By staff reporters Li Qing and Ling Huawei
As expected, no breakthroughs in the financial field were reported when the third round of the China-U.S. Strategic Economic Dialogue (SED) ended December 13.
“China has honored its commitment, while the U.S. expected more,” was how one Chinese financial official, who asked not to be named, summarized the talks.
According to post-negotiation statements issued by the two sides, a series of agreements were reached to strengthen cooperation in the financial services sector. The parties also agreed to mutually open the securities and banking sectors.
“During this dialogue, China pledged mainly to make assessments and do research, and little substantive progress was achieved,” the official said.
Securities Talks Reach Expectations
The bull market for Chinese stocks that began in the second half 2005 has made China’s A-share market the most attractive international destination for investors. China’s strong economic growth has further encouraged an upsurge in interest among foreign investment banks eager to enter the Chinese market.
“In the China-U.S. SED, the U.S. put forward a lot of requirements concerning the opening up of the securities sector, and held high expectations with respects to operating scales and share ratios,” the official said. “Of course, we will make decisions in accord with China’s national interests.”
Before the December talks, the China Securities Regulatory Commission (CSRC) announced plans to resume approvals for setting up new, joint venture securities companies. But this “restoration” did not mark a breakthrough for rules about foreign securities companies, and the July 2007 “Rules for Foreign Investment in Securities Companies” remained unchanged. Under the rules, joint venture securities companies can only be engaged in the initial public offerings of Chinese domestic companies and foreign brokerages, but cannot be involved with brokers handling domestic A-shares or derivatives, and share ratios must be less than one-third. As a matter of fact, the SED agreement reached the same conclusions.
The U.S. description of the negotiations’ outcome indicated that China would resume licensing joint venture securities companies, adding that China had declared it would allow foreign securities companies including brokerages to invest in financial markets with their own capital, and let fund management firms expand in China. These had been mentioned in the second SED, but at that time no specific timetable was set.
It is understood that CSRC is now drafting “Measures for the Administration of Joint Venture Securities Companies,” and that significant problems about relaxing share ratios and business scales will be dealt with conditionally, step by step.
“No breakthrough is expected at present, and full licenses will probably be issued three years from now, according to the situation,” said a CSRC official who asked not to be named.
Caijing has learned that CSRC is also drafting measures that would allow foreign funds to make strategic investments in listed companies and meet legal requirements. Under these measures, foreign funds could obtain shares in listed securities companies through a variety of strategic moves, such as specific share allotments and share exchanges.
“The approach requires that the foreign investment not be a simple financial investor, but also develop more strategic cooperation in the future, similar to Citic Securities and Bear Stearns,” said the CSRC official. “The share ratio will not increase, but remains one-third.”
Yuan-denominated stocks and corporate bonds were created to fulfill a frequently cited promise to let “foreign companies issue A-share stocks.” However, no relevant laws or regulations have been formulated by CSRC, and although related research is under way on the Shanghai Stock Exchange, fulfillment is a long way off. “Issuing A-share stocks by foreign companies will not be allowed until the return of the red chips,” said the CSRC official.
Securities: Sino-Foreign Ventures
As the SED talks opened, a market rumor predicted the development of joint ventures involving several foreign investment banks and Chinese securities companies.
Recently, the municipality of Shanghai noted in its Pudong financial development strategy that it would encourage the introduction of foreign financial institutions, in particular foreign corporations and financial institutions, and make introducing foreign investment banks a new priority. A Morgan Stanley senior executive recently told Caijing that the firm had signed a strategic cooperation agreement with China Fortune Securities of Shanghai Electronic Development Holding Group, and hoped to obtain 33 percent of the shares of the joint venture, specializing in investment banking, with regulatory permission.
In addition, Caijing learned that Credit Suisse Group has signed an official agreement with China’s Founder Securities to establish a joint venture specializing in investment banking. Credit Suisse would hold one-third of the shares and Founder Securities would exit investment banking. It is also known that Founder Securities is planning an IPO; doubtless, the joint venture program would increase its value.
