China's Nasdaq-style Growth Enterprise Market (GEM), also known as ChiNext, opened on October 30, making it easier for start-up companies to raise money on the capital markets.

Before its launch, the China securities regulator drew up strict rules to prevent excessive speculation and warned investors of the high risk of investing in the market. Despite these moves, ChiNext has turned out to be a far cry from what the regulator wanted to see. By the close of the first day of trading, the 28 listed companies had almost doubled in value. Investors scrambled for listed stocks as share prices were inflated by feverish buying.

On the second day of trading, 27 of the 28 stocks on the newly-launched market had dropped by their 10 percent permitted daily limit, a signal that money was being withdrawn from GEM and transferred to the main board.

The average GEM-listed company has a price-to-earnings ratio of about 100. That means investors have to pay about $100 for every $1 of 2008 earnings. By comparison, the average price-to-earnings ratio on NASDAQ stands at a relatively-modest 26.

The wave of speculation was, in large part, a wild buying spree by individual investors. A survey showed that institutional investors bought 11.429 million shares on the first trading day, just 2.62 percent of the traded shares, while individual investors bought the remaining 97.37 percent.

This raises the question: Is ChiNext a stock market or a casino? If it is a casino, how long can it last?

I always disagreed with opening GEM in such a hurried manner. ChiNext is more vulnerable to speculation and manipulation than the Shanghai and Shenzhen stock exchanges. And apart from America's NASDAQ, GEM-style markets have failed in most other countries. Considering the existing capital markets system on the Chinese mainland, it will be no easy task to create a stock market on the lines of NASDAQ.

Not a few investors have asked me whether they should put money in GEM, and I told them the market is certain to be very volatile and they should be very cautious. My view is that if investing in GEM turns into a form of gambling, the market is unlikely to last long because the majority of players will eventually pull their money out.

The creation of GEM was intended to provide an alternative source of financing for innovative companies. Most of the newly-listed companies work in the fields of biotechnology, information technology, agriculture and the Internet. They are mostly too small to be able to compete with companies listed on NASDAQ.

Of course, I do not expect each of the listed companies to grow into a giant like Microsoft, but they should at least be held accountable to the investors who have pinned their hopes on potential earnings and future growth. In fact, some companies are there just to grab money from the market. By the end of the first trading day on Friday, the 28 newly listed companies had managed to raise more than US$2 billion from the market, producing fortunes for their founders and investors.

The truth is that the current capital markets system is fundamentally flawed and allows companies to take advantage of its weaknesses. Often, companies go public simply for the purpose of cashing in on the stock market.

Many private equity funds have reportedly reaped enormous windfall profits from ChiNext. It is unknown whether this was the result of their insight or insider information. But one thing is for sure; behind the scenes there is government intervention and corruption. If the capital markets system remains unchanged, unreasonable trading and risky speculation are inevitable.

GEM should be an open, transparent, fair and just market, not a casino. Only an efficient market system can channel capital to the small but innovative enterprises that will help fundamentally reshape China's economy in the long term.

(This post was first published in Chinese on November 3, 2009 and translated by He Shan.)