chinese securities companies: an analysis of economic growth, financial structure transformation,...

ChineseSecuritiesCompaniesCompanies

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ChineseSecuritiesCompaniesCompanies

An Analysis of Economic Growth,Financial Structure Transformation,

and Future Development

WU XIAOQIU

This publication is supported by the Chinese Fund for the Humanities and Social Sciences.

Cover Illustration: Maxine LewisCover design: Wiley

Copyright © 2014 by Wu Xiaoqiu. All rights reserved.

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DISCLAIMER

Names of individual securities mentioned in this publication are for the pur-poses of comparison and illustration only and prices for those securities were approximate fi gures for the period when this publication was being prepared.

Every attempt has been made to update securities industry practices and regulations to refl ect conditions at the time of publication. While information in this publication has been obtained from sources we believe to be reliable, such information cannot be guaranteed nor does it purport to treat each sub-ject exhaustively and should not be interpreted as a recommendation for any specifi c product, service, use, or course of action. CSI and Moody’s Analytics assume no obligation to update the content in this publication.

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vii

Core Points of View xi

Preface xiii

Acknowledgments xv

IntroductionEconomic Growth, Financial Restructuring, and Prospectsof Securities Companies 1

Understanding the Economic Trends of China from a Securities Firm’s Perspective 1

The Evolution of Chinese Financial Structure in the Future 11Core Competitive Edge 18References 21

CHAPTER 1Review and Judgment of Historical Roles of ChineseSecurities Companies 23

The Birth and Growth of Chinese SecuritiesCompanies—A Brief History 25

Review of the Pros and Cons of Chinese Securities Companies 43Historic Contributions of Chinese Securities Firms 46Case Studies: Typical Chinese Securities Firms 72References 93

CHAPTER 2Analysis of Functions of Chinese Securities Companies 95

Theoretical Analysis of Financial Functionality 96Functional Orientation for Securities Firms 101Change of the Chinese Depository System for Security

Deposits and How Chinese Securities Firms Function 113

ContentsContents

viii CONTENTS

Institutional Change and Functional Evolution for Chinese Securities Firms—An Analysis with Particular Interest in the Function of an Underwriter’s Goodwill 120

References 140

CHAPTER 3Analysis of the Management Model of Chinese Securities Companies 143

Introduction 144Organization and Management in Investment Banks:

A General Analysis Based on Institutional Banking and Functional Banking 146

Organization and Management in Chinese Securities Firms: A Historical and Theoretical Review 156

Selection of Models (Goals) for Change of Organizationand Management in Chinese Securities Firms 169

Some Ideas of Overall Policy for Future Organizational and Management Transformation in Chinese Securities Firms 191

References 201

CHAPTER 4Analysis of the Profi t Model of Chinese Securities Companies 203

Theoretical Analysis of Profi tability Models 204Profi tability Structures of Chinese Securities Companies 210Profi t Methods of the Main Business of

Securities Companies 218Characteristics of the Profi tability Model of Securities

Companies 234Construction of New Profi tability Models 237Case Studies 253References 264

CHAPTER 5Analysis of Risk Management in Chinese Securities Companies 267

Status Quo and Trend Analysis of Risk Management in Securities Companies 268

Management of Risks Associated with TraditionalBusiness of Chinese Securities Companies 286

Management of Risks Associated with Innovative Business of Securities Companies 307

References 316

Contents ix

CHAPTER 6Analysis on Structure and Competitiveness of Talent in ChineseSecurities Companies 317

Development Trend and Core Competitive Strength in the Securities Industry 317

Demand for Talents in the Development of the SecuritiesIndustry 321

Comparative Advantages and Disadvantages of Wealth Management Talent in the Securities Industry 328

Effective Talent Management in Securities Companies 339References 347

CHAPTER 7Analysis of Sponsor Regime for Chinese Securities Companies 349

Origin and Development of the Sponsor Regime in China 349

Analysis of Punishments Imposed by the CSRC on Rule-Breaching Sponsors 359

Rule Breaking Sponsor—Case Studies 378Intrinsic Flaw of the Sponsor System: Imbalance between

Profi t and Risk 386Direction for Sponsor System Reform 390References 394

CHAPTER 8Experience and Lessons from International Investment Banks(Securities Companies) in Mature Markets 397

Overview of the Development History of Investment Banks in the Mature Overseas Market 397

Analysis of Investment Bank Regulation in Mature Overseas Markets 410

Analysis of the Organizational Structures of Investment Banks in Mature International Markets 416

Analysis of Business Structures of Investment Banks in Mature International Markets 435

Analysis of the Internal Control of Investment Banks in Mature International Markets 448

What China Can Learn from the Development of Investment Banks in Mature International Markets 467

References 476

x CONTENTS

CHAPTER 9Future Development and Reform Focuses of Chinese SecuritiesCompanies—General Principle 479

Some Directions for the Future Development of Chinese Securities Firms 480

Some Priorities of Future Reform in Chinese Securities Firms 496References 510

About the Author 513

Index 515

xi

Core Points of View Core Points of View

A t the turn of this century, China’s capital market entered a new era. Since then, the continuously fast growth and rising income levels in China have

led to signifi cant change in the market’s fi nancial structure. Increasingly, active fi nancial investments are becoming more market‐oriented, and indi-vidual demand for fi nancial services has brought about increasing need for diversity, securitization, and portfolio management services.

Meanwhile, securities companies in China, as the major providers of fi nancial services in the capital market, are going through a period of sig-nifi cant opportunity. Taking into account the broad space for development and increasingly tough competition, Chinese securities companies face chal-lenges in areas such as functional position, organizational structure, profi t model, risk management and control, talent structure, core competitiveness, and international vision.

As we go forward, four elements are crucial if Chinese securities com-panies are to dominate in the fi ercely competitive capital markets: (1) solidcapital power accompanying a fl uent and effi cient mechanism of capital formation and complementary factors; (2) matchless core competitiveness based on outstanding innovative ability in human resources; (3) rigorous risk management and control mechanisms and the ability to cope with risks effi ciently; and (4) broad international vision combined with top‐ranking international ability. The securities companies that can look forward to abright future in China are those that can synthesize capital, talent, insti-tution, and vision, which combined will build incomparable competitive power in the market.

When mapping and analyzing the future development and institutional transformation of Chinese securities companies, it is necessary to tease apart the history of their development and judge them in the light of several cases; namely, Wanguo Securities, Junan Securities, GF Securities, Haitong Securities, Industrial Securities, China International Capital Corporation, and CITIC Securities. These seven companies present a microcosm of theChinese securities industry as it has existed in the past two decades.

It is necessary for the future development of Chinese securities com-panies to take example from and absorb the experience and lessons of

xii CORE POINTS OF VIEW

international investment banks (securities companies) in mature markets. The 100‐year history of international investment banks’ development rep-resents the whole world history of modern fi nance, with its basic character-istics of spectacularity, secretiveness, fl uctuation, and unpredictability. The question we must ask is: How will Chinese securities companies fi nd their position in this history, intertwined as it is with both fog and sunshine?

xiii

Preface Preface

A fter receiving an invitation from the Canada Securities Institute (CSI, a Moody’s Analytics company), I paid a visit to CSI and other fi nancial

institutions from September 17 to 28, 2012. During the visit with my friendsat the CSI, I made a detailed introduction to China’s capital markets. At that time, China’s Securities Companies: Present and Future , a book of which I was the lead author, was just published in China. Therefore, I focused my review on the status quo and the future of China’s securities fi rms during our meeting. CSI is now a fully owned subsidiary of Moody’s Corporation. As a reputable professional research, education, and training institute in the fi eld of the fi nancial services industry, CSI has enjoyed a long history of recognition in North America. With its well‐established curriculum, a wide array of credentials and designations, and a team of proven instructors, CSI has long been a respected partner of China’s fi nancial services industry. Todate, the institute has trained a large number of talented professionals from China’s securities fi rms, banks, and other fi nancial institutions. After my presentation and upon learning of the recent publication of China’s Securi-ties Companies: Present and Future , my CSI friends proposed to translatethe book into English and publish it in North America. With great pleasure, I committed myself to this generous offer.

Back in December 2012, Mr. Anthony Sue‐A‐Quan, CSI’s vice president and the head of education and training for China at Moody’s Analytics, and Mrs. Rose Ding, CSI’s marketing director and chief representative to China, came to Renmin University of China to discuss with me the publishing of the English version of the book. Anthony’s elegance and Rose’s passion have created within me some very fond memories. With their support, a team of translators and editors, led by Dr. Yawei Cui, CSI’s academic director andchief interpreter, have engaged in a 10‐month collective effort in translating and editing the book. Their work has not only added a special value to the book, but has also made a laudable contribution in helping the world have a better grasp of China’s capital markets in general fi rms and securities fi rms,in particular.

Chinese Fund for the Humanities and Social Sciences (CFHSS) and the Publishing House of the Renmin University of China (RUC Press) have also

xiv PREFACE

provided very generous support for the publishing of the English version of the book. I hereby would like to extend my heartfelt gratitude to CSI,CFHSS, and RUC Press.

Professor Wu Xiaoqiu Renmin University of China

Beijing October 10, 2013

xv

Academic Advisors

Chen Gong Ji Baocheng Wang Chuanlun

Huang Da Liu Hongru Zhou Shengye

Contributors

Chief author: Wu Xiaoqiu

Deputy chief authors: Dong Ansheng, Qu Qiang, Shi Wei, Zhao Xijun

Authors

Acknowledgments Acknowledgments

English: Ji Jie (translation), Zhao Xijun (review)

Editing Staff: Liu Tingzhu, Zhao Zhenling

NOTE FROM THE AUTHOR

This book was produced by chief author Professor Wu Xiaoqiu, director of the Finance and Securities Institute (FSI), with the help of experts fromthe FSI research team. Its content comes from the sixteenth of a series of

Bai Jinsheng Jiang Zeshen Lv Yujing Ying Zhanyu

Cheng Guoyan Ji Jie Ou Tianyi Yin Zhifeng

Deng Miaochang Ji Xiang Shi Wei Zhang Xia

Dong Ansheng Lin Shiwei Su Xiaoyong Zhang Yong

Fu Min Li Shaojun Tao Yanyan Zhao Pengfei

Gao Peiliang Liu Shiguang Wu Xiaoqiu Zhao Xijun

He Yi Liu Tingzhu Xu Rong Zheng Zhigang

Huang Chunyan Liu Yang Xu Yue Zhong Jun

Hu Song Lu Chao Ying Weiwei Zuo Zhifang

Hu Zhaoping

xvi ACKNOWLEDGMENTS

research reports on China’s capital market and also the keynote researchreport of the sixteenth (2012) China Capital Market Forum held by Renmin University of China on January 7, 2012.

Jiao Jinpu, director of the Graduate Department of People’s Bank of China; Zhuang Yuanfang, vice president of Xingye Securities Co. Ltd.; and researcher Lin Shiwei, among others, participated in writing important parts of this research report at the invitation of the forum’s host, Professor Wu Xiaoqiu.

Professor Zhao Xijun assisted in drafting the content and reviewing the English translation. Professor Wu Xiaoqiu reviewed key content and madenecessary corrections to the fi nal manuscript.

This research report received substantial support from the Social Science Department of the Ministry of Education. In fact, the serial capital market research reports chief authored by Professor Wu Xiaoqiu have been selectedas a sponsorship project of philosophy and social science research (devel-opment) by the Ministry of Education since 2011. The publishing style of this report should therefore be in accordance with the requirements of the Ministry of Education, which is very unlike the style of former reports. This research report also received help and support from Xinyuan Real Estate Co. Ltd.; Xingye Securities Co. Ltd.; Caida Securities Co. Ltd.; and China Renmin University Press. We express our acknowledgement to these institutions.

This research report represents the main standpoints of its host and FSI on the past, present, and future development of Chinese securities companies.

1

INTRODUCTION

Economic Growth, FinancialRestructuring, and Prospects of

Securities Companies

S ince the beginning of the twenty‐fi rst century, China has seen rapid eco-nomic growth: Gross domestic product (GDP) per capita increased from

USD 949 in 2000 to USD 5,000 in 2011, while residents’ disposable incomealso ballooned proportionally. During this time, drastic changes have struckChina’s fi nancial structure with increasingly active fi nancial investments, markedly improved market openness, and greater demands for diverse fi nan-cial services, securities, and portfolios. The Chinese capital market and thesecurities industry are therefore looking at a new era of historic changes andmajor opportunities. As the main provider of fi nancial services in the capitalmarket, Chinese securities fi rms have heralded a new phase of growth.

But how does a securities company succeed when competing for these opportunities? To grip the future, securities fi rms must have the followingthree abilities:

1. Understand Chinese economic trends 2. Comprehend the evolution of Chinese fi nancial structure 3. Possess a core competitive edge

UNDERSTANDING THE ECONOMIC TRENDS OF CHINA FROM A SECURITIES FIRM’S PERSPECTIVE

In terms of China’s economic prospects, a securities company should focus on two specifi c issues:

1. The general trends of China’s economic growth: contribution of invest-ment, spending, and import and export to economic growth

2 CHINESE SECURITIES COMPANIES

2. Changes of GDP and disposable incomes per capita: proportions and system of national income distribution and shifts of income streams in particular

Changes in these factors usually give rise to changes and upgrades in fi nancial demands, which are expected to result in major shakeups in the fi nancial structure.

The General Growth Trend of the ChineseEconomy Going Forward

China recently completed its “11th Five Years” period. During this period, China registered remarkable growth in its productivity and overall national competitiveness. China’s GDP was barely CNY 364.5 billion in 1987, but skyrocketed to over CNY 10 trillion in 2001, over CNY 20 trillion in 2006, over CNY 30 trillion in 2008, more than CNY 40 trillion in 2010, and over CNY 47 trillion in 2011. This is approximately equivalent to USD 7 trillionat current exchange rates, with a GDP per capita estimated near USD 5,000. The Chinese economy has kept growing at a rate of 9.5 percent per annumon average since 2000 (see Tables I.1 and I.2 ).

TABLE I.1 Economic Growth in China and Global Rankings (2000–2011)

Year

GDP (in billions) GrowthRate (%)

World Ranking China/USACNY USD

2000 9,921.46 1,198.48 8.4 6 12.1

2001 10,965.52 1,324.80 8.3 6 12.9

2002 12,033.27 1,453.83 9.1 5 13.7

2003 13,582.28 1,640.96 10.0 6 14.8

2004 15,987.83 1,931.64 10.1 6 16.4

2005 18,493.74 2,256.90 11.3 5 17.9

2006 21,631.44 2,712.95 12.7 4 20.3

2007 26,581.03 3,494.06 14.2 3 25.0

2008 31,404.54 4,521.83 9.6 3 31.6

2009 34,050.69 4,991.26 9.2 3 35.5

2010 40,120.20 5,878.63 10.4 2 40.3

2011 43,811.20 6,954.16 9.3 2 46.8

Notes:1. GDP fi gures are calculated at prices and exchange rates of the respective year, whereas growth rate fi gures are based on constant price. 2. Figures for 2011 are estimates. Source: National Bureau of Statistics of China and World Bank.

Economic Growth, Financial Restructuring, and Prospects of Securities Companies 3

TABLE I.2 Growth of GDP per Capita in China (2000–2011)

YearGDP per

Capita (CNY)Growth

Rate (%)GDP per

Capita (USD)Growth

Rate (%)

2000 7,858 9.76 949 9.71

2001 8,622 9.72 1,042 9.80

2002 9,398 9.00 1,135 8.93

2003 10,542 12.17 1,274 12.25

2004 12,336 17.02 1,490 16.95

2005 14,185 14.99 1,731 16.17

2006 16,500 16.32 2,069 19.53

2007 20,169 22.24 2,651 28.13

2008 23,708 17.55 3,414 28.78

2009 25,575 7.87 3,749 9.81

2010 29,748 16.32 4,313 15.04

2011 31,900 7.23 5,000 15.93

Notes:1. Figures for 2011 are estimates. 2. The population in 2011 was estimated at 1.37 billion.Source: National Bureau of Statistics of China and World Bank.

Despite the transition of the growth model, the rise of labor cost, and the greater uncertainties in internal and external demands induced by violent fl uctu-ations in the world market, the Chinese economy will continue to grow at a rate seen in the fi rst decade of the twenty‐fi rst century. This is thanks to the urban–rural integration, economic industrialization and informationization, industrial structure adjustment, and other factors. Most experts and renowned organiza-tions believe that the growth rate of the Chinese economy will remain at a range of 8 percent to 8.5 percent per annum until 2020. GDP is expected to hit CNY 87 trillion (equivalent to USD 13.9 trillion at current CNY/USD exchange rates of 6.3/1). This is calculated using the CNY 40 trillion Chinese GDP in 2011 as the base number and 8 percent as the annual growth rate, ignoring price factor. It is comparable to 80 percent of the U.S. GDP of USD 17.7 trillion, calculated using the USD 13.9 trillion in 2010 GDP as the base number and 2 percent as the annual growth rate, or higher if factors such as U.S. dollar depreciation and RMB appreciation are taken into account (see Table I.3 ).

Changes of GDP and Disposal Income Per Capita

China’s GDP per capital growth will advance in accord with the economic growth between 2010 and 2020, as the economy remains on the fast track


TABLE I.3 China–USA Comparison of GDP (2011–2020)

Year

China GDP(CNY in billions) USA GDP

(USD)China/

USA (%)CNY USD

2011 43,811.2 6,954.2 14,874.0 46.8

2012 47,316.1 7,510.5 15,171.5 49.5

2013 51,101.4 8,111.3 15,474.9 52.4

2014 55,189.5 8,760.2 15,784.4 55.5

2015 59,604.7 9,461.1 16,100.1 58.8

2016 64,373.0 10,217.9 16,422.1 62.2

2017 69,522.9 11,035.4 16,750.5 65.9

2018 75,084.7 11,918.2 17,085.6 69.8

2019 81,091.5 12,871.7 17,427.3 73.9

2020 87,578.8 13,901.4 17,775.8 78.2

Note: All fi gures are estimates ignoring price factor.

and population grows at a stable rate (see Table I.4 ). If RMB appreciatesduring this period, the GDP per capital (calculated in USD) will grow faster than the economy.

Changes in the distribution proportions of national incomes can be traced back to 1993. Government income has been increasing as national incomes have grown rapidly. However, income for citizens has grown at amuch lower rate than the government’s (see Table I.5 and Figure I.1 ).

After entering the “12th Five Years” period, China will experience a long‐term transition in its economic growth model, as strategically planned. One core purpose of the transition is to expand the contribution of domes-tic demand—consumption/spending demand, specifi cally—to the economicgrowth. Expansion of consumption demand depends on rapid expansion of incremental revenue and wealth stock. Therefore, the proportion and systemof national income distribution must be adjusted to keep the incomes of citizens (workers) consistent with economic growth. Both the growth rateof government revenue and the proportion of government in the national income can then be lowered properly. If the adjustment is actualized and the income of citizens (workers) grows proportionally with the economy, thedisposable income of citizens per capita will be CNY 25,800 by the year 2020 (compared to CNY 12,500 in 2010), or higher if the wealth stock (property income) is taken into account (see Table I.6 ).


TABLE I.4 Growth of Chinese GDP Per Capita (2011–2020)

Year

GDP per Capita

CNY USD

2011 31,900 5,000

2012 33,700 5,300

2013 36,500 5,700

2014 39,400 6,200

2015 42,500 6,700

2016 45,900 7,200

2017 49,600 7,800

2018 53,600 8,500

2019 57,900 9,100

2020 62,500 9,900

Notes:1. All fi gures are estimates. 2. Infl ation is ignored for the estimates. 3. The Chinese population is expected to remain at 1.4 billion throughout this period, except in 2011 (1.37 billion).

For a long period, investment was the leading stimulus to Chinese eco-nomic growth. The investment volume for the years of 2000 and 2010 was CNY 3,291.7 billion and CNY 27,812.2 billion, respectively, with the aver-age annual growth rate as high as 22.7 percent (see Table I.7 ).

After joining the World Trade Organization (WTO) in 2011, China became increasingly dependent on external factors in its economic growth. For example, its imports and exports swelled to an average annual growthrate of 21.62 percent and volume grew 6.17 times between 2000 (USD 540.2 billion) and 2010 (USD 3,335.1 billion). Specifi cally, commodities grew 6.23 times, from USD 474.2 billion to USD 2,972.8 billion, at an aver-age annual growth rate of 22.06 percent, while services grew 5.49 times,from USD 66 billion to USD 362.3 billion, at an average annual growth rate of 22.06 percent. China topped all other countries in export transactions in the same period (see Table I.8 ).

Despite substantial growth in investments and in import and export business, domestic consumption/spending demand did not perform satis-factorily as one of China’s economic engines. Domestic demand grew from CNY 3,415.3 billion in 2000 to CNY 15,699.8 billion in 2010, at an aver-age annual growth rate of 13.6 percent (see Table I.9 ). The disappointing

6

TABL

E I.5

Dis

trib

utio

n of

Nat

iona

l Inc

ome

(200

0–20

10)

Dis

posa

ble

Inco

me

for

the

Gove

rnm

ent

Dis

posa

ble

Inco

me

for

Com

panie

sD

isp

osa

ble

In

com

e fo

r C

itiz

ens

Yea

rN

ati

onal

Inco

me

Tota

lA

mt.

Gro

wth

Rate

Pro

port

ion

Am

tG

row

th

Rate

Pro

port

ion

Am

tG

row

th

Rate

Pro

po

rtio

n

2000

9,

800.

0517

221.

6616

.13%

0.17

5730

43,

373.

401

12.8

0%0.

3442

234,

704.

478

7.55

%0.

4800

466

2001

10

,806

.82

2068

6.04

20.1

2%0.

1914

165

3,55

8.44

15.

49%

0.32

9277

35,

179.

777

10.1

0%0.

4793

062

2002

11

,909

.57

2338

2.64

13.0

4%0.

1963

349

3,76

6.64

15.

85%

0.31

6270

15,

804.

664

12.0

6%0.

4873

95

2003

13

,517

.40

2628

2.05

12.4

0%0.

1944

313

4,43

6.60

717

.79%

0.32

8214

66,

452.

586

11.1

6%0.

4773

542

2004

15

,958

.67

3109

5.65

18.3

2%0.

1948

511

5,51

1.78

124

.23%

0.34

5378

47,

337.

329

13.7

1%0.

4597

706

2005

18

,580

.86

3719

3.45

19.6

1%0.

2001

708

6,53

6.85

318

.60%

0.35

1805

88,

324.

658

13.4

6%0.

4480

234

2006

21

,752

.27

4516

8.08

21.4

4%0.

2076

477

7,75

6.83

218

.66%

0.35

6598

89,

478.

627

13.8

6%0.

4357

535

2007

26

,776

.37

5814

2.10

28.7

2%0.

2171

396

9,64

3.19

224

.32%

0.36

0138

211

,318

.964

19.4

2%0.

4227

222

2008

31

,622

.88

6794

7.60

16.8

6%0.

2148

685

11,6

29.0

0120

.59%

0.36

7740

113

,199

.121

16.6

1%0.

4173

915

2009

34

,346

.47

7493

2.95

10.2

8%0.

2181

678

12,2

20.9

395.

09%

0.35

5813

514

,632

.235

10.8

6%0.

4260

186

2010

40

,326

.00

8995

4.86

20.0

5%0.

2230

692

14,5

58.9

9819

.13%

0.36

1032

616

,771

.512

14.6

2%0.

4158

983

Not

e: A

ll da

ta b

ased

on

Chi

na S

tati

stic

al Y

earb

ook

(200

2–20

11).


TABLE I.6 Growth of Income and Disposable Income of Chinese Citizens (2011–2020)

Year

Disposable Income forthe Residents Division

(in billion RMB)

DisposableIncome per

Capita (RMB) Note

2011 18,113 13,200 Incomes of this division arebased on an annual growthrate of 8 percent on average, ignoring the price factor.

2012 19,562 14,000

2013 21,127 15,100

2014 22,817 16,300

2015 24,642 17,600

2016 26,614 19,000

2017 28,743 20,500

2018 31,042 22,100

2019 33,526 23,900

2020 36,208 25,800

Notes:1. All data based on estimates ignoring price fl uctuation. 2. The Chinese population is expected to remain at 1.4 billion throughout this period, except in 2011 (1.37 billion).

0.6

0.5

0.4

Disposable Income for Government

Disposable Income for Citizens

Disposable Income for Companies

0.3

0.2

0.1

0

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

FIGURE I.1 Distribution of National Income (2000–2010)

growth of consumption demand is directly related to income distribution policy and slow growth in resident income.

The three factors that most greatly contributed to Chinese economic growth between 2000 and 2010 are investments, consumption, and imports and exports. Among these, investments led in growth,


TABLE I.7 Investments in China (2000–2010)

Year

TotalInvestment

GovernmentalInvestment

Non‐GovernmentalInvestment

Volume (CNY in billions)

GrowthRate (%)


GrowthRate (%)


GrowthRate (%)

2000 3,291.7 10.3 210.95 13.9 3,080.76 11.1

2001 3,721.3 13.1 254.64 20.7 3,466.66 12.5

2002 4,349.9 16.9 316.10 24.1 4,033.80 16.4

2003 5,556.6 27.7 268.78 −15.0 5,287.82 31.1

2004 7,047.7 26.8 325.49 21.1 6,722.21 27.1

2005 8,877.3 26.0 415.43 27.6 8,461.87 25.9

2006 10,999.8 23.9 467.20 12.5 10,532.60 24.4

2007 13,732.4 24.8 585.71 25.4 13,146.69 24.8

2008 17,282.8 25.9 795.48 35.8 16,487.32 25.4

2009 22,459.9 30.0 1,268.57 59.5 21,191.33 28.5

2010 27,812.2 23.8 1,467.78 15.7 26,344.42 24.3

Source: National Bureau of Statistics of China (adapted).

TABLE I.8 Imports and Exports in China (2000–2010)

Year

Import and ExportCommodityTransactions Service Transactions


GrowthRate (%)


GrowthRate (%)


GrowthRate (%)

2000 540.2 29.29 474.2 31.50 66.0 15.40

2001 581.5 7.65 509.6 7.47 71.9 8.90

2002 706.2 21.44 620.7 21.80 85.5 18.90

2003 952.2 34.83 850.9 37.09 101.3 18.50

2004 1,288.2 35.29 1,154.5 35.68 133.7 32.00

2005 1,579.0 22.57 1,421.9 23.16 157.1 17.50

2006 1,952.1 23.63 1,760.4 23.81 191.7 22.00

2007 2,424.6 24.20 2,173.7 23.48 250.9 30.90

2008 2,867.7 18.28 2,563.2 17.92 304.5 21.40

2009 2,494.2 −13.02 2,207.5 −13.88 286.7 −5.80

2010 3,335.1 33.71 2,972.8 34.67 362.3 26.37

Source: National Bureau of Statistics of China, General Administration of Customs of the People’s Republic of China, and Ministry of Commerce of the People’s Republic of China.


TABLE I.9 Growth of Domestic Consumption Demand (2000–2010)

Year

Domestic ConsumptionDemand Urban Areas Rural Areas


GrowthRate (%)


GrowthRate (%)


GrowthRate (%)

2000 3,415.3 9.7 2,111.0 10.6 1,304.3 8.3

2001 3,759.5 10.1 2,354.3 11.5 1,405.2 7.7

2002 4,091.1 8.8 2,589.8 10.0 1,501.3 6.8

2003 4,584.3 9.1 2,977.7 10.3 1,606.5 6.8

2004 5,395.0 13.3 3,557.3 14.7 1,837.7 10.7

2005 6,717.7 12.9 4,509.5 13.6 2,208.2 11.5

2006 7,641.0 13.7 5,154.3 14.3 2,486.7 12.6

2007 8,921.0 16.8 6,041.1 17.2 2,879.9 15.8

2008 10,848.8 21.6 7,373.5 22.1 3,475.3 20.7

2009 12,534.3 15.5 8,513.3 15.5 4,021.0 15.7

2010 15,699.8 18.3 13,612.3 18.7 2,087.5 16.2

Note: The data for 2010 is not reliable. Source: Statistics Bulletin on National Economy and Social Development 2010,issued by National Bureau of Statistics of China.

consumption declined, and imports and exports fl uctuated (see Table I.10 and Figure I.2 ).

Since 2010, the Chinese government has made great efforts toward the following measures:

■ Transition of the economic growth model ■ Reform of national income distribution system ■ Adjustment of national income distribution proportions ■ Expansion of domestic demand ■ Lowering of economic dependency on external factors ■ Adjustment of imported and exported commodities mix ■ Reduction of resource consumption of exported commodities ■ Increase of technological level ■ Added value of exported commodities ■ Implementation of prudent macroeconomic policy

If these governmental initiatives persist, there will be a noticeable increase in the consumption contribution to economic growth by 2020. The

10

TABL

E I.1

0 C

ontr

ibut

ion

from

Inv

estm

ents

, Con

sum

ptio

n, a

nd I

mpo

rts

and

Exp

orts

to

Chi

nese

Eco

nom

ic G

row

th

Eco

nom

ic G

row

thIn

vest

men

tC

onsu

mpti

on

Imp

ort

an

d E

xp

ort

Bu

sin

ess

Yea

r

GD

P(C

NY

in

billions)

Gro

wth

R

ate

(%)

Vo

lum

e(C

NY

in

billions)

Contr

ibuti

on

Rate

( %)

Vo

lum

e(C

NY

in

bil

lions)

Contr

ibuti

on

Rate

(%)

Vo

lum

e(U

SD

in

bil

lions)

Net

Ex

po

rtV

olu

me

(CN

Yin

bil

lio

ns)

Contr

ibu

tion

Rate

( %)

2000

9,92

1.46

8.4

3,29

1.7

22.4

3,41

5.3

65.1

540.

223

9.0

12.5

2001

10,9

65.5

28.

33,

721.

349

.93,

759.

550

.258

1.5

232.

5−0

.1

2002

12,0

33.2

79.

14,

349.

948

.54,

091.

143

.970

6.2

309.

47.

6

2003

13,5

82.2

810

.05,

556.

663

.24,

584.

335

.895

2.2

298.

61.

0

2004

15,9

87.8

310

.17,

047.