“Citigroup, Merrill Lynch, JP Morgan and Deutsche Bank all want to set up joint ventures with Chinese securities companies, although now it’s not as easy to get the kind of special grant that Goldman Sachs and UBS did,” said a foreign investment bank official. “Therefore, whoever acts first will win, Foreign companies cannot increase their share ratio in joint ventures, but may get management rights.”
“Since 2004, an overhaul of securities companies has greatly reduced systematic risks in the securities industry, and the market’s overall strengthening has provided a guarantee for their performance,” said one insider. “However, the overall competitiveness of securities companies was not strengthened in nature. The major obstacle is their lack of innovative capacity, while the relevant policies and environment also limit the innovation of securities companies."
Unlike foreign securities companies, domestic firms have developed extensive sales webs and large client lists. In the recently completed restructuring of securities companies, large domestic firms enlarged their industry domains and acquired large commissions by buying risky firms or putting their sales departments into trusteeships.
WIND, a markets researcher, said that stock, fund and warrant transactions on the Shanghai and Shenzhen stock exchanges reached nearly 48 trillion yuan in the first 10 months of 2007. If commission rates were 0.1 percent, security firms’ commission income during that period exceeded 95 billion yuan.
Third quarter reports from listed securities companies show that commission income of several securities companies accounts for more than 50 percent of revenues. These include Hong Yuan Securities at 50 percent, Citic Securities at 53 percent, Haitong Securities at 64 percent, and Northeast Securities at 67 percent.
While domestic securities companies continue expanding their brokerage businesses and earning huge amounts of income, joint venture securities -- even those with full licenses -- have exited this field without trying.
Currently, only three joint venture securities companies hold Chinese A-share brokerage licenses: China International Capital Corp. Ltd.; Goldman Sachs-Gao Hua; and UBS. Coincidentally, each firm targets high-end customers.
During the securities restructuring in 2005, management intended to hand over securities assets of some risky securities companies to China International Capital. These included securities sales departments and subordinate staff. From the perspective of traditional domestic securities companies, this should be a cost-effective and debt-free deal that retains large numbers of customers, with reasonable costs. China International Capital didn’t get involved but maintained a high-end position through securities sales departments in Beijing, Shanghai and Shenzhen.
Beijing Securities had 27 sales departments when it was first targeted for reorganization by UBS. Applying its global experience, UBS sold 21 of the sales departments to China Merchants Securities -- and kept only six -- as soon as its joint venture with Beijing Securities received regulatory approval. Similarly, Goldman Sachs Gao Hua now owns only two sales departments -- in Beijing and Shanghai -- and markets to high-end clients.
“Now the money earned by the companies from the brokerage business is easy money,” said a senior official at a joint venture securities firm, adding that income from the brokerage sales fluctuates. “Can we ensure such good opportunities every year? A long time ago, the big international investment banks shifted their attention to fields such as capital management and direct investment, and their product innovation is exactly what we lack and need.”
In addition, when competing against Chinese securities companies, foreign securities firms emphasize their global research resources and global marketing platforms. “When we evaluate a Chinese company, we don’t simply set a value according to the Chinese market but, instead, from a global perspective,” Cai Hongping, executive general manager for UBS’ Investment Banking Department, told Caijing.
Based on the performance of domestic investment banks in the A-share market so far, China International Capital and Citic seem to continue ranking at the top. But joint ventures UBS and Goldman Sachs Gao Hua were rapidly increasing market share. According to Thomson Financial data released December 13, China International Capital, Citic and China Galaxy were the top A-share underwriting firms, while UBS and Goldman Sachs Gao Hua ranked fourth and seventh, respectively. The previous year, UBS and Goldman Sachs Gao Hua got none of the business, while the top five were China International Capital, Citic, Guotai Junan, China Galaxy and BOC International.
“It is true that joint venture securities companies grabbed some big projects this year, and many were done together with us,” said a Citic official. “However, their labor and sales costs are far higher than ours, so we will not lose our competitiveness in the future.”
