Mainland fund managers received an invitation they could not refuse recently. On June 4, representatives of every fund management firm in the country were summoned to a meeting with the China Securities Regulatory Commission in Beijing. More than 200 fund managers, whose companies manage more than US$45 billion, flew to the capital to be chastised by the regulators. CSRC officials reviewed the market's recent dismal performance and explained their plans for the future. 'They didn't come right out and tell us to buy, but they may as well have,' says one Shanghai-based fund manager who attended the meeting. 'Some blue chips were dumped heavily [last month] and, with the benchmark index hitting eight-year lows, the authorities decided it was time for action.' Rumours were already circulating in the Shanghai market that the government was planning a 100 billion yuan stabilisation fund that would target the insolvent brokerage sector, and officials, while not confirming the reports, did little to play them down. Four days later, after the CSRC announced new rules allowing companies to buy shares back, the market bounced more than 8 per cent as fund managers heeded the regulator's directive. The June 4 showdown was a telling episode in the evolution of China's financial markets, and powerful evidence of their immaturity. For, arguably, the urgency on display only risks making things worse. Recent weeks have seen the CSRC announce a host of initiatives aimed at boosting prices. But stock investors are a notoriously tough bunch to corral. Having tasted temporary relief, prices have slid back towards eight-year lows in the past two weeks. That share prices in the world's fastest-growing major economy continually plumb new depths is a farcical situation 15 years in the making. When the Shanghai and Shenzhen stock exchanges were established in 1990, the government saw the experiment primarily as a way of raising capital for bloated state-owned enterprises. 'There were no investment options in the early 1990s and there was little understanding of how markets worked,' says the Shanghai fund manager. But the government baulked at fully disposing of 'the people's' assets that would lead to the creation of so-called state and legal-person shares. When each state-owned enterprise gained approval to list, about 33 per cent of its shares were listed on the Shanghai or Shenzhen exchanges (so-called A shares). Another 33 per cent were designated 'state shares' held by the central or regional governments, while the remaining 'legal-person' shares are held by companies themselves. But all remained common stock, with the same voting and dividend rights. As of the end of March, the Shanghai and Shenzhen markets' capitalisation was 3.48 trillion yuan (down from 5.04 trillion yuan a year earlier) but only 1.1 trillion yuan of that was tradable. By comparison, Hong Kong's market capitalisation at the end of April was 7.04 trillion yuan. An early problem that emerged was the lively trade in state and legal-person shares that sprang up around the country. These 'non-tradable' shares changed hands through auctions, on semi-official asset exchanges and through private sales, often at a massive discount to their A-share counterparts. Despite recent CSRC measures to make these transactions more transparent, as many as 200 listed companies have been effectively privatised through off-exchange transfers of state and legal-person shares with no reference to A-share prices and beyond the jurisdiction of regulators. 'If you were an investor in Microsoft and you woke up to the news Bill Gates was selling his stake at 90 per cent below market prices to Warren Buffett, you'd wonder what the hell was going on,' says Fraser Howie, an investment banker and author of Privatizing China. 'That is exactly what is happening in China.' By 1999, the government had resolved to render all non-tradable shares tradable on the exchanges. The prospect of shares being diluted by 66 per cent sent the markets into a tailspin and the reform was called off. Another abortive attempt was made in 2001 and since then valuations have been on the slide. Even so, A shares have traditionally traded at a large premium to their H-share counterparts for the 24 companies listed both in the mainland and Hong Kong. Only now are the valuations nearing parity, although Chinese stocks are still overpriced. 'How can you possibly justify the Shanghai index trading at 18.5 times earnings when Hong Kong, regarded as the most expensive market in Asia, trades at 15 times and [South] Korea trades at seven times earnings?' asks Garry Evans, HSBC's pan-Asian equity strategist. Three years ago, Shanghai stocks were trading at 40 times earnings. 'The [mainland] stock markets have lost their appeal, not only because they've been falling and been exposed as extremely corrupt and manipulated but also because there are other things worth buying now,' adds Mr Howie, noting that vast sums have been diverted to property, creating a potentially dangerous bubble. With mainland share prices assumed to be nearing their real value, the government has embarked on a new round of state share reform, choosing four relatively small companies for a pilot programme to make all state and legal-person shares tradable on the exchanges. The four - Sany Heavy Industry, Tsinghua Tongfang, Shanghai Zi Jiang Enterprise Group and Hebei Jinniu Energy Resources - will compensate holders of A shares for any losses resulting from stock dilution by giving them shares and, in one case, a lump sum cash payment. When the programme was first announced, the price of three of the companies rose sharply. But when state shares in Sany began trading yesterday, its price dropped more than 30 per cent. This news will give the regulators something to worry about this weekend, but most analysts agree there is far more resolve to push through the reform than in the previous two attempts. 'Phase two will begin [next month],' says Stephen Green, an economist at Standard Chartered. 'They've bitten the bullet and now are moving full steam ahead to get larger-cap companies, including some in the petrochemicals and steel industries, to come up with state share sale plans.' Deutsche Bank predicts that initially 100 to 200 of the 1,379 A-share firms will succeed in making all of their shares tradable, but plans are not even being contemplated for some listed enterprises. 'Eventually, reforms are going to have to involve the delisting of companies. I'm talking of 300 to 400 companies that are total destroyers of value,' Mr Howie says. 'No amount of pressure from regulators is going to make anyone buy those.'