754

.55,

395.

039

.51,

288.

240

7.9

6.0

2005

18,4

93.7

411

.38,

877.

339

.06,

717.

737

.91,

579.

01,

022.

323

.1

200 6

21,6

31.4

412

.710

,999

.843

.97,

641.

040

.01,

952.

11,

665.

416

.1

2 007

26,5

81.0

314

.213

,732

.442

.78,

921.

039

.22,

424.

62,

338.

118

.1

2008

31,4

04.5

49.

617

,282

.847

.510

,848

.843

.52,

867.

72,

422.

99.

0

2009

34,0

50.6

99.

222

,459

.991

.312

,534

.347

.62,

494.

21,

503.

3−3

8.9

2010

40,1

20.2

10.4

27,8

12.2

54.0

15,6

99.8

36.8

3,33

5.1

1,57

1.2

9.2

Not

e: A

ll co

ntri

buti

on r

ates

list

ed u

nder

“Im

port

and

Exp

ort

Bus

ines

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re f

or t

he im

port

and

exp

ort

of c

omm

odit

y an

d se

rvic

e on

ly.

Sour

ce: N

atio

nal B

urea

u of

Sta

tist

ics

of C

hina

.


FIGURE I.2 Contribution from Investments, Consumption, and Imports and Exports to Chinese Economic Growth

100

80

Investment

Import and ExportBusiness

Consumption

60

40

20

0

(20)

(40)

(60)

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

proportion of contribution of investment, consumption, and imports andexports to economic growth will also change moderately. These changes inthe macro economy will serve both as the macro background for the devel-opment of Chinese capital markets and as prerequisites for the survival and growth of Chinese securities companies in the future.

THE EVOLUTION OF CHINESE FINANCIAL STRUCTUREIN THE FUTURE

Historical Data

Generally, Chinese fi nance has become increasingly marketized over time. This tendency has been accelerating since the reform of equity division in February 2007. This assertion is based on the following three changes in fi nancial/economic data:

1. Rise in the ratio of fi nancial assets (F) to GDP (G), F:G. 2. Rise in the ratio of market value of shares (S) (excluding debentures) to

GDP, S:G. 3. Rise in the weight of market value of shares (excluding debentures) in

total fi nancial assets, S:F.


The Rise of F/G Table I.11 shows the fl uctuation of F/G since 1990. The ratio was 2.13 in 1990, when total fi nancial assets were CNY 3,973.2 billionand GDP was CNY 1,866.8 billion. The ratio was 2.51 in 2000 and 2.90 in 2010, indicating a tendency of constant rise (see Figure I.3 ).

The Rise of S/G Despite little fl uctuation before the equity division reform began in May 2005, the value of S/G has increased considerably since thereform in early 2007, along with reform in fi nancial structure, gradual rise in F/G, and rapid expansion of fi nancial assets (see Table I.12 and Figure I.4 ).

TABLE I.11 Fluctuation of F/G Since 1990

YearValue of Total Financial Assets (CNY in billions) (F)

GDP (CNY inbillions) (G) F/G

1990 3,973.2 1,866.78 2.13

1991 4,276.6 2,178.15 1.96

1992 5,417.1 2,692.35 2.01

1993 7,438.6 3,533.39 2.11

1994 9,656.8 4,819.79 2.00

1995 12,198.7 6,079.37 2.01

1996 15,109.0 7,117.66 2.12

1997 18,572.9 7,897.30 2.35

1998 19,763.1 8,440.23 2.34

1999 22,664.5 8,967.71 2.53

2000 24,951.0 9,921.46 2.51

2001 23,176.1 10,965.52 2.11

2002 20,114.9 12,033.27 1.67

2003 27,808.6 13,582.28 2.05

2004 32,047.8 15,987.83 2.00

2005 36,135.1 18,493.74 1.95

2006 49,031.7 21,631.44 2.27

2007 83,353.6 26,581.03 3.14

2008 72,646.3 31,404.54 2.31

2009 100,025.8 34,050.69 2.94

2010 116,232.3 40,120.20 2.90

Data Source: National Bureau of Statistics of China and State Administration of Foreign Exchange (adapted).


As one of the major indices of assets liquidity, S/F is a symbol of the infl uence of the capital market on economic activities, and the capacity of resources stock to be reorganized. It also represents the marketization levelof wealth management, and serves as the key indicator of room for develop-ment in the securities industry.

The Fluctuation of S/F Formulated as the ratio of the securitized fi nancial assets to the total fi nancial assets, S/F represents the fl uidity of fi nancial assets and the capacity of risk allocation. See Table I.13 for the fl uctuation of the weight of the market value of share in the total fi nancial assets (exclud-ing the debentures) (S/F) since 1990.

FIGURE I.3 Fluctuation of F/G Since 199020

00

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

1990

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

1991

1992

1993

1994

1995

1996

1997

1998

1999

FIGURE I.4 Fluctuation of S/G Since 1990

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

1990

0

0.2

0.4

S/G in a Narrow Sense

S/G in a Broad Sense0.6

0.8

1

1.2

1.4

1991

1992

1993

1994

1995

1996

1997

1998

1999


TABLE I.12 Fluctuation of S/G Since 1990

Market Value of Shares (CNY in billions)

GDP (CNY inbillions) (G)

S/G in aNarrow Sense(%) (L)/(G)

S/G in aBroad Sense(%) (T)/(G)Year

LiquidVolume (L)

TotalVolume (T)

1990 — — 1,866.78 — —

1991 — 10.9 2,178.15 — 0.50

1992 — 104.8 2,692.35 — 3.89

1993 86.2 353.101 3,533.39 2.44 9.99

1994 96.9 369.062 4,819.79 2.01 7.66

1995 93.794 347.4 6,079.37 1.54 5.71

1996 286.703 984.237 7,117.66 4.03 13.83

1997 520.443 1,752.923 7,897.30 6.59 22.20

1998 574.559 1,950.564 8,440.23 6.81 23.11

1999 821.397 2,647.117 8,967.71 9.16 29.52

2000 1,608.752 4,809.094 9,921.46 16.21 48.47

2001 1,446.316 4,352.219 10,965.52 13.19 39.69

2002 1,248.455 3,832.912 12,033.27 10.38 31.85

2003 1,317.852 4,245.772 13,582.28 9.70 31.26

2004 1,168.864 3,705.557 15,987.83 7.31 23.18

2005 1,063.051 3,243.028 18,493.74 5.75 17.54

2006 2,500.364 8,940.389 21,631.44 11.56 41.33

2007 9,306.435 32,714.089 26,581.03 35.01 123.07

2008 4,521.39 12,136.644 31,404.54 14.40 38.65

2009 15,125.865 24,393.912 34,050.69 44.42 71.64

2010 19,311.041 26,542.259 40,120.20 48.13 66.16

Note: S/G in a “narrow sense” refers to the ratio of the liquid/tradable market value of shares to GDP, and S/G in a “broad sense” refers to the total liquid market value of shares to GDP. As Chinese shares become increasingly tradable, the two ratios tend to converge. Source: National Bureau of Statistics of China, China Securities Regulatory Commission.


TABLE I.13 The Fluctuation of S/F Since 1990

Year

Market Value of Shares (CNY in billions)

FinancialAssets (CNYin billions) (3)

S/F

Tradable/liquid Volume

(1)

TotalVolume

(2)

In a NarrowSense (%)

(1)/(3)

In a BroadSense (%)

(2)/(3)

1990 — — 3,973.2 — —

1991 — 10.90 4,276.6 — 0.25

1992 — 104.80 5,417.1 — 1.93

1993 86.20 353.10 7,438.6 1.16 4.75

1994 96.90 369.06 9,656.8 1.00 3.82

1995 93.79 347.40 12,198.7 0.77 2.85

1996 286.70 984.24 15,109.0 1.90 6.51

1997 520.44 1,752.92 18,572.9 2.80 9.44

1998 574.56 1,950.56 19,763.1 2.91 9.87

1999 821.40 2,647.12 22,664.5 3.62 11.68

2000 1,608.75 4,809.09 24,951.0 6.45 19.27

2001 1,446.32 4,352.22 23,176.1 6.24 18.78

2002 1,248.46 3,832.91 20,114.9 6.21 19.06

2003 1,317.85 4,245.77 27,808.6 4.74 15.27

2004 1,168.86 3,705.56 32,047.8 3.65 11.56

2005 1,063.05 3,243.03 36,135.1 2.94 8.97

2006 2,500.36 8,940.39 49,031.7 5.10 18.23

2007 9,306.44 32,714.09 83,353.6 11.17 39.25

2008 4,521.39 12,136.64 72,646.3 6.22 16.71

2009 15,125.87 24,393.91 100,025.8 15.12 24.39

2010 19,311.04 26,542.26 116,232.3 16.61 22.84

Source: National Bureau of Statistics of China, State Administration of Foreign Exchange and China Securities Regulatory Commission (adapted).


Generally, the value of S/F has been rising continuously. This illustrates the rise in the marketization level of fi nancial markets and the emergence of the role of capital markets as the cornerstone of the Chinese fi nancial system.

Evolution Prediction

Based on studies and conclusions, we can make the following predictions regarding the values of F/G, S/G, and S/F (see Table I.14 ):1

■ The average annual economic growth rate between 2011 and 2020 will be 8 percent.

■ The market value of shares will be CNY 100 trillion by 2020. ■ The average growth rate of fi nancial assets is not expected to be much lower than 12 percent. This is calculated as the sum of the average growth rate of the economic growth of the same period (8 percent), plus expected infl ation (1–2 percent) and the rate of rise in monetizationcoeffi cient (1–2 percent).

Signifi cant differences in specifi c data are due to fl uctuations and uncertainty of the stock market. However, the general trend is shown in

TABLE I.14 Predicted Values of F/G, S/G, and S/F (2011–2020)

YearGDP (CNYin billions)

Financial Assets(F) (CNY in

billions)

Market Value of Shares (S) (CNY

in billions) F/G (%) S/G (%) S/F (%)

2011 43,811.2 130,180.2 30,311.3 297 69 23

2012 47,316.1 145,801.8 34,615.5 308 73 24

2013 51,101.4 163,298.0 39,530.9 320 77 24

2014 55,189.5 182,893.8 45,144.2 331 82 25

2015 59,604.7 204,841.0 51,554.7 344 86 25

2016 64,373.0 229,422.0 58,875.5 356 91 26

2017 69,522.9 256,952.6 67,235.8 370 97 26

2018 75,084.7 287,786.9 76,783.3 383 102 27

2019 81,091.5 322,321.3 87,686.5 397 108 27

2020 87,578.8 361,000.0 100,000.0 412 114 28

Notes:1. All fi gures are estimates. 2. Price factor is ignored in these estimates.

1 Xiaoqiu et al. (2011).


Table I.14 . By 2020, the F/G of the Chinese economy will be approximately 400 percent, S/G will be 100 to 120 percent, and S/F will be approximately30 percent. Based on this information, China’s fi nancial structure willapproach or reach the level of developed countries by that time.

Internal Incentives for Market Evolution of China’s Financial Structure

A detailed analysis of the internal incentives for the market evolution of the Chinese fi nancial structure is covered in the book Essentials for Analysis of China Capital Market.2 Below is a brief summary of several key areas:

■ China’s improvement of economic monetization or money supply (M2)/GDP, paved the way for market‐oriented evolution of China’s fi nancial structure, without which its market transformation would be suspended. In fact, China’s economic monetization (M2/GDP) has maintained an upward trend since the beginning of China’s reform and opening‐up ini-tiative in 1978, from 32 percent in 1978 to 82.5 percent in 1990, 150.6percent in 2000, 180.9 percent in 2010, and 245.5 percent in the thirdquarter of 2011 (see Figure I.5 ).

Although the constant ascent of M2/GDP has resulted in rising price levels at different stages, it has also been driving the continuousgrowth of the Chinese economy, more importantly, and has created themarket‐ended shakeup of the Chinese fi nancial structure.

■ Preference in the distribution of national income has been given appro-priately to residents, thereby moderately improving the proportion of this

2 Xiaoqui (2006, 47–89).

FIGURE I.5 Evolution of China Economic Monetization

1996

1998

2000

2002

2004

2006

2008

2010

1978

0

0.5

1

1.5

2

2.5

3

M2/GDP

1980

1982

1984

1986

1988

1990

1992

1994


division in the total pie. This has served as the foundation for the market‐tended evolution of the Chinese fi nancial structure. The residents’ division becoming the main provider of fi nancial resources for economic growth has posed the following demands for changes in the fi nancial system:

■ The fi nancial services offered in the fi nancial system will be effi cient, fl exible, and optional, in order to meet the constantly escalating fi nan-cial demands from the residents’ division.

■ The vast capital surplus in the residents’ division requires channels and vehicles for smooth, optional conversion into investments. If the huge monetary surplus in the residents’ division becomes the main fi nancial resource for economic growth, the capital foundation will be made avail-able for the development of fi nancial markets, especially capital markets.

One important reason why the market evolution of China’s fi nan-cial structure has been stagnant in recent years is the relative slowdown of the rising incomes in the residents’ division. However, with the tran-sition of the economic growth model and reforms of the income dis-tribution regime, incomes in the residents’ division are expected to seeremarkable growth for a long time. This will facilitate the continuity of the market evolution of Chinese fi nancial structure.

■ The capitalization trend of incomes in the residents’ division gives momentum to a market‐oriented transformation of the Chinese fi nancial structure. This indicates a rising tendency of the proportion of capital expenditures in residents’ incomes seeking capital returns. This con-cept carries both broad and narrow interpretations. In the broad sense,capital expenditures represent all capital spending, both securitized and nonsecuritized, whereas in the narrow sense, capital expenditures only refer to securitized capital spending. 3 Studies show that the capitaliza-tion of incomes in China’s residents’ division has seen a constant rising trend, 4 although fl uctuations did occur at times.

CORE COMPETITIVE EDGE

Four Factors Determining the Competitive Edge of Securities Companies

The previous analysis has assured us of a vast growth space for China’s capital market in the future. However, securities fi rms still confront a host of challenges, ranging from the need for fundamental transition of the prof-itability model to heated, cruel market competition. Acquisitions, mergers,

3 Xiaoqiu (2006, 56–61).4 Xiaoqiu (200 6, 56–61) and Xiaoqiu and Rong (2009).


and transition of models will reign as the basic rules of survival for the secu-rities industry in the future. In order to take a dominant position in future competition, securities fi rms must grasp the future development of Chineseeconomic and market transformation of the country’s fi nancial structure, onone hand, and understand their positions and improve general competitive-ness, on the other. To do this, the following four factors are critical:

1. Strong capital capability and a smooth, effective mechanism to create and supplement capital

2. Hard‐to‐replicate core competitiveness 3. A stringent risk‐management mechanism and a swift and effective risk

disposal capacity 4. Broad international perspective and fi rst‐rate international abilities

Strong Capital Capability and a Smooth, Effective Mechanism to Create and Supplement Capital The Chinese securities industry will experience at least one round of major market‐oriented acquisitions and mergers by 2020, after which the num-ber of securities fi rms in China will drop from the current estimate of 100 to about 60. The stimulus for such acquisitions and mergers derives mainly from the pressure for survival triggered by fi erce market competition, as opposed to the fi nancial crisis that may result from the defects in institutional design. This is because institutional loopholes for major fi nancial risks in securities fi rms were mended in the general regulating of the securities business in 2006, after which risks were greatly reduced for a large‐scale burst of the industry.

The fi rst defense against market competition in the future will be capital, provided the institutional conditions are sound. The basic orientations, from a capital perspective, of future mergers and acquisitions (M&A) in the industry will consist of listed brokerages acquiring nonlisted brokerages, andbrokerages with strong capital capability purchasing those with weak capital strength. Listed brokerages boast a unique channel for effective generation and supplementation of capital. Among them, the giant fi rms with strongoverall competitiveness will champion the future M&A in the securitiesindustry. Nonlisted brokerages will obviously stay at a comparatively disadvantaged position, although those with controlling shareholdersor actual controllers who have a strong capability for continuous capital generation will uplift their position to a certain extent. However, going public will continue to be the goal of those brokerages. While the securities regulatory and management institutions will continue to exert all‐around oversight of the traders, capital will remain the core, most solid factor, asexpansions of all business dealings are interlocked with the scales of capital.

This means that capital strength, both static and dynamic, is the key ele-ment for securities traders to succeed in future competition.


Hard-to-Replicate Core Competitiveness Few securities brokerages would beable to attain competitiveness in all elements. The agenda for the majority of securities traders will not pursue scale and comprehensiveness, but rathercore competitiveness with unique advantages. This is also necessary for the few giant fi rms with all‐element competitiveness. In China’s current services portfolio of securities companies, specifi c advantages could be developedfrom all elements, including brokering, wealth management, M&A, fi nanc-ing and refi nancing, assets securitization, and derivatives trading. For exam-ple, in order to become competitive in the brokering business, brokerages must have powerful marketing capability; a smooth, effective trading net-work; and superb service capabilities. To stand out in wealth management,a securities fi rm must be able to grasp the bigger picture of the market, have fi rst‐rate market consciousness, and be effective in risk allocation. To make a mark in the M&A business, a brokerage requires excellent innovative capability and an all‐around fi nancial support system. The isomorphism era of the profi tability model in the Chinese securities industry is about to end. Proprietary competitive strengths established on a “big” foundation repre-sent the future development direction of Chinese securities fi rms.

To develop such core competitiveness, the key lies in talent. Competing in the fi nancial securities industry means competing well‐trained, synergic, and innovative talent to provide the fundamental insurance for the develop-ment of core competitiveness.

Stringent Risk-Management Mechanism, Swift and Effective Risk Disposal Capacity Man-aging risk is key to all fi nancial institutions, and securities fi rms are no excep-tion. One reason for the eventual demise of some powerful prime investment banks that even boosted reforms in fi nancial structure was indifference to crisis. Self‐destroying risks crept onto those fi rms just as they were amass-ing huge profi ts. While in pursuit of their own ultimate interests, their risk‐management regimes were either ineffective or too vulnerable. When serious fi nancial storms arrived, they found themselves powerless.

Mounting experience and lessons have unveiled the following fact: Liquidity risks affect the lifeline of all fi nancial institutions. Managing riskis key to survival. Only by surviving, can the fi rm hope to grow.

To establish an effective risk‐management program, securities fi rms must develop their internal systems, including corporate governance structure,information transparency, front‐ and back‐offi ce risk‐separation mecha-nisms, capital liquidity, and risk response capabilities.

Broad International Perspective, First-Rate International Abilities The strategic goal of the reforms and development of China’s fi nancial system is as fol-lows: Turn the Shanghai–Shenzhen‐anchored Chinese fi nancial market into a fi nancial market growth pivot with global implications by 2020, and make


Shanghai (and Shenzhen) the new international fi nancial center to facilitatethe market, international, and modern appeals of the Chinese fi nancial sys-tem across the spectrum.5

In order to become an international fi nancial center, China needs to have a substantial number of blue‐chip companies and growth‐oriented enterprises with investment values, complete corporate governance struc-ture, and international infl uences. In addition, the fi nancial services in the Chinese capital market also need to achieve international caliber. Therefore,China must develop a number of securities fi rms (investment banks) with international perspectives and global implications. However, such a goal is still far away from the current Chinese securities industry.

For Chinese securities fi rms to develop their international horizons, pri-orities are as follows: Understand and master the rules of the international money market, grasp the operating laws and transitional trends of the inter-national fi nancial market, maneuver the complex fi nancial vehicles in the international market, and know the operating characteristics and changingdirections of the macroeconomic policies internationally.

To be international, the Chinese capital market needs to be bidirectional, drawing foreign investors into the Chinese market, on one hand, and having legitimate foreign companies listed in the Chinese market, on the other. As such, Chinese securities fi rms must improve their international capabilities, in terms of fi nancial services, by both developing a strong ability for market expansion and by exploring and meeting the diverse fi nancial needs of offshore investors.

In summary, China’s companies of tomorrow must incorporate capital, talent, systems, and perspectives within their own structure, in addition to having an articulate understanding of the future economic developments in China and the transitional trend of the Chinese fi nancial structure. A seam-less combination of these four elements will generate powerful vitality and unparalleled competitiveness.

REFERENCES

Xiaoqui , Wu . 2006 . Essentials for Analysis of China Capital Market . Beijing : Renmin tUniversity Press .

———. 2010 . The Chinese Finance and Capital Market amidst Global Financial Changes . Beijing : Renmin University Press .

Xiaoqiu , Wu , and Xu Rong . 2009 . Market Trend of Finance and Structural Changes of Chinese Finance, Finance & Trade Economics . Beijing : Renmin University Press .

Xiaoqiu , Wu . 2011 . Changes and Rise: Exploring the Road for China’s Financial Rise . Beijing : China Financial Publishing House Press .

5 Xiaoqiu (2010, 31).

23

CHAPTER 1 1 Review and Judgment of

Historical Roles of ChineseSecurities Companies

There is a high degree of consistency between the evolution trend and prog-ress of Chinese securities companies and the tracks of economic, fi nan-

cial, and social development along China’s reform and opening‐up program. However, some inconsistency is also evident. Various aspects are involved in China’s social and economic development, fi nancial reform, development of the securities market, and regulatory reform of the securities industry. Inrespect to these aspects, the history of Chinese securities companies can bedivided into the following four important stages:

1. Stage one: 1987 to 1995. This is the embryonic period. 2. Stage two: 1996 to 2001. This is the phase into prosperity. 3. Stage three: 2001 to 2005. This is the time to pick up the slack. 4. Stage four: This is the phase of standardized development after the

shareholding reform in 2005.

Historical and modern fi nancial theory defi ne the fundamental function of securities companies—an important intermediary of capital markets—asrisk fi ltering, asset pricing, and asset management. On this basis, we identify the way to judge the contributions Chinese securities companies have made to benefi t economic and fi nancial development, and the existing problems they should acknowledge of the past two decades.

The resulting conclusion is as follows: Securities companies have been assisting in the promotion of the privatization of state‐owned enterpriseand the improvement of the quality of enterprise management. They havemade great contributions in mobilizing the nation’s capital stock effi ciently and further improving the quality of the nation’s economic performance.


They have also had an effect on constructing the fi nancial system with the securities market at its heart, diversifying the nation’s capital structure andresidents’ investment channels and increasing information transparency of capital markets. The existing problems include tunneling caused by direct investments and initial public offerings (IPOs), damages to the credibility of the market and interests of investors boiled down to insider trading, and securities companies’ lack of innovation and core competitiveness.

In this chapter, we highlight seven securities companies as a typical case study, which supports the above review and conclusion.

As the new member and an integral part of the new Chinese fi nan-cial system, securities fi rms are a major achievement of China’s reform and opening‐up program. They evolved as the institutional factors hinderingChina’s economic growth were removed and the country developed in terms of economy, fi nance, and society. During the evolution, securities companiesexpanded in scale and diversifi ed their services, which gradually raised theirprofi tability and contributed greatly to the development of China’s capitalmarket. In the fi rst half of 2011, China had 109 securities companies. Their total business income for that year was CNY 75.102 billion (including net profi t: CNY 26.054). That total comprised CNY 40.995 billion from securi-ties brokerage (their primary business); CNY 13.277 billion from securitiesunderwriting and sponsorship and from fi nancial consultation; CNY 0.898billion from trusted customer asset management; and CNY 6.897 billion (including changes in fair value) from securities investment. Of these 109securities companies, only 94 (86.24 percent) were profi table. As of June 30,2011, these 109 companies had total assets of CNY 1,670 billion, their total net assets were CNY 580.896 billion, their net capital was CNY 435.717 billion, and their total trust fund was CNY 248.673 billion.

To better serve the reform and opening‐up program in China’s economy and society, 1 efforts were made to modernize and improve the fi nancialsystem and market. With fi nancial “uniformity”2 removed, the securities companies developed differently from other fi nancial institutions, as the keyintermediaries in China’s capital market. But before we can understand theuniqueness of the development of Chinese securities companies and their

1 Although the Chinese economic reform started with the household contract respon-sibility system for farming in the countryside, the reform of government‐owned com-panies was the prelude to the extensive makeover of the Chinese investment, fi nance, and fi nancial system. Because of that, the Chinese fi nancial system reform fell one step behind and came to respond to internal needs and serve the overall economicreform and opening. 2 See Chapter 1 in Wu ( 2006 ) for a systematic review of the Chinese fi nancial system reform.

Review and Judgment of Historical Roles of Chinese Securities Companies 25

infl uence on China’s economic and social development, an overall analysisof the economy, society, fi nancial system, trade supervision, and market of the country is needed.

This book is an overview of the merits and demerits of Chinese securi-ties companies. To ensure the comprehensiveness and accuracy of this over-view, the book covers the causes of the existence, evolution, and features of all phases of the securities company, as well as trends and functionaldemands on the global fi nancial system. A comparison is then made between Chinese and foreign securities companies. The study moves chronologicallyover impacts on different population groups, in terms of variables. Facts and logic are well integrated, and theory and practice are equally emphasized.

THE BIRTH AND GROWTH OF CHINESE SECURITIESCOMPANIES—A BRIEF HISTORY

As a key intermediary and participant in China’s capital market, securities companies are closely linked to the formation of the Chinese capital market. The internal demands for reformed investing and fi nancing systems, diver-sifi ed fi nancing channels, optimized capital portfolio, and an established fi nancial market appeared as the planned economic system was loosened. At the same time, companies and individuals became more recognized as keymarket entities in the market economy and the national model of resourceallocation, characteristic of the period of planned economy, collapsed. All these changes were made possible by the structural reform of the country’s economy, which was a forceful and underlined institutional innovation. With these internal demands,3 the securities market appeared to further the shareholding reform for companies, diversifying the fi nancing channels and optimizing the capital portfolio. It also introduced more investment chan-nels and products to the public. Before securities companies emerged asspecialized security organizations, securities were being traded in trust andinvestment companies—fi rms that are not specialized in securities.

A review of the 20‐year history of Chinese securities companies, as well as the economic and social development, fi nancial system reform, securities

3 In particular, the 12th CPC Central Committee adopted in the third plenary ses-sion in 1984 the Decision on Economic Reform, which further pushed the economic reform in cities and the countryside. Faced with increasing capital fl ows and a rapid demand for funds, and under great pressure of capital supply, Chinese banking had an urgent need for a diversifi ed means of fi nance to gather idle money for the pur-pose of huge, long‐term investment. Such a need was the initial contributing factorfor the emergence of the Chinese securities market.


market development, and supervision system evolution of the securitiesindustry, reveals the following four major phases in the development of Chinese securities companies:

1. The preliminary phase 2. The fast‐developing phase 3. The rectifi cation phase 4. The normalized development phase

The Preliminary Phase of Chinese SecuritiesCompanies—1987 to 1995

If we take the inceptions of Shanghai and Shenzhen stock exchanges as the symbolic nodes, this phase could be divided into two obvious secondaryphases:

1. The infancy phase—1987 to 1990 2. The quick startup phase—1990 to 1995

The Infancy Phase—1987 to 1990 The initial issuance of Treasury bonds by the Ministry of Finance in 1981 marked the beginning of new developmentsof the Chinese securities market in a new age. This was followed by the gov-ernment and corporate world raising money by issuing government bonds and corporate bonds and stocks. Shanghai Feilo Acoustics Co. Ltd. debutedwith China’s fi rst corporate stocks in November 1984. In January 1985, Shanghai Yanzhong Industrials Co. Ltd. was incepted to become the fi rst collectively owned company in China, openly issuing stocks and raising allmoney through stocks. September 1985 saw the approval of China’s fi rstprofessional securities company—Shenzhen Securities, Inc.—by the People’s Bank of China (PBC). The Jing’an Trust of the Industrial and Commercial Bank of Shanghai established a dedicated securities division on September26, 1986, to represent two stocks: Feilo Acoustics and Yanzhong Industrials.

As the scales of fi nancing vehicles such as bonds and stocks expanded, the necessity to set up specialized securities fi rms became apparent. Shenzhen Securities, Inc., was therefore established in 1987 to offi cially engage in over‐the‐counter (OTC) trading of stocks in the city. More than 20 prov-inces, autonomous regions, and special municipalities followed suit to estab-lish their own securities fi rms. The three major fi rms in Shanghai at that time were Shenyin Securities, Wanguo Securities, and Haitong Securities. Most securities fi rms were founded by the regional branches of the People’s Bank of China to issue stocks, manage and represent securities transactions and other securities services, and perform issuance of government bonds and


bonds of regional joint‐stock companies. Regional fi nance authorities alsoestablished their own securities fi rms, such as Shanghai Finance Securities and Harbin Finance Securities, mainly to manage government bonds. These securities fi rms played a boosting role for the initial development of the securities market, forming the infancy of the securities industry. Apart from these specialized securities institutions, securities divisions were establishedby trust and investment companies and by general banks to conduct securi-ties business. This was in addition to the government bonds managementunit set up by the fi nance departments.

In regard to system development, the State Council of China published the Interim Regulations for Corporate Bonds Management in March 1987. This was the fi rst ever document that provided specifi c rules for the issuance, management, and legal accountabilities of corporate bonds. It became the basic legal reference for the issuance of corporate bonds in China. The municipal government of Shanghai launched the InterimRegulations of Shanghai for Stocks in May of the same year, which wasalso the fi rst legal document for the management of stocks issuance. From 1981 through 1987, values of all securities issued nationwide totaled CNY 100 billion. This was a period of varying natures of securities fi rms, fast-growing numbers, small‐scale companies, and limited business scope nar-rowed down to the represented transactions of small volumes and types of OTC stocks.

