Taiwan Today

The Taiwan bourse took a severe beating in 1990. Better government regulation may prevent a recurrence.

Since the Taiwan stock market crash last year, the government has been trying to improve the health of the local bourse to pre­vent a recurrence. In the eight months from mid-February to early October 1990, the Taiwan Stock Exchange index plunged by more than 80 percent to 2,560 points. The total market value shrank a staggering US$200 billion. For the 3 million active investors in the market, the loss amounted to an average of US$67,000, more than eight times Taiwan's per capita income.

Among the major reasons for the market's sharp plunge and continuing fall were a rapid decline in money supply growth, a slowing economy, and linger­ing fears about an oil crisis because of Iraq's invasion of Kuwait. But there were also many fundamental destabiliz­ing factors that made the stock market especially vulnerable to adverse econom­ic changes, and these helped precipitate the crash. Some of the factors were an abnormally high ratio of individual investors, widespread insider trading, and rampant stock price manipulation. Current government efforts to stabilize the bourse are focusing primarily on overcoming these major problems. Au­thorities consider their correction necessary before the market can develop on a healthy track.

Individual investors currently make up as much as 90 percent of the players in the market. This abnormally high ratio of individual investors has long been blamed for the market's volatility, because such investors tend to look for quick profits, rushing to buy or sell shares based on rumors circulated by big players and other unreliable sources in the marketplace. To address this prob­lem, the government has taken a num­ber of steps to increase the ratio of in­stitutional investors. Such buyers usually believe in market fundamentals, are less inclined to trade under the influence of daily changes in technical factors, and thus can constitute a stabilizing force in the market.

As a first step, the government in late 1990 authorized the labor pension fund, the only significant pension fund in Taiwan, to invest up to 20 percent of its total US$1.6 billion assets in the stock market. Although the funds that can now be put into the market are not large compared with the average daily turn­ over of US$1.8 billion, it does increase institutional movement in the bourse.

This process will receive further stimulus if the government approves the establishment of new investment trust companies in June 1991. This move aims to increase the number of mutual funds investing in the market. Currently, there are only four such firms allowed to trade on the market.

In January 1991, the government opened the stock market to direct invest­ment by foreign institutions, such as insurance companies, banks, and pen­sion funds management companies. There has already been warm response to the move from foreign institutional investors. For example, Jardine Fleming of Hong Kong applied in January to the Securities and Exchange Commission (SEC) for a permit to invest in the Taiwan Stock Exchange. The firm plans to invest under the name Jardine flem­ing Taiwan Fund. The fund, with an ini­tial capital of US$5 million, is to increase up to US$50 million, which is expected to be remitted into Taiwan within three months of SEC approval of the application.

Under a new policy, the government gives foreign institutional investors quotas ranging from US$5 million to US$50 million. The total direct invest­ment by all foreign institutions will be al­ lowed to reach US$2.5 billion in the first year of the policy. Foreign investors will be permitted to invest in listed stocks as well as bonds and money market instru­ments. Each foreign investor will be limited to a maximum of a 5 percent shareholding in anyone company; the maximum on total foreign shareholding in a single company will be 10 percent.

Investment regulations require that the principal must remain in Taiwan at least three months, and that profits can only be remitted out of the island once each year. To qualify as investors, for­eign institutions must have managed at least US$3 billion for five years, and have no less than two years' experience in international investment. Besides the application by Jardine Fleming, SEC officials have indicated that many foreign in­stitutional investors, especially in Japan, have expressed an interest in investing in the Taiwan stock market.

Since the February 1990 crash, gov­ernment authorities have stepped up ef­forts to crack down on insider trading and stock price manipulation. As a result of increasing vigilance, the SEC has uncovered more than three hundred cases of insider trading, price manipula­tion, and other illegal trading activities. Among the more successful efforts thus far has been the efforts of an ad hoc group established to monitor insider trading. The special group performs its duties with the backing of a newly set up data base on listed companies and their boards of directors, large shareholders, stock buyers, and details on daily transactions.

To check insider trading, the SEC has also tightened its disclosure regula­tions by requiring that all listed compa­nies publish monthly, quarterly, and annual performance reports as well as provide timely public disclosure of changes in personnel, management, and business procedures and policies.

"Government authorities have stepped up efforts to crack down on insider trading and stock price manipulation. "

Despite the increasing attempts to crack down on insider trad­ing, it remains a major concern among regulating authorities. In interviews with the press during Janu­ary 1991, SEC chairman C.P. Chang admitted slow progress in eliminating insid­er trading, but he vowed to fight with in­ creased vigor in the year ahead. Chang says: "It's not an easy task to gather evi­dence against a shareholder or company employee suspected of insider trading if he uses a dummy investor account or an outsider, because it is difficult to ascer­tain the relations between them."

