boost liberalization of the market, in April 2012 the China Securities Regulatory Commission, the People's Bank of China and the State Administration of Foreign Exchange jointly increased the total investment amounts of the Qualified Foreign Institutional Investor (QFII) scheme from $30 billion to $80 billion. In December 2012 the China Securities Regulatory Commission, the Central Bank and Foreign Exchange Bureau raised the investment quota of RMB QFII by 200 billion yuan ($32 billion), making a total investment of 270 billion yuan. The Shanghai-Hong Kong Stock Connect is the latest move to establish an open market by the central government. The recent plunge of the two mainland stock markets reflects the impact of the new measures.

The launch of index futures trading in mainland stock markets was a clear sign of deepening financial reform. Nonetheless, with the growing varieties of the newly released index futures, the volatility of spot transactions of the stock index increased. The reason why the Chinese authorities have tightened regulation of the short-selling of index futures after shares plunged is that the stock index futures transactions have been taken advantage of by malicious speculators - responsible for the collapse of the stock market.

Mainland stock markets are now linked with those in Hong Kong and the global stock market via mechanisms like QFII and Shanghai-Hong Kong Stock Connect. The interaction between foreign capital flowing in and mainland capital has undoubtedly increased fluctuations of the stock markets. There is no point denying foreign investment is a major player in the mainland market. It has played a role in recent stock market turbulence.

History shows major reform and progress can be achieved in financial markets right after a crisis, when the problems have been identified and a consensus reached on how to resolve them. Following the 1997-98 Asian financial crisis, the SAR government unprecedentedly intervened in the market by merging the Stock Exchange and the Futures Exchange in 2000.

Likewise, the mainland stock market crash has fully exposed a series of problems. For example, the financing provided by institutions like banks, trusts and private lending companies, which rose drastically in the first half of the year, was actually circulating outside the supervision of the regulators and posed a huge risk for the market. Furthermore, mainland individual investors, who clearly lacked a comprehensive understanding of new derivatives like securities margin trading and index futures trading, failed to remain vigilant when the market rose and acted irrationally when the market fell. The central government's forceful measures to intervene in the stock market to curb malicious short-selling and calm the nerves of individual investors are only temporary solutions that will not last for long. The government will gradually introduce reforms when the stability of the stock market is restored. When it is time to lift such intervention in the market, the central government will be extremely cautious so as to minimize the financial losses of investors, institutions and individuals alike. It will be a huge challenge for the central government. Failure is not an option.

After the crisis, the central government will expedite the merging process of mainland securities companies in order to form a large-scale investment bank that is capable of competing against foreign institutional investors. The securities and futures fund companies will be required to consciously operate according to the law and to strike a balance between maximizing shareholder interests and safeguarding the healthy functioning of financial markets. Moreover, individual investors' risk awareness and risk management skills, essential to making profits, will be improved when they know the government cannot and will not guarantee the profitability of their investments in the securities market.

(HK Edition 07/16/2015 page9)