The Quick Startup Phase—1990 to 1995 As stocks and bonds issuance esca-lated, OTC trading surged as well, albeit with a number of restrictions. Trad-ing became very active as investors’ demands for stocks infl ated. However,trading at this time was primitive, unregulated, and brimming with disputes, making it necessary to establish specialized stock exchanges. The Shanghai Stock Exchange was therefore inaugurated per the People’s Bank of China’sapproval on November 28, 1990. This was followed by the Shenzhen StockExchange in February 1991. Together they symbolized the offi cial formation of the Chinese securities market. Three major features of this startup phase were as follows:

1. Rapidly expanding stock market 2. Sharp rise of securities companies and assets under management 3. Preliminary formation of a separated regulation model

Rapidly Expanding Stock Market Deng Xiaoping recognized in his famous“Speech of the South Tour” in 1992 the correctness of the stock system reform and the securities market trial in China’s economic reforms. The Securities Trading Automated Quotations System (STAQ) was green‐lighted in 1990 by


the People’s Bank of China (PBC), kicking off automated trading in China. 4 In1992, the B‐share market of Shanghai was offi cially established with the launch of the Management Regulations for Special RMB Shares (B Shares) as the sym-bol. Thanks to this, the Chinese stock market quickly expanded. According to Wind Information statistics, only 13 companies were listed in 1990, with 1.3 billion shares valued at CNY 12 billion. However, 323 companies were listed by the end of 1995, with 38.1 billion shares valued at CNY 79.7 billion. The number of listed companies, shares, and market values skyrocketed by 9.42 times, 2.18 times, and 5.64 times during that fi ve‐year window.

Sharply Rising Number and Assets of Securities Companies The securitiescompanies in China gained swift growth following the establishment of the Shanghai and Shenzhen stock exchanges in 1990. By the end of that year, the number of securities fi rms and trust investment fi rms jumped to 44 and 339, respectively. By the end of 1991, the numbers increased to 66 and 376, respec-tively, with 913 securities units and 5,384 securities trading outlets. There were also 14 companies especially engaged in government bonds, 661 government bonds service providers, and 868 outlets set up by the fi nance system. Table 1.1 shows the changes in the number of securities institutions (securities fi rms and

4 After that, there was constant improvement of the automatic order matching (AOM) trading system for the Chinese securities market. In July 1991, the Shanghai Stock Market put into use the automatic transfer system, which allowed for computer‐based transfer in sync with transaction and greatly improved trading effi ciency. InFebruary 1992, the Shenzhen Stock Exchange introduced the AOM bidding systemand completed the transition from manual bidding to automatic matching.

TABLE 1.1 Changes of Number of Chinese Securities Institutions and Assets (1990–1995) (RMB in billions)

Total Securities FirmsTrust and

Investment fi rms

Year Amount Assets Amount Assets Amount Assets

1990 383 129.6 44 7.2 339 122.4

1991 442 191.8 66 18.9 376 172.9

1992 473 300.2 87 48.9 386 251.3

1993 480 489.3 91 56.4 389 432.9

1994 482 616.4 91 63.0 391 553.4

1995 489 653.9 97 83.1 392 570.8

Source: Yang ( 2000 ).


trust and investment companies) and their assets from 1990 through 1995. As the fi rms gained in number, their assets scale also ballooned, from CNY 7.22 billion held by 44 securities fi rms nationwide in 1990 to CNY 83.1 billion held by 87 securities fi rms in 1992, an increase of 10.5 times.

Among them, a large number of specialized large securities fi rms emerged, such as the Junan Securities Co., Ltd., green‐lighted by the PBC and founded in Shenzhen in August 1992. In October 1992, the three securities companies—Huaxia, Guotai, and Nanfang—were formed with registered capital totaling CNY 1 billion. The three fi rms were stewarded by the government and sup-ported by the Industrial and Commercial Bank of China, China Construction Bank, and the Agricultural Bank of China, respectively. In 1994, Hongyuan Securities became the fi rst listed securities company in China. The fi rst joint‐venture investment bank in China, China International Capital Corp., was offi cially founded in 1995. Securities fi rms incorporated by powerful trust and investment businesses such as China Everbright and CITIC also emerged. China Guangfa Bank, Junan, Dapeng, Hubei Securities, and Beijing Securities also saw their capital strength markedly improve with capital gain and share expansion. The business scope of these fi rms diversifi ed from brokerage ser-vice to brokerage, underwriting, and proprietary services.

Preliminary Formation of a Separated Regulation Model in the Securities Industry The State Council Securities Committee and the China Securi-ties Regulatory Commission were established in October 1992, signifying the shaping of a specialized securities market regulation and management system 5 in China. However, the offi cial implementation of the Commercial Banking Law and Insurance Law in 1995 laid down the legal groundwork for separated fi nancial regulation over Chinese banking, insurance, trust,and securities industries, respectively. The founding of the China Securities Regulatory Commission (CSRC) and the confi rmed regulatory responsi-bilities of PBC and CSRC helped improve the previous status of securities market regulations mired in excessive administration, scattered forces, andweak management. Government administration of the securities market and securities institutions was thus strengthened. The Chinese securities indus-try has since then been developing in a regulated way. (Table 1.2 highlightsthese regulatory milestones.)

5 Regarding specifi c oversight responsibilities for fi nancial institutions dealing insecurities, the PBC and CSRC have separate regulatory duties. The former approves and supervises such institutions on a centralized basis, while the latter oversees their securities‐related business activities, proprietary stock trading in particular. Fordetails, see the State Council’s Circular of Further Macroeconomic Regulation and Control of the Securities Market (Ref. GF. [1992]68).

30

TABL

E 1.

2 M

ain

Reg

ulat

ions

and

Man

agem

ent

Mea

sure

s in

the

Sec

urit

ies

Indu

stry

1

Yea

rM

ajo

r R

egula

tions

and M

easu

res

1990

Oct

ober

: Int

erim

Reg

ulat

ions

for

Man

agem

ent

of S

ecur

itie

s Fi

rms

publ

ishe

dN

ovem

ber:

Reg

ulat

ions

of

Shan

ghai

for

Man

agem

ent

of S

ecur

itie

s T

radi

ng is

sued

by

Shan

ghai

1991

June

: Int

erim

Reg

ulat

ions

for

Man

agem

ent

of S

ecur

itie

s In

stit

utio

ns in

She

nzhe

n pu

blis

hed

by P

BC

She

nzhe

n B

ranc

hA

ugus

t: T

he S

ecur

itie

s A

ssoc

iati

on o

f C

hina

fou

nded

in B

eijin

gD

ecem

ber:

PB

C a

nd S

henz

hen

mun

icip

al g

over

nmen

t pu

blis

hing

Int

erim

Reg

ulat

ions

of

Shen

zhen

for

Man

agem

ent

of

Spec

ial R

MB

Sha

res

and

impl

emen

ted

rule

s of

the

reg

ulat

ions

1992

Janu

ary:

Reg

ulat

ions

of

Shan

ghai

for

Man

agem

ent

of S

peci

al R

MB

Sha

res

(B S

hare

s) o

ffi c

ially

pub

lishe

dO

ctob

er: T

he S

tate

Cou

ncil

Secu

riti

es C

omm

itte

e an

d th

e C

hina

Sec

urit

ies

Re g

ulat

ory

Com

mis

sion

fou

nded

Dec

embe

r: I

nter

im R

egul

atio

ns o

f Sh

enzh

en f

or M

anag

emen

t of

Tru

sted

Aut

omat

ed T

elep

honi

c Se

curi

ties

Tra

ding

and

Inte

rim

Reg

ulat

ions

of

Shen

zhen

for

Lis

ted

A‐S

hare

Reg

istr

atio

n an

d Se

ttle

men

t M

anag

emen

t pu

blis

hed

by P

BC

She

nzhe

nB

ranc

h, a

nd C

ircu

lar

on F

urth

er S

tren

gthe

ning

Mac

ro M

anag

emen

t of

the

Sec

urit

ies

Mar

ket

issu

ed b

y th

e St

ate

Cou

ncil

1993

Febr

uary

: Int

erim

Pro

visi

ons

on t

he C

onfi r

mat

ion

of Q

ualifi

cat

ions

of

Eng

agem

ents

in L

egal

Pra

ctic

e of

Sec

urit

ies

and

Law

Fi

rms

join

tly

issu

ed b

y th

e M

inis

try

of J

usti

ce a

nd C

hina

Sec

urit

ies

Reg

ulat

ory

Com

mis

sion

Apr

il: I

nter

im R

egul

atio

ns o

n St

ock

Issu

ance

and

Tra

ding

Adm

inis

trat

ion

offi c

ially

pub

lishe

d by

the

Sta

te C

ounc

ilJu

l y: I

nter

im M

easu

res

for

Adm

inis

trat

ion

of S

tock

Exc

hang

es la

unch

ed b

y th

e St

ate

Cou

ncil

Secu

riti

es C

omm

itte

eA

ugus

t: R

egul

atio

ns f

or A

dmin

istr

atio

n of

Cor

pora

te B

onds

pub

lishe

d by

the

Sta

te C

ounc

ilSe

ptem

ber:

Int

erim

Mea

sure

s fo

r Pr

even

tion

of

Secu

riti

es C

heat

ing

Act

s pu

blis

hed

by t

he S

tate

Cou

ncil

Secu

riti

es C

omm

itte

e pe

r St

ate

Cou

ncil

appr

oval

Dec

embe

r: C

ompa

ny L

aw o

f th

e Pe

ople

’s R

epub

lic o

f C

hina

gre

en‐l

ight

ed b

y th

e St

andi

ng C

omm

itte

e of

the

Nat

iona

l Pe

ople

’s C

ongr

ess

31

1994

Janu

ary:

Int

erim

Mea

sure

s of

She

nzhe

n fo

r C

usto

dy T

rans

fer

of L

iste

d Se

curi

ties

pub

lishe

d by

Chi

na S

ecur

itie

s D

epos

itor

y an

d C

lear

ing

Cor

p .Ju

ly: “

Thr

ee M

arke

t Sa

ving

Pol

icie

s” p

ublis

hed

by C

hina

Sec

urit

ies

Reg

ulat

ory

Com

mis

sion

and

con

cern

ed S

tate

Cou

ncil

depa

rtm

ent s

Aug

ust:

Spe

cial

Pro

visi

ons

on O

ffsh

ore

Shar

e R

aisi

ng a

nd L

isti

ng o

f St

ock

Lim

ited

Com

pani

es a

nd R

equi

site

Pro

visi

ons

on

Art

icle

s of

Ass

ocia

tion

for

Lis

ting

Abr

oad

publ

ishe

dN

ovem

ber:

B‐s

hare

acc

ount

s se

rvic

e la

unch

ed b

y C

hina

Sec

urit

ies

Dep

osit

ory

and

Cle

arin

g C

orp.

Dec

embe

r: T

he c

entr

al s

ettl

emen

t da

ta c

omm

unic

atio

n sy

stem

offi

cia

lly k

icke

d of

f in

She

nzhe

n

1995

May

: The

Int

erim

Adm

inis

trat

ive

Mea

sure

s on

Qua

lifi c

atio

ns o

f Se

curi

ties

Pra

ctit

ione

rs is

sued

by

the

Stat

e C

ounc

il Se

curi

ties

C

omm

itte

eC

ircu

lar

on T

utor

ing

of C

ompa

nies

Mak

ing

Publ

ic S

tock

Iss

uanc

e pu

blis

hed

by C

hina

Sec

urit

ies

Sept

embe

r: R

egul

ator

y C

omm

issi

on a

nd M

easu

res

for

Adm

inis

trat

ion

on S

etti

ng u

p O

ffsh

ore

Chi

nese

Ind

ustr

ial I

nves

tmen

t Fu

nds

appr

oved

by

the

Stat

e C

ounc

ilD

ecem

ber:

Spe

cifi c

atio

ns f

or A

dmin

istr

atio

n of

Tra

ders

at

Shan

ghai

Sto

ck E

xcha

nge

(Int

erim

) pu

blis

hed

by S

hang

hai S

tock

E

xcha

nge

1 Se

e th

e fo

llow

ing

sect

ions

for

the

CSR

C’s

mea

sure

s an

d sa

ncti

ons

in t

he o

vera

ll im

prov

emen

t in

itia

tive

for

the

sec

urit

ies

indu

stry

.


The Fast -Development Phase of Chinese Securities Companies, 1996 to 2001

Many factors prompted the quick growth of Chinese securities companies in this phase, including the following events. The Decisions of the Com-munist Party of China (CPC) on Issues Regarding Reforms and Develop-ment of State‐Owned Companies, passed at the Fourth Plenary Session of the Fifteenth CPC National Congress, laid down the specifi c arrangements for the strategic adjustments of state‐owned economic entities and strategicrestructuring of state‐owned companies. This provided opportunities for thegrowth of the Chinese securities industry. The market of restorative valuereturns, started in early 1996, and the emerging of the “5/19 blowout mar-ket” in 1999, marked the turnaround in the development of the Chinese securities market. Following this, the Chinese stock market entered a long‐lasting bull market. Securities institutions also entered a phase of regulated development. As regulators sorted out and regulated the business scope, internal control system, outlet distribution, and risk‐control conducts of securities companies, they accepted a number of highly effective regulatory measures. Three major features of this fast‐growing phase were as follows:

1. Profi tability of securities fi rms enhanced 2. Number of securities companies stabilized 3. Securities regulation system further streamlined

Profi tability of Securities Firms Enhanced Securities companies saw their busi-ness quickly grow and profi ts turn positive staring in the latter half of 1996, following the improvement of the entire business environment for the secu-rities industry.

By the end of December 2001, the total market value of the stock mar-ket increased 342 percent from CNY 984.237 billion at the end of 1996 to CNY 4,352.2 billion. The GDP proportion of the stock market jumpedfrom 7.9 percent at the end of 1994 to around 44.7 percent, and the num-ber of listed companies surged 73.58 percent from 530 at the end of 1996 to 1,160. Bonds issuance also swelled signifi cantly, with government bonds issued hitting CNY 247.6 billion and CNY 389.1 billion in 1997 and 1998, up by 24.71 percent and 57.51 percent, respectively, from the previous year. In late August 1999, the number of investor accounts in the securities market amounted to 42.98 million. By the end of September 1999, 15 secu-rities investment funds, totaling CNY 35 billion, were issued.

By the end of 1996, the 96 securities companies nationwide saw their total assets, actualized capitals, investors’ trading deposits, self‐managed securi-ties, annual securities transactions, and profi ts reach CNY 159.053 billion,


16.89 billion, 39.12 billion, 19.369 billion, 1,896.52 billion, and 0.462 billion, respectively, shattering the CNY 0.585‐billion loss of 1995. In 1997, the most profi table securities company in China, Junan Securities, saw its netprofi ts hit CNY 740 million, while profi ts of the top 20 earners totaled CNY5.358 billion. By 2000, the top earner in China, Haitong Securities, reapedCNY 1.521 billion in profi ts, while the combined profi ts of the top 20 earners reached approximately CNY 15.4 billion, up by 106 percent and 187 percent,respectively. 6

Number of Securities Companies Stabilized, Industry Competition Sharply Increased The number of securities companies increased from the 94 in 1996 to a total of 109 in 2001. The number of service outlets rose by merely 11.57 percent from 2,420 to 2,700 (see Figure 1.1 ).

In order to leverage the opportunities brought on by the prosperity of the securities market, however, competitiveness of the industry improved withmergers and acquisitions, and a number of outstanding companies emerged. Meanwhile, securities institutions entered a phase of regulated growth, withregulators cleaning up the business scope, internal control system, outlets

6 Xie, Liu, and Wang ( 2004 , 26–27).

FIGURE 1.1 Changes of Number of Chinese Securities Companies and Outlets(1996–2004) Source: China Securities and Futures Statistical Yearbook (2005).

3,500Number of Securities CompaniesNumber of Service Outlets

3,000

2,500

2,000

1,500

1,000

500

01996 1997 1998 1999 2000 2001 2002 2003 2004

0

20

40

60

80

100

120

140


distribution, and risk control of securities fi rms. Securities companies them-selves also strengthened their regulatory development and risk controls. With the capital and shares expansion program in 1999, a number of major securities brokerages of strong monetary prowess quickly arose. Business competition in the industry became increasingly furious. Securities compa-nies rushed to upgrade their strength through M&A and internal consolida-tion, resulting in drastically increased size and assets, coupled with business scale. Issuance in the fi rst‐tier market signifi cantly increased, and vitality in the second‐tier market became unprecedented. Some listed companies also participated in the securities operation institutions. Meanwhile, securities fi rms actively engaged in business expansion by starting underwriting and wealth management services, among other activities.

Securities Regulation System Further Streamlined The People’s Bank of Chinapublished the Circular on Separating PBC‐Affi liated Securities Firms from All Levels of PBC Branches on July 2, 1996. This rule required the 63 secu-rities fi rms with equity relationships with the PBC to clear up their con-nection within the specifi ed term. Starting in October of that year, the PBC enforced the principle of separated operations by removing and transfer-ring 763 securities trading units set up under commercial banks, insurers, urban credits unions, corporate fi nancial enterprises, leasing companies, and pawnshops. This strengthened the idea of separate operations among bank-ing, insurance, and securities industries. Meanwhile, the PBC cleared up and regulated the business scope, internal control system development, outlets distribution, and risk control of securities fi rms. It explicitly prohibited secu-rities units from engaging in self‐manipulation, lending, or appropriation of investor deposits. Specifi cally, the PBC demanded securities fi rms to estab-lish a complete and effective system for internal controls, in addition to a number of other measures for active regulation.

The CPC central committee and the State Council decided in November 1997 that the PBC would transfer its regulatory responsibilities over securi-ties institutions to the China Securities Regulatory Commission, which would take complete control of the regulation of the securities market and insti-tutions. With this drastic move, China corrected the regulatory system for securities entities, giving a strong push to the growth of the Chinese securities market and institutions. The regulatory baton was offi cially transferred from the PBC to CSRS in June 1998. The enacting of Securities Law of the Peo-ple’s Republic of China in December 1998 further established the “separated operation and administration” system for the securities, banking, trust, and insurance industries. As instructed by the Commercial Banking Law and the Securities Law, a major number of securities units were separated from com-mercial banks and trust companies to become independent securities fi rms.


Administration and Rectifi cation Phase, 2001 to 2005

Although governance of the Chinese securities companies started as early as 1995,7 the offi cial complete establishment of the Chinese securities reg-ulatory system and full‐scale cleanup of securities companies started in 2001. For our purposes, the time frame from June 2001 to 2005 consists of the full‐scale cleansing and rectifi cation phase for the Chinese securities industry.

Structural adjustments of the Chinese securities market that commenced on June 24, 2001, caused four consecutive years of securities market slump,resulting in a challenging situation for Chinese securities companies. Sta-tistics indicate that by 2004, total assets of the 114 securities fi rms wereCNY 329.373 billion, each company averaging CNY 2.989 billion. This is aconsiderable fall from the average of CNY 4.013 billion registered in 2003. Their net assets fell sharply from CNY 587 million to CNY 996 million. 8

Many securities companies faced a survival crisis in such a harsh market environment. A number of securities fi rms were at serious operational riskas a result. Some fi rms were taken into custody, while others were controlled by the government or shut down altogether due to serious insolvency, hugecapital “black holes,” and enormous social risks.

Figures show that in August 2002, 31 securities fi rms, including Anshan Securities, were disposed of because of serious violations and the huge risks they faced. This accounted for 22.79 percent of all fi rms. Among the 31fi rms punished, most conducted behaviors such as appropriation of client deposits and government bonds and illegal wealth management actions. Some fi rms loaned personal OTC bonds or manipulated the market, among other illegal activities. For example, Anshan Securities was censured by theCSRC in August 2002 for embezzling CNY 1.517 billion of client transac-tion funds, and for lending out CNY 2.63 billion in personal OTC bonds, for a total of CNY 4.147 billion. Dalian Securities was shut down by the CSRC for rectifi cation in September 2002. Dalian embezzled CNY 580 mil-lion of client transaction funds and loaned out CNY 830 million in personal OTC bonds for a total of CNY 1.41 billion. Table 1.3 details violations by securities companies punished between 2002 and 2006.

These securities fi rms were subjected to remedies including govern-ment aid, suspended rectifi cation, forced closure and cancellation, merger

7 From 1995, the regulatory authorities started to deal with high‐risk securities fi rmssuch as Wanguo Securities (1996) and Zhongchuang Investment (1998). Statistics show that as of August 2002 (exclusive), eight securities fi rms had been taken into receivership. 8 Wang ( 2006 ).

36

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or acquisition, government takeover, and bankruptcy. In order to manage future risk, the CSRC optimized related regimes in market access, corpo-rate governance, categorized management, third‐party capital depository, and information disclosure. Brand new frameworks for comprehensive administration of securities fi rms were subsequently established. Most important was the enacting of the Regulations for Administration of Clients’ Trading and Settlement Funds in 2002. This stipulated that clients’ trading and settlement capital must be placed at an independent third‐party institution, inhibiting securities fi rms from embezzling clients’ funds and providing a solid institutional foundation for the regulated operationsof securities fi rms.

This phase also ushered China’s entry in the WTO, an important histori-cal event. The time had come for Chinese securities companies to open up to the international market. The CSRC published the Rules for the Establish-ment of Foreign‐Shared Securities Companies on June 4, 2002. The rules required that the proportion of shares held by overseas institutions in a securities fi rm in China should be capped at one‐third. Following this pro-vision, three Sino‐foreign joint ventures—China Euro Securities, Changjia Paris Peregrine, and Daiwa SSC Securities—were established. However, international cooperation in the Chinese securities industry had actually started some time before that. In addition to the China International Capital Corp. Ltd., incorporated in 1995, approximately 20 joint Chinese‐foreign securities institutions 9 were founded, or were about to incorporate, during the 2000 to 2001 window.

Normalized Development Phase, 2005 to 2011

On April 29, 2005, the CSRC published the CSRC Circular on Issues Concerning the Trial Reform for Equity Division of Listed Companies, offi cially kicking off the trial for reforming shares distribution of listedcompanies. As a major reform of the Chinese capital market to improve fundamental market regime and operation mechanism, the equity division reform is signifi cant not only in resolving historic issues, but also in creat-ing conditions for various other reforms and institutional innovations in the capital market.

Founded in August 2005 with a registered capital of CNY 6.3 billion, China Securities Investor Protection Fund Corp. Ltd. is responsible for liq-uidating creditors according to competent state policies when securitiescompanies are removed, shut down, bankrupt, or have other mandatory

9 Jiang ( 2001 , 23–27).


regulatory measures imposed on them by the CSRC, such as government takeover and trusted operations. July 2007 saw the CSRC recategorize secu-rities companies on the basis of their risk management abilities and market impacts into 11 levels of 5 major categories as follows:

1. A (AAA, AA, A) 2. B (BBB, BB, B) 3. C (CCC, CC, C) 4. D 5. E

The A, B, C, and D categories are confi rmed according to specifi c score bands of all normal companies, with the middle value as the benchmark.As such, the CSRC showed support for quality securities fi rms. The general rectifi cation work for securities companies successfully wrapped up in late August 2007, in which all major rectifi cation goals were realized. Through the general rectifi cation, long‐term risks and historic issues of securities companies were smoothly resolved, along with such problems long hinder-ing the healthy development of securities companies, including false fi nan-cial information, off‐book operations, embezzlement of client assets, and appropriation of shareholders and stakeholders. A long‐term mechanism for risk prevention was therefore established, and various basic systemswere reformed and improved. 10 Risk control, compliant operation aware-ness, and authenticity of fi nancial information of securities companies were generally boosted. Innovative activities were commenced in order, and theindustry structure was being optimized. Table 1.4 highlights several relevant institutional developments.

In this phase, securities companies saw their capital strength constantly boosted, assets scale continuously expanded, business scope expanded, products enriched, risk control and management abilities improved, and business performance steadily enhanced. A great growth momen-tum was witnessed, albeit at a modest drop in 2011 (see Figure 1.2 and Table 1.5 ).

Regarding the income structure of securities companies, contributions from the traditional brokerage business dropped due to the constant fall of the commission rate. However, income from investment banking ser-vices grew signifi cantly, and the scale and profi ts contribution of the assets management business saw modest improvement. The impact of innova-tive businesses such as securities margin trading, share price index futures

10 Data from the CSRC’s Report on the Chinese Capital Market.


TABLE 1.4 Regulations in the Securities Industry (2005 to 2011)

Year Main Regulations

2005 Share division reform executed, Law of the People’s Republic of Chinaon Funds for Investment in Securities published, Securities Law of thePeople’s Republic of China and Company Law of the People’s Republic of China revised

2006 April: Administrative Regulations on Issuance of Securities by ListedCompanies and Administrative Regulations on IPOs and Listing publishedMay: Regulations on Administration of Securities Registration andSettlement publishedJune: Regulations on prohibition from the securities marketJuly: Administrative regulations on acquisition of listed companiesAugust: Regulations on administration of legitimate offshore institutionalinvestors investing in domestic securitiesSeptember: Regulations on administration of securities issuance andunderwritingNovember: Regulatory measures on employment qualifi cations of directors, supervisors, and senior management personnel at securities fi rms

2007 April: Interim regulations on legitimate domestic institutional investorsinvesting in offshore securitiesJune: Rules for administration of futures companiesAugust: Trial measures for issuance of corporate bonds

2008 April: Measures for administration of major assets, recapitalization of listed companies, supervisory and administrative regulations for securitiescompanies, and regulations on risks disposal at securities fi rmsOctober: Administrative measures for the sponsorship business of theissuance and listing of securities

2009 March: Administrative measures for initial public offerings and listing onthe second boardNovember: Revision of regulations on administration of securitiesregistration and settlement

2010 September: Measures for the anti–money laundering work in the securitiesand futures sectorsPublishing the decision on revision of the Regulations on Administrationof Securities Issuance and Underwriting

2011 March: Trial measures for futures investment and consultation business of futures companiesJune: Measures for administration of sales of securities investment fundsAugust: Decision on revising relevant measures for major assetsrecapitalization and supplementary fi nancing of listed companies; trialmeasures for fund management companies to provide asset managementfor specifi c clientsOctober: Trial Measures for oversight and administration of refi nancing business


TABLE 1.5 Basic Profi les of Listed Securities Companies (RMB in billions)

CompanyTotalAssets

Paid‐InCapital

BusinessRevenue

NetProfi ts

Guohai Securities 11.347 0.717 0.846 0.063

Pacifi c Securities 5.429 1.503 0.550 0.122

Shanxi Securities 13.142 2.400 0.764 0.123

SinoLink Securities 8.861 1.000 0.934 0.235

Dongbei Securities 13.017 0.639 0.678 −0.018

Xinan Securities 19.345 2.323 0.699 0.202

Guoyuan Securities 22.980 1.964 1.315 0.459

Industrial Securities 20.550 2.200 1.793 0.499

Founder Securities 26.452 6.100 1.299 0.214

Changjiang Securities 29.632 2.371 1.338 0.330

Hongyuan Securities 20.215 1.461 1.874 0.680

Everbright Securities 49.470 3.418 3.520 1.421

China MerchantsSecurities 67.417 4.661 4.245 1.857

Huatai Securities 82.962 5.6.00 4.342 1.352

Haitong Securities 100.867 8.228 6.950 2.888

GF Securities 77.857 2.960 4.325 1.553

CITIC Securities 119.993 9.946 9.450 3.339

Note: Period ended third quarter 2011. Source: Wind Information Co.

(SPIF), and direct securities investment on profi tability of big securities companies was also signifi cant. Market competition escalated, however, and securities companies saw slow progress in terms of the adjustment of profi tability structure and transition of the business development model (see Figure 1.3 ).

It is worth noting that since this phase, the organizational struc-ture of Chinese securities companies further evolved in response to busi-ness development, and independent operations were made in the areas of investment banking, asset management, direct securities investment, research and consultancy, and overseas business. Shares of futures com-panies also increased. A new form of fi nancial companies anchored on the securities business emerged, prompting the faster diversifi ed, inter-national development of business and further boosting their impact on economic fi nance.


FIGURE 1.2 Evolution of Total Assets, Business Revenue, and Net Profi ts in the Securities Industry Since 2008 Note: Data ended in October 2011, in CNY 100 million. Source: The Securities Association of China.

0

100

200

300

400

500

600

700

800

900

1,000

−3,000

2,000

7,000

12,000

17,000

22,000

2008 2009 2010 2011

Total Assets Business Revenue Net Profit

FIGURE 1.3 Variations of Securities Companies Income Structure Source: The Securities Association of China.

−25%

−5%

15%

35%

55%

75%

95%

115%

2008 2009 2010 2011

Commission Interest

Investment Return Asset Management

Net Income and Changes in Fair Value


REVIEW OF THE PROS AND CONS OF CHINESE SECURITIES COMPANIES

Theoretical and Practical Judgment Based on Functions ofSecurities Companies

From a review of the development of Chinese securities companies, it is clear that China’s quick economic and social developments provided hugeopportunities and expansive space for fi nancial system reform and growth of capital markets and securities businesses. The growth of the Chinesecapital market and securities businesses has also actively contributed to the growth of fi nancial economics in China. On the other hand, securities com-panies have been given signifi cant responsibilities, including that of a posi-tive role model, as China drives economic reforms and tackles the myriad issues confronting reform and development of the Chinese fi nancial system, capital market, and securities fi rms.

Growth Traits of Securities Companies Before we can pass judgment on theChinese securities fi rms, we must identify their functions and roles in the capital market and fi nancial system. We can then objectively analyze the prosand cons of securities companies in the economic and social developmentof China from the perspective of internal demands of economic growth, development of the fi nancial system, and effi ciency of market operations. This is also done in conjunction with elements such as structure of market competition, governance structure, business system, and profi tability abili-ties of securities fi rms. Basically, an accurate view of the growth features of Chinese securities fi rms is required, in respect of the following four factors:

1. Phasing characteristic of the development of securities companies 2. Passiveness of development 3. Subordinate position in the fi nancial system 4. High growth prospects in the future

Phasing Characteristic of the Development of Securities Companies Becausesecurities companies and the capital market were born and developed out of their respective historic missions, their development shared a consistent and phasing nature with the development of the economy and fi nance.

Passiveness of Development The development of the Chinese securitiescompanies has been subject to a number of impacts, such as the low mar-ketization level of the Chinese fi nancial system, immaturity of the securi-ties market, restrictions of the separated fi nancial regulation, and stringent


oversight over the securities industry, as well as a weak vitality for innova-tion caused by the ownership structure of securities companies.

Subordinate Position of the Financial System Although a marketized mod-ern fi nancial system has been established in the reforms of the Chinese fi nan-cial system as a goal, the banking sector still plays a dominant role in theChinese fi nancial system after 20 years, while the infl uences of the securities sector are still very weak in the overall fi nancial system. Even today, the total assets (CNY 1.2 trillion) of the entire securities industry are merely as high as the assets of a common commercial bank, and profi tability is only aroundCNY 100 billion. These fi gures are starkly disproportionate to the critical role the securities industry plays.

