By staff reporter Li Qing and Shen Hu

As securities firms strengthen in China, a dramatic scramble is under way for control of several major brokerages active on China’s hot stock market.

As a result, nine securities firms controlled for three years by the government’s China SAFE Investment and its holding company China Jianyin Investment Securities (Jianyin) may get new owners in the second half of 2008.

“Many parties are eyeing stocks held by SAFE because SAFE’s sale of stocks was prescribed in the contract signed three years ago,” said one inside source. “But how to price the transfer is complicated.”

Galaxy’s Transfer

Caijing has learned that SAFE plans to sell at a low price its shares in China Galaxy Securities to state-owned China Securities Investor Protection Fund Co.

“SAFE has no profit in this deal,” the source said. “And this signals the beginning of the stock transfer of securities firms controlled by China SAFE Investment.”

Already, the source said, the transfer is under way and “related documents are being prepared. This is a policy-oriented transfer, so that there will be no big premium.”

SAFE declared a capital-infusion plan as a bailout for Galaxy on June 15, 2005, leading to the creation of China Galaxy Financial Holding Co. Ltd. (CGFH), which was registered seven weeks later with 7 billion yuan in registered capital. SAFE contributed 5.5 billion yuan, and the Ministry of Finance (MOF) the rest. The firm was the first approved by the State Council, China’s cabinet, with the title “financial holding.”

According to the restructuring plan, CGFH used 6 billion yuan to buy premium assets from the old Galaxy. Non-performing assets were left with an asset manager.
   
Galaxy, ranked the nation’s No. 2 broker in 1996, was revamped and formally launched a new version on January 26, 2007, as China Galaxy Securities Co. Ltd., with registered capital of 6 billion yuan and five stakeholders. CGFH ponied up 5.939 billion yuan. 
 
After the restructuring, however, disputes over management-level human resource issues and bond-converted stocks surfaced. But as the bull market roared, problems dimmed. The new Galaxy reported good performance in the brokerage and investment banking businesses.
   
In August 2007, Galaxy paid off debts and many creditors bought unlisted stock for 5 yuan per share. Meanwhile, creditors agree to split the premium with CGFH if the company went public.
   
But Galaxy will not meet profit requirements set by domestic securities regulators this year or next. So to accelerate the listing process, Galaxy has applied to China Securities Regulatory Committee (CSRC) for exemption from the requirement that a company must post three years of profits before being listed on the stock market.
 
“Galaxy Securities is owned by SAFE and MOF, and is a company under the direct control of CSRC,” an analyst said. “Getting listed as soon as possible is the common wish of these departments, and therefore it is quite probable that the exemption application will be approved by the State Council.”

A CSRC official said “the policy regarding securities firms being restructured in a large scale is that they do not need to meet the requirement of three years of recorded profits. And as long as they have the record of an accounting year, they can apply for a special treatment.” That’s why, the official said, “many securities firms are applying now and quite a few might get the exemption to go public.”
 
As the market anticipates a listing, Galaxy’s evaluated value is rising. “Our evaluation is around 50 yuan, lower than that of Citic Securities and higher than that of Hongyuan Securiites,” a Galaxy source said. Citic stock is 88 yuan and Hongyuan’s is 39 yuan.

“The stock cannot be sold publicly, but the per-share price for dividend rights is 30 yuan for illegal deals,” the source said.
    
Based on current market performance, SAFE’s sale of shares in securities companies that plan to be listed seem to make all its past efforts worthless, without any material reward. But a source said many have “widely accepted” that profits are not needed for a policy-oriented capital infusion.
 
The Investor Protection Fund (IPF), a state-owned enterprise legally registered as a non-profit, was set up in September 2005 with registered capital of 6.3 billion yuan. IPF is under the control of CSRC. Its registered capital comes from the interest on frozen, IPO purchase capital. And its initial fund included a loan from the central bank of 61.7 billion yuan.
   
