“Tiger Mom” vs. Montessori: A Simple Analogy for Comparing Chinese and U.S. Financial Regulation
Jason Hsu, Ph.D.
Chairman & CIO
Most people tend to compare Chinese financial regulation to US financial regulation through a lens of communism vs. capitalism, or perhaps a one-party system versus a multi-party democracy. However, a more useful analogy might be the “tiger-parent” vs. Montessori framework for parenting.
Like “tiger parenting”, Chinese financial market regulators start with the assumption that market participants are naïve and will make self-harmful mistakes and be preyed upon by evil operators. It additionally assumes that these participants will never take personal accountability to learn and eventually make well-informed decisions. Thus it is up to the regulators to actively monitor and intervene. As a result, Chinese regulators generally are activists–they engage listed companies and financial institutions frequently and regularly comment on market sentiment, business practices and potential risks to alert the public. Additionally, there are frequent changes in rules to close loopholes and address new issues which arise. In fact, this activist approach requires a degree of ambiguity in the rules and thus forces financial institutions to stay in close conversation with regulators for “window guidance.” This ensures that “schemers” face challenges in engineering policy arbitrage. The defining attitude is to protect the little guys. The model is regulator as judge and jury, and the regulators often need to be extremely experienced professionals to perform the duty well.
The list below provides examples of ways Chinese regulators actively get involved:
1. The IPO process, in China today, is approval-based instead of the registration-based approach used in the U.S. In China the stock exchanges themselves often conduct independent DD on the listing applicant instead of relying on the investment bank’s underwriting process. In fact, the regulator holds the attitude that the underwriter is likely colluding with the firm to fool investors. This independent DD is far from ceremonial, as the exchange officials have implicit personal liability if a listed company turns out to be a bad actor.
2. Fearing investors might overpay for hot IPO shares, the exchange also sets tight guidance on valuation multiples for shares at IPO. This has had the unintended consequence of universal over-subscription for IPO shares followed up shares hitting daily up-limits in the days after the IPO.
3. The stock exchanges also actively research listed companies similar to sell-side brokers. The exchanges hire an army of equity analysts to conduct forensic accounting and to research company management and governance. They then act like active investors and engage company’s management. The exchange inquiries often challenge public statements made by the firm’s CEO during earnings calls or identify inconsistencies in quarterly income statements versus other pro forma information filed with the exchanges and other regulators.
4. The CSRC routinely restricts thematic mutual fund launches (by delaying mutual fund approval indefinitely) when it observes hot retail money driving thematic stocks to stratospheric valuation levels. This is to help prevent a speculative bubble in the stock market and to reduce additional flows of capital to further drive up share prices in speculative thematic stocks.
On the other hand, Western regulators have a more laissez faire approach, one that like Montessori, is focused on the institutional environment. They assume that participants in financial markets are consenting adults, who will take responsibility for making bad or otherwise uninformed decisions. The emphasis is on disclosure and in the clarity and stability of the rules of the game. If you don’t like the rules, don’t play; there is little consideration for establishing a “level playing field.” Rules are designed to ensure the system’s stability and the resulting “theoretical” resource allocation efficiency. The regulators don’t have to be proactive and are often waiting for and responding to legal disputes to examine whether there are structural issues. The existence of legal disputes and large settlements are more indications of the system working than the need for more rules, more enforcement and more interventions. The defining attitude is more about protecting a system which is believed to serve the efficiency of our financial markets than protecting a particular group. The model is more about checks and balances with regulators, financial institutions, the legal system and consumers all wielding formidable power.
As China continues to grow and attract global investors, it may adapt somewhat to the “Montessori-like” U.S. model of regulation. Chinese regulators are aware of the benefits of the Western model and the challenges inherent in their own. The opening of its financial markets to attract institutional investors is in large part an attempt to import sophisticated market participants who can help identify and discipline bad firms and to compete the bad financial institutions out of business, perhaps creating a more hybrid-like framework in China. However, as we have observed, the Western methods can often be culturally incompatible with deep rooted Chinese approaches. So the jury is still out on whether a “merging” will produce the desired results. After all, the Montessori approach to education in China, even after an auspicious start in the country, has largely failed to gain popularity. While Chinese financial regulation will undoubtedly evolve, it is unclear to what extent it will absorb a more Western framework.
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