High Growth Prospects in the Future The continuous, healthy develop-ment of the Chinese economy requires leapfrog development of the Chinesefi nance and capital market, which represents a wider space for the devel-opment of the Chinese capital market and securities companies. This will prompt securities fi rms to step up their innovation and development effortsto meet the shifts of the fi nancial demand structure and demands of the reforms in the fi nancial system, in order play the role expected from secu-rities fi rms. So, despite the preliminary stage in which Chinese securities companies presently fi nd themselves, there is no doubt that the future holdssignifi cant prospects.

Basic Functions of Securities Companies in the Financial System According to thetheories of modern fi nancial intermediation and fi nancial functions, roles of the securities companies in the fi nancial system are mainly embodied in the following three aspects:

1. Risk fi ltration function 2. Products creation and asset pricing function 3. Risk portfolios based on asset appreciation

Risk Filtration Function Risk fi ltration is the elimination of incorrect information or noise‐making information in the capital market through operations of fi nancial intermediations, enabling investors to have correct information for securities investment and to make their best decisions. As an important intermediary in the capital market, securities companies work together with accounting fi rms, assets evaluation institutes, and creditrating entities, among other fi nancial institutions, to consolidate and analyzeinformation about companies. This ensures that investors can access the operations, management, and future development trends of the securities


issuers (companies and institutions) in a correct and prompt manner, which enables them to make correct analysis of the investment values of their targets. In this way, securities businesses work as an effective barrier fi ltering risk.

The theory of information dissymmetry was applied in the 1970s to justify the existence of fi nancial intermediaries. Economists such as HayneLeland and David Pyle, Peter Diamond, Douglas Gale, Martin Hellwig, Tim Campbell and William Kracaw, John Boyd and Edward Prescott, and Frederic Mishkin stressed the role of fi nancial intermediaries in solving the problem of information dissymmetry. Leland and Pyle stated that by invest-ing in their specialized fi eld of knowledge, intermediary institutions like securities fi rms could show their predominance in the area of information. The reputation system was believed to be the guarantee of reliability of infor-mation produced by fi nancial intermediaries. Chemmanur and Fulghieri( 1999 ) explained from the angle of reputation generation the reason the reputation of intermediary institutions in the fi nancial market could play areliable information verifi cation role. Gurley, Shaw, and Enthoven ( 1960 ), and Scholes, Benston, and Smith ( 1976 ) believed that from the viewpoint of transaction costs, fi nancial institutions could provide clients liquidity with rather low capital conversion costs, reducing the transaction costs in clients’ near‐term and long‐term spending decisions; leverage their specialist know‐how and “economy of scale” to reduce assets assessment costs and commis-sioning and supervisory costs; and reduce the search and information costs by establishing their own reputation system and providing the venues.

Product Creation and Asset Pricing Function In the fi nancial system, inves-tors realize risk dispersing and value appreciation through fi nancial prod-ucts. Robert C. Merton ( 1995 ) pointed out that fi nancial intermediaries could make custom products for clients with special fi nancial needs. Once becoming routinely tradable, these fi nancial products could be traded in thefi nancial market and serve mass clients.

Apart from product creation, fi nancial intermediaries such as securities companies also have the function of asset pricing. From the static point of view, the market‐based assets pricing function is realized via the underwrit-ing business and the related fi nancing and M&A services of securities fi rms. Securities underwriting is the rudimentary business of investment banks. We could easily identify the pricing function of investment banks in compa-nies’ fi nancing efforts through bonds and IPOs. The asset pricing function of securities fi rms is also found in their value discovery function in M&A prac-tices. Securities companies discover and acquire undervalued companies and prompt M&A of companies with appreciation values. From a dynamic point of view, values of some securities change in line with changes in elements such


as price, taxes, market, technique, and resource supply in the areas of policies, basics, and techniques, and therefore deviate from their supposed values. This requires securities companies to make prompt discovery of value underesti-mations and take effective measures to realize the regression of stock values.

Risk Portfolios Based on Assets Appreciation Modern fi nancial intermedi-ary theories have placed more emphasis on the function of fi nancial interme-diaries for values appreciation, which is the main driving force behind thedevelopment of modern fi nancial intermediaries. The function of risk port-folios based on asset appreciation in the modern fi nancial system is realizedthrough fi nancial intermediaries like universal banks, as well as securities fi rms, mutual funds, and asset management companies. Scholtens and van Wensveen (2000) believed that fi nancial intermediaries such as securities fi rms could create fi nancial products, and through conversion of fi nancial risks, terms, scales, locations, and liquidity, could provide added value to clients. Merton (1989) shared the idea that fi nancial intermediaries are able to distribute risks among different participants. Allen and Santomero (1998)pointed out that the main function of fi nancial intermediaries is to representthe transaction of fi nancial assets and manage risk. Financial intermediariesare therefore the propeller of risk diversion and the facilitators for dealing with the increasingly complex fi nancial vehicles and market issues.

The three functions of fi nancial market intermediaries such as securities fi rms, as previously discussed (risk fi ltration, product creation and asset pric-ing, and risk portfolios based on value appreciation) are closely interconnected and logically complete. One function is the foundation for the next, and the next function is the “sublimation” of the former. Without the improvementof information completeness and transparency, investors would not be able to get correct information, create products, and make effective asset pricing choices. Without this, investors could fail to adjust their investment structures and lose the balance between risk and returns of their asset portfolios, which would lose any appreciation of the asset values. As indispensable parts of an intact establishment, these functions together determine the effi ciency of the fi nancial system. Our judgment of securities companies could therefore be analyzed along those three basic functions.

HISTORIC CONTRIBUTIONS OF CHINESE SECURITIES FIRMS

Over the past three decades, Chinese securities fi rms made signifi cant con-tributions to the securities market in China. As fi nancial intermediaries, they played an instrumental role in the birth of China’s modern capital markets by fostering distribution channels for China’s capital.


Facilitating Stock Reforms of State-Owned Companies and Improving Quality of Corporate Operations

Once the CPC central committee decided on the general objective of reforms and the opening‐up program in 1978, stimulating the state‐owned economy and stock reform in state‐owned companies became the top priorities in economic reform. This directly gave birth to the Chinese capital market andcarried the signifi cant historic responsibilities of offering capital mobiliza-tion, equity pricing, and liquidity for stock reforms of state‐owned compa-nies onto the Chinese capital market. And it has been the securities fi rmsthat have been fulfi lling this historic mission for the China capital market. The last 20 years of growth have confi rmed that Chinese securities fi rms have achieved this historic mission rather successfully.

According to statistics from the State‐Owned Assets Supervision and Administration Commission (SASAC), among the 121 corporations ownedby the central government and overseen by the SASAC, 43 have gone publicwith their main businesses. Their total assets, net assets, business incomes,and net profi ts accounted for 52.88 percent, 68.05 percent, 59.88 percent,and 130 percent, respectively, of the totals of all 121 companies (listed com-panies onshore and offshore totaled 336).

As indicated by the proportion and importance of state‐owned com-panies in the overall economy, the quantity and quality of state‐ownedeconomy gained signifi cant improvement. For example, Wind Information statistics show that since 1999, the proportion of assets of state‐owned and state‐controlled industrial companies in comparison to all industrial compa-nies dropped about 27 percent, from 69 percent in February 1999 to 42.34percent in September 2011. Their total assets gained 2.85 times, from CNY6.9 trillion to CNY 26.6 trillion, thereby effectively realizing the conserva-tion and appreciation of values of state‐owned assets. The percentage of profi ts of state‐owned and controlled industrial companies compared to all industrial companies rose from 8.38 percent to 56.64 percent in September2000, and dropped from there to about 31 percent currently, for a net gain of more than 22 percent. Their total profi ts skyrocketed 1,215 times, fromCNY 945 million to the current CNY 1.15 trillion (see Figure 1.4 ).

Chinese securities fi rms also played an important intermediary role in the capital market, in the reforms and development of the state‐ownedcompanies, and provided strong support for the development of the overalleconomy while making important contributions to the growth of economicentities of other natures. According to statistics, the number of public com-panies shot up by more than 1,200 (from 1,120 in 2001 to 2,304 in Novem-ber 2011), and their market values surged from CNY 5.3 trillion to CNY 24.93 trillion in the same period (maximizing at CNY 32.7 trillion in 2007), realizing remarkable growth of social wealth (see Figure 1.5 ).


FIGURE 1.4 Proportion Shifts of Assets and Profi ts of State‐Owned Industrial Companies Compared to All Industrial CompaniesSource: Wind Information Co.

0%

10%

20%

30%

40%

50%

60%

70%

80%F

eb 1

999

Oct

199

9

Jun

200

0

Feb

200

1

Oct

200

1

Jun

2002

Feb

200

3

Oct

200

3

Jun

200

4

Feb

200

5

Oct

200

5

Jun

200

6

Feb

200

7

Oct

200

7

Jun

200

8

Feb

200

9

Oct

200

9

Jun

201

0

Feb

201

1

Profit Proportion

Asset Proportion

FIGURE 1.5 Changing Number and Market Values of Listed Companies in China Since 2005Source: Wind Information Co.

0

500

1,000

1,500

2,000

2,500

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

May

200

1

Dec

200

1

Jul 2

002

Feb

200

3

Sep

200

3

Apr

200

4

Nov

200

4

Jun

2005

Jan

2006

Aug

200

6

Mar

200

7

Oct

200

7

May

200

8

Dec

200

8

Jul 2

009

Feb

201

0

Sep

201

0

Apr

201

1Market Value (¥ in 100 million)

Number of listed companies


Meanwhile, the money‐raising function of the Chinese capital market has steadily improved. Securities fi rms have been making distinct contribu-tions to the optimization of the social investment and fi nancing system andstructures. They have also been strongly promoting the fast and healthy growth of the Chinese economy (see Figures 1.6 and 1.7 ).

Active Contributions to Activating Idle Social Assets and Improving Overall Operational Quality of National Economy Chinese securities companies fully played a role in adjustment and optimization of the idle social assets, adjusting the structure of the national economy, optimizing the industrial landscape, and bolsteringsmooth and healthy growth of the overall economy by actively promoting IPOs and M&As.

Regarding M&As of listed companies, statistics provided by An Qingsong ( 2011 ) show an increase in M&A volume. The total trading vol-ume ballooned more than 40 times, from CNY 22.503 billion in the 2002to 2005 period to CNY 910.9 billion in the 2006 to 2009 period. The aver-age merger transaction also surged 11 times, from CNY 0.417 billion to CNY 4.67 billion. M&A transactions of listed companies in China gained 7.7 times in that period.

M&As of listed companies also played a distinct role in promoting eco-nomic restructuring. In total, 114 listed companies completed integrated restruc-turing from 2006 to 2009, with trading volume totaling CNY 641 billion.

FIGURE 1.6 Capital Raised by the Chinese Lending Market and Capital Market Source: Wind Information Co.

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Raising Capital from Equity MarketLending Growth


After the restructuring in 2006, the companies saw their total assets, reve-nue, and net profi ts increase by an average of 306 percent, 208 percent, and 187 percent, respectively, in three years. Also, 27 public companies completed industrial upgrading through M&As with transactions totaling CNY 245.6 billion. Their total assets, revenue, and net profi ts increased by an average of 332 percent, 318 percent, and 595 percent, respectively, in three years. And 49 losing public companies eliminated their underperforming capacities and realized profi tability through M&As. These deals involved CNY 125.7 billion in total and protected the interests of 1.06 million investors and tens of thou-sands of employees. The companies restructured in 2006 and saw their total assets, revenue, and net profi ts rise by an average of 41 percent, 32 percent, and 536 percent respectively in the following three years. Of state‐owned listed companies, 121 in total completed strategic M&As with transactions totaling CNY 805.8 billion. Those companies that restructured in 2006 saw their total assets, revenue, and net profi ts boost by an average of 338 percent, 200 percent, and 181 percent, on average, in the next three years. 11

From an overall national economy viewpoint, the proportions of fi rst, secondary, and tertiary industries steadily optimized to a reasonable level, especially since 2006. The fueling role of the tertiary industry for economic

FIGURE 1.7 Relevancy between GDP, Lending, and Stock Market Source: Wind Information Co.

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

500,000

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

GDP

Total Lending

Total Market Value

11 An ( 2011 ).


growth constantly improved, and the industrialization of the national econ-omy attained effective quality assurance (see Figure 1.8 ).

The structures, growth speed, and quality of main sectors in the national economy also adjusted and optimized. For example, the number and marketvalues of public companies in the main sectors have been gradually adjusted. Despite high market values of the manufacturing and mining industries, sectors in the tertiary industry, such as fi nance, insurance, transportation, storage, and information technology, also saw their proportions steadily improve (see Table 1.6 ).

Boosted Development of a Financial System Anchored on the Securities Market The goal of the reforms in the Chinese fi nancial system is as follows: Shatter the fi nancial structure of “uniformity” erected under the regime of traditional planned economy; establish a system of diverse fi nancial entities includ-ing banks, securities fi rms, and insurers; set up a fi nancial market system anchored on the capital market; and create a fi nancial regulatory system mainly comprised of “one sector and three entities,” thus constantly enhanc-ing the vitality, fl exibility, and effi ciency of the Chinese fi nancial system. More than 20 years later, this goal is materializing. The Chinese securitiesfi rms are not only products of the reforms, but they also made their respec-tive contributions to furthering the reforms and developments in the fi nan-cial system in the process.

FIGURE 1.8 Structural Changes of the Three Industries in China Since 2006 Source: Wind Information Co.

100%

80%

60%

GDP: Primary Industry:Aggregated Amount

GDP: Secondary Industry:Aggregated Amount

GDP: Tertiary Industry:Aggregated Amount

40%

20%

0%

Dec

200

6

May

200

7

Oct

200

7

Mar

200

8

Aug

200

8

Jan

2009

Jun

2009

Nov

200

9

Apr

201

0

Sep

201

0

Feb

201

1

Jul 2

011

52

TABL

E 1.

6 M

ain

Inde

x of

Sec

tors

of

Lis

ted

Com

pani

es (

End

ed N

ovem

ber

2011

)

Sec

tors

Tota

l M

ark

etV

alu

es (

RM

Bin

bil

lions)

A‐S

hare

V

alu

es (

RM

Bin

bil

lions)

B‐S

hare

Valu

es(R

MB

in

billi

ons)

Ave

rage

P/E

Rati

oA

vera

ge

P/B

Rati

o

To

tal

Share

s (i

nbilli

on

s)

Gen

eral

346,

156.

809

2,91

3.78

819

.672

23.9

032.

695

497.

351

Man

ufac

turi

n g99

6,08

8.33

966

,448

.215

2,56

2.98

222

.111

2.88

68,

833.

205

Info

tec

h99

1.82

16,

910.

525

74.1

5534

.640

3.29

281

6.06

4

Soci

al s

ervi

ce42

1,56

5.92

52,

328.

039

174.

100

29.3

223.

196

406.

267

Who

lesa

le a

nd r

etai

l83

,766

.229

5,79

4.13

012

3.88

521

.063

3.15

970

4.19

3

Farm

ing,

for

estr

y, h

usba

ndry

, and

fi sh

ery

263,

399.

976

1,76

6.01

203

.884

44.8

594.

332

203.

006

Fina

nce

and

insu

ranc

e74

8,81

4.56

740

,036

.851

0.00

07.

959

1.52

015

,588

.401

Tra

nspo

rt a

nd s

tora

ge10

2,27

4.75

67,

178.

073

146.

109

12.9

841.

585

2,05

2.40

9

Con

stru

ctio

n59

7,92

8.54

13,

511.

864

07.6

1310

.959

1.55

71,

167.

321

Rea

l est

ate

950,

414.

106

6,98

2.93

344

0.52

511

.967

1.89

41,

472.

997

Prod

ucti

on a

nd s

uppl

y of

pow

er, g

as,

and

wat

er78

4,21

8.35

95,

160.

467

109.

642

23.3

481.

833

1,38

8.33

3

Com

mun

icat

ions

and

cul

ture

171,

505.

836

979.

512

0.00

027

.282

3.61

812

4.93

4

Min

ing

42,8

19.5

2333

,965

.604

238.

412

11.7

952.

071

3,83

4.02

5

Not

e: P

/E r

atio

: sha

re p

rice

to

earn

ings

per

sha

re r

atio

; P/B

rat

io: s

hare

pri

ce t

o bo

ok v

alue

per

sha

re r

atio

. So

urce

: Win

d In

form

atio

n C

o.


Securities fi rms gave a positive boost to the shareholding system reforms and developments of the state‐owned banks in China. According to arrange-ments of the central government, after peeling off their toxic assets fromthe four major state‐owned banks (Bank of China, the China Construction Bank, the Industrial and Commercial Bank of China, and the Agricultural Bank of China), the next priorities for the four asset management compa-nies established in 1999 were to reform the shareholding system and IPOs for the four banks. Securities fi rms performed excessive work to directlyboost reforms and IPOs of the four banks. In the process, they made signifi -cant contributions to the key issues in the reforms of the Chinese fi nancial system.

Via maneuvers of the securities fi rms, other banks and fi nancial institu-tions also made active progress in the reform of shareholding systems and establishment of a modern corporate regime. Financial institutions experi-enced dramatic changes in terms of ownership rights, assets, total debts, andstructures. The vigor of the Chinese fi nancial system was further boosted (see Tables 1.7 and 1.8 for comparisons).

Promoted the Creation of Diverse Social Assets and Expanded Citizens’ Investment Options The capital market cannot develop without the constant growth of the number and scale of fi nancial products. For more than 20 years, Chinese securities fi rms have been actively creating new products in line with the competent requirements and development laws of the capital market. Theyhave been constantly enriching products and smoothing investment chan-nels to meet the fi nancial demands of corporate entities and individuals, thus playing an important intermediary role in the capital market.

With the fi nancial assets structure further adjusted, and with the num-ber and market values of shares, bonds and various wealth managementproducts constantly improved. Figures 1.9 and 1.10 and Tables 1.9 , 1.10 , 1.11 , and 1.12 provide a detailed illustration of the status of stocks, bonds, funds, and wealth management products, as well as investor accounts and transactions.

Strongly Enhanced the Development of Transparency in the Capital Market The information disclosure system is the basic system in the capital market. It is also an important backup for boosting the highly effective fl ow of social capital and improving market restrictions. After offi cially taking over thesecurities regulation responsibility, the CSRC has been engaged in promot-ing the development of an information disclosure system among public companies since 1998, and has in the process taken a series of major mea-sures. After the equity separation reform in 2005, the CSRC devoted major efforts to the development of an information disclosure system among


TABLE 1.7 Sources and Application Structure of Funds at Chinese Financial Institutions in 1999 (RMB in Billions)

Fund Sources, Totals 12,323.06Applications of Funds, Totals 12,323.06

Different savings 10,877.89 Different loans 9,373.43

Corporate savings 3,718.24 Short‐term loans 6,388.76

Government savings 212.84 Industrial loans 1,794.89

Savings of social groups 181.45 Commercial loans 1,989.09

Savings deposits 5,962.18 Construction loans 147.69

Current savings 1,466.67 Agricultural loans 479.24

Fixed savings 4,495.51 Other short‐term loans 1,977.86

Agricultural savings 212.63 Mid‐ and long‐term loans 2,396.83

Trust savings 307.22 Trust loans 250.46

Other savings 283.37 Other loans 337.38

Financial bonds 3.95 Securities and investments 1,250.58

Currency in circulation 1,345.55 Funds outstanding for gold and silver 1.20

Debts in internationalfi nancial institutions

37.19 Funds outstanding for foreignexchange

1,479.24

Others 58.48 Government borrowings 158.21

Assets against internationalfi nancial institutions

60.41

Source: PBC website.

public companies. It made stricter and more detailed regulations in theareas of sponsorship, underwriting, constant regulation, and standardiza-tion of information disclosure, resulting in the rather complete system we see today.

The most important disclosures are the board of directors (BOD) report and the fi nancial report. The BOD report mainly provides the following three items: (1) emphasized items and reserved opinions in the audit report after the company’s fi nancial report has been audited by the fi rm’s accoun-tants; (2) statement of accounting policies, estimated accounting changes,major corrections of accounting errors, and their impacts; and (3) the profi tsdistribution draft or draft for converting capital surplus into shares. Annualreports of listed companies are comprised of the accounting statement, notesfor statement, auditing report, accounting data, business data extracts, andother nonaccounting (fi nancial) information.

55

TABL

E 1.

8 So

urce

s an

d A

pplic

atio

ns o

f Fu

nds

in t

he C

hine

se F

inan

cial

Sys

tem

(R

MB

in b

illio

ns)

Item

Jan 2

011

Feb

20

11

Mar

201

1A

pr

2011

May

201

1Ju

ne

2011

July

2011

Au

gu

st 2

01

1Sep

t 2

01

1O

ct 2

01

1

Sour

cing

item

1. V

ario

us s

avin

gs72

,765

.535

74,1

04.6

1076

,837

.003

77,1

73.1

1478

,284

.582

80,3

02.6

6179

,569

.176

80,3

15.4

5781

,034

.682

80,8

49.0

89

1)

Ins

titu

tion

aI

sav i

ngs

36,0

71.4

5636

,722

.611

38,5

10.4

7038

,907

.193

39,6

00.6

1840

,530

.005

40,0

70.2

2540

,720

.582

40,7

00.6

5840

,814

.202

Incl

udin

g cu

rren

tsa

v ing

s17

,093

.735

17,7

01.8

9418

,379

.189

18,3

81.3

3418

,544

.751

19,1

67.0

0718

,640

.054

18,8

04.0

3418

,273

.503

19,0

31.8

59

‐ Fi

xed

savi

ngs

9,43

2.16

99,

501.

428

9,85

3.10

210

,006

.151

10,2

00.6

9210

,275

.483

10,4

27.5

5310

,634

.635

10,7

50.9

6210

,592

.823

‐ Sa

ving

s at

not

ice

1,66

1.50

91,

469.

204

1,62

3.48

11,

666.

770

1,55

3.62

11,

493.

081

1,43

4.03

51,

417.

670

1,99

9.79

01,

490.

092

‐ D

epos

it s

avin

gs3,

683.

180

3,60

9.31

83,

960.

582

4,13

8.79

54,

364.

771

4,59

4.57

24,

536.

693

4,73

6.76

44,

627.

997

4,48

0.97

3

2)

Per

sona

l sav

ings

32,2

70.3

2032

,522

.305

33,5

74.6

9333

,108

.912

33,2

01.2

9234

,231

.153

33,6

08.4

2633

,650

.875

34,6

69.8

3333

,977

.891

‐ Sa

ving

s de

posi

t31

,869

.022

32,1

03.8

8833

,082

.854

32,5

77.0

4732

,715

.732

33,6

07.7

7332

,942

.345

33,0

30.3

4633

,747

.103

33,1

29.1

04

‐ D

epos

it s

avin

gs16

.874

15.6

4115

.877

17.8

6018

.341

19.4

2520

.261

22.2

2923

.547

26.9

15

‐ Str

uctu

ral s

avin

gs38

4.42

440

2.77

547

5.96

251

4.00

646

7.21

960

3.95

664

5.82

059

3.29

989

9.18

482

1.87

2

3)

Gov

ernm

ent

savi

ngs

2,90

1.98

93,

239.

997

2,99

8.17

53,

408.

233

3,76

1.39

93,

627.

154

4,08

6.33

24,

187.

843

3,81

6.01

04,

211.

112

4)

Tem

pora

ry s

avin

gs18

8.62

823

2.08

519

7.64

622

8.84

121

5.63

223

9.37

123

7.68

120

4.28

722

1.72

123

6.08

1

5)

Con

sign

ed s

avin

gs41

.522

4.94

227

.180

48.0

5622

.820

19.6

4524

.341

17.1

1315

.714

19.1

97

6)

Oth

er s

avin

gs1,

291.

621

1,38

2.67

01,

528.

844

1,47

1.87

81,

482.

820

1,65

5.33

21,

542.

170

1,53

4.75

81,

610.

745

1,59

0.60

7

2. F

inan

cial

bon

ds67

3.45

970

4.42

163

6.37

073

1.94

075

2.99

379

4.64

878

2.22

480

1.37

676

6.92

186

0.38

5

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ebts

to

inte

rnat

iona

l fi n

anci

al in

stit

utio

ns66

.805

67.1

8877

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5780

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1280

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ther

s−1

2,06

5.60

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03,6

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4,31

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4,69

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Sourc

e fu

nd

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tal

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97

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63

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66

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5.8

28

71

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2.3

99

71

,83

9.2

28

(con

tinu

ed)

56

Item

Jan 2

011

Feb

20

11

Mar

201

1A

pr

2011

May

201

1Ju

ne

2011

July

2011

Augu

st 2

01

1Sep

t 2

01

1O

ct 2

01

1

App

lied

item

1. V

ario

us lo

ans

51,4

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.789

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omes

tic

loan

s50

,406

.619

50,9

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52,3

56.5

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,952

.607

53,6

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0454

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54,6

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8455

,198

.804

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hort

‐ter

m lo

ans

18,2

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id‐

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rm lo

ans

30,4

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cing

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e30

0.55

531

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1.43

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otes

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dvan

ces

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17.6

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vers

eas

loan

s99

7.22

21,

000.

686

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013.

109

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ecur

itie

s8,

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064

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quit

ies

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r in

vest

men

ts99

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81,

240.

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240.

266

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406.

234

4. F

unds

out

stan

ding

fo

r go

ld66

.984

66.9

8466

.984

66.9

8466

.984

66.9

8466

.984

66.9

8466

.984

66.9

84

5. A

sset

s at

inte

rnat

iona

lfi n

anci

al in

stit

utio

ns16

8.43

816

8.81

618

4.82

218

5.94

118

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718

4.45

218

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018

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7.01

817

8.45

1

Fund a

pp

lied

, to

tals

61,4

40.1

97

62,0

51.0

30

62,0

36.1

32

63,6

60.1

93

64,4

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57

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09

66

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20

71

,64

2.3

99

71

,03

9.2

20

Sour

ce : P

BC

web

site

.

TABL

E 1.

8(C

onti

nued

)

57

TABL

E 1.

9 St

atis

tics

of

Bon

ds I

ssua

nce

(RM

B in

Bill

ions

)

Gove

rnm

ent

Bonds

Fin

anci

al

Bon

ds

Cen

tral

Bank B

ills

Ente

rpri

seB

onds

Conve

rtib

le

Deb

tsC

orp

ora

teB

onds

To

tals

1991

35.1

9135

.191

1992

40.5

860.

500

41.0

86

1993

52.7

7052

.770

1994

113.

755

18.2

000.

100

132.

055

1995

144.

871

84.2

6022

9.13

1

1996

231.

013

208.

200

0.90

044

0.11

3

1997

245.

749

294.

242

6.46

054

6.45

1

1998

906.

860

203.

023

13.5

360.

350

1,12

3.76

9

1999

405.

603

175.

100

16.2

061.

500

598.

409

2000

461.

950

164.

500

10.5

302.

850

639.

830

2001

468.

353

262.

500

14.4

0074

5.25

3

2002

660.

140

325.

630

193.

750

32.5

004.

150

1,21

6.17

0

2003

850.

237

452.

500

763.

820

45.8

0018

.550

2,13

0.90

7

2004

82.9

4051

2.83

01,

516.

050

32.2

0020

.903

2,91

1.32

3

2005

802.

760

712.

560

2,74

6.20

065

.400

4,47

9.99

4

2006

985.

000

957.

470

3,65

2.27

010

1.50

04.

387

6,01

8.86

1

2007

2,35

9.94

81,

191.

860

4,05

7.10

017

0.93

510

.648

112.

008,

173.

289

2008

861.

500

1,17

8.53

04,

296.

000

236.

690

7.72

028

8.00

7,31

0.27

6

2009

164.

110

1,37

5.85

03,

824.

000

425.

233

4.66

173

4.90

8,70

0.51

4

2010

1,78

8.19

01,

457.

420

4,23

5.00

036

2.70

371

.730

511.

509,

352.

485

2011

1,46

5.75

92,

111.

860

1,28

6.00

029

5.74

841

.320

1,16

6.20

7,21

2.79

4

Sour

ce: W

ind

Info

rmat

ion

Co.

58

TABL

E 1.

10 D

evel

opm

ent

Scal

e of

Chi

nese

Fun

d In

dust

ry

All F

unds

Open

Fun

ds

Due

Date

Tota

lShare

s (i

nbillions )

Net

ass

ets

(CN

Y in

billions )

Quanti

tyPer

centa

ge

Share

s (i

nbil

lions )

Per

centa

ge

Net

ass

ets

(CN

Y in

b

illi

on

s )Per

cen

tage

1993

320.

479

00

1994

3 72.

139

00

199 5

372.

267

00

1996

382.

667

00

1997

382.

667

00

1998

421.

267

10.3

640

0

1999

5 646

.763

60.3

20

0

2000

5557

.831

87.1

980

0

2001

5981

.59

8.36

35.

0811

.726

14.3

711

.801

14.0

9

2002

7713

4.23

112

2.63

1722

.08

51.3

438

.25

48.9

6639

.93

2003

114

163.

785

168.

123

5649

.12

81.5

7649

.81

8.10

948

.24

2004

162

331.

072

322.

568

107

66.0

524

9.17

275

.26

241.

339

74.8

2

2005

219

471.

692

469.

384

164

74.8

938

9.79

282

.64

386.

905

82.4

3

2006

308

622.

079

856.

461

255

82.7

954

0.87

986

.95

694.

111

81.0

4

2007

346

2,23

3.16

3,27

5.59

312

90.1

72,

156.

5996

.57

3,03

9.33

92.7

9

2008

439

2,57

4.30

1,93

8.87

409

93.1

72,

496.

3196

.98

1,87

1.55

96.5

3

2009

557

2,45

3.60

2,66

9.54

529

94.9

72,

361.

1396

.23

2,54

7.43

95.4

3

2010

704

2,42

2.84

2,49

7.25

669

95.0

32,

301.

