China's stock market has been running for 22 years, and problems such as financial fraud, insider trading and power-for-money deals obviously exist. Many reckon that the current IPO approval system shoulders some of the blame for the problems, and they have called for its abolition.

The approval system, aimed at protecting investors, has failed to do that job for as long as the Chinese stock market has existed. It distorts the relationship between supply and demand, puts price/earnings ratios at a dangerously high level, and damages the stock market's function of optimizing the distribution of resources.

High price/earnings ratios also create huge arbitrage opportunities for listed companies, encouraging some to forge financial reports. The approval system also creates opportunities for rampant rent seeking.

As IPO approvals have become the main business of the China Securities Regulatory Commission, its function as a supervisor has diminished.

Listed companies have been overwhelmed with financing and arbitrage, lacking the motivation to realize long-term growth, and investors have opted for short-term investment. Thus the annual turnover of China's stock market has been among the world's highest in recent years.

Guo Shuqing, chairman of the China Securities Regulatory Commission, has introduced a number of reforms since he took office 16 months ago. However, the question about whether administrative approval for IPO launches should be abolished has never been answered. The delisting policy, on which great hopes were pinned, unraveled in the face of strong opposition, and China's stock market remains at a low level.

The IPO approval system clearly has many shortcomings, and the securities market is still in need of big changes.

However, there is stiff opposition to adopting a registration system, much of the opposition coming, of course, from those with vested interests. After all, rent seeking can be a highly profitable activity.

Some reckon that the lack of an IPO approval system would make things even worse, but those fears are groundless. The approval system is not a solution to the current problems, it caused them.

Under such a system, the regulatory commission is neither able nor motivated to verify financial fraud. A look at the history of China's stock market reveals that financial fraud was uncovered by companies themselves, by the media or by members of the public.

The great rent-seeking temptation under the approval system has made the system itself a shelter for fraudsters.

A system of registration does fraudsters no favors, but instead ensures transparency. Once transparency is guaranteed and media and people's rights to report frauds are fully protected, the fraudsters are out of business.

In addition, it is only when the approval system is abolished that the regulatory commission can focus on supervising the market.

Which all boils down to this: China's seemingly intractable stock market problems would evaporate if the approval system was abolished and supervision tightened.

Such reforms would obviously produce teething problems. The number of companies going public would increase, and in the short term stock prices would drop.

But it needs to be remembered that the IPO prices would just be dropping to reasonable levels, and China's stock market will not develop in a healthy way until the supply-demand relationship is back in kilter.

Of course, risks exist. It is true that China's legal environment still has many problems, but at present the media and public are more effective than the approval system. With media supervision, abandoning the approval system will do the market no harm. More importantly, a registration system is the only low-risk solution to the Chinese stock market's woes.

If policymakers are willing to face the challenge of change, they will soon find that the so-called risky leap they faced was not that much of a risk after all.

The author is the deputy director of CEIBS Lujiazui International Finance Research Center.

(China Daily 02/22/2013 page7)