China Brokers Move Offshore

By Maria Trombly | Securities Industry News | August 22, 2005

Until last month, Chinese brokerages were forbidden to do business outside the mainland, even as World Trade Organization commitments by the Chinese government allowed foreign brokerages to set up shop inside of China through joint ventures and partnerships.

Finally, in July, the China Securities Regulatory Commission (CSRC) gave preliminary approval to a dozen "pilot" cases in which domestic firms will be allowed to open operations overseas.

Now, two of the pilot program participants, Shenzhen-based China Merchants Securities (CMS)--which had already been operating outside the mainland--and Citic Securities, have received final, official approval for their plans to open offices in Hong Kong.

CMS and Citic are two of the largest securities firms in China, but they pale in terms of size and experience alongside the foreign firms that have set up or are in the process of setting up joint ventures here, including UBS, Goldman Sachs, Morgan Stanley and Merrill Lynch.

More and more foreign investment banks and brokerages are entering the Chinese market, as China opens up its financial sector. In 2002, for example, in accordance with China's WTO commitments, the CSRC revoked the regulation that prevented foreign brokerages from forming joint ventures in China.

The competition has not been all bad news for domestic Chinese firms. "They bring us advanced investing ideas and experience from the global market, which will help a lot in nurturing mature institutional investors in China and promoting the domestic market's merging into the world," says Jianxiong Wu, a strategic analyst in the research department of Guotai & Junan Securities.

On the other hand, the competition has undeniably put stress on local brokerages and markets. The Chinese stock market is currently at eight-year lows, and the China Securities Association reports that 114 national brokers posted combined losses of CNY15 billion ($1.85 billion) last year.

"Whether by capital size, risk-control ability or management capacity, we lag far behind international investment banks," says Jing Liang, also an analyst in Guotai & Junan's research department. "We have no strength if we are just limited to the domestic market."

Up From the Underground

That's why it's so important for domestic brokers to go abroad and absorb fresh ideas, Liang says. In fact, some domestic brokers had already done so, without waiting for government approval.

According to unofficial estimates, nearly 20 domestic brokers have already set up branches or "international business departments" in Hong Kong. The list includes such major firms as Guotai & Junan, Shinnying & Wangguo and Everbright Securities.

According to Liang, for example, Guotai & Junan opened a Hong Kong branch several years ago.

"In comparison with poor performance in the lackluster domestic market, it did quite well and contributed a lot to the company's total profit," Liang says.

Back then, Chinese government regulations were more relaxed. Domestic Chinese brokerages faced few difficulties in setting up Hong Kong offices.

That changed quickly in the last several years. "At the end of the 1990s, the CSRC forbade domestic brokers to set up branches overseas," says Qinli Fang, chief inspector of Citic Securities. "In other words, the offices established after that point are illegal."

CMS was among the firms that had their operations declared illegal, but last month's approval puts it back in the realm of legitimacy, Liang says.

It wasn't easy to get approval, however, says Fang. Only a few brokerages able to meet strict criteria have qualified for the pilot status.

Liang says the CSRC classifies brokerages into four classes, according to asset quality, degree of standardized operations, and risk controls.

"It's at the beginning phase," Liang says. "Only 12 brokerages are classified as pilot brokers, the highest classification rung. These brokerages enjoy relatively favorable performance in the sluggish market and have the most opportunity to move abroad."

The Hong Kong Edge

Experts pointed out that setting up offices in Hong Kong can help a firm expand its customer base and confront growing global competition by diversifying its revenues, enhancing profitability and reducing adverse effects due to the systematic risk of operating in a single market.

"It's also an important step to implementing a globalization strategy," says Kun Yang, president of CMS.

According to Yang, the Hong Kong market enjoys international regulatory standards, and building up a cross-market business platform is a good way to keep a step ahead of the opening up of domestic capital markets in an effort to integrate them into global markets.

Chinese brokerages in Hong Kong, says Liang, can take advantage of the increasing IPO demands arising from domestic companies going public in Hong Kong. A broker can also set up an office there to consolidate connections with foreign institutions and serve foreign customers.

"Now we can provide full service to our clients, covering both domestic and overseas markets," says Citic's Fang.

Before, the firm's clients had to go elsewhere for the international component, Fang says.

"In addition, by setting up offices in Hong Kong--where there is a well-developed market infrastructure, advanced information technology networks and a high-quality talent pool--we can improve our own competitiveness through talent exchange and communication," Fang says. "We can even improve our domestic talent pool."

Challenges

There are other problems with opening operations abroad, including the lack of a freely convertible currency.

"The foreign exchange policy is an impediment," says Jian Fan, VP of South West Securities. "We aren't planning to go abroad due to the tight controls on foreign exchange."

The move to Hong Kong also requires significant financial resources, which many domestic brokerages do not have.

Both Citic and CMS not only have good domestic client bases, but also enjoy considerable financial backing from Hong Kong-based parent corporations.

For example, Citic's major shareholder is Citic Group, based in Hong Kong. "They will give us support, definitely," says Fang.

CMS is also a member of the China Merchants Group. The Hong Kong-based CMS is among the top 70 of the 500 brokers in Hong Kong and has been the main underwriter of mainland-based companies listing in Hong Kong, including the China Life Insurance Co. and Picc Property & Casualty Co.

CMS says that it earned a profit of CNY661.6 million in China last year, making it the fifth most profitable domestic broker.

Wendy Yu contributed to this report.