The loan should not be free of charge, according to the government’s Rules on Securities Investor Protection Funds, which stipulates that the fund should return such a loan, said an official from the Financial Stability Bureau of the central bank. “It is why the fund was set up in the form of a company,” the official said.

The transfer aims to give IPF a windfall to pay off its debt to the central bank. IPF’s revenue consists of earmarked money of different securities brokers and the IPO fund interest which, according to some statistics, contributed at least 4 billion yuan in 2007. “However, as the revenue of interest is not stable and the loan has to been paid off as soon as possible, IPF applied for policy-oriented support,” said a source close to SAFE. 

Some analysts say IPF will sell some of Galaxy’s shares after the IPO to pay off the central bank. The market value of the Galaxy should reach 300 billion yuan, based on the estimated price of 50 yuan per share. The stock held by SAFE is worth 235 billion yuan, much more than the central bank loan. 

“Both IPF and China Investment Corp. (the government’s sovereign wealth fund manager) are owned by MOF. To transfer assets from SAFE, a branch of China Investment Corp., to IPF has no legal problems,” a Galaxy source said. “It’s just the reshuffling of interests.”
 
However, there is concern of conflict of interests if IPF holds a stake in a securities firm.

It’s believed that IPF is considering separating from a broker called Essence Securities because IPF, whose responsibility is to supervise securities brokers and protect investors, cannot be a fair umpire and hold interests in securities firms. “IPF’s holding Galaxy Securities shares is temporary, and they will be sold after Galaxy lists on the market,” said the Galaxy source.

SYWG Disputes

In December 2007, a high-level manager at Shenyin & Wanguo Securities Co. Ltd. (SYWG) complained to visiting leaders from the Shanghai municipal government that the firm was “ready to be listed, but SAFE has to quit first.”
 
In addition to Galaxy, SAFE infused capital into SYWG and Guotai Junan Securities Co. Ltd. (GTJA), according to a State Council order in the second half of 2005. Jianyin then pumped capital into six other local securities firms.

“Capital-infusion plans after the case of Galaxy Securities all make it clear that these stocks will be held for three years and then bought back by local governments,” said an insider. Under these terms “after three years, if SAFE wants to sell these stocks, local governments have promised to ask some specific entities to buy at a price higher than 1 yuan per share.” The term of 1 yuan per share triggered the controversy.

SAFE’s deal with SYWG dated to August 30, 2005, when the two signed a memorandum for SAFE to infuse 2.5 billion yuan and offer 1.5 billion yuan to retire SYWG’s liquidity. That increased SYWG’s registered capital by about one-third to 6. 716 billion yuan. SAFE held 37.3 percent of the shares and became the biggest shareholder in SYWG.

After taking over SYWG, SAFE’s director Xie Ping became the general manager of SYWG and controlled seven seats of the firm’s board. And SAFE appointed Hu Qiang vice president of SYWG for investment banking.

However, according to the State Council’s requirements for policy-oriented capital infusions, SAFE should not interfere very much in SYWG. So Everbright Bank’s Feng Guorong remained as president of SYWG and, a year after the takeover, SAFE capital market director Ding Guo Rong took over Xie Ping’s position as chairman. In the second half 2005, Hu Qiang transferred to Hongyuan Securities as general manger. 

SWYG’s financial statements said its business turnover in 2006 was 1.98 billion yuan, for which commission accounted for 90 percent, or 1.75 billion yuan. Proprietary trading lost 538 million yuan, and consigned assets management totalled 151,000 yuan. Net profit was 1.255 billion yuan and retained profit was 3.652 billion yuan. Net capital was 2.338 billion yuan at the end of 2006.

The financial report for the first half of 2007 showed that SYWG’s turnover was 5.826 billion yuan, with 4.415 billion yuan from commissions and 911.1 million yuan profit from security investments.