9895

.01

2,35

8.40

94.4

4

2011

884

2,47

0.35

2,12

1.37

844

95.4

82,

330.

3994

.33

1,97

8.13

93.2

5

Sour

ce: W

ind

Info

rmat

ion

Co.


TABLE 1.11 Statistics of Bonds Outstanding in China (by November 29, 2011)

CategoryQuantityof Bonds

QuantityProportion

(%)

Values(RMB inbillions)

Value Proportion

(%)

National bonds 169 5.28 6,369.235 30.54

Local government bonds 74 2.31 597.800 2.87

Enterprise bonds 813 25.40 1,698.424 8.14

Financial bonds 499 15.59 7,145.003 34.26

PBC bills 81 2.53 1,812.000 8.69

Short‐term fi nancing bonds 554 17.31 788.810 3.78

Asset backed securities 12 0.37 10.947 0.05

Corporate bonds 152 4.75 271.860 1.30

Mid‐term notes 809 25.27 1,959.112 9.39

Convertible bonds 19 0.59 117.595 0.56

Bond with warrants 19 0.59 87.115 0.42

Total 3,201 100.00 20,857.901 100.00

Source: Wind Information Co.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Jan

2007

Apr

200

7

Jul 2

007

Oct

200

7

Jan

2008

Apr

200

8

Jul 2

008

Oct

200

8

Jan

2009

Apr

200

9

Jul 2

009

Oct

200

9

Jan

2010

Apr

201

0

Jul 2

010

Oct

201

0

Jan

2011

Apr

201

1

Jul 2

011

Proportion of Total Stock Values AgainstAll Financial Assets

FIGURE 1.9 Proportion of Total Stock Values against All Financial Assets Data from: Wind Information Co.

60

TABL

E 1.

12 St

atis

tics

of W

ealt

h M

anag

emen

t Pr

oduc

ts o

f Se

curi

ties

Com

pani

es

Mix

ed T

ype

Bo

nd T

ype

Due

Date

No.

Share

s Is

sued

( in

billions)

Ave

rage

Share

s Is

sued

(in

billions)

No.

Share

s Is

sued

( in

billions)

Ave

rage

Share

s Is

sued

(in

billions)

No.

Sh

are

s Is

sued

( in

billio

ns)

Ave

rage

Sh

are

s Is

sued

(in

bil

lio

ns)

Dec

. 200

55

8.62

71.

725

10.

394

0.39

41

0.76

30.

763

June

200

65

7.07

81.

416

45.

810

1.45

30

Dec

. 200

66

10.0

021.

667

25.

055

2.52

82

2.13

01.

065

June

200

74

11.0

952.

774

411

.095

2.77

40

Dec

. 200

73

6.46

02.

153

36.

460

2.15

30

June

200

89

8.72

70.

970

32.

535

0.84

50

Dec

. 200

813

13.9

271.

071

52.

296

0.45

96

8.81

71.

469

June

200

921

33.0

531.

574

1322

.733

1.74

98

10.3

201.

290

Dec

. 200

926

30.3

171.

166

1716

.921

0.99

56

7.65

71.

276

June

201

040

35.7

300.

893

3230

.134

0.94

23

3.21

31.

071

Dec

. 201

057

47.7

420.

838

4744

.416

0.94

50

June

201

150

39.8

070.

796

4133

.965

0.82

82

2.11

41.

057

Dec

. 201

155

19.2

540.

470

4013

.077

0.43

67

3.33

70.

556

Not

e: D

ata

end

date

is D

ecem

ber

5, 2

011.

So

urce

: Win

d In

form

atio

n C

o.


In actual practices, market intermediary entities mostly represented by the securities fi rms could in general provide complete, real, accurate, and regulated disclosures of information for listed companies. With regard to the completeness of information, surveys show that in the analysis of the prospectuses of 69 listed companies in 2008, 59 of them (85.51 percent) mentioned special risks in their reminders of major items. In the stan-dardization of information disclosure, only one of the 69 prospectuses was not drafted completely, according to the specifi cations of the four effectiveness evaluation quota for information disclosure in securities issuance in China.12

Regarding real‐case researches, Chinese scholars have made the follow-ing three different conclusions in the constant follow‐up and study of the effectiveness of the securities market:

12 Hu and Hou ( 2010 ).

FIGURE 1.10 Citizens’ Stock Accounts and Transactions Source: Wind Information Co.

−3,000

2,000

7,000

12,000

17,000

22,000

0

100,000

200,000

300,000

400,000

500,000

600,000

May

200

1

Dec

200

1

Jul 2

002

Feb

200

3

Sep

200

3

Apr

200

4

Nov

200

4

Jun

2005

Jan

2006

Aug

200

6

Mar

200

7

Oct

200

7

May

200

8

Dec

200

8

Jul 2

009

Feb

201

0

Sep

201

0

Apr

201

1Volume of Transactions: Stock and Fund (100 million CNY)

Total Number of Accounts Opened (Million)


1. The Chinese stock market has yet to reach a weak form of effi ciency. 2. The Chinese stock market has reached a weak form of effi ciency. 3. The Chinese stock market has not yet reached a semi‐strong form of

effi ciency.

The Chinese Stock Market Has Yet to Reach a Weak Form of Effi ciency Yu Qiao, Qin Chijiang, and Lin Tao ( 1994 ) discovered that the past price fl uc-tuations in the stock price will impact future changes in stock price, thus shattering the noneffi ciency theory in the Chinese stock market. Wu Shinong ( 1997 ) believed that the Chinese stock market has not reached a weak form of effi ciency in its real sense. Other scholars such as Feng Licheng, Ye Zhong-hang and Cao Yijian, Hu Bo, Jia Quan and Chen Zhangwu, Lu Rong and Xu Longbing, and Wu Zhenxiang and Chen Min all believed that a weak form of effi ciency is not established in the Chinese stock market.

The Chinese Stock Market Has Reached a Weak Form of Effi ciency Researchfrom a variety of Chinese economists, such as Li Xue, Zhang Bing and Li Xiaoming, Dai Xiaofeng, Wang Shaoping and Yang Jisheng showed that the Chinese stock market features a weak form of effi ciency.

The Chinese Stock Market Has Not Yet Reached a Semi‐Strong Form of Effi ciency Other notable researchers, such as Xu Xiaolei and HuangLiang, Xiao Jun and Xu Xinzhong, Chen Zhiguo and Zhou Wenhai, and Tang Qiming and Huang Suxin all believed that the Chinese stock market is not in a semi‐strong form of effi ciency.13

Regardless of the conclusions, it is clear that the Chinese stock mar-ket is seeing steady improvements in terms of information disclosure and market effectiveness. Regulators and intermediary entities, such as securi-ties fi rms, market system development, listed companies, investor structure, and investment behaviors have played their roles; and there is no denying the active roles played by securities fi rms in the issuance, underwriting, andconstant supervisory process.

Missteps of Chinese Securities Firms and Lessons Learned

As important intermediary institutions in the capital market, securities fi rms provide clients with brokerage, sponsorship, underwriting, asset manage-ment, research, and consultancy services. They also play an active role in improving the varieties of market securities, information transparency, and

13 Ji ( 2011 ).


trading effi ciency. Competition and pursuit of profi ts are key to the constantinnovations and development of core competitiveness in securities fi rms. This has resulted in the formation and continuous improvement of com-petitive edges in the entire fi nancial system. Therefore, they are also key toboosting vitality in the fi nancial system and effi ciency of resources alloca-tion in the entire society.

Over the past 20 years, Chinese securities fi rms have made outstanding achievements in their respective roles. But, due to underdevelopment of the capital market, imperfections in the relevant systems, and yet‐to‐be‐improved regulatory measures and force, securities fi rms still face problems after more than three years of strict rectifi cation. They have even forgotten their basic functions, thus hindering the healthy growth of the capital market.

Tunneling Caused by Direct Investments and IPOs After receiving permission for direct investment business in 2007, securities fi rms started subsidiarycompanies to reserve projects for direct investments. Among those listed,CITIC Securities, Haitong Securities, and Huatai Securities were fi rst to start subsidiary companies, followed by Everbright and GF Securities. Securitiesfi rms usually choose to conduct their direct securities investment engage-ments in the Small‐ and Medium‐Sized Enterprise (SME) Boards and the Growth Enterprise Market (GEM) Board.

According to reliable stipulations, securities fi rms performing sponsor-ship and underwriting could make a small amount of equity investments in the “to‐be‐listed companies” they represent through their subsidiary com-panies for direct securities investment, with the proportion of investment capped at 7 percent of the shares to be issued. This policy was intended to tie the sponsorship and underwriting behavior of securities fi rms with the equity investments of companies to be listed, thereby demonstrating the securities fi rms’ understanding of and confi dence in the companies to be listed. This practice usually yields very high returns, thanks to the invest-ment preferences and structures of today’s investors. As a result, this has become a new portal of profi ts favored by many securities fi rms. For exam-ple, according to Wind Info statistics, the subsidiary unit for direct invest-ments of CITIC, Goldstone Investment Ltd., has invested in nine projectssponsored and underwritten by the company since 2010 (see Table 1.13 ).

How were the returns of the direct securities investment business of securities fi rms? Data show the following results from venture capital and private equity (VC/PE) institutions in 2011:

■ January 15: Received an average return of 13.21 times their investments ■ February 19: Received an average return of 9.95 times their investments ■ March 19: Received an average return of 10.68 times their investments

64

TABL

E 1.

13 L

ist

of P

roje

cts

Fund

ed b

y C

ITIC

Dir

ect

Inve

stm

ent

Uni

t Si

nce

2010

Rais

erFin

anci

ng

Data

Money

Fin

ance

d (

in

thousa

nds)

No. o

f In

vest

or s

Equit

y

Per

centa

ge

(%)

Det

ail

s

Xin

jiang

Rad

io

and

TV

Aug

. 31,

201

171

,111

.11

10.0

0X

injia

ng R

adio

and

TV

new

ly a

dded

106

,858

,909

.34

RM

Bof

re g

iste

red

capi

tal i

n A

ugus

t 20

11; G

olds

tone

pur

chas

ed23

,746

,424

.3 o

f th

em w

ith

71,1

11,1

11 t

o pu

rcha

se 1

0% o

f it

s sh

ares

.

Ram

axel

Te

chno

logy

Sh

enzh

en

July

26,

201

150

,000

.04

4.96

Gol

dsto

ne, C

MX

J In

vest

men

t, an

d Ji

anxi

n B

eijin

g In

vest

men

tM

anag

emen

t ac

quir

ed 4

.96%

of

Ram

axel

Tec

hnol

ogy

Shen

zhen

’s s

hare

sfor

CN

Y 5

0 m

illio

n in

Jul

y 20

11.

SKSH

U P

aint

June

30,

201

147

,500

.02

PreI

PO a

nd G

olds

tone

inve

sted

47.

5 m

illio

n in

SK

SHU

Pai

nt

Lin

gxia

n Te

chno

logy

Ji

lin

Sept

. 27,

201

068

8,11

0.0

431

.51

Lin

gxia

n Te

chno

logy

issu

ed 3

3,95

7,70

8; 1

3,16

5,07

7;

4,92

4,98

9; a

nd 3

,565

,762

; tot

alin

g 68

8 m

illio

n, o

f pr

ivat

e eq

uiti

es (

RM

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■ April 23: Received an average return of 27.02 times their investments ■ May 17: Received an average return of 30.74 times their investments, as yields drastically surged for venture investments

Under the current sponsorship system, securities fi rms are only respon-sible for two to three years of supervision for projects they sponsor. Theystand to make huge returns after being released from investment locking for their direct investments. Because regulatory requirements for sponsors are hard to materialize under the current system, a strong contrast between the huge benefi ts and small responsibilities is created. Some securities com-panies are therefore not performing any protective work, and as a result, scandals have been emerging since the opening of the GEM Board. Morelegal work is required to restrict the behavior of sponsors, who are currently functioning both as the referee and the athlete.

The Impairment of Insider Trading on Market Accountability and Investor Interests The securities market has been always accompanied by insider trading of various forms. Currently, insider trading exists mainly in two forms: traditional or specifi c to current sponsorship systems.

Traditional insider trading has moved from the securities companies to fund companies, due to rigid regulations and numerous fl uctuations of thesecurities trade. Insider trading within fund companies is also known as “rat trading,” a practice that has never ceased to exist. Since 2011, the regulation authorities have campaigned against such acts. Many individuals and fund companies supported the campaign, including Li Xuli, the former invest-ment director of Chongyang, and Huang Lin, the former fund manager of Franklin Templeton Sealand Fund Management Co. Ltd.

In the securities industry, insider trading tends to happen to the spon-sor representatives because they are the insiders of the related project. Two major cases—the Xie Fanghua and An Xuemei case (CITIC Securities, May2011) and the Li Shaowu case14 (Guosen Securities, June–July 2011)—fell like a bombshell in the capital market, unveiling the corruption in investment banking and under‐the‐table aspects of the sponsoring practice. Accordingto offi cials of CSRC, 29 criminal cases involving insider trading have been brought to the public security authority by CSRC since 2008, including the

14 An Xuemei was found guilty of insider trading and unjust enrichment of morethan CNY 1.67 million in the Fujian Tianbao Mining Group’s RTO of Wanhao Wanjia Hotels (stock symbol: 600576) and the Changzhou EGING PV’s RTO of Haitong Group (stock symbol: 600537). See http://english.caixin.com/2010‐08‐20/100172499.html .

http://english.caixin.com/2010%E2%80%9008%E2%80%9020/100172499.html

http://english.caixin.com/2010%E2%80%9008%E2%80%9020/100172499.html


Huang Guangyu, Liu Baochun, ZPUG, Shanghai Zulong, Hongpu, GuanYawei, and Gao Yangcai cases. Between January and October 2011, 114 reports of insider trading were received by CSRC. Of these, 42 were fi led for investigation. Through the investigation, 16 individuals and two orga-nizations were penalized administratively, and 12 cases of insider trading were brought to the public security authority. All of these cases indicate theunprecedented severity of CSRC’s struggle against insider trading.

Obviously, there must be great incentive behind rule breaking. For insider trading, the incentive is huge fortunes. When the investment bank has the ability to infl uence the listing, the few sponsors involved who hold signing authority tend to solicit the equity from the company to be listed. There is great potential profi t for investing before the equity is listed. Venture investors attempt to canvas the sponsors for the opportunity to invest in the Pre‐IPO company during the tutoring. This creates a “golden triangle” involving the sponsor (or team), middleman, and venture investor to reap high IPO benefi ts.

Undermotivated Innovation and Underdeveloped Competitiveness of Securities Companies Despite considerable growth of Chinese securities companies in terms of capital strength and business range over more than 20 years, there has not been substantial change in the profi t‐generation model. This is char-acterized as “leaving the result to the fortune,” and is considered a major problem to the Chinese capital market, hindering its growth and participationin global competition. There are three main reasons for this lack of success:

1. Capital power is weak with low risk tolerance. 2. Corporate governance structure needs improvement. 3. The profi t model is old fashioned.

Capital Power Is Weak with Low Risk Tolerance Capital strength is an inte-gral part of the competitiveness of a securities company. According to the sta-tistics of the Securities Industry and Financial Markets Association (SIFMA), the aggregate capital of the U.S. securities industry was USD 3161.34 billion and rose to USD 4638.142 by 2010. That same fi gure for China in the fi rst half of 2011 was only CNY 1670 billion. The total business income of the American securities industry for 2010 was USD 254.752 billion, while the same fi gure for China in the same year was CNY 191.1 billion. The net profi t of the American securities industry was USD 24.8 billion, while the same fi gure for China in the same year was CNY 77.557.

The gap between Chinese securities fi rms and their U.S. counterparts is still wide with respect to net capital (risk provisions deducted). See Table 1.14 for a net capital comparison of 10 leading American investment banks (2001) and Chinese securities fi rms (2011).


The situation is even worse in regard to the capital strength of a securities fi rm. See Table 1.15 for a simple analysis of listed Chinese securities fi rms.

Corporate Governance Structure Needs Improvement Tables 1.16 and 1.17 illustrate a simple comparison of the ownership structure of American invest-ment banks and Chinese securities fi rms.

We can learn from this information that even in listed Chinese securities fi rms, the ownership concentration is still generally higher than that of U.S. investment banks. The level of concentration is much higher if we includemany more unlisted Chinese securities fi rms in the picture. Of course, Chi-nese securities fi rms have made efforts to optimize their ownership structureand improve corporate governance.

Still, relatively high levels of concentration in ownership structure and low liquidity of equity (mostly in nonlisted securities fi rms) automatically lead to one main boss in control of insiders, which goes against the improve-ment of corporate governance and decision‐making effi ciency.

TABLE 1.14 A Comparison of Net Assets of 10 Leading American Investment Banks (2002) and Chinese Securities Firms (2011)

Globally Leading Investment Banks (2001)

Leading Chinese SecuritiesFirms (2011)

Name

Net Assets(USD in billions) Name

Net Assets(CNY inbillions)

Schwab 5.0 Guoyuan Securities 11.771

Deutsche Bank Alex. Brown 8.283 GF Securities 11.963

Paine Webber 21.147 Shenyin and Wanguo Securities 12.084

Salomon Brothers 21.369 Guoxin Securities 12.490

Bear Stearns 26.252 China Merchants Securities 14.063

Lehman Brothers 43.874 Guotai Jun’an Securities 17.347

First Boston 46.553 Everbright Securities 17.647

Goldman Sachs 47.925 Huatai Securities 21.658

Morgan Stanley 49.637 Haitong Securities 32.460

Merrill Lynch 72.569 CITIC Securities 41.050

Source: Feng ( 2005 ); globally leading investment banks; Wind Information Co.; Chinese securities fi rms.


TABLE 1.15 Capital and Profi tability of Listed Chinese Securities Firms

Total Share Capital (shares

in billions)

Gross AssetValue (CNY in billions)

Net Profi t(CNY inbillions)

Northeast Securities 0.639 19.576 0.528

Guoyuan Securities 1.964 24.901 0.926

GF Securities 2.960 95.947 4.198

Changjiang Securities 2.371 35.773 1.283

CITIC Securities 11.017 153.178 12.136

Guojin Securities 1.000 11.030 0.438

Southwest Securities 2.323 22.778 0.805

Haitong Securities 8.228 115.413 3.868

China Merchants Securities 4.661 95.359 3.229

Pacifi c Securities 1.503 5.856 0.204

Huatai Securities 5.600 113.463 3.480


TABLE 1.16 Ownership Concentration in Listed Chinese Securities Firms

Ownership by the Controlling

Shareholder(%)

Ownershipby Top 10

Shareholders(%)

Pacifi c Securities 12.01 82.32

Northeast Securities 30.71 70.89

Guojin Securities 27.35 75.02

Changjiang Securities 14.72 60.85

Guoyuan Securities 23.55 68.71

Haitong Securities 5.87 38.93

GF Securities 21.12 88.65

Southwest Securities 40.45 71.78

China Merchants Securities 28.78 80.63

Huatai Securities 24.423 70.9556

CITIC Securities 20.3 37.23


70

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The Profi t Model Is Old Fashioned According to modern fi nancial theory and practice, securities fi rms are supposed to be the most active and inno-vative fi nancial institutions in the modern fi nancial system. However, theproblem with the status quo in China is that Chinese securities fi rms arestill engaged in few business activities and are still dependent on supporting government policy at the mercy of the market for business growth.

Since the explosion of the American subprime mortgage crisis in 2008, due to a huge impact on the conventional profi t model, investment banks have suffered sharp fl uctuations in revenue and earnings. Many pioneerbrokers/dealers have failed to maintain their profi tability with innovative activities. In the United States, where the subprime mortgage crisis started, the overall level of profi tability of American investment banks fell sharply and the earnings were cut by nearly half, down from USD 474.2 billion in2007 to USD 254.8 billion in 2010.

However, an analysis of revenue structure of American investment banks and Chinese securities fi rms shows that the former have maintained, on areasonable basis, relatively stable revenue from each of their main activities.Investment banking remains the main source of revenue, brokerage revenue remains at a relatively low level, and revenue from asset management andother activities (e.g., research and consulting) grows steadily (see Figures 1.11and 1.12 ).

It is a critical moment for change in the profi t models of the Chinese securities industry. Many brokers have already begun planning for a realistic approach to adapt to future growth and constantly enhance the core com-petencies. Their ideas include:

■ Curb the decline in commission rates, keep customers and maintain stable brokerage revenue by shaping new business offi ces, and promotepaid investment advisory services, among others

■ Develop innovative activities and fi nd new profi t‐generating activities ■ Stimulate interaction between conventional business activities and bring about synergy

In its 2011 interim report, CITIC Securities Co. suggested more practi-cal development ideas, such as investing more, promoting buyer‐oriented business activities, building a sound mechanism, inspiring innovation, con-solidating domestic business, increasing international presence, and encour-aging customer‐oriented business.

Chinese securities fi rms can successfully transform their business model and go on to a broader road to growth, as long as they can keep up with the pace of development trends, focus on customer needs, and constantlypromote innovation.


FIGURE 1.11 Shift in Revenue Structure in the American Securities Industry(1980–2010)Notes:1. Commissions and revenue from sale of funds refers to brokerage commissionrevenue and revenue from sale of funds. 2. Trading revenue refers to revenue generated by the bid–ask spread when an invest-ment bank is making a market. 3. Revenue from investment banking refers to revenue from securities underwriting gand other securities‐related investment banking activities. 4. Other revenue refers to revenue from research and development, settlement of spot commodities and futures, and other income. Source: Securities Industry and Financial Markets Association (SIFMA).

100%

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80%

70%

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50%

40%

30%

20%

10%

0%

Other Revenue

Interest Revenue

Return on Investment

Revenue from Asset Management

Revenue from Investment Banking

Trading Revenue

Commissions and Revenue from Sale of Funds

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

CASE STUDIES: TYPICAL CHINESE SECURITIES FIRMS

Wanguo Securities: A Story about a Broken Dream

History Wanguo Securities Co. (now known as Shenyin and Wanguo Secu-rities Co.) was incorporated in 1988 as one of the fi rst securities fi rms in China, organized as a corporation in the real sense (in contrast with Southern


Securities and Haitong Securities). Shanghai International Trust and Invest-ment Corp. plus another nine shareholders invested CNY 35 million in thecompany. Guan Jinsheng acted in the capacity of general manager, at age 41. From the outset, Wanguo Securities had pursued a goal to become the Chinese Merrill Lynch.

Within two months after incorporation, the company made a success-ful debut as the fi rst Chinese securities fi rm in the international securities industry. In an underwriters group of more than 20 international securi-ties fi rms gathered to underwrite the Euroyen bond issued in London by BNL (Singapore Branch), Nomura Securities was the director general andWanguo Securities was deputy director general.

Wanguo Securities completed its primitive accumulation of capital from reselling Treasury bonds. When the Chinese Government started to issue Treasury bonds in 1981, their lack of liquidity made them very unpopular. Many local authorities required a compulsory purchase order. This allowedsome buyers to acquire Treasury bonds at a low price in the undergroundmarket. Some companies even accepted Treasury bonds in the sale of over-stock merchandise with a disguised discount. In March 1988, the Ministryof Finance released the Pilot Implementation Scheme for an Open Market

FIGURE 1.12 Shift in Revenue Structure in the CITIC Securities Industry Source: Wind Information Co.

100%

80%

60%

40%

20%

0%

−20%2006

Net Income from Securities Trading

Net Income from Asset Management

Net Gains on Change of Fair Value

Net Income from Securities Underwriting

Net Interest Income

Net Return on Investment

Other Revenue

2007 2008 2009 2010


for the Transfer of Treasury Bonds, allowing for the open market trading of Treasury bonds in Shanghai, Shenzhen, Wuhan, and another 51 cities. At that time, Wanguo Securities, with fewer than 20 employees, went out buy-ing Treasury bonds. In 1989, Wanguo Securities realized a turnover of CNY 300 million, topping all other securities fi rms. Arbitrage in Treasury bonds constituted the major part of its business.

In 1992, Wanguo Securities, together with China New Tech Venture Invest-ment Corp. and Cheung Kong Holdings Ltd., acquired a 51 percent stake in the Public International Ltd., a listed company in the Hong Kong Stock Exchange,to become the fi rst Chinese mainland securities fi rm that had successfully com-pleted a purchase of a listed company in Hong Kong. In 1993, Wanguo Securi-ties had an AAA credit rating—the only broker with such a rating in China. In1994, the company contributed 22 percent (in A shares) and 50 percent (in Bshares) of the total trading volume of the Shanghai Stock Exchange. It was also the domestic lead underwriter for 8 out of 12 companies that went public inthe B‐shares market. Meanwhile, Wanguo Securities had set up branch offi ces in Singapore and London, and was also preparing for a U.S. branch offi ce.

Wanguo Securities also played an indispensable role in the creation and development of the Shanghai Stock Exchange. It was the fi rst securities fi rmthat developed trading rules, offered offsite trading services in Shenzhen and Shanghai stock exchanges, and promoted and adopted paperless trading inChina. Wanguo’s constructive suggestions even resulted in many securities market regulatory provisions.

327 Treasury Bond Incident Starting on December 28, 1992, securities brokers were allowed to conduct proprietary trading in Treasury bond futures at the Shanghai Stock Exchange. As of October 25, 1993, individual buyersand sellers were allowed to participate in Treasury bond futures trading at the Shanghai Stock Exchange. At the same time, the Beijing MercantileExchange also began to offer the same trading services, making it the fi rst of all Chinese futures exchanges for Treasury bond futures trading. Shortly afterthat, the number of Treasury bond futures trading marketplaces increased from 2 to 14 (including 2 stock exchanges, 2 securities trading centers and 10 mercantile exchanges). In 1994, the trading aggregate reached CNY 2.8 trillion in the Chinese Treasury bond futures market.

Then, the “327 incident” occurred. The 327 Treasury bond refers to the three‐year bond issued by the Chinese Government in 1992, due in June 1995. Between 1992 and 1994, the Chinese government, facing pressure from high infl ation, promised infl ation protection to help the issuance of Treasury bonds. Different expectations of infl ation rates and infl ation com-pensation rates resulted in a huge difference in bullish and bearish marketforecasts on the 327 Treasury bond.


In February 1995, rumors suggested that the Ministry of Finance might pay CNY 148, rather than 132, on the 327 Treasury bond with a par valueof CNY 100. Despite the rumors, Wanguo Securities decided to go short. On February 23, 1995, the Ministry of Finance announced that it would payCNY 148.50 on the 327 Treasury bond at maturity. At that time, Wanguo Securities was holding a large short position on the Bond.

As the market opened on the morning of February 23, buyers bullish about the 327 Treasury bond, led by the China Economic Development Trust and Investment Co., pushed the price from the previous night’s closing price of CNY 148.21 to 148.50 by buying 800,000 lots. In the afternoon, the price reached 151.98. When Liaoguo Securities, one of allies of Wanguo Securities, suddenly changed sides and started to buy, the price rose by 3.77. A rise of CNY 1.00 would cost Wanguo Securities more than CNY 1 billion. In the last minutes before the market closed, sellers led by Wanguo Securitiesstarted to fi ght back. They fi rst lowered the price from 151.30 to 150 by selling 500,000 lots. Then, they kept pounding the price with lots of hun-dreds of thousands, and eventually brought the price down to 148. Finally, they threw a selling bomb and dragged the price down to 147.40 with amassive sales order of 7.3 million lots. (In accordance with the provisionsof the Shanghai Stock Exchange, a lot in the Treasury bond futures trad-ing represents the number of contracts of underlying Treasury bonds worth CNY 20,000 in face value. A sales order of 7.3 million lots represents CNY 146 billion, but all of the 327 Treasury bonds issued are only worth CNY24 billion).

After the market closed that evening, the Shanghai Stock Exchange released an emergency announcement that all 327 Treasury bond transac-tions after 16:22:13 were deemed invalid. Accordingly, the adjusted Trea-sury bond futures trading amount was CNY 540 billion, and the closingprice of 327 Treasury bond futures was the price of the last valid transac-tion at CNY 151.30. At that closing price, Wanguo Securities would incur a CNY 6 billion loss. The next day, there was a run on Wanguo Securities. Three months later, the Treasury bond futures market was closed.

Lessons As one of the fi rst three Chinese securities fi rms, Wanguo Securities once played a signifi cant role in promoting the Chinese securities market. From its boom and bust, we can learn the following lessons:

■ The success of fi nancial products depends on many elements, includ-ing favorable external environment, appropriate investor mix, rationalinvestment behavior, and sound regulatory rules and systems.

■ Firms must be fully aware of the risks of fi nancial derivatives and have an objective understanding of their roles. Effective risk management for


fi nancial derivatives requires a risk‐management system with suffi cient technical support that fi ts the derivatives trading model. This is the coreof risk management in the entire derivatives market.

■ An effective corporate governance structure is essential to corporate risk control. Wanguo Securities adopted a family business style management,under which no one can prevent a wrong decision of the managementfrom being exercised, even though the company had the best manage-ment minds and business professionals at that time. If a functional boardof directors had discussed and analyzed the consequences of such a rashdecision, Wanguo Securities might have succeeded to realize all its goals.

Jun’an Securities: The Fall of a Star

Early Glory Like Wanguo Securities, Jun’an Securities was one of the prom-ising Chinese securities fi rms at the end of the twentieth century. The com-pany was incorporated in 1992. Its charter members included Shenzhen Heneng Real Estate Development Ltd., ABC (Shenzhen) Trust and Invest-ment Corp., CITIC Industrial Bank (Shenzhen Branch), and two other government‐owned companies. The initial investment was CNY 50 million.Zhang Guoqing acted as president.

Thanks to a stimulating environment for innovation and a fl exible mech-anism, the company developed after incorporation a distinct, daring corpo-rate culture and achieved good business results. Between 1993 and 1998, Jun’an Securities helped more than 100 companies raise a total of about CNY 30 billion in A or B shares, IPOs, or placements on the primary market. Interms of brokerage, Jun’an Securities had more than 60 business offi ces and ranked fi rst or second on the Shenzhen Stock Exchange. It was among the top six fi rms on the Shanghai Stock Exchange in trading volume. The company was also very active in proprietary trading. It was widely acknowledged as the securities fi rm (among all Chinese securities fi rms) that invested most and was most capable in research and development. In regard to asset management, the company created Jun’an Benefi t (one of the fi rst Chinese funds) and brought about the fi rst merger and acquisition in China’s stock market, known as the battle between Jun’an and Vanke. The company also had a fl exible distribution arrangement and employee incentive programs (for employees below offi cers). The company generated great corporate earnings and shareholder returns. Asof December 31, 1997, the company had total assets of CNY 17.5 billion and more than 2,300 employees. It had earned record‐high net profi ts of CNY 711 million—the highest amount among all Chinese securities brokers.