Currently, wages are much higher at joint venture companies than domestic firms. One rumor said UBS wanted to recruit underwriters by offering annual salaries in the millions, although the Citic general manager only earns 980,000 yuan a year.
The strongest competitive advantage for investment banks lies in their pricing abilities and sales networks. Pricing on the A-share market is not adequately market-oriented, and market quotes do not always represent the opinion of investors because the regulator usually offers suggestions for IPO pricing. Meanwhile, low-pricing principles eliminate all underwriting risks for investment banks, which needn’t worry about selling stock. Therefore, in the A-share market, the investment banks’ priority is finding projects, and as long as there is a project, pricing and sales won’t be problems.
“We don’t feel anything is unattainable in their operating mode,” said a senior official at a domestic securities firm. “We hold obvious advantage in the sales channels of securities business, and high costs limit their (joint ventures’) expansion in this field.
Therefore, the official said, the market’s opening to foreign-led joint ventures “is not that frightening. We welcome opening.”
Slowdown in Bank Reform Pace
Opening up China’s commercial banking industry was once a thorny issue. But the process moved forward, and the banking industry now ranks between the insurance and securities industries in terms of foreign access. Currently, 33 foreign companies hold shares in 25 Chinese banks.
Years of reform have seemingly allowed the banking industry to cast off previous predicaments. Now it’s the darling of the capital market. Yet whenever bank stock prices change slightly on the Chinese or foreign markets, the industry incurs so-called “undervalued ” criticism, contributing to what’s now a timid, delicate period for the opening up process.
One issue left unanswered by the latest SED is also of high concern: Whether the share ratio restriction for foreign investment in the Chinese banking industry should be increased from the current restrictions limiting a single foreign investor to 20 percent and all foreign investors to 25 percent. Judging from the attitude of the China Banking Regulatory Commission (CBRC), there is little chance for a change in the restriction anytime soon.
Caijing learned that recently CBRC launched an investigation of the status quo, as well as results and problems tied to the participation of foreign funds in Chinese banks. A preliminary report is expected in early 2008. The report would then undergo further analysis, discussion and modification before being submitted as a reference work to the State Council, which would make decisions about further reform steps.
CBRC officials said that although the trend and general direction of opening up would not change, it was too early to say whether the share ratio of foreign funds would be allowed to increase in 2008.
At Caijing’s annual meeting December 10, CBRC Chairman Liu Mingkang said the agency’s research department was sending questionnaires to Chinese banks and foreign shareholders of Chinese banks. The plan was to collect the views of high-level officials, asking whether or not they were satisfied with the cooperation, assessing the tie-ups, and trying to understand any problems that may be connected with the share ratio rule.
Liu said if researchers find that problems have nothing to do with the share ratio, but with legal or environmental factors, then there will be no need to increase share limits.
What’s more, following the latest SED talks, China’s banking regulator is more likely to let QDII units at Chinese banks to invest in U.S. markets. It was also rumored that an agreement had been reached between China and British regulators allowing QDII to invest in British markets.
Currently, 50 percent of the banks’ QDII mechanisms are allowed to invest overseas, but only in the Hong Kong market.
CBRC Deputy Chairman Wang Huaqing, in an exclusive interview with Caijing, said since implementation of “Interim Administrative Measures for Commercial Banks to Provide Overseas Financing Management Services” in April 2006, many domestic and foreign commercial banks have actively applied for QDII business. Through October 2007, 23 domestic and foreign banks were qualified to do QDII business. These included 21 who reached the US＄ 16.1 billion in QDII investment quota. Another 16 have offered 154 QDII products, with revenues of 35.2 billion yuan and US＄ 1 billion in foreign currency revenue.
Since June, Wang said, CBRC has communicated with counterparts in Britain, U.S., Germany and Singapore about regulatory cooperation concerning offshore fund management of commercial banks, and plans to expand the QDII investment project to markets in mature markets such as London, New York, Frankfurt and Singapore. It can be said that the latest SED merely reaffirmed this process.
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