Brokers on Hold

China Puts Foreign Securities Firms on Hold

Link to Originally published in Securities Industry News

The China Securities Regulatory Commission (CSRC) has said that it will issue no new licenses to brokerages set up as joint ventures with foreign firms until the country’s market reforms are completed. In a Sept. 13 statement, the agency gave no indication of when the ban will be lifted.

New branches and subsidiaries of domestic securities firms are also on hold, except when the restructuring is part of a government-initiated risk reduction or reform initiative. According to the official China Securities News, the CSRC wants a cooling-off period to defuse risks.

"With the WTO [World Trade Organization] transition period coming to an end, the capital market will face a more competitive economic and financial environment," CSRC chairman Shang Fulin said in a speech, quoted in the newspaper, at the third International Financial Forum in Beijing. "Enhancing competitiveness and improving risk controls will be especially difficult." Fulin also reportedly said that the reforms won’t be fully completed until October 2007.

"They’re trying to sort things out internally first," said Fraser Howie, co-author of "Privatizing China" and a longtime observer of the country’s securities industry. He said that the interruption won’t have much practical effect because only a few joint ventures are in place.

Since Morgan Stanley set up an investment banking joint venture, CICC, with China Construction Bank in the mid-1990s, other foreign securities firms have been seeking permission to follow suit. But only Goldman Sachs Group, Japan’s Daiwa Securities SMBC Co., France’s BNP Paribas and the CLSA unit of Credit Agricole have succeeded.

Beijing’s rationale for going so far as to halt new entrants is unclear, since less dramatic moves would have had the same result, according to Howie. "They can just postpone and delay," Howie said. "I don’t understand why they came right out and said it."

"It’s surprising news," said Thomas Liu, a professor of economics at Shanghai’s Jiao Tong University, adding, "It’s ridiculous."

Chinese officials have frequently said that foreign securities firms will bring in expertise and better controls to China’s emerging securities sector. Liu speculated that regulators might be wary of foreign securities firms manipulating domestic stock prices. There is also a concern that the immature domestic brokerages won’t be able to compete with foreign firms, but, said Liu, "I think this is not the main reason. The main concern is that prices will be influenced by dominant foreign brokerages."

The news is particularly surprising in view of the progress made in opening China’s financial sector to foreign competition. In December, China is expected to open its banking sector in accord with WTO guidelines. The WTO agreements don’t include specific rules for the brokerage sector, but Howie doesn’t expect the ban to hold indefinitely.

"Ultimately, they will start issuing joint venture licenses again," he said. "There’s no way you can have an international capital market if you restrict foreign participation. … But whether it’s weeks, months or years, there’s no way of telling."

"Anything the Chinese government does has the potential to drag on for a while," said Neil Katkov, a Tokyo-based analyst for research firm Celent. He contends that the joint ventures have been operating in a poorly defined area of Chinese securities law: It took Goldman Sachs two tries to get a joint venture deal approved. "The first one didn’t go through," said Katkov, "and then they circled back and did another. It’s a pretty colorful situation–a wild frontier."

China’s domestic securities industry has been plagued by corruption, mismanagement and bankruptcies. Meanwhile, both local and joint-venture brokerages have been looking to offer new products to investors, such as the recently approved margin trading. The regulators may have felt that things were moving too fast, Katkov said.

"This signifies that the regulators have decided to focus on this area," he continued. "Regulation of the securities industry is very undeveloped to begin with, compared to banking or insurance. The regulators probably felt that they don’t understand what these types of joint ventures signify. They could introduce new, complex products before the regulators find out what’s going on. They probably wanted to slow the process."