The Coup In 1997, in the full fl ush of success, Jun’an Securities started an ownership makeover. By means of management buyout (MBO), Zhang


Guoqing, Yang Jun, and other management members bought back corporate equity, causing the government‐owned business to be secretly controlled by private shareholders. This resulted in the well‐known Jun’an incident.

Upon incorporation, three government‐owned companies—Shenzhen Heneng Real Estate Development Ltd., ABC (Shenzhen) Trust and Investment Corp., and CITIC Industrial Bank (Shenzhen Branch)—had a 75 percent stake in Jun’an Securities. With the approval of the People’s Bank of China, in November 1996 the company increased its share capital from CNY 50 million to CNY 700 million. After the increase, Shenzhen Xinchangying Investment and Development Co. Ltd. and Shenzhen Taidong Industrial Co. Ltd. controlled the company, and ABC (Shenzhen) Trust and Investment Corp. and CITIC Industrial Bank (Shenzhen Branch) withdrew from the company.

Zhang Guoqing and Yang Jun were legal representatives and members inthe boards of directors and supervisory boards of Xinchangying and Taidong, respectively. They were also members of the board of directors and the man-agement of Jun’an Securities. According to the corporate information fi led with the administration for industry and commerce, Shenzhen Xinchangying Investment and Development Co. Ltd., the largest shareholder of Jun’an Securities, was incorporated in May 1994. It had a registered capital of CNY 500 million. Zhang Guoqing acted as legal representative. The fi rm had threeshareholders—Shenzhen Gensheng Industrial Co. (50 percent), Shenzhen Minyifu Industrial Co. (30 percent), and Wuhan Yihui Economic and Trad-ing Co. (20 percent). Gensheng also held an 80 percent stake in Minyifu and was controlled by Jun’an Securities’ Labor Union Committee (with a 60 percent stake), Jun’an Property Management Co. (with 10 percent), and Shenzhen Hemu Investment Co. (with 30 percent), which was also controlled by Jun’an Securities’ Labor Union Committee (with 75 percent). Shenzhen Taidong Industrial Co. Ltd., the second‐largest shareholder of Jun’an Secu-rities, was incorporated in June 1994. It had a registered capital of CNY 250 million. Acting as legal representative was Yang Jun, who was also the incumbent vice president of Jun’an Securities at the time. Two other share-holders were Hemu (50 percent) and Minyifu (50 percent).

Clearly, both Xinchangying and Taidong, the largest and second‐largest shareholders, were controlled by the management of Jun’an Securities, whichcontrolled the company via such a holding structure. After an increase of share capital in 1996, the company was renamed Jun’an Securities Co. Ltd.According to the new company’s Articles of Association, a shareholders’meeting would be the highest authority of the company. Its board of direc-tors had the three members: Yang Jun, Zhang Guoqing, and Yin Ke. Zhang Guoqing, as the controlling shareholder’s representative, would be elected chairman of the board and president of the company. Yang Jun and Yin Kewould be elected vice presidents. All three were members of management.


Factions led to the fall of Zhang Guoqing. A deputy general manager, who was in charge of corporate fi nance but lost ground in offi ce poli-tics, blew the whistle on the MBO scheme and disclosed all accounts. In the fi nal act, the authorities found that Zhang Guoqing was suspected of embezzlement of government‐owned assets and fraudulent conveyance of government‐owned assets into private ownership in a disguised form.

Lessons From Jun’an Securities, we can learn the following lessons:

■ A company should create and maintain a functional corporate gover-nance mechanism that satisfi es the requirements of a modern businesssystem. A company with a relatively balanced or dispersed ownershipstructure should make an effort to prevent “insider control.” Share-holders should specify in the Articles of Association the subjects of deliberations and rules of procedure of a shareholders’ meeting and a board of directors meeting. Shareholder representatives should faith-fully discharge their duties in the exercise of rights on behalf of share-holders and protect the legitimate rights and interests of shareholders. The board of directors should comply with the provisions set forth in Chinese laws and regulations and the company’s Articles of Associationin the exercise of power, and should also keep offi cers in check. Theboard should also have a considerable number of independent direc-tors who are expected to play a watchdog role. Qualifi ed candidates who can represent and safeguard the interests of various interest groups should be recommended and selected for members of the board.

■ A company with a relatively balanced or dispersed ownership structure should create and maintain practical incentive and restraint mechanisms. It should design a relatively reasonable employee compensation plan and sci-entifi cally proven performance assessment indicators and make the best of equity incentive plans (e.g., cash or stock options) and performance assess-ment to encourage management members to deliver their best performance.

■ A company should enable the supervisory board, or a like committee, to ful-fi ll its role to supervise the management in all activities and particularly to oversee the company’s fi nancial activities and carry out independent audits. Qualifi ed candidates with professional backgrounds (e.g., fi nancial, legal, or management) and suffi cient time and energy to fulfi ll the duties should be recommended and preferred as members of the supervisory board.

GF Securities: A Success Story of an Ordinary Unprivileged Business

Hard-Earned Success Unlike the government‐owned Wanguo Securities andthe military‐backed Jun’an Securities, GF Securities can trace its history


back to the Securities Department the Guangdong Development Bank cre-ated on September 8, 1991. Back then, there were only six employees and CNY 10 million in capital.

Over the past 20 years, GF Securities has continued growing by its own efforts and through several market‐based mergers and acquisitions. Its rev-enue has increased from CNY 4 million to 10.219 billion. Its business offi ces have increased in number from 1 to 199. The 6 employees have increased to11,000, providing services to more than 3.5 million customers. Its main busi-ness activities have expanded from single‐line securities brokerage to a full range of securities‐related activities that cover stocks, bonds and debentures, funds, futures, and equity investment. The company now consists of wholly owned GF Futures, GF Hong Kong, and GF Xinde, and partially owned GF Fund and E‐Fund management companies. It has the business structure of an emerging fi nancial holding conglomerate involved in business activities in securities, funds, futures, and equity investments. According to its consolidated fi nancial statements as of December 31, 2010, GF Securities has total assets of CNY 95.947 billion, which have been increased by 181 times, for an averagegrowth of 136 percent per annum in the past 17 years for which statistical data are available. Its net assets are CNY 19.401 billion, which have increased 692 times, for an average growth of 147 percent per annum in the past 17 years. Its revenue is CNY 10.219 billion, which has increased 309 times, for an aver-age growth of 140 percent per annum in the past 17 years. Its net profi ts are CNY 4.027 billion, which have increased 237 times, for an average growth of 138 percent per annum in the past 17 years. The company has improved its market share (in terms of stock trading amount) from 3.1 percent in 1999 to 4.18 percent at the end of 2010, ranking fourth in the market.

Strategy Is Vital to Success In the past 20 years, the Chinese securities market has greatly changed. Many brokers experienced everything from boom to bust, but GF Securities has managed to grow and remain robust. The secret to sustainable growth is the commitment to compliance and innovation. (In the industry, the GF was a pioneer and leader in many business activi-ties). GF has been defi nite about corporate strategy. Early in 1995, the man-agement put forward strategic goals toward corporation, conglomeration, internationalization, and standardization, and such goals were achievedalong with rapid business growth in the fi rst decade. In 2004, managementdefi ned its new goal to be a large, reputable, and highly competitive Chinese investment bank with quality assets and stringent standards. Its objective was to be ranked among the top fi ve investment banks in China in terms of size, profi tability, and market capitalization. GF has now basically realized its goals, or is smoothly making its way toward them.

During the implementation of its strategy, GF has accurately seized market opportunities. When many commercial bank‐sponsored securities


departments still limited themselves in secondary market activities in 1993, the GF Securities management put forward the guidelines to promoteinvestment banking and explore new territories, which allowed a head start in investment banking. When the Chinese stock market slumped in 1996, management immediately adjusted its strategy for overall businessexpansion. When the stock market soared in 1997, management asked offi cers and employees to stay alert for sound growth opportunities. In 2000, GF management put forward guidelines for standard practice‐based development, which helped the company weather a long bear market from 2001 to 2005.

Business Growth Is Driven by Innovation GF Securities regards investment banking—one of the fountainhead business activities of securities fi rms—as activities that determine the company’s market position and long‐term growth potential. The company has been heavily investing in its investmentbanking division, which was created in 1993. It is committed to providingcustomers with professional services in an effi cient manner and is highly rec-ognized by many corporate clients. According to available data, since 1993,GF Securities has entered into 187 underwriting or sponsorship contracts(including 120 IPO contracts) as main underwriter or sponsor, worth CNY111.5 billion in total. In the past 20 years, GF has been an award‐winning pioneer in multiple business innovations in the Chinese securities history.

GF Securities has also attached great importance to brokerage—an important pillar business activity of securities fi rms—for the purpose of business growth over the long run. Between 1991 and 2011, the company expanded its brokerage with several market‐based M&A deals, as well as by its own efforts. As of June 2011, GF had established a securities servicenetwork with 199 offi ces, basically covering every strategic city and region around China. It had established quite a brokerage system that enabled the company to compete with the best Chinese securities fi rms. In terms of range of business activities, it is one of the Chinese securities fi rms with the most brokerage qualifi cations. As for business performance, GF has been inthe top 10 Chinese mainland securities brokers for 17 years running (since 1994) in terms of main business indicators for brokerage and has been in a leading position with regard to its secondary market business.

GF Securities is one of the fi rst Chinese securities fi rms qualifi ed as an asset management service provider. It is also the fi rst Chinese securities bro-ker to release a pooled wealth management product. So far, the company has released fi ve pooled asset management plans and two small pool products. It has managed assets of more than CNY 9 billion, which places GF in a forefront position in the industry. In the second year of the Best Chinese PE Fund Management Company Awards in 2010, GF Securities was awarded


the Best Manager of the Year, in recognition of its good practice in opera-tions and management and outstanding results in investment activities.

The GF Securities Development Research Center has a history dating back to 1995. It established a post‐doctoral workstation (the fi rst of itskind in the industry) in 2001. It started to transform into a sell‐side analyst in 2008 and made breakthroughs in 2010 with an income of nearly CNY 100 million from position‐sizing research. The Research Center now hasabout 100 employees. Its research teams keep a close watch on main indus-tries and conduct research in all main areas. In the eighth annual New Wealth Best Analyst Awards in 2010, the GF Research Center was awarded the fi rst prize for High Achievers and was named one of the top 10 best sales teams. Five GF research teams were awarded Best Analysts in coalmining, real estate development, transportation, machinery manufacturing, and automotive industry.

In addition to conventional business activities (brokerage, investment banking, and asset management), GF Securities also excels in institutional client services, investment and proprietary trading, and margin trading and short selling, among others, where signs of great growth potential and com-petitive advantages are present.

Compliance Generates Power for the Sustainable Development Mechanism In its 20‐year growth, GF Securities has remained alert and aware of risks and has continued to improve its practice for compliance, which is an essential partof the company’s corporate culture. In the Stock Exchange Executive Coun-cil (SEEC)‐sponsored online voting in 2010, the company was awarded Best Securities Broker in Risk Management.

Haitong Securities: A Shady Deal

History As the only securities fi rm with a history of more than 20 years in the Chinese stock market, Haitong Securities has kept a relatively low‐keyprofi le. When it was incorporated in 1988, Haitong had a registered capital of CNY 10 million and the Bank of Communications, Shanghai Branch,was the controlling shareholder. Haitong was converted into a company of limited liability in 1994, and later into a corporation in a makeover in 2001.In 2002, Haitong increased its registered capital to CNY 8.734 billion and became the largest multi‐business securities fi rm in terms of capital size in the Chinese mainland securities industry. Haitong acquired the Huanghai Futures Co. and renamed it Haitong Futures Co. Ltd. It also created FullgoalFund Management Co. and HFT Investment Management Co. Ltd. After ittook over Gansu Securities and Xinan Securities in 2005, Haitong owned124 business offi ces and 57 securities service centers.


On June 7, 2007, Haitong Securities went public by way of a reverse takeover of the Dushi Corp. (stock symbol: 600837) on the Shanghai Stock Exchange. (Haitong was the fi rst Chinese mainland securities fi rm that went public successfully by way of a reverse takeover.) In October 2007, with the approval of the China Securities Regulatory Commission, Haitong made aprivate placement of no more than 100,000 shares, increased the total sharecapital by CNY 725 million to 4.114 billion, and optimized its ownership structure by bringing on board the CITIC Group, Ping An, CPIC, and other strategic investors. Haitong now has about CNY 34 billion in net capitaland 39 billion in net assets.

In 2008, the Haitong (Hong Kong) Financial Holdings Ltd. obtained offi cial business permissions and licenses. In October of that same year, Haitong Kaiyuan Investment Co. Ltd. was incorporated and engaged in direct equity investment activities. In 2009, Haitong Securities acquired theTaifook Securities Group Ltd. of Hong Kong, establishing a solid plat-form for overseas development and taking a substantial step toward strategic internationalization. Haitong Securities had a stock and fund trading amount of CNY 4.4937 trillion as an aggregate, ranked fourth in the industry, and held a market share of 4.14 percent. Haitong was also allowed to create 10 subsidiaries and was qualifi ed as a securities brokerand a social security fund trustee and custodian (for government‐owned and transferred equity). The Shanghai Securities News voted Haitong as Best Securities Broker.

Low-Profi le Reverse Takeover Deal-Making On June 7, 2007, the China SecuritiesRegulatory Commission gave its permission to the Dushi Corp’s proposal to sell major assets and merge with Haitong Securities, with a bargained equivalence between one Haitong share and 0.347 Dushi share. By June 22, 2007, Haitong Securities had delivered to Dushi Corp. on a complete and legal basis, and Dushi Corp. had accepted without objection all assets andall liabilities of Haitong as of May 31, 2007. On July 6, 2007, Dushi Corp.obtained a new business license (registered capital: CNY 3.389 billion) and was renamed Haitong Securities Corp. Ltd. Before the merger, HaitongSecurities had 8.734 billion shares and traded them for 3.031 billion Dushi shares.

Shareholders of the original Haitong Securities traded corporate net assets for a convenient path to go public. In addition, the new Haitong Secu-rities paid a CNY 200 million compensation to shareholders of the former Dushi Corp. in consideration of their loss in the split‐share structure reform.Haitong Securities paid a premium of CNY 188 million for the exchange of shares and took CNY 5.115 billion out of retained earnings to make up for the loss in the exchange.


After the completion of the merger, Haitong Securities became a listed company with 3.389 billion shares. According to the proposal, the equity arrangement among the three stakeholders is as follows:

■ Bright Group, the controlling shareholder of the former Dushi Corp., would have a 7.12 percent stake in the surviving company and wouldpay CNY 756 million in cash in consideration of all assets, all liabilities,and the staff of Dushi Corp., whose net assets thereby would carry a 7 percent premium in the book value.

■ The holders of marketable shares of the former Dushi Corp. would have a 3.45 percent stake in the surviving company (subject to dilution after a private placement), with net asset value per share (NAVPS) and earn-ings per share (EPS) signifi cantly diluted.

■ The 66 shareholders of the former Haitong Securities would have an 89.43 percent stake in the surviving company (subject to dilution after a private placement), with an equity downsizing ratio at 0.347.

Some Puzzling Aspects of This Reverse Takeover Deal

Goodwill This merger brought to Haitong Securities great amounts of good-will. The CNY 205 million in goodwill, as stated in fi nancial statements, consisted of 200 million coming from the merger and 5 million coming from previous acquisitions of the former Haitong Securities. In fact, the CNY 200 million was a part of the takeover agreement, to be paid in cash to the shareholders of Dushi Corp. in consideration of their loss in the split‐share structure reform.

However, Haitong Securities did not disclose any basis for such account-ing treatment. Although on the surface Dushi Corp. exchanged their 3.031billion shares for 8.734 billion shares of Haitong Securities in the merger,the Haitong shareholders actually obtained the 89.43 percent marketableshares of Dushi by giving away a 10.57 percent stake (equity ownershipfrom 100 percent to 89.43 percent) and bringing on board Dushi sharehold-ers. Haitong Securities wrote off the CNY 200 million in goodwill in the 2007 annual report, and gave no reasons or references, making the account-ing treatment in this merger questionable.

Consolidation of Financial Statements and Information Disclosure In itsinterim report, Haitong Securities claimed that this was “a merger between companies not under the same control.” However, Haitong adopted an accounting treatment similar to that commonly used for mergers of compa-nies under the same control. There was basically no increase in the value of net assets; that is, no new assets were formed. In accordance with applicable International Financial Reporting Standards (IFRS) rules, the information stated in the consolidated statements in the interim report seems fi ne. But such


information is unreliable to faithfully refl ect the merger and give a true and fair view of the operating results and fi nancial position of the surviving company.

Business Valuation As the fi nancial advisor in this merger, Huatai Securities calculated Haitong’s book value of equity per share to be between CNY 2.10 and 2.38 using the price‐to‐earnings (P/E) ratio method, and 2.10 per share using the present value‐based income method. It determined the book value of equity per share at CNY 2.01 per share. The closing price of CNY 5.80 per share of Dushi Corp. on the last market day before the trading halt was determined as the reference price for the exchange of shares. Huatai’s posi-tion on business valuation was that over the next decade, the Chinese securi-ties industry would see 20 percent year‐over‐year growth and securities fi rms would have a P/E ratio between 25 to 35, therefore concluding that Haitong Securities had a P/E ratio between 30 and 34, and a book value to share price ratio of CNY 2.10 and 2.38. There is a problem in this statement. Obviously, there is a lack of evidence, making the reliability of such valuation question-able. According to the fi nancial statements released by Haitong Securities, the net asset value per share was CNY 0.37 as of September 30, 2006. Assuming that the price was at CNY 2.1 per share, the price‐to‐book ratio would be 5.68 as of September 30, 2006. Considering the market conditions at the time, the resulting business valuation, based on the P/E ratio approach or income approach, would not be sound enough to be rational and reliable.

Accounting Treatment of Loss In the consolidated statements of Haitong Securities, the retained earnings were CNY 5.267 billion in red at the begin-ning of the year and 2.432 billion in black at the end of the accounting period. However, the pretax profi t was listed as only CNY 3.263 billion on the income statement of the same period. This means that Haitong did not use the pretax profi t to make up for loss. According to the statement of changes in ownership interests, during the same accounting period, Haitong reduced its share capital by CNY 5.703 billion, increased retained earnings by 5.515 billion, and added 188 million to capital reserves. This was done for reasons other than owners’ capital contributions and share‐based payment recognized into owners’ equity. In fact, the reduction of share capital refl ected the reduction in the shares of the former Haitong Securities (from 8.734 billion to 3.031 billion shares) in the exchange of shares for the purpose of the merger. It was by such accounting treatment that Haitong Securities turned a defi cit into a surplus.

Industrial Securities: Robust Management

Industrial Securities, previously known as the Industrial Bank’s Securities Department (created in 1991), was incorporated in April 1994 as Fujian Industrial Securities Co. with a registered capital of CNY 100 million.


Since then, Industrial has grown into a multi‐business fi nancial hold-ing conglomerate controlling 4 fi nancial subsidiaries, 4 branch offi ces, and 60 securities business offi ces. It also deals in securities and futures‐relatedservices, fund management, direct investment, and overseas business. It is among the top 20 fi rms in the industry in terms of main business activi-ties and operating indicators. Industrial has won multiple awards for beingamong the most unusual securities brokers, most infl uential securities fi rms (top 20), and most generous Chinese fi nancial institutions in charitable donations. Industrial had total assets of CNY 30.537 billion and a net capi-tal of 6.536 billion as of December 31, 2010. It also realized gross revenueof 2.738 billion as of that year end.

Innovation-Powered Business Growth: Two Transformations

Innovative Transformation 1: From Shopkeeper to Peddler When the Chinese stock market fell into a slump and the securities industry started to take ahit from the second half of 2001, Industrial Securities was the fi rst securitiesfi rm to make a change and seek transformation by exploring a customer‐oriented business model and by adjusting its corporate organizational struc-ture accordingly.

Industrial offered a range of new brokerage services and made an effort to expand low‐risk activities (e.g., Treasury bond repurchase, mar-gin marketing, targeted marketing) while improving market share with diversifi ed marketing tools. Industrial made new breakthroughs in invest-ment banking every year. In 2003, as lead underwriter, it underwrote the Steel and Vanadium Company’s convertible bond, which was the larg-est convertible bond issuance in the securities market at that time. In 2004, it acted in the capacity of the acquiree’s fi nancial advisor in the merger between the First Department Store and Hualian Department Store, which was the fi rst merger between two listed companies. In 2005, it helped Pangang Steel and Vanadium Co. sell put warrants in the fi rst share and succeed in the split‐share structure reform. (Industrial Securi-ties was the fi rst securities fi rm to offer a put warrant–based plan to the split‐share structure reform.)

Industrial Securities made outstanding achievements in research. In 2005, it was awarded the fi rst, second, and third prizes by the New Wealth Best Analyst Awards for research fi ndings in nonmetallic building materials,construction, and pharmaceutical industries, respectively. Its research and development center was named one of the best 10 Chinese research teams of the year. Industrial also explored new territories in fund management. Following its equity participation with China Southern Asset Management Co., it created the Industrial Fund Management Co. and launched its fi rst product in 1993: the Industrial Convertible Bond Fund.


In July 2004, Industrial Securities started a workfl ow reengineering pro-gram. Management used workfl ow reengineering as a breakthrough point, exercised more effi cient performance management as well as basic controls, and focused on the improvement of customer services in an attempt to bring a makeover to business, management, and team building. Its purpose was to attract more customers and help them increase their fi nancial assets. Theprogram helped rearrange and remodel business workfl ows, operating mod-els, and management workfl ows; more clearly defi ne organizational goal; and also improve execution. In 2005, Industrial Securities was qualifi ed asone of the fi rst securities brokers for standard business activities.

Innovative Transformation 2: From Peddler to Service Provider Faced withincreasingly fi erce competition in the industry, in September 2009, man-agement put forward another strategic transformation. Industrial Securities focused on fi nding opportunities offered by the industrial upgrading, andaiming toward a goal for better professional services. Upgrading the busi-ness model was at the core of the transformation. Management wanted to replace the old business model, which mainly focused on trading channel‐based services, with a new business model built upon trading channel‐based services but more focused on professional investment services.

To achieve that, management adopted the following measures:

■ Consolidate the base of the wealth management business model. ■ Reevaluate and rearrange the wealth management product system. ■ Launch an industry‐leading wealth management platform that inte-grates investment advisory services, research and information, customermanagement, and marketing support.

■ Build a wealth management team and invest more in professional training. ■ Reevaluate and reform the compensation and performance manage-ment system, making it a better fi t for the wealth management–orientedtransformation.

■ Build an organizational system for wealth management. ■ Adjust the headquarters’ organizational framework on the principle that such a framework allows customer‐oriented specialization.

■ Increase strategic investment in research activities and IT facilities (related to HR development, compensation and performance management, system construction, and others) to support the wealth management–oriented transformation.

In 2007, Industrial Securities further increased its share capital (its reg-istered capital increased from CNY 908 million to CNY 1.49 billion) and was qualifi ed as a securities fi rm for innovative business activities. In 2009,


it further increased its registered capital to CNY 1.937 billion. After tak-ing over and making additional investment in the Huashang Futures (now known as Industrial Futures) in 2007, Industrial became an emerging securi-ties holding group, participating in securities, futures, and fund management services. In 2010, Industrial Securities went public with a smash, providing strong support for the second strategic transformation.

Lessons Innovation is the most important highlight of the Industrial Secu-rities business growth model, providing vigor and helping explore new ter-ritories for business growth.

■ Innovation is an effective way for a securities fi rm to distinguish itself from others. According to the theory of industrial organization, in any industry, an effective organizational structure is basically a pyramid struc-ture in terms of technical skills. The lower the technical skills, the greater the chances of being imitated and having more competitors; whereas the higher the technical skills, the fewer the chances of being imitated and the better likelihood of having fewer competitors. Currently, there is a serious homogeneity problem in the products and services offered by Chi-nese securities fi rms. They have no signifi cant competitive advantage and are unable to meet diversifi ed fi nancial needs of customers. Meanwhile, most Chinese securities fi rms have a single‐line, identical profi t model and are still at the mercy of the market. Market volatility can have a seri-ous impact on profi tability. A securities fi rm has to rely on innovation in service differentiation, product system design, internal control, resource integration, and risk management in order to develop its own advantage, better satisfy customer needs, and survive in intense market competition.

■ Financial innovation is an effective means for a securities fi rm to expand business territories. Innovation should be targeted at specifi c business activities in accordance with the characteristics of that activity. For con-ventional activities, a securities fi rm should focus on variety development, create a complete range of products, and build a brand on strengths, while improving internal coordination and integration of resources. For innovative activities, the fi rm should bring innovative and conventional activities to complement each other in an effi cient and effective way, and promote common development for sound business growth.

The CICC: Going Upscale

About the CICC China International Capital Corp. Ltd. (CICC) was the fi rstChinese foreign‐securities fi rm (joint venture). It was incorporated in June1995 by the former China Construction Bank, Morgan Stanley International


Corp., China National Investment and Guaranty Co. Ltd., the Government of Singapore Investment Corp., and the Mingly Holdings Ltd. From the outset, CICC has been the leader in the Chinese securities industry.

After its reorganization, China Construction Bank passed its stake in CICC to the China Jianyin Investment Co. Ltd., who in August 2010 relin-quished its entire 43.35 percent stake in CICC to the Central Huijin Invest-ment Co. Ltd. (the controlling shareholder of CICC). In December 2010, Morgan Stanley transferred its entire 34.30 percent stake in CICC to TPG Asia V Delaware LP, KKR Institutions Investments LP, Great Eastern Life Assurance Co. Ltd., and the Government of Singapore Investment Corp.CICC created its own wholly owned subsidiaries as follows:

■ CICC (Hong Kong): created in September 1997, in Hong Kong, with a registered capital of HKD 39 million

■ CICC‐JIA CHENG Investment Management Co. Ltd.: created in October 2007, in Beijing, with a registered capital of CNY 50 million, and with direct investment as its main business activity

CICC (Hong Kong) then created the following wholly owned subsidiaries of its own:

■ CICC (HK) Securities Ltd.: created in March 1998, in Hong Kong, who later created its own wholly owned CICC US in August 2005, in theUnited States

■ CICC Singapore: created in July 2008, in Singapore, with securities‐related activities

■ CICC UK: created in August 2009, in the United Kingdom, with securities‐ related activities

■ CICC (HK) Futures: created in August 2010, in Hong Kong, with futures trading

As of December 31, 2010, CICC had total assets of CNY 33.9 billion and a realized revenue of CNY 5.56 billion. This included a net income of CNY109 million on average (among all business offi ces) from securities trading andbrokerage services (ranking fi rst in the industry). It also had a net income of CNY 2.466 billion from underwriting, sponsorship, M&A, and other fi nancialadvisory services (ranking fi rst in the industry). The funds (principal amount) under its management totaled CNY 23.037 billion, making CICC a runner‐up after CITIC Securities. By the end of 2010, CICC underwrote stocks, bonds, and debentures in an aggregate amount of CNY 137.6 billion (ranking second after CITIC Securities) and underwrote CNY 104.7 billion as lead underwriter (ranking fi rst). The company realized a profi t of CNY 1.22 billion.


Appeal to Upscale Clients CICC was of “noble lineage” at birth. Back then,several large international investment banks kept the secret to success in the investment banking industry. For CICC, its parentage enabled it to learnfrom the giant Morgan Stanley. Since its incorporation, CICC has kept growing at a rapid speed. By building upon expanding business activities, constant improvement and innovation of products and services, as well asoutstanding business performance, CICC stands in a leading position in the Chinese investment banking and enjoys a good reputation in the global cap-ital market. CICC has successfully accomplished many milestone projects in the capital market, which have had a profound infl uence on the Chinese investment banking industry.

CICC almost dominates the overseas issuance projects of Chinese government‐owned companies and has an amazing underwriting record. Since 1997, when large Chinese government‐owned companies started to appear in the international capital market, CICC has remained on the top in terms of cumulative totals of IPO underwriting amount in Asia (except Japan), overseas IPO underwriting amount, and overseas fi nancing in general.

In October 1997, CICC helped China Telecom (Hong Kong) go public in New York and Hong Kong in the capacity of joint global coordinator, bookrunner, lead underwriter, and sponsor. After that, CICC promoted suc-cessful international fl otation of China Unicom, PetroChina, Sinopec, andmany other large Chinese government‐owned companies. It became the main Chinese facilitator, helping Chinese companies in overseas fi nance as an irreplaceable intermediary between Chinese companies and the interna-tional capital market.

In 1999, CICC helped China International Trade Co. go public on the Chinese A‐share market. After that, CICC underwrote the A‐share IPOs of Baosteel, Sinopc, China Merchants Bank, China Unicom, and other large government‐owned companies on the Chinese stock market. Its “noble lin-eage” is not the only quality that dims the light of other brokers. CICC also has superior investment banking skills and a management philosophy that other brokers envy.

In recent years, CICC obtained several big IPO underwriting contracts (e.g., China Construction Bank, China Shenhua, and PetroChina). Mean-while, management has been working on internal structural adjustment in the hope of becoming a multi‐business securities fi rm that participates in acomplete range of activities. CICC had previously served institutional inves-tors until 2007, when it started to offer services to individuals after seeing the fast‐growing demand of asset management services in the Chinese mar-ket. Committed to providing upscale customers in the Chinese mainland a market with professional investment services of international standards, CICC has made available to domestic investors securities trading, brokerage


services, and investment advisory services at its Beijing, Shanghai, and Shenzhen business offi ces. It also offers Hong Kong securities investment advice and other services via CICC (HK).

