CICC powers on
NOW MIGHT NOT seem to be the most opportune time for a foreign investment bank to be doing business in China’s domestic equity market. After the heady heights of 2007, the country’s CSI 300 index is down 54% this year, with turnover in the Shanghai and Shenzhen A-share markets hitting 20-month lows in mid-August.
Still, that will not stop Credit Suisse from celebrating the fact that, after a two-year hiatus, Beijing has lifted its embargo on global investment banks entering into joint ventures with local securities firms and so allow it to underwrite domestic capital markets offerings.
The European firm is the first to benefit from this reopening of the door and has gained approval for a deal with Founder Securities, a mid-tier local broker. Other foreign investment banks could follow. Deutsche Bank has agreed to establish an investment banking joint venture with Shanxi Securities but is awaiting regulatory approval. Citi is thought to be sniffing around potential partners, among them Central China Securities. JPMorgan and Merrill Lynch have entered discussions with local firms in the past, which came to nothing, and continue to assess their opportunities.
Morgan Stanley is in the middle of resolving its relationship with China International Capital Corporation (CICC), and might enter into a partnership with China Fortune Securities, another mainland broker. It has signed a preliminary agreement with China Fortune but the authorities have told the US firm that it cannot be in two separate investment banking ventures. It has also bought a commercial bank, Nan Tung Bank, which Morgan Stanley might be able to turn into a securities firm one day, regulations permitting.
Which of these investment banks next gain the green light from the Chinese authorities remains to be seen, although Deutsche Bank and Morgan Stanley will hope to have their futures resolved soon. No one knows how long the opportunity to win a domestic capital markets underwriting licence will remain open before the regulator, the China Securities Regulatory Commission (CSRC), shuts the door again. In 2004–06, the government allowed Goldman Sachs and UBS to agree and establish partnerships, of differing natures, with locally licensed securities businesses before prohibiting any further such deals.
Why the authorities have done an about-turn this year remains a matter of conjecture, although some cynics say it is precisely because of the poor performance of the stock market. Goldman Sachs and UBS were both granted their licences when the A-share market was struggling, while nothing was forthcoming during the boom years of 2006–07.
Bankers, used to dealing with the political vagaries of the Beijing government, dismiss such talk as nothing more than coincidence. "When the regulator was first considering our licence the market was still strong," says Liping Zhang, head of China investment banking at Credit Suisse.
A rival investment banker in Beijing agrees that there’s little correlation. "I’m not convinced there is a link between the performance of the market and the approval of the licences. There’s clearly a measured approach to what the CSRC does," he says.
Another investment banker suggests that outside influences might have played their part. "You have to look at the decisions over a long time horizon," he says. "The securities regulator took the steps because of outside pressure from the US and Europe."
Talks between senior policymakers in the US and China, in particular, have become commonplace through the Sino-US Strategic Economic Dialogue. It is through this forum that US pressure on the Chinese to open the securities market further has become more intense, especially with the A-share market booming in recent years – until this year anyway.
At the same time, however, the Chinese authorities have always been reluctant to move too fast. "The regulator is wary of freeing the market too quickly," adds the investment banker. "The government realizes it’s a very fragile market."
In the back of the authorities’ mind is the fear that the local investment banks will get overpowered and swamped by the better-managed and more sophisticated foreign firms.
New guidelines
The new joint venture approval for Credit Suisse, which was announced in June, is the first since the revised Rules on the Establishment of Securities Companies with Foreign Equity Participation were issued at the end of last year.
These rules are supposed to ease restrictions on foreign investment in securities companies. Under the revised rules, the joint ventures can be structured in forms other than as a limited liability company. Another change is that foreign investors can buy shares of a publicly listed Chinese-invested securities company, although there are limits to the size of shareholding allowed.
Crucially, however, some restrictions remain, most notably that foreign investors are not permitted to own more than a passive one-third of the shares of the domestic securities ventures.
In addition, the new rules barely change the scope of business the joint venture is allowed to participate in, namely underwriting debt and equity offerings in China and trading in government bonds. The only addition is that now joint ventures will be allowed to sponsor equity and debt issuances too.
The licence does not, however, allow for the provision of asset management or private banking services, or for basic equity broking activities, such as sales, trading and distribution. One investment banker says the situation is "less than ideal".
He describes the process as follows: the rules allow a foreign investment bank to enter a deal with a local securities company, one that might have multiple licences. But when the two set up their joint venture, only the local firm’s underwriting licence gets transferred across. "The regulator is not increasing the number of licences but moving a particular licence from one entity to another," he says.
If, over at least five years, the joint venture performs well, management may apply for further licences. For example, CLSA Asia-Pacific Markets, which had set up an investment banking joint venture in 2003 to underwrite A-shares and renminbi bonds, announced in June that it had now won a licence to start an institutional research, sales and broking business in the Yangtze River Delta area. It is the first joint venture between a foreign and local firm to win a broking licence since the introduction of the new rules.