Improving China's OTC business is a vital for the creation of a multi-layered capital market

Obvious weaknesses have been seen in China's capital market over the past 20 years of development. It would be impossible to form a complete capital market without a comprehensive and ordered over-the-counter (OTC) market, and therefore impossible for the capital market to function well if activity was solely focused on the stock exchange.

Essential role of OTC market

The OTC market serves private placement and private companies, although it has less liquidity compared with the stock market, where major fund raising takes place. One of the most important roles of the OTC market is to support small and medium-sized companies in their start-up and growth stages - fulfilling their funding needs and incentivising improved guidance.

Additionally, the OTC market helps small and medium-sized companies to understand capital market developments. Therefore, the maturity of the OTC market is of great importance to the healthy development of market entities in a market economy - something that cannot be achieved solely by a healthy stock exchange.

Liquid finance and trading are important for sure, but the essential role of the OTC market needs to be emphasised in developing the overall capital market's architecture.

Governments in all countries take the development of small and medium-sized companies as their major responsibility since these companies contribute most of the GDP in terms of offering jobs. In 2012, the US passed the Jumpstart Our Business Startups (Jobs) Act, focusing on addressing the international financial crisis and rebooting the US economy, reforming the regulation of the capital market, including deregulation for the registration of growth companies and development of OTC activities, establishing rules for crowd funding, as well as the deregulation of public companies' surveillance to provide more space for private financing activities.

This act was an important move by the US government by encouraging private financing, which is a great example for China to follow.

Further development required

At present, China's OTC market is insufficiently developed because of the process of reform in China. It would be hard to create a perfect design, but it is still possible to quickly prevent and solve problems to support the system. China's capital market has had a short history so far, so it has not had time yet to fully grow and mature. In the past 20 years, one of the main features of the capital market has been that the legal and political systems are set up around the stock exchange, with very little focus on the OTC market. After a very long period of time, security institutions approved by the CSRC were only active in stock exchange activities, but almost none of them carried out OTC business.

OTC market breakthroughs

Since 2012, China's OTC market development has achieved three major breakthroughs:

First, the issuance of private placement bonds for small and medium-sized companies. OTC and private financing practices are of great importance for the development of the country's OTC market and the establishment of a multi-layered capital market.

Second, all provinces and municipalities were allowed to set up regional equity exchange centres, covering mainly private financing activities for non-public and private companies.

So far, there are 31 equity exchange centres serving small and medium-sized companies, and 12,000 listed companies that have been formed, pushing the amount of financing to 110 billion yuan ($17.6 billion).

Third, private financial services offered by security and fund companies have developed greatly. Regional equity exchange centres - including the one in Zhejiang province, which was built in 2012 - have helped 1,500 listed companies raise more than 10 billion yuan through bond financing, despite the difficulties of OTC equity financing.

The regional equity exchange centres provide small and medium-sized companies with equity capital, and exert an important influence on the improvement, restructuring and listing of these companies.

These three breakthroughs represent important steps in the development of the OTC market, and contributed to the establishment of a multi-layered capital market. These hard-won achievements need to be developed further with future guidance, regulations and enhancements.

Suggestions for the revision of the security law

Further specific regulations on OTC financing are needed to:

• Prevent and fight illegal deposit luring, security issuing and fund raising. Many of the financial demands in this field are reasonable, but with no legal solutions. The revision of the security law would help to clarify and specify legal practices, especially for private financing.
• Take into consideration the legal range, special needs and regulatory responsibilities of regional equity exchange practices.
• As demonstrated by the US Jobs Act, regulate and legalise crowd financing. In fact, there are a huge number of companies trying to follow the US model of crowd financing, but without protection by rules and regulations.
• Complete the policies for regional market development. There are few policies designed for the OTC market, since previous financial practices mainly occurred on the stock exchange. The two existing stock exchanges serve only a limited 2,000 companies, forcing more companies to seek opportunities in the OTC market. Therefore, policies that encourage OTC market practices with legal support would provide more space for OTC development.
• Encourage financial institutions, such as brokers, to participate more in regional equity exchanges and private financing. Private financing, with less profit and smaller scale, attracts very few professional security institutions. But more professional institutions need to be involved.
• The diversity and convenience of internet finance and development of information technology have strengthened the capacity of data collection and analysis. Therefore, the stock exchange, the OTC market, public and private financial markets will all need new architecture in the future, with private financing comprising a bigger portion of the market, becoming more important in capital market practices, and serving more small and medium-sized companies, so reducing the financing costs of the whole capital market. The combination of the OTC market, private financing and internet technology will diversify the multi-layered development of the financial and capital markets.