As the fi rst Chinese foreign‐securities fi rm (joint venture) incorporated with special approval, CICC is undergoing a transformation in an attempt to make use of its noble legacy and expand its market share in the upscale market. It also aims to achieve a balanced growth by making an effort in the downscale market.

Lessons CICC has superior investment banking technical skills, manage-ment philosophy, international capital market experience, and an extensive global support network. This gives CICC a competitive edge over other Chi-nese mainland securities brokers. The lessons to learn from CICC are asfollows:

■ Local presence is as important as a global vision. A unique interna-tional perspective and shareholder background enables CICC to gain real‐world experience in international capital markets and build an extensive global support network. To make the most of such advan-tages, CICC must adapt to the changes in the market and focus on the needs of customers. China continues to enjoy economic growth at a fast pace despite a global recession. However, it faces a great challenge in industrial upgrading and developmental transformation, which could bring along great opportunities in the Chinese capital market and a huge potential demand for securities services. Therefore, CICC must focus on the great Chinese market and make the most of its strengthsfor a successful business transformation, as well as further and faster business growth.

■ A great team of professionals continues to be essential. CICC has brought together a group of Chinese and international professionalsthat have professional ethics as well as outstanding business skill sets. They are experienced and have been growing with the Chinese capital market. CICC’s team of professionals is the hope for future growth andthe builders and champions of the CICC brand.

CITIC Securities: The Benchmark Maker

About CITIC Securities CITIC Securities Co. Ltd. was incorporated in October1995. CITIC went public on the Shanghai Stock Exchange on January 6, 2003, and on the Hong Kong Stock Exchange on October 6, 2011.

Committed to its business principle of “prudent management and bold innovation,” CITIC Securities has maintained or taken a leading position


in many business activities. As of December 31, 2010, CITIC ranked fi rst for market share in terms of brokerage services in exchange‐based securi-ties trading (8.60 percent, combined), stock and bond underwriting (9.20 percent), and assets under management (22.20 percent, exclusive of China AMC). It had two shareholders with more than a 5 percent stake in the company: China Life Insurance Co. Ltd. (5.01 percent) and China CITICGroup (23.45 percent), which controls the CITIC Bank, CITIC Trust,Prudential Life Insurance Co., and CITIC International Financial Holdings.This allows the integration of multiple business activities and providing cus-tomers with a full range of fi nancial services at home and abroad.

CITIC Securities owns and is a controlling shareholder of the following six subsidiaries:

1. CITIC Jintong Securities Co. Ltd. 2. CITIC Wantong Securities Co. Ltd. 3. CITIC Securities International Co. Ltd. 4. ChinaAMC 5. CITIC Securities Futures Co. Ltd. 6. Goldstone Investment Ltd.

CITIC also partially owns, by equity participation, the CITIC Private Equity Funds Management Co. Ltd., China Capital Management Co. Ltd., and S&P/CITIC Index Information Services (Beijing) Co. Ltd. By December31, 2010, CITIC was the largest securities fi rm in China, with total assets of CNY 153.178 billion, net assets of CNY 70.435 billion, and a net capital of CNY 41.050 billion.

Farsighted Development Strategy and Effi cient Capital Operation In the beginning, CITIC Securities was not the best securities fi rm in China. However, with its principle of “prudent management and bold innovation,” CITIC made gooduse of capital operation. It phased out each business development plan in order of priority and shaped itself with overall development as one of the top securities brokers in terms of asset size, profi tability, customer base, andbrand image. Eventually, CITIC took the leading position in the industry. During this process, capital operation was its best-played and most success-ful card.

After it took over Wantong Securities in 2004, CITIC Securities created, together with China Jianyin Investment Co., the China Securities Co. Ltd. It aimed to take over the entire securities business assets of the former Huaxia Securities. CITIC Securities later also acquired Jintong Securities. After an expansion with a series of acquisitions, CITIC now has a number of sub-sidiaries, 165 securities business offi ces, and 60 securities service centers in


Mainland China, helping it build a retail network that was absent for a longtime. Along with an increasing market share of brokerage and substantial sales improvement, CITIC has topped all other Chinese brokers in terms of trading volume and amounts of stocks and funds.

With regard to asset management, CITIC has laid out the strategy for “concerted development of buyer‐side and seller‐side services” as one of the fi rst securities fi rms qualifi ed for innovative business activities. After the acquisition of the Huaxia Fund Management Co. Ltd. in 2006, CITIC cre-ated a number of new buyer‐side business lines and made efforts toward developing fund management, asset management, collective wealth manage-ment, industrial investment funds, private equity funds, risk management, fi nancial derivatives, futures, and merchant banking. Meanwhile, CITIC has also made some breakthroughs in the seller‐side services. It has managedto realize a balanced growth in profi tability and to successfully combine its strengths in fi nance, sales network, capital operations, and management.

In regard to international business, CITIC created in 2005 the CITIC Securities (Hong Kong) Ltd., which took over the China CITIC Group’sinvestment banking business in Hong Kong and built a cross‐border bridgebetween capital markets. In the fi rst half of 2007, CITIC caused the capital of the CITIC Securities (Hong Kong) to be increased for the second time, and changed its name to the CITIC Securities International Ltd.

CITIC Securities has been a leader in Chinese investment banking. In 2010, CITIC realized a total bond/debenture sales amount of CNY 232.8 bil-lion and ranked fi rst in regard to the sales of Treasury bonds, China Develop-ment Bank (CDB) bonds, Agricultural Development Bank of China (ADBC) bonds, and Export‐Import Bank of China (EXIMBANK) bonds. CITIC real-ized a spot bond/debenture trading amount of CNY 3 trillion and ranked fi rst in terms of total trading amount and volume of interest rate swaps and spot bond/debenture trading. It ranked second in terms of securities underwrit-ing and stock trading, fund position sizing‐generated commissions, and num-ber of qualifi ed foreign institutional investors (QFII) clients. CITIC was also awarded the fi rst prize for New Wealth Best Sales Service Team.

As for research activities, CITIC was awarded fi rst prize in the 2010 New Wealth best analyst awards for the Best Chinese Research Team for fi ve consecutive years. It also won the fi rst prize for research teams in the Secu-rities Market Weekly Crystal Ball Awards and the China Securities/CCTVGolden Bull Analyst Awards.

Lessons The lessons to be learned from CITIC Securities are as follows:

■ A securities fi rm has to learn how to seize market opportunity and make use of capital operation. In the securities industry, where securities


fi rms are at the mercy of the market and compete against each other in homogenous products and services, an up‐and‐coming company must learn how to identify and seize opportunity and make good use of capital operation for rapid business expansion and improvement of competitiveness.

■ Integration and conglomeration can help ensure balanced business growth and steady improvement of profi tability. By now, the integration and conglomeration models have emerged. As securities fi rms at large consolidate their capital strengths and the regulatory authorities lower the thresholds for access to some activities, the arena of competition is expanding. Further and faster growth builds upon steady enhancement of overall competency, which requires a company to integrate resources, create internal synergies, diversify profi t‐generating activities, and stim-ulate interaction between business activities.

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An , Qingsong . 2011 . “ On the Tendency towards M&As and Restructuring in Chi-nese Listed Companies .” Chinese Finance 16 : 55 – 56 .

Chemmanur , T. J., and P. Fulghieri . 1999 . “ A Theory of the Going‐Public Decision .” The Review of Financial Studies 12 ( 2 ): 249 – 279 .

Chen , Zhaosong . 2008 . “A Study of Ownership Structure and Corporate Governance Effi ciency in Chinese Securities Firms.” PhD thesis, Southwestern University of Finance and Economics.

Feng , Enxin . 2005 . A Study of the Economies of Scale in Securities Firms . Beijing : China Financial Publishing House .

Gurley , J. G. , E. S. Shaw , and A. C. Enthoven . 1960 . Money in a Theory of Finance . Washington, DC : Brookings Institution .

Hu , Jingbo , and Jun Hou . 2010 . “ A Functionality Analysis of IPO Information Dis-closure by Chinese pre‐IPO Companies .” Journal of the Northeastern University (Philosophy and Social Sciences) 4 : 191 – 193 .

Hu , Song . 2006 . “A Capital Market‐Based Study of Asset‐Liability Management in Chinese Commercial Banks.” PhD thesis, Renmin University of China.

———. 2008 . “ On the Governance Mechanism in Financial Holding Companies—An Analysis Based on the Operating Characteristics [J] .” Economic Survey 5 .

———. 2009 . “A Study on Risk Management in Financial Holding Companies.” Post‐doctoral thesis, Renmin University of China.

Ji , Huadong . 2011 . “ An Overview of a Functionality Study of the Chinese Stock Market .” Market Weekly—Theoretical Studies 1 : 85 – 86 .

Jiang , Yang . 2000 . “A Study of the Chinese Securities Broker‐Dealer Regulatory System.” PhD thesis, Southwestern University of Finance and Economics.


Jiang , Xueqing . 2001 . “ A Face‐to‐Face Interview with a Chinese‐Foreign Securities Firm .” Capital Market 11 . t

Li , Hongyao . 2006 . “A Study on the Development and Innovation of the Chinese Securities Industry.” PhD thesis, Jilin University.

Merton , R. C. 1995 . “ A Functional Perspective of Financial Intermediation .” Financial Management 24 : 23 41 . t

Merton, R. C. 1989 . “ On the Application of the Continuous-Time Theory of Finance to Financial Intermediation and Insurance.” The Geneva Papers on Risk and Insurance (July): 225–262 .

Scholes , M. , G. J. Benston , and C. W. Smith . 1976 . A Transactions Cost Approach to the Theory of Financial Intermediation . The Journal of Finance 31 : 215 – 231 .

Scholtens, B., and D. van Wensveen . 2000 . “A Critique on the Theory of Financial Intermediation.” Journal of Banking and Finance 24(8): 1243 – 1251 .

Statistical Yearbook of China (Securities and Futures). 2005 . Shanghai : AcademiaPress .

Wang , Min . 2006 . “A Study of Risk Management in Chinese Securities Firms.” PhD thesis, Renmin University of China.

Wang , Xuhua . 2006 . “A Study of the Survival Crisis of Chinese Securities Firms.” PhD thesis, Fudan University.

Wu , Shinong . Contemporary Financial Theories and Research Methods . China Economy Publishing House , 1997 .

Wu , Xiaoqiu . 2006 . Market‐Oriented or Bank‐Based Financial System—A Com-parative Study of the Chinese Financial System. Beijing : Renmin University of China Press .

Xie , Taifeng , Youyi Liu , and Jianmei Wang . 2004 . A Theory of Development forChinese Brokers. Beijing : Economic Science Press .

Yu , Qiao , Chijiang Qin , and Tao Lin . 1994 . “Money, Output, Prices and Interest Rates in China’s Heterogenous Economy during Reforms.’’ Working paper, the Institute of Banking and Finance of the PBC.

95

CHAPTER 2 2 Analysis of Functions

of Chinese Securities Companies

As the most important fi nancial intermediaries in capital markets, securities companies play an important role in the economic and fi nancial system

by providing fi nancial services for the following four unique core functions:

1. Securities issuing and underwriting 2. Asset securitization 3. Merger and acquisition of stock of resources 4. Wealth management

In the fi rst two sections of this chapter we will discuss, from the perspec-tives of both theory and reality, the theoretical fundamentals of these four core functions and the performances of international investment banks and Chinese securities companies. The third section of this chapter will describe the effects of reforming the fund custody regime on Chinese securities com-panies’ functions. Embezzlement of customers’ margin funds, before the reform, led to veiled increases in leverage ratio and speculative activities of securities companies, resulting in the systemic crisis that has swept the sector. However, the establishment of the third‐party custody system has institu-tionally assisted securities companies to control the investment leverage and standardize fi nancial services, which has made for a well‐functioning system on the basis of the institution. We reinforce the important implications the reform of capital custody regime had in staving off systemic crises and assist-ing securities companies to play their core functions. We do this by com-paring and analyzing the fact that investment banks embezzled customers’ margin funds, which led to high leverage in the global fi nancial crisis.

The fourth section investigates from an empirical perspective whether various institutional reforms such as listing, classifi cation management, andameliorating governance structure by securities companies were benefi cial to help them fulfi ll their core functions. The results indicate that there was


signifi cant improvement of underwriters’ reputation for securities companies. Specifi cally, the function of reputation in the underwriting activities hasbecome visible in the Growth Enterprise Market (GEM).

Securities fi rms are known as investment banks in Europe and the United States, but are called securities fi rms in China and Japan. Undereither name, they have a long history. They came along in the early days of capitalism as merchants’ banks that accepted bills, helping to facilitate tradeand commerce. They then developed into modern investment banks in an early form, handling government bonds, corporate debentures, and securi-ties underwriting. They have grown further into fi nancial giants, with con-siderable interests in every corner of the fi nancial market. A review of such evolution would unveil economic development, technological advances, and social change right through today.

Securities fi rms are no longer limited to conventional business activities such as securities underwriting and fi nancial advisory services for M&A anddivestitures. Having completed organizational transformations from part-nerships to corporations and solved capital problems that constrained busi-ness growth, securities fi rms have made new breakthroughs in proprietary trading and asset management to become great creative minds for fi nancial derivatives and structured products, showing great strength in all aspects of the fi nancial market. The 2008 subprime crisis ended with the collapse of Bear Stearns and Lehman Brothers and the conversion of Morgan Stanley and Goldman Sachs. However, the disappearance of the investment bankingmodel that features large independent investment banks does not mean the end of mission and investment banks, which continue to exist in another form. Securities fi rms still play a pivotal role in global capital markets in terms of fi nance and information dissemination.

THEORETICAL ANALYSIS OF FINANCIAL FUNCTIONALITY1

Particularities of Securities Issuance and Trading

Similar to the situation in product and labor markets, asymmetric informa-tion also exists in capital markets. The asymmetry problem is even worsebetween fund seekers and investors. In such a capital and information‐intensive market, fund seekers with limited fi nancial strength aim to attractinvestors to invest money in their business, while investors are eager to getcompany information (e.g., business model, innovation, and management)

1 For detailed discussion of the functionality of investment banking, please see Morrison and Wilhelm ( 2006 ).

Analysis of Functions of Chinese Securities Companies 97

to determine potential growth prospects before making an investment decision. As fi nancial intermediaries, securities fi rms come in at this point to help both parties. To some extent, securities fi rms supply investors with a specialcommodity: price‐related information. It is securities fi rms that facilitate thepairing of funds in the market with projects and companies, bringing aboutthe exchange of information and capital fl ows.

Such exchange works on the premise that the parties to the exchange have specifi c ownership of their respective products. The price‐related infor-mation in capital markets is unlike general tangible goods. It is diffi cultto establish property rights to such information, even though it is of greatvalue. The diffi culty lies in the following areas:

■ How to prove to potential investors the value of such information for the purpose of reasonable consideration

■ How to clearly identify an information producer as the source of the information obtained by certain investors who should be charged for the use of such information

■ From the investors’ perspective, how to make sure the information owner will not resell such information, which would lose value as a result of wide dissemination

Market economy is in a sense bound by covenants. However, even a legally binding contract cannot have much effect in a market of price‐relatedinformation for the following three reasons:

1. A covenant simply cannot be formed with an agreement whose exis-tence is questionable, whose subject (information) cannot be confi rmed as to quality and effectiveness, and whose consequences and terms andconditions cannot be verifi ed

2. The law simply cannot offer protection in the absence of a valid accusa-tion because there is no proven approach to determine how a specifi c investor benefi ts from certain information from an information producer.

3. Even if the above two obstacles were removed, there would be no proven approach to ensure the confi dentiality of such information in the course of discovery or proceeding. The value of the informationwould diminish substantially once it had been widely disseminated.

Functions of Information Marketplaces and Securities Firms

Because it is impossible to establish a covenant relationship for price‐related information, one has to organize a private information marketplacebuilt upon an informal network of connections. To build and maintain


a functional private information marketplace, securities fi rms offer informa-tion providers incentives in the form of compensation for the information provided. They also make threats of expulsion against providers who fail to comply with market rules and give false information. (Of course, a credible threat works on the premise that the increase in gains from short‐term fraud is far lower than the benefi ts of long‐term involvement.)

To attract investors, securities fi rms are responsible for ensuring the high quality of, and accurate pricing for, the subjects for investment. If a securities fi rm fails its due diligence or is incapable of bringing about effective pricing of assets, it would lose the investor’s trust and would be consequently abandoned, suffering a profi t loss in the long run. There-fore, securities fi rms are motivated to treat every business in a prudent manner and to make every effort to maintain their reputation. Figure 2.1 depicts the relationships between the parties in a private information marketplace.

FIGURE 2.1 Securities Firm’s Information Marketplace Source: Morrison and Wilhelm ( 2007 ).

Info Producers Sellers of Info

Large InvestorsSellers of Liquidity

IssuersBuyers of Info

Retail InvestorsSupply Some

Liquidity AggregateDemand Info

Secondary MarketBuyers of Liquidity

Aggregate Demand InfoBuyers of Market

Expertise

Securities Firm

Info Network Liquidity Network


Information producers create and supply useful information to secu-rities fi rms in exchange for compensation. Large investors provide suffi -cient liquidity that helps the successful issuance of securities. As buyers of information, issuers normally learn about market reaction and demand forthe securities issued via securities fi rms. Retail investors, whose aggregate demand accounts for a certain portion in every market, constitute an inves-tor group that cannot be ignored because they take advantage of large investors. Securities fi rms also participate in some investment activities in the secondary market for the following reasons 2 :

■ It could provide an exit path for the parties in the primary market, thereby helping reduce the cost of the liquidity network.

■ It could learn directly about market reaction, helping promote issuance in the primary market.

■ It could make additional gains for the information network.

Securities fi rms may also channel the secondary market of derivatives and services into the IPO process.

How Securities Firms Function: Information Network,Reputation Management, and Tacit Skills

In those circumstances in which a covenant is not an option given the par-ticularity of price‐related information, it is natural for investment banks to make use of their goodwill to build and maintain a functional informa-tion marketplace for the purpose of a well‐ordered exchange of information and capital fl ows. Reputation management is therefore crucial to securities fi rms. To maintain a good reputation, securities fi rms perform due diligence for every fi nance request, reject the securities of a company that is involved in fraudulent disclosure or poor performance, offer reasonable compensa-tion in consideration of useful information provided, and make it possiblefor liquidity providers/investors to get reasonable returns in the secondary market. (This requires certain premiums to be offered to investors who sub-scribe to IPOs in the primary market.)

In a knowledge‐intensive industry in which players invest heavily in human capital, conventional securities fi rms build their reputation on good performance and stable customer relationships over the years. For example, Goldman Sachs has been acting as fi nancial advisor for the Ford Motor Co. for decades. Achieving consistently good business performance and maintaining a long‐term customer relationship both require great efforts and commitment

2 See Morrison and Wilhelm (2007).


over a long period, rather than hard work in a short period. Because of this, securities fi rms make demanding requirements of their employees in terms of technical skills and connections. They also heavily invest time and effort in training, particularly apprenticeship programs in which masters teach appren-tices the essence of business and secrets to success, known as tacit skills.

For investment banks, such investment in employees is costly. It also comes with a risk of possible loss of customers and market share if elite employees leave for competing fi rms. To cope with such a risk, conventional investment banks have introduced partnerships to improve employee cohesion and loyalty. It was for this reason that Goldman Sachs and Lazard struck a partnership until they went public and became corporations in 1999 and 2005, respec-tively, even though they had faced capital limitations and restrictions.

The development and widespread application of information technology, as well as structural changes in capital markets accompanying IT develop-ment and application, have led investment banks to become more concerned with capital than human resources. Rapid IT development and widespread application in fi nancial markets have greatly expanded and increased the complexity of market transactions. The information network established by conventional investment banks is being eroded as the public and investors have greater access to private information that was previously nonexistent in the information marketplace. There is also a growing number of business school programs that integrate such subjects as asset pricing and valuation techniques, making secrets that once were exclusively owned by investment banks more accessible and less mysterious simply with the help of a computer. This has presented a challenge to investment banks’ apprenticeship programs.

However, modern fi nancial markets with a great variety of fi nancial instruments and huge trading volumes pose a more challenging test of thefi nancial strength of investment banks. Increasing competition and decreas-ing commission rates are resulting in declining contributions of conventional brokerages to profi ts. Proprietary trading and investment backed by strongfi nancial strength seems to be the only way to make money and survive in fi erce competition. Unlike commercial banks, which have customer deposits as a stable fi nancial source, investment banks have to incur debts constantly and increase fi nancial leverage by fi nancing in money and repossession markets or by issuing bonds and other securitized products. Therefore, modern securi-ties fi rms build their business activities on tacit and technical skills, while money and expertise play other important roles (see Figure 2.2 ).

M&A advisory services rely on reputation and connections and have high requirements of employees in terms of tacit skills. IPO services equally rely highly on brokers’ private information network and connections. Con-versely, secondary market trading is a well‐marked technical skill‐oriented activity. Computer technology and sophisticated engineering modeling


techniques have been introduced into this market. Many transactions in thesecondary stock market today do not even involve actual human partici-pants. Computers can complete transactions automatically, once the preset conditions are met. Skills used in the fi nancial markets for derivatives (e.g.,swaps and options) and structured products are no longer tacit, and can beacquired and copied by technicians. Also, unlike activities relying on tacitskills, such trading has transaction records, even for high and ultra‐high frequency trading, in which transactions are executed thousands of times per second. Such records provide evidence that can be proved and that islegally admissible.

FUNCTIONAL ORIENTATION FOR SECURITIES FIRMS

Financial Market Service Providers

As the most important fi nancial intermediaries in capital markets, securities fi rms emerged to help companies and governments in fi nancing. For securi-ties fi rms, whose business activities have expanded from the very beginning

FIGURE 2.2 Relative Importance of Tacit and Technical Skills for InvestmentBanking Activities Source: Morrison and Wilhelm ( 2006 ).

M&A AdvisoryService

Initial Public Offerings

AssetManagement

SecondaryMarket Trading

Retail InvestmentServices

Tacit Skills

Tec

hnic

al S

kills


with acceptance of commercial paper (commercial banking activities) to current underwriting and issuance of government bonds and corporate deben-tures, fi nance has always been a fountainhead activity. For these companies, issuance of securities and debentures helps not only overcome fi nancial con-straint but also bring about added value. Good performance in capital markets can help boost reputation, which may contribute to long‐term growth. Asfor investors, they can share the profi ts generated from business growth.In this virtuous circle that involves multiple stakeholders, securities fi rmsplay a crucial role in reducing information asymmetry by establishing pri-vate information marketplaces. Although in capital markets securities fi rms bring less money to IPO companies than commercial banks do (indirectfi nance), this does not diminish the role of capital markets in allocation of resources available in the market.

In today’s U.S. market, along with structural change and increasing fi nancial products, investment banks focus less on the revenue from secu-rities issuance and underwriting (another fountainhead activity), although that revenue remains at about 10 percent of their total revenue. And unliketheir Chinese counterparts whose underwriting revenue comes mainly from the stock market (specifi cally from IPOs, additional issuance, allotments, and issuance of convertible bonds and others), large investment banks in foreign markets have more underwriting revenue from debt underwriting than equity underwriting (including IPOs, issuance of convertible bonds, and subsequent issuance). Obviously, the reason is largely that compared with the Chinese market, foreign markets have far more bond products,ranging from corporate debentures to mortgage or asset‐backed securities(see Table 2.1 ).

The Chinese capital market is different from the mature U.S. market. As China’s economy keeps growing, Chinese companies keep improving their innovation capabilities. The Chinese capital market keeps promoting and consolidating diversifi cation based on the main board, the small andmedium‐sized enterprise board (SME market), and the growth enterprise board. More companies with fi nancing needs tend to go public, and even more companies go public in international markets.

For Chinese securities fi rms, therefore, the securities underwriting busi-ness may remain thriving, regardless of IPOs, additional issuance, or allot-ment. Underwriting is clearly an investment banking activity about which Chinese securities fi rms are confi dent. However, in the largest IPO market in the world, Chinese securities brokers still get fewer contracts than major international brokers. Table 2.2 details the Chinese brokers’ net incomefrom securities underwriting in 2010.

On the other hand, in the Chinese debt underwriting market, commer-cial banks can claim a landslide win over securities fi rms in terms of central


TABLE 2.1 Top 10 Investment Banks Regarding Revenue from Securities Underwriting in 2010 (USD in millions)

Securities Underwriting Debt Underwriting

J.P. Morgan Chase 1,480.58 J.P. Morgan Chase 1,699.92

Morgan Stanley 1,443.68 BofA Merrill Lynch 1,553.98

Goldman Sachs 1,278.75 Citigroup 1,296.03

BofA Merrill Lynch 1,130.12 Deutsche Bank 1,212.78

UBS 924.98 Barclays Capital 1,144.92

Credit Suisse 907.46 Credit Suisse 1,068.52

Citigroup 803.56 Morgan Stanley 962.2

Deutsche Bank 787.7 Goldman Sachs 950.55

Nomura Securities 724.75 RBS 757.61

Barclays Capital 559.11 UBS 636.21

Total 10,040.69 Total 11,282.72

Source: Thomson Reuters.

TABLE 2.2 Top 10 Chinese Securities Brokers Regarding Underwriting ContractAmount and Underwriting Costs in 2010 (CNY in millions)

Contract Amount Rankings Cost Rankings

CICC 162,629.05 Ping An Securities 1,992.94

CITIC Securities 162,488.15 Guosen Securities 1,347.57

BOC International 108,286.73 CITIC Securities 1,275.89

Guotai Junan Securities 85,082.03 Huatai Securities 1,062.08

Galaxy Securities 80,256.66 China Merchants Securities(CMS)

935.12

UBS Securities 73,790.96 GF Securities 725.82

China Securities (CSC) 68,927.28 CICC 703.44

Haitong Securities 63,197.71 China Investment Securities 689.48

Ping An Securities 59,844.46 Haitong Securities 638.29

Guosen Securities 53,553.33 Essence Securities 521.70

China MerchantsSecurities (CMS)

46,861.02 BOC International 525.91

Total 964,917.37 Total 10,418.26



bank bills, treasury bonds, and short‐term commercial paper. Securities fi rms easily dominate corporate debentures traded in stock exchanges. Today, theincome that securities brokers earn from underwriting corporate debenturesis more than half as much as from underwriting IPOs. A growing bond market with an increasing number of well‐regulated corporate debentures is a desirable marketplace for more corporate fi nancing activities. Therefore, securities fi rms still have promising business prospects in the corporate debt underwriting market.

In addition to fi nancing services, securities brokerage is another business activity long practiced in securities fi rms. Securities fi rms acting as brokersnormally offer securities and custodial services and collect commissions on sales and purchase transactions of marketable securities (including fi xed‐income products and derivatives). So far, Chinese securities brokerage has been limited chiefl y to trading channel services, including helping customers open securities accounts, providing facilities for transactions, and offering competitive commission rates at each business offi ce. Such a profi t model may generate great profi ts in the early stages of a growing market, but homogeneity in this business model makes it very hard to main-tain stable growth and consistent progress with increasing competition and deregulation.

In May 2002, the CSRC National Planning Commission and the State Administration of Taxation (SAT) issued a Notice on Adjustment of Standard Securities Trading Commission Rates. The notice specifi ed the following:

Floating rates up to the maximum will apply to trading commis-sions on stocks (A and B shares) and securities investment funds.A commission charged against a customer by a securities com-pany (including the securities and exchange regulatory fee, stock exchange fees and other fees and charges collected by the securitiescompany on behalf of the regulatory agency, exchange and others)shall be no more than 3 percent of the transaction amount and noless than the aggregate amount of the securities and exchange regu-latory fee, stock exchange fees and other fees and charges.

The call‐off of fi xed commissions, together with a stock market down-turn (which continued until 2005) and an epidemic of misappropriation of clients’ security deposits, eventually resulted in industry‐wide losses. Thesituation did not persist after the trading volume ballooned, along with theCSRC’s escrow requirement for security deposits, the split‐share structure reform, the return of overseas‐listed Chinese blue chips to the A‐share mar-kets, the relaunch of the SME market, and the creation of the growth enter-prise board. Despite all this, securities fi rms are still fi ghting a commission


war. However, industrial restructuring seems inevitable if no change occurs in this profi t model that relies only on commissions.

Globally, the liberalization of brokerage commissions is a general trend. The U.S. securities market replaced fi xed commissions with negotiable com-missions in May 1975. After that, brokerage‐commission liberalizationspread to France, Australia, and Japan, and intense competition resulted inthe dropping of commission rates (see Figure 2.3 ).

The United States avoided the massive loss China sustained because American securities fi rms used their good judgment in such situations and adjusted their strategy and business mix. There are two business models: integrated and discount broker.

Typical examples of the integrated model include Merrill Lynch (now known as Bank of America Merrill Lynch) and Morgan Stanley. For exam-ple, Merrill Lynch introduced fi nancial advisors to the market and combined brokerage with fi nancial advisory services and asset management services.

A typical discount broker is Schwab, an online wealth management ser-vice provider. With the help of the Internet, Schwab gained rapid growth and popularity. With low transaction costs, it attracted a great number of retail investors.

FIGURE 2.3 Activity‐Specifi c Revenue Curves of Top 10 American Securities Firms (as per market value) Source: Morrison and Wilhelm ( 2006 ).

0%1980 1985 1990 1995 2000

10%

20%

30%

40%

50%

60%Commissions Trading

Fees, Asset ManagementUnderwritingOther Related to Securities Business


Such accurate positioning in competitive differentiation and market segmentation helps American securities brokers overcome the infl uence of dropping commission rates and become stronger. This is a great business lesson from which Chinese securities fi rms should learn.

Asset Securitization Capabilities

Securities fi rms also play a crucial role in asset securitization, one of the most important results of fi nancial innovation. Although the collapse of BearStearns and Lehman Brothers is inseparable from those structured fi nancial products that once brought huge profi ts and benefi ts to the companies, asset securitization does have a profound impact on modern fi nancial markets.