Feng, the president, is quite confident about the status quo. “We scored a 9 billion yuan profit in 2007,” he said. “As our problems are all solved and corporate governance becomes more streamlined, we are fully prepared for going listed.”

Another SYWG senior manager said the firm can go public either through a reverse merger, called a shell listing, or by applying for special policies. But CSRC will not allow any other shell listing now, so approval through the State Council is the only way. The Shanghai Financial Service Office also supports SWYG’s going public. After a recent leadership reshuffle in Shanghai’s municipal government, a public listing for SYWG has become a high priority.

Now SAFE’s retreat is necessary. Caijing learned that SYWG has proposed a two-step plan for SAFE. First, other shareholders should get voting rights that were transferred to SAFE before the capital infusion three years ago. SYWG thinks voting rights were transferred to SAFE because the equity per share is only 0.18 yuan, but equity per share has reached 1.5 yuan, and SYWG said SAFE has noticed. The current situation is neither conducive to establishing a sound corporate governance structure nor getting approval for the listing from the State Council.

Second, SAFE is pulling out. Local funds would be infused into SYWG to make it a local securities firm again. “A capital infusion’s purpose is a bailout instead of an investment for profit. Now we are capable of taking the company back,” Feng said.

A source at the top of Shanghai’s financial sector said that, in light of the recent bull market, SAFE should receive some premium when it transfers stocks. Caijing learned that the two parties are negotiating, and that the time and price linked to SAFE’s departure have not been set. “Though it was agreed that SAFE would transfer the stock at 1 yuan per share, I will not stick to the agreement if I were in SAFE’s shoes,” said a senior manager at SYWG. After all, an IPO is right around the corner, and it is quite reasonable for SAFE to decide not to quit.

In addition to Galaxy and SYWG, SAFE also pumped 1 billion yuan into GTJA to become its second largest shareholder, with a 21 percent stake. Now, GTJA is also considering issuing more stock and SAFE faces the same problem it found with SYWG.

At the same time, the Shanghai government is planning to consolidate all local financial assets under Shanghai International Group (SIG), which would make SIG a local financial holding giant, with Pudong Development Bank as its core. Beyond SYWG, Shanghai’s local, state-owned capital controls several securities firms. Shanghai State-owned Assets Operation Co. Ltd. is the biggest shareholder of GTJA, with 23.81 percent of the shares. SIG controls Shanghai Securities Co. Ltd. Shenergy Co. Ltd. has a controlling position in Orient Securities. And Haitong Securities is controlled by local state-owned enterprises.

“After a restructuring, SIG will control GTJA, Shanghai Securities, Orient Securities and Haitong Securities,” said the financial sector source. “Whether SYWG can be included is still a question mark. Nevertheless, the schedule is tight, as the deadline is September.”

A SAFE source said the agency is willing to exit, but price is a crucial factor. “A price of 1 yuan per share is not proper for the dawn of an IPO.”

SAFE’s holding company Jianyin has been involved in financial restructuring for six securities firms including Citic, China Jianyin Investment Securities, Hongyuan Securities, Southwest Securities, Beijing Securities and Qilu Securities.

Information from Jianyin revealed that SAFE’s final retreat is mentioned in the capital-infusion plan for Southwest and Qilu. But the fates of the other four have yet to be sealed.

1 yuan = 13 U.S. cents

Who is SAFE?

China SAFE Investment is a state owned company that was established at the end of 2003 by China’s central bank, Ministry of Finance and the State Administration of Foreign Exchange (also called SAFE), which is an arm of the central bank.  The SAFE Investment Company (also called Central Huijin Investment Company) holds stakes in many of China’s leading commercial banks, policy banks and security firms. Many of these companys have been bailed out via dollar injections in exchange for heightened state involvement, which aims at influencing banking reform. The company was aquired by the internationally controversial sovereign wealth fund China Investment Coporation (CIC) and pulled from the state forex reserve arm for 32 billion yuan. The new ownership hasn’t changed the plan to continue restructuring banks in the near future.

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