HONG KONG -- The Chinese government is getting set to trim the fat of the economy, despite opposition by vested interests such as employees of such companies and local governments. Acting in concert with the administration of President Xi Jinping, the securities regulatory authorities have started addressing the long-standing problem of so-called "zombie" unprofitable state-owned companies that have been acting as a chronic weight on the Chinese economy.

The 13th Five Year Plan for 2016-2020, adopted by China in March at its National People's Congress, calls for restructuring or shutting down zombies.

First casualty

The Shanghai Stock Exchange decided on March 21 to delist ZhuHai BoYuan Investment, making the investment company the first casualty under stricter delisting rules introduced in 2014.

ZhuHai BoYuan was previously called Zhejiang Phoenix Chemical, one of the eight prestigious companies first listed on the Shanghai bourse when it opened in December 1990 as China's first stock exchange. But the company has since descended into a disgraceful state.

The company reportedly began to pad its assets, revenue and profit in around 2010. It even forged a bank bill to make up for a major shareholder's failure to pay 380 million yuan ($58.6 million), according to people familiar with the matter.

The revelation of highly fraudulent activities by Zhuhai Boyuan resulted in the transfer of investigating rights to the public security authorities from the securities industry watchdog at the end of March 2015.

The Shanghai exchange designated Zhuhai Boyuan as a "special treatment" stock to warn investors of the company's high risk of removal from the market. Trading in Zhuhai Boyuan shares has been suspended for almost a year as the bourse imposed a temporary halt in May last year. The stock was transferred to the liquidation post on March 29.

The survival of ZhuHai BoYuan on the stock exchange, despite its scandalous behavior, points to defects in China's capital market.

Loopholes

The Shanghai bourse has delisting rules applicable to companies such as those remaining in the red for four years in a row or posting sales of less than 10 million yuan for three years running. But few companies have actually been delisted, due to the presence of so many loopholes in the rules.

For example, a company can readily dodge the delisting rules if it sells its assets to an affiliated company or merges with an unlisted firm. The securities industry watchdog has continued to give tacit approval to such practices.

Local governments often help troubled companies remain listed through subsidies and other support, to avoid a decrease in the number of listed local companies.

Distortions are created on stock exchanges when companies that should be eliminated remain listed. On the Shanghai bourse, special treatment stocks have become targets for speculative investors.

Xi is trying to change the state of affairs in stock trading with his reform initiative. The Chinese government announced a set of measures in May 2014 to promote the development of capital markets in China roughly for the first time in 10 years, including reforms in the delisting system. In October of the same year, the securities regulator changed rules to enable the mandatory delisting of companies that have falsified earnings or committed legal violations.

It may be fair to say that 2014 was a turning point. In June, Nanjing Tanker of China Changjiang National Shipping (Group) was delisted after logging a net loss in the year through December 2013 for the fourth consecutive year. The removal of the stock drew strong attention as the first delisting of a state-owned company affiliated with the central government.

The China Securities Daily noted the presence of opaque companies, including so-called "phoenix" companies that arise out of the collapse of other companies and carry on with a facade of "business as usual." These compnaies, such as Zhuhai Boyuan, have been a source of disease in the country's stock market, and the newspaper stressed that the delisting of such stocks will help normalize the market.

Phoenixes must die

The removal of companies that should be delisted serves as a warning for investors whose gambling spirit tends to be incited by excessive stock price rises.

As the head of the China Securities Regulatory Commission was replaced earlier this year, some market players said the government is serious about cleaning up the Chinese stock market.

Nevertheless, Chinese individual investors have been able to indulge in risky money games because the targets of their investment were phoenixes. They will lose everything if the targets are delisted.

More than 80 companies are candidates for delisting, according to the Chinese newspaper Securities Times. In addition, 30 to 40 other companies are on the securities regulator's blacklist, according to a number of news media outlets.

But in the short run, investor sentiment may be dampened as a result of an increase in selling of stocks expected to follow the fate of ZhuHai BoYuan, said Huang Yongxi, head of Japanese brokerage house Toyo Securities' Shanghai office.

In fact, some securities companies have reportedly issued reminders to clients holding shares in companies that may be delisted.

While the thorough implementation of delisting rules is a positive step that will help improve the Chinese stock market in the long run, the move is highly likely to lead to an exodus of speculative money. The measure of the last resort tapped by the Chinese government is a double-edged sword.