Chang adds that the SEC is also ham­pered in its efforts to eliminate insider trading and other illegal trading activities because it has not been given the right to search suspects and gather evidence. Under existing law, all investigation rights belong to the judicial branch of the government. Chang said he is seek­ing a revision of the Securities and Exchange Law to allow the SEC to collect evidence and become directly involved in investigations.

Meanwhile, although the efforts to deter rampant stock price manipulation have increased, they have failed to meet expectations. As put recently by a mar­ket specialist, Richard Hsu, vice general manager of Tai Yu Securities Company, price manipulation remains a problem far more widespread than insider trading. The sharp price fluctuations and the especially high stock turnover rate provide strong proof of rampant price manipula­tion. In the last year, the local stock market had a turnover rate of 500 per­ cent. In other words, the shares in the more than 200 listed companies changed hands an average of five times during the year.

According to Danny Chan, manag­ing director of Fidelity Securities Invest­ment Consulting Corporation, there are probably more major players on the Taiwan stock market than in any other of the world's markets. He estimated that these major players account for about 30 percent of the daily stock market turnover. As a result, they have tremendous power in influencing the di­rection of the market. These players, many of whom have their own groups of faithful followers, can usually manipulate the prices of certain stocks up or down as they wish. A large number of individual investors, instead of spending their time analyzing the fundamentals of a stock, simply try to find out what the major players are buying or selling, then follow suit.

The many relatively small investors also playa major part in Taiwan's highly volatile stock market through their organized price-manipulating practices. These investors often trade based on the recommendations given by securities in­ vestment consulting firms or investment clubs, organizations which have sprung up throughout the island in the last few years.

For a fee, these firms and clubs use facsimile machines and newspaper ads to tell their members what to buy or sell each day before the opening of the market. The information includes favor­ able and unfavorable news about listed companies as well as market trend ana­lyses. But more important, these organi­zations give their member investors in­structions urging them to concentrate buying or selling on certain stocks. Says Noreen Niu, an analyst at the Golden Securities International Corporation: "Concentrated buying or selling, partic­ularly in the case of investment clubs or consulting firms that have large mem­berships, can often influence the price movement of the targeted stocks."

Barrier to a mature market! "Under existing regulations, the rise and fall of daily share prices are all limited to 7 percent. "

According to Richard Hsu of Tai Yu Securities, if the government is to be more effective in deterring various price­ manipulating practices, it must remove the daily price movement limit. Under existing regulations, the rise and fall of daily share prices are all limited to 7 per­ cent. Hsu believes the price fluctuation limit makes it safer for players to engage in price manipulation or stock specula­tion. "If the fluctuation limit is lifted," he says, "it will increase risk. Thus the players will have to think twice before making an investment decision and this will reduce speculative activities."

But the SEC holds an opposing posi­tion. It has no intention of lifting the price limit until the market becomes more mature. That is, according to rank­ing SEC officials, when regulating au­thorities can effectively tackle insider trading, price manipulation, and other illegal practices, and when the ratio of in­stitutional investors increases to more than 40 percent from the small 5 percent at present. Before that time arrives, the SEC only plans a gradual widening of the daily price movement limit as market conditions improve.

It can be expected that the stock market will undergo steady improve­ment in health as the government con­tinues its efforts to correct detrimental market practices. As the market ma­tures, pure speculative activities will de­cline and investors will pay more atten­tion to the basics of economic and corpo­rate performances.

Despite the recession in many indus­trialized countries, corporate perform­ance may be quite acceptable this year. Generally speaking, the Taiwan economy is performing well, mainly because of successful diversification of sales abroad and continuously growing demands at home. The gross national product this year is expected to grow a vigorous 7 percent, nearly two percent­ age points higher than the rate registered in 1990, amid sharply increasing public sector spending called for under the re­cently launched six-year national devel­opment plan.

The plan, which calls for the govern­ment to invest in the next six years more than US$300 billion mainly in transporta­tion systems, power-generating facilities, housing projects, and pollution control equipment, is likely to give a substantial boost to demands for products and serv­ices. Listed companies, particularly those engaged in industries such as building materials and machinery, will especially benefit from the expected greater demands.

Exports, which began to rebound in September 1990, are gathering strength. Seeing the growing trend of new orders booked by local companies, many observers anticipate that overseas sales will expand in the months ahead. There is strong reason to expect exports to main­tain stable growth because local compa­nies have reduced their heavy reliance on the U.S. market and have diversified their sales to Southeast Asia, Mainland China, and Europe. This means that ex­ ports will be less vulnerable to the reces­sion in the United States. Analysts hope that government efforts to regulate the Taiwan stock market also will make it less vulnerable to volatile fluctuations.- Osman Tseng (曾慶祥) is a senior economic and political journalist based in Taipei.