China's fast-growing market for mergers and acquisitions is likely to heat up even more, thanks to proposed new rules that will give buyers more flexibility in how they pay for deals, market players said.

The move comes as the massive share reform programme that will convert all government-owned non-tradable shares into ordinary equity is reaching a climax. By making it easier for government bodies to sell company stakes, that programme is also expected to give M&As a significant boost.

Non-tradable shares, those held by the state and government-affiliated entities, at one point represented about 65 per cent of China's domestic market capitalisation.

Under the proposal by the China Securities Regulatory Commission, companies will be able to pay for acquisitions with stock or assets in addition to cash, the only method now allowed. That has been a serious obstacle to many potential deals because so many mainland companies are strapped for cash.

The new rules come not long after Beijing gave foreign investors the right to buy more than 10 per cent of the freely traded shares of domestic companies subject to a requirement that they retain the stakes for at least three years.

Before, only cash and non-tradable shares were an option but now the total market is open, said Qiu Zhongwei, director at mainland buyout firm Hony Capital. This is very suitable to a house like us. Hony manages US$125 million in two funds and has investments in seven mainland firms in the industrial and agricultural sectors.

A significant increase in mergers and acquisitions could benefit China's economy in many ways. For one thing, it would promote the creation of regional or national firms in industries that are now highly fragmented. That could give the resulting companies more clout in negotiating with suppliers and make them better able to fend off competition as China gradually opens its market to foreign firms.

Consolidation could also ease the threat of overcapacity in many industries and help direct capital to companies that can make the best use of it. Stronger companies would also be less likely to default on their debts, easing the strains on the banking system.

China Glass Holdings is one firm aiming to gain dominance in its business. It expects to complete the acquisition of seven glassmakers by the end of the year, making it the country's biggest producer.

The purchases will add 11 production lines to its three and roughly triple the firm's daily melting capacity to 4,780 tonnes from 1,500 tonnes. China Glass also intends to make additional acquisitions. Hony Capital, controlled by Legend Holdings, the parent of China's largest computer maker Lenovo, owns 25 per cent of China Glass.

Steel, cement, construction machinery and pharmaceuticals are sectors that market players see as the most likely to consolidate first.

The potential market for M&A is enormous. But for now, it is still something of a cottage industry. Domestic M&A transactions - mainland firms buying other mainland outfits - totalled US$18.8 billion in 517 transactions by the middle of the month, an almost 50 per cent jump from the US$12.6 billion from 406 deals at this time last year, said Dealogic.

However, that total is dwarfed by the US$56.2 billion worth of domestic mergers and acquisitions that have taken place this year in Britain. The largest deals outside financial services this year include Ningbo Qingchun Investment's purchase of a 39.5 per cent stake in textile firm Youngor Group for US$783 million and the US$730 million purchase by Shanxi Taigang Stainless Steel of assets from Taiyuan Iron & Steel.

Taiyuan is the world's seventh-largest steelmaker with a 5 per cent global market share and 1.1 million tonnes of capacity, according to consultant CRU International. Germany's ThyssenKrupp occupies the top spot with 13 per cent of the global market and 2.9 million tonnes of capacity.

The proposed rules are likely to affect foreign purchases of mainland assets, in part because most such deals are for cash - something domestic buyers are often lacking. We'll see how it develops but there are other opportunities that are easier to do, said Jamie Paton of private equity group 3i. The market's big enough to put our attention to other opportunities.

X.D. Yang of the Carlyle Group said it would not change the company's focus in the short term.

Inbound cross-border deals, where a foreign buyer acquires a mainland firm, climbed to US$16.5 billion by the middle of this month with 320 transactions, more than double the US$7 billion in deal volume from the 262 transactions this time last year, Dealogic said.

And those numbers give a distorted picture as they are dominated by foreign financial institutions buying minority stakes in mainland banks - deals that give them little or no control. The largest such transaction this year was Goldman Sachs' purchase of a 7 per cent stake in Industrial and Commercial Bank of China for US$2.58 billion.

The final rules are being drafted by the CSRC and some confusion remains among investors. They are seeking guidance over what happens when a stake reaches 30 per cent. The draft states that anyone with a 30 per cent stake who wants to raise that holding must make a general offer. In other jurisdictions, an offer becomes mandatory when a stake reaches 30 per cent.

How that 30 per cent stake is arrived at is another area of confusion. If, say, 29 per cent was bought from the company and 1 per cent from the market, how would that be viewed under the regulations? asked Carson Wen, a partner at law firm Jones Day.

However these questions are resolved, the new rules are likely to be just the beginning. The CSRC will run the market to international standards, Mr Qiu said. While this is a first step in that direction, we expect lots of new directives regarding tradable shares.