According to the SEC Rules for Asset‐Backed Securities (2005), asset securitization is a fi nancing technique in which fi nancial assets (in manycases less liquid themselves) are pooled and converted into instrumentsthat may be offered and sold more freely in the capital markets. Professor Frank J. Fabozzi from Yale University (see, for example, Fabozzi & Kothari, 2008 ) believes that asset securitization is a process whereby mortgage loans, installment contracts, and other less liquid assets of common characteristics are packaged into market‐oriented, interest‐bearing securities of investment value. Generally, securitized products can be divided into mortgage‐backed securities (MBS), asset‐backed securities (ABS), and collateralized debt obli-gations (CDOs), among others. Figure 2.4 shows the rationale for assetsecuritization (MBS).

Usually, when granting loans to borrowers, commercial banks are faced with certain risks over a long period. They are also required by regulatory authorities to set aside risk provisions in proportion to the loan size. Before the advent of asset securitization, loaning banks had to count on loan repay-ment and interest and could not do anything about default and payment diffi culties. However, by means of asset securitization, a bank may redivideand regroup its loans by bundling loans of the same or similar type, period,and default risk. The underlying assets are then repackaged into an assetpool and cause a special purpose vehicle (SPV) to be formed to fund the bank‐held loans and buy the underlying assets by issuing securities. In thisway, securitized assets are separated from the bankruptcy risk that may exist in asset owners. Certainly, this process also needs credit enhancement and rating. Investors invest in SPV‐issued securities and receive repayment and interest that fl ows in on a stable basis.

To cater to investors of different risk preferences, such securities may be split into tranches. For example, mortgage‐backed securities (MBS) are usu-ally split into six tranches. Figure 2.4 showed three tranches—senior, mez-zanine, and junk tranches. The senior tranche has the least risk exposure and


the lowest returns, whereas the junk tranche has the maximum risk exposure but the highest returns. The mezzanine tranche falls somewhere between the two as to risk exposure and returns. Cash fl ows usually cascade from senior to junk tranches, while loss is absorbed from junk to senior tranches.

Commercial banks are very keen on securitization of mortgage assets. Because asset securitization is an off‐balance‐sheet business activity (mean-ing it is not refl ected in the balance sheet), commercial banks can circum-vent mandatory regulatory capital requirements, reinvest the money gainedfrom the transfer of loans in new activities, and also collect certain fees andcharges in the process. As this business evolves, the subject of securitizationis supplemented with car loans, credit card receivables, student loans, intel-lectual property, carbon emission infrastructure, and many others. In other words, securitized products have been or are being developed for any asset that can generate cash fl ows in the foreseeable future. Encouraged by strong market demand, Wall Street “rocket scientists” and quantitative analysts push securitization even further. Figure 2.5 shows the notional amount of global over‐the‐counter (OTC) derivatives as of July 2011.

From Figure 2.5 , we can see that there is an enormous amount of out-standing OTC derivatives, totaling up to USD 707 trillion in notional value.

FIGURE 2.4 Rationale for Asset Securitization

Bor

row

ers

Issu

ers Special

PurposeVehicle

Und

erw

riter

s

Credit Enhancement

Credit Rating Agencies

SeniorTranche

MezzanineTranche

JunkTranche


(In contrast, the gross value for such derivatives is USD 19.52 trillion as of July 2011, according to the estimates of the Bank for International Settle-ments.) Interest rate derivatives occupy the largest portion, and interest rateswaps take the lion’s share thereof. Credit default swaps (CDS) is a prod-uct once developed to further circumvent and hedge credit risk, which hasnow gone astray from its original purpose due to speculation. During the2008 fi nancial crisis, which was triggered by a subprime mortgage crisis, the American International Group (AIG) suffered a huge loss in CDS insurance policies.

Capabilities in M&A and Reorganizationof Resources Available

Mergers and acquisitions are an important means to effectively and effi -ciently integrate resources available in capital markets. M&As may result ina synergy, economies of scale and reduction of cost per unit, helping com-panies obtain economic benefi ts of horizontal or vertical integration. Also,improvement in management and corporate governance may help eliminateineffi cient management and enhance performance.

M&As and related fi nancial advisory services are also long‐practiced business activities of securities fi rms. Modern M&A services can be tracedback to milestone integration accomplished by the John Morgan–led

FIGURE 2.5 Notional Amount of Global OTC Derivatives (USD in billions) Source: BIS Quarterly Review, December 2011.

64,698.126

6,841.283

3,196.664

32,409.444

46,543.332

FX Derivatives

Interest Rate Derivatives

Equity Derivatives

Commodity Derivatives

Credit Default Swaps

Others

553,880.052


Morgan Consortium in the American railroad industry and the iron and steel industry in late nineteenth and early twentieth centuries. What makesmodern M&A services different from similar services of Morgan’s time isthat today’s fi nancial markets offer suffi cient liquidity and a great variety of means for fi nancing. Parties to M&A deals are no longer limited to compa-nies. Private equity (PE) funds, hedge funds, asset management companies, and investment banks have started to play an increasingly important role in M&A services. In recent years, leveraged buyouts facilitated M&A deals,pushing transaction volumes to a new record high in the global market. Between January 2011 and the end of September 2011, the gross market value of global M&A transactions reached USD 1.685 trillion. Figure 2.6details the distribution of M&A transactions (sorted by industrial sectors).

M&As relate to many aspects of society (economy, politics, law, com-munity, etc.) and involve multiple stakeholders. In a bona fi de acquisition, the parties normally not only bargain the transaction price based on busi-ness and fi nancial performance and asset evaluation but also take into con-sideration regulatory and legal implications. A hostile takeover attempt mayfurther complicate the process. Therefore, a securities fi rm is capable of playing an irreplaceable role in a successful transaction.

For securities fi rms, M&A‐related services have been a business activity that requires tacit skills more than technical skills, and consequently ben-efi ts from private information marketplaces and connections. As the market evolves and the industry develops, securities fi rms no longer confi ne their roles to consultants and advisors. They are starting to invest in and assistthe parties in the whole process. For example, a securities fi rm may provide

FIGURE 2.6 Global M&A Transactions Sorted by Industrial Sectors and Calculated by Market Value (USD in millions) Source: Thomson Reuters.

Energy, Mining, andElectric Power

Manufacturing

387,013;23 percent

298,697;18 percent

203,997; 12 percent

160,031;9 percent

140,087;8 percent

494,987;30 percent

Banking

Pharmaceutical,Healthcare, and Biotech

Consumer

Others


bridge loans to the acquired party and may design complex structuredfi nancial products for the acquirer, helping it obtain suffi cient funds for the acquisition.

Even investment banks themselves are becoming diverse. Some no lon-ger play the conventional “good guy” role, choosing instead to work for hostile takeovers. For example, Morgan Stanley started in the 1970s by offering consulting services to hostile takeovers. Between the late 1970s and the 1980s, junk bonds with active promotion by the “Junk Bond King,” Michael Milken from Drexel, became unprecedentedly important in M&As. Junk bonds remain controversial among professionals and aca-demics regarding their economic and social consequences. However, there is no denying that the role junk bonds played in leveraged buyouts in the late 1980s has greatly changed corporate governance and the fi nancial market in the United States.

Compared with the active American market, the Chinese capital market seems calm. Although major mergers between large enterprises do occur, the government usually does the matchmaking. The story of a listed com-pany in fi nancial distress getting acquired by some profi t‐making business for the purpose of backdoor listing is seen more frequently in newspapers. But consensus is found in almost every case, and one rarely hears of hos-tile takeovers. With the advance of market‐oriented reforms, there is someterritory still to be explored by Chinese securities fi rms in terms of M&A advisory services.

The main difference in market activeness is the fact that Chinese securi-ties fi rms need more practice in their services and need to go further in busi-ness development. The underlying reasons are as follows:

■ Unlike public companies in the U.S. capital market, where dispersed ownership is relatively common, most Chinese listed companies areunder “one big boss,” meaning one controlling shareholder holds a con-siderable number of shares. This makes M&As subject to the wishesof the controlling shareholder, rather than the need for allocation of resources in the market.

■ Government is a controlling shareholder. This is a universal phenom-enon in government‐owned corporations. Political interests and social implications must be considered. This leads to a form of administrative intervention in resource integration that would best be left to the free market. To some extent, this makes it more diffi cult for securities fi rmsto act.

■ Chinese regulators retain tight control over the business. A great deal of fi nancing and fi nancial products that are available in the fi nancial mar-kets in developed countries are not yet available in the Chinese market.


■ Obviously, there are also cultural factors. Conservative Chinese culture has a deep infl uence on the Chinese people and public opinions. To some extent, this makes hostile takeovers unworkable, even though thatkind of larger‐than‐life transaction may help improve management effi -ciency and corporate governance.

Wealth Management Capabilities

Wealth management services appeal to high‐net‐worth individuals and large investors. A service provider employs professional wealth advisors to tailor fi nancial plans to the needs of customers. Wealth advisors defi ne, track, and adjust as appropriate the portfolios of assets and select suitable fi nancial products for the purpose of infl ation‐proof wealth protection and creation. Securities fi rms are not alone in providing wealth manage-ment services. They compete against asset management companies and commercial banks, as well as public funds, PE funds, and hedge funds. Asset management works along the following two mainstream business models:

1. Business model A: Internalize asset management activities into a broker-age (e.g., investment advisory, cash management, and collective wealth management services).

2. Business model B: Form a separate legal entity for asset management activities.

Business Model A Merrill Lynch (BofA Merrill Lynch) is a typical case of business model A. Its global wealth management department is responsiblefor wealth management services and is further divided into a global private client (GPC) group and a global investment management (GIM) group. The GPC group serves high‐net‐worth clients, providing them with conventionalinvestment products. The GIM group offers investment opportunities in hedge funds and other alternative investments and has also managed Merrill Lynch’s stake in BlackRock since the merger between BlackRock and Merrill Lynch Investment Managers (MLIM) took place.

For Merrill Lynch, separation strategy is the key to success. Based on the conditions of investable assets, Merrill Lynch offers specifi c target custom-ers with specifi c target services. It also provides professional back offi ce sup-port to customers at each level. For example, private wealth advisors serve ultra‐high‐net‐worth clients with more than USD 10 million in assets; fi nan-cial advisors serve high‐net‐worth clients with assets between USD 100,000 and 10 million; and the fi nancial advisory center offers support to individual investors with less than USD 100,000 in assets.


In addition to professional segmented services, Merrill Lynch also provides clients the option of a variety of its own and third‐party services and investment and wealth management products. These optional services include the following:

■ Conventional commission‐based broker services and online securities brokerage

■ Wealth management services ■ Investment advisory services (e.g., services offered by Merrill Lynch Consulting, an independent asset management company that managesasset accounts and delivers a range of specialized products)

■ Mutual funds, closed‐end funds, and exchange‐traded funds (ETF) that cover multiple industries, regions, and types

■ Deposit and cash management products (including Cash Management Accounts, Beyond Banking, and Visa card accounts)

■ Retirement plans and pension products, including IRA and 401(k) ■ Trust schemes ■ Consumer loans, small business loans, mortgage loans, insurance and annuity products, and alternative investment products

■ Financial planning (including full‐coverage and specifi c fi nancial products) 3

Business Model B Business model B works in a similar way to asset manage-ment companies and PE funds. A securities fi rm may promote and manage a fund directly and may also act as trustee of a fund, helping the client man-age the fund and collecting management fees and performance fees. Manyinvestment banks, such as Goldman Sachs, Morgan Stanley, Barclays Capital, and BofA Merrill Lynch, are today widely engaged in asset management. They manage assets that are even higher than some well‐established fund management companies such as Fidelity Investments and Vanguard Group.

Chinese securities fi rms are falling far behind fund and asset manage-ment companies in terms of size of assets and the variety of products. Thecollective asset management plans available at securities fi rms mainly con-sist of restrictive and nonrestrictive plans. Restrictive plans are subject tospecifi c provisions regarding investment deals and ratios and invest largely in fi xed‐income securities other than equity. Nonrestrictive plans are not bound by any provisions on investment preference, but usually set higherthresholds, promise higher returns, and carry higher risks. As of November2011, nearly 60 securities brokers (about 60 percent of all brokerage houses

3 See Merrill Lynch Factbook (2007).


in China) have offered their own wealth management products, and eachhas begun to defi ne its own style by specializing in one or a few products. 4

CHANGE OF THE CHINESE DEPOSITORY SYSTEMFOR SECURITY DEPOSITS AND HOW CHINESE SECURITIES FIRMS FUNCTION

Misappropriation of Clients’ Security Deposits by Securities Firms and the Industry-Wide Crisis

Generally, modern securities trading is subject to multilevel clearing and settlement. A depository and clearinghouse offers corporate clearing services (also known as primary clearing ) to securities fi rms and other clearinghouse gparticipants as to capital and securities. Securities fi rms complete secondary clearing with their customers (i.e., investors). Multilateral netting is applied to the primary settlement where the clearinghouse, as the central counterparty to both buyers and sellers, offsets receivables against payables in all transac-tions of each clearinghouse participant and settles with participants at the net fi gures. This method greatly reduces the workloads and the need for funds in the clearing and settlement, thereby reducing the need for collateral.

The secondary clearing is on a transaction‐by‐transaction basis. Securi-ties fi rms complete, instead of netting, full‐amount clearing and settlement with investors in every transaction. Before any transaction, an investor mustmake a security deposit available to the full amount of transaction. After the transaction, the balances of capital account and securities account changeaccordingly to refl ect the deal. This multilevel clearing and settlement system may result in a considerable amount of clients’ money staying in a securitiescompany’s account. If left unsupervised, that money (i.e., funds available in client clearing accounts) could be easy‐to‐access ideal funds for misappro-priation should the securities company face fi nancial strain.

In the prereform custody mode, securities fi rms accessed those funds in client clearing accounts by setting up money ledgers and asset ledgers. Secu-rities fi rms were prohibited from misappropriating client security deposits. However, regulators and custodian banks had no access to the information of a client’s asset portfolio. Therefore, they could not check the client’s secu-rity deposits by cross‐referencing general and subsidiary ledgers. This under-mined the enforcement of such a prohibition and resulted in uncontrollablebreaches. Banks were also less motivated to supervise detail records main-tained by securities fi rms concerning funds in client clearing accounts, which gave securities fi rms free rein for misappropriating such money.

4 See Tang ( 2011 ).


A Case Study of Misappropriation of Client Security Deposits by Chinese Securi-ties Firms After 2001, the Chinese securities market fell into a persistent downturn and investors increasingly withdrew their money from the stock market. A misappropriation scandal was exposed in a security fi rm that depended on a single‐line profi t model, did poorly in risk management, and faced an insuffi cient supply of funds. Between the end of 2003 and thefi rst half of 2004, the industry‐wide loss for several years on end led to the exposure of multiple, long‐accumulating, risky practices. Breaches included misappropriation of client security deposits, noncompliance with CSRCrules in wealth management services, and market manipulation. For the fi rst time after the establishment of the Chinese securities market, securities brokers faced an industry‐wide crisis. Investors lost their confi dence in thewhole industry. Information about securities fi rms that received administra-tive disposition by the CSRC disclosed that misappropriation of securitydeposits was prevalent across the industry. Many brokers drove themselves to a hopeless situation with massive distressed debts as a result of such misappropriation.

In August 2002, Anshan Securities became the fi rst broker to have its broker’s license revoked. Later, Changjiang Securities, Xinhua Securities, and many others received administrative disposition. By the end of 2006, 30 securities fi rms received administrative disposition,5 including Minfa Securities (for cumulative misappropriation of CNY 3.0085 billion in 68 unauthorized transfers between May 1997 and April 2004) and Dapeng Securities (for cumulative misappropriation of CNY 1.65 billion as of December 31, 2004).

In this crisis, Southern Securities presented the most typical case. Southern Securities Corp. (formerly a limited company) was incorporated on December 21, 1992, having a registered capital of CNY 1 billion. Its founding members included the Industrial and Commercial Bank of China (ICAC), the Agricultural Bank of China (ABC), Bank of China (BoC), China Construc-tion Bank (CCB), Bank of Communications (BoComm), and the People’s Insurance Company of China (PICC). More than 40 well‐known Chinese enterprises also made capital contributions. After an increase of share capital in February 2001, Southern had a registered capital of CNY 3.45 billion, becoming a “giant” in the Chinese securities market. However, due to illegal practices and misappropriation, Southern shut down its business by order of the authorities in 2005. It misappropriated more than CNY 8 billion from individual investors, and owed large investors up to CNY 12 billion.

When the market was doing well in 2000, Southern Securities entered into many wealth management contracts paying guaranteed minimum rates

5 Xia ( 2006 ).


of return. This led Southern to its fi rst step in the increase of share capital, and also paved the way for massive indebtedness. After the second half of 2001, as the stock market slumped, Southern fell deeper in debt and rumors of its default started to spread. On January 19, 2002, Southern obtained the CSRC’s approval for an increase in share capital and became a corporation.

In October 2003, a massive credibility crisis broke out against the cor-poration. Customers swarmed in to redeem principal and claim returns on wealth management contracts. Back then, client security deposits with Southern (amounts available in cash only) added up to about CNY 8 billion,which happened to be approximately the same amount as the wealth man-agement contracts. Southern decided to misappropriate that money to repay the principal to customers who terminated wealth management contracts.

On January 2, 2004, the authorities took over Southern for misappro-priation and other illegal practices. In February 2005, the People’s Bank of China (PBC) offered a refi nance plan worth more than CNY 8 billion to help Southern repay the misappropriated money and maintain functionaloperations in brokerage. But on April 29, 2005, the CSRC shut down Southern, separated out brokerage and investment banking, and repack-aged it for public sale. On August 1, 2005, CCB Investment announced that it had acquired Southern’s investment division, as well as 74 business offi ces, at a price of CNY 350 million. Later, on September 28, 2005, CCB Investment Securities Co. Ltd. was incorporated with a registered capital of CNY 1.5 billion. This regrouped and closed the curtain for Southern Securities.

In addition to Southern Securities, the PBC also offered refi nance plans to Anshan, Xinhua, and Hantang, in the amounts of CNY 1.5 billion, 1.45 billion, and 4 billion, respectively, to help them repay misappropriated funds. This was an attempt to maintain social stability and shelter the securities market from systemic risk. In total, PBC’s refi nance plans for the debts owed by failed securi-ties fi rms to individual investors were worth CNY 61.7 billion.6 According to a CSRC bulletin, between 2000 and 2005, many securities fi rms were shut down and placed into the hands of receivers for cash fl ow problems. Most of them misappropriated client security deposits. The list includes Southern, Deheng, Hengxin, Zhongfu, Hantang, Minfa, Liaoning, Dalian, Zhuhai, Anshan, Henan, Fuyou, Hainan, Xinhua, Yunnan, and Jiamusi, among others. Table 2.3 lists the preliminary statistics of these acts of misappropriation.

Case Study: The Infl uence of Margin Financing on Leverage in American Investment Banks As far as brokerage is concerned, services offered to largeinvestors contribute to large profi ts in American and European securities

6 Ling ( 2005 ).


brokerage houses. Large investors are wooed by investment banks because fi nancially capable large investors engage in block trading, which results in generous commissions for investment banks. As brokers, investment banks are allowed to use client assets (such as cash and securities) in margin accounts to offer fi nancing services (e.g., asset‐backed fi nancing and hypothecation). Investment banks thereby benefi t by diversifying sources of revenue.

These services offered to professional investors, known as prime brokerage,are very common in American and European fi nancial markets. Targeted clients are usually hedge funds and private equity fi rms that manage awealth of assets. Hedge funds prefer investment banks to commercial banks because of more favorable terms, a wider range of collateral options (whichhelps improve liquidity), and well‐established reputations for expertise and good practice.

Margin fi nancing bears much resemblance to the epidemic of misap-propriation of security deposits in the Chinese capital market prior to 2005. Securities fi rms use margin fi nancing to access clients’ cash and securities, facilitating their own business and indirectly increasing their fi nancial leverage. Margin fi nancing helps bring about high capital effi -ciency by the same principle commercial bank loans follow. For securities fi rms, cash or securities are always available in the account, which can be used to satisfy the needs of borrowers. Securities fi rms can increase the turnover rate for higher capital effi ciency. They can also benefi t by earning a profi t and by charging fees for services. However, much like a bank run on commercial banks, securities fi rms with liquidity problems inevitably suffer fatal blows when clients line up to withdraw their assets for safety

TABLE 2.3 Statistics of Misappropriation of Funds in Clients’ Clearing Accounts (CNY in millions)

Guangdong Securities 6479.349 Hebei Securities 570.4588

Zhongke Securities 6319.809 Wuzhou Securities 409.70

Deheng Securities 3256.474 Kunlun Securities 327.20

Minfa Securities 3008.50 Taiyang Securities 322.80

Hantang Securities 2413.715 Northwest Securities 278.9655

Dapeng Securities 1650.00 Xing’an Securities 252.9267

Min’an Securities 577.00 Yunnan Securities 154.9859

Wuhan Securities 572.00 First Securities about 100.00

Note: Security deposits are considered misappropriated if cash available or an over-draft is taken out of the account. Source: CSRC web page, www.csrc.gov.cn/pub/zjhpublic.

http://www.csrc.gov.cn/pub/zjhpublic


concerns, because of rearrangement of clients’ cash and securities. This was one trigger in the 2008 fi nancial crisis in the United States, in addition to the underlying cause of the industry‐wide loss in the Chinese securities industry in the early 2000s.

Professionals and academics are still in heated debate about the causes of the 2008 fi nancial crisis. They point to a wide range of factors, from thefederal government’s low interest rate policy since 9‐11 to fi nancial deriva-tives (considered to have gone too far). Those criticisms and accusations are warranted. But prime brokerage helped securities fi rms increase theirfi nancial leverage in a disguised way, and fi nally gave these companies a devastating blow when liquidity problems worsened in the market.

Bear Stearns was founded in 1923 and was once the fi fth‐largest invest-ment bank on Wall Street. It maintained a wide range of activities, includ-ing corporate fi nancing services, M&A advisory services, securities research, private client services, asset management, and custody services, as well as sales and trading of securities, FX, futures, derivatives, and fi xed‐incomeproducts. It also provided hedge funds, brokers, and investment advisors with fi nancing, securities lending and clearing services, and technical solu-tions. Its prime brokerage clients included Renaissance Technologies, D. E. Shaw, and other hedge fund giants. As one of the main players, Bear Stearns once made quite a profi t in the CDO market.

When the U.S. home mortgage market started to respond to rising interest rates, mortgage default rates increased signifi cantly. In June 2007,affected by the widening subprime mortgage crisis and the sharp fall in value of ABS, CDOs, and other bonds, Bear Stearns announced the liqui-dation of two hedge funds, which marked the start of the countdown tothe collapse of the company. As subprime mortgage–related assets further depreciated, Bear Stearns still held a large number of positions in the sub-prime mortgage market. It was faced with liquidity strains as a result of signifi cant devaluation of CDO collateral. As the problem got worse, BearStearns’ prime brokerage clients started to withdraw cash assets from their Bear Stearns accounts. In March 2008, Renaissance Technologies, a hedge fund widely known for its quantitative investments, withdrew USD 5 billion. Other funds followed suit. Within two days, up to USD 17 billion was with-drawn from Bear Stearns. Having failed to get an extension on loans from the market counterparty, Bear Sterns could not borrow from the reposses-sion market due to liquidity problems. The situation was hopeless. In thefi nal act, with the federal government’s help, J.P. Morgan Chase acquired the company.

The fall of Bear Stearns was due to heavy investment in nonperforming loan–related derivatives that resulted in asset depreciation. However, the sudden withdrawal of considerable assets by major institutional investor


clients at a crucial moment hastened the collapse of the company, which had lost its borrowing power. One underlying cause of a run on investment banks is prime brokerage. Securities fi rms make use of clients’ cash and securities to offer asset‐backed fi nancing and hypothecation services. In this way, clients’ assets are used in a disguised form to help securities fi rms facilitate their business and greatly increase their invisible leverage. It can be benefi cial in a booming market. But if the securities fi rm faces liquidity problems, clients may soon line up to withdraw the assets they deposited in the securities fi rm. They rush to do so for better asset security and in consideration of “fi rst come, fi rstserved” rules. In regard of an established long‐term relationship, some clients refrain from withdrawing their assets, but they usually ask for higher margins, which can make matters even worse. As securities are rehypothecated, the securities fi rm has to turn to the repossession market, commercial paper market, or mutual fund market. However, borrowing money in these markets would be diffi cult because of spreading rumors. The only remaining option is to realize other available assets, despite huge losses. In Bear Stearns’s case specifi cally, the company suffered severe depreciation of portfolio securities, leaving it with no choice but to accept J.P. Morgan Chase’s acquisition offer. The collapse of Lehman Brothers was a similar story. In the end, the clearing bank’s margin call for cash became their last straw.

Chinese Depository System Reform

Faced with the persistent problem of misappropriation, which presented a real threat to the survival and development of the securities industry, the Chinese regulatory authorities were determined to put an end to such mis-appropriation from the source. In addition to having a separate depository,high‐risk brokers are mandated to place clients’ security deposits in escrow.After being put into the hands of the administrative receiver in 2004, South-ern Securities became the fi rst brokerage house subject to the escrow mode.Section 139 of the Securities Act (revised in 2005) provides that “the funds in a securities fi rm client’s clearing account should be deposited into a sepa-rate account in the client’s name with a commercial bank.” The Act offers a legal basis for the escrow depository system by specifying that security deposits are the property of clients, instead of a liability of the securities fi rm. This helps protect investors’ interests. The revised Securities Act also provides that “a securities fi rm shall not regard the funds and securities in a client’s clearing account as its own assets. It is prohibited to misappropri-ate such funds and securities in any form. Such funds and securities shall not be included in the assets of a securities fi rm when it goes into bank-ruptcy or liquidation. Except for the collection of the client’s debts or othercircumstances as provided by law, such funds and securities shall not be


seized, frozen, deducted or subject to any enforcement order.” There is an additional provision that “the funds in a securities fi rm client’s clearingaccount should be deposited into a separate account in the client’s namewith a commercial bank.” This also expressly establishes the commercial bank’s status as custodian.

In the escrow mode, a custodian bank opens a separate security deposit account in the investor’s name, as instructed by the investor. The bank con-nects such an account with the investor’s securities trading capital ledger and bank settlement account. Securities fi rms no longer provide clients withcapital deposit and withdrawal services. With the money outside of the secu-rities clearing account to be directed into the bank settlement account only,the investor can only access a security deposit via bank‐securities account transfers. In this way, security deposits are placed in closed operation. The custodian bank opens a general account for the securities fi rm to hold all the security deposits paid by clients. The securities fi rm may open any num-ber of subaccounts with any branch of the bank for business needs. Thataccount only pays money upon an investor’s withdrawal request, or for securities trading and related commissions and fees. This follows the prin-ciple that “the broker manages securities and the bank manages money.”Securities fi rms serve clients in securities trading, shares management, and securities clearing and settlement. Custodian banks manage general account and subsidiary ledgers of security deposits. They also offer clients depositand withdrawal services. They provide securities fi rms with clearing andsettlement support for corporate capital settlement between securities fi rms and the depository and clearing company and OTC settlement participants,keeping securities fi rms’ capital separate from clients’ security deposits. 7

The escrow depository system enables investors to check their capital balance with either the custodian bank or the security fi rm. The bank sendsout a statement on a regular basis to the investor for the capital manage-ment account and offers inquiry services on the balance in the account, as well as the (capital) information of the capital account with the securi-ties fi rm. Securities regulators can oversee the investor’s security deposits by comparing business data from the securities fi rm and capital managementaccount data from the custodian bank. Investors can also monitor their security deposits by comparing capital data from the bank against that from the securities fi rm. Such escrow arrangements help build a fi rewall betweensecurities fi rms and clients’ money, eliminating the opportunity for securities fi rms to misappropriate clients’ security deposits.

The escrow depository system has proved to be as effective as expected. Although the Chinese stock market had an abrupt fall in 2008 (SSE composite

7 Hou, Lijuan, and Xiaoxian ( 2007 ).


index slumped from over 6,000 to 1,600), no securities fi rm fi led for bankruptcy. Among other factors, the overall improvement initiative for brokers, with insti-tutional measures for security deposits in particular, can take credit for that. 8

INSTITUTIONAL CHANGE AND FUNCTIONAL EVOLUTIONFOR CHINESE SECURITIES FIRMS—AN ANALYSIS WITH PARTICULAR INTEREST IN THE FUNCTIONOF AN UNDERWRITER’S GOODWILL

Institutional Change

The Impact of Securities Firms as Public Companies Institutional change could help us understand the impact of fl otation on the goodwill of securities fi rms.

The fi rst Chinese securities fi rm, Shenzhen SEZ Securities Co., was established in 1987. Back then, in the general climate of a planned economy,protection policy and administrative monopoly imposed strict restrictionson market access and posed a huge impediment to the development of Chinese securities fi rms. Organizationally, all securities fi rms were solelyowned by the government.

With the advance of commercial process and market‐oriented reform of Chinese fi nancial institutions, and after the enactment of the Companies Act of 1994 and Financial Institutions Regulations, securities fi rms started toregard a limited liability company as the fi rst‐choice organizational model for reorganization. Around 1997, some securities fi rms reorganized themselves as companies limited by shares for the purpose of increasing share capital.

After China acceded to the WTO in 2001, Chinese fi nancial institu-tions faced increasing competitive pressure from foreign competitors. The economies of scale and scope were no longer the only competitive advan-tage. Securities fi rms began competing in capital and corporate governance structure. Chinese securities fi rms were largely less competitive as a result of sole ownership by the government. In 2006, regulators put forth the RiskControl Indicators‐Based Regulatory Measures for Securities Firms and the Notice of Standard Computation of a Securities Firm’s Net Capital, con-fi rming net capital as the core risk control indicator. Thus, many securities fi rms chose to go public to approach more investors than they had in equity participation. They aimed to expand capital, meet net assets requirements,and improve corporate governance structure.

IPOs in China are subject to strict regulatory endorsement and profi tability criteria. Therefore, securities fi rms face diffi culty and uncertainty getting an IPO approved, since their performance is dependent on how the market is

8 Xiaoqiu ( 2010 ).


doing. Backdoor listing thus has become a popular choice, whereby securities fi rms may face less pressure with regard to fi nancial criteria.

Recently, the CSRC attempted to regulate backdoor listing. It made a decision to modify provisions on major asset restructuring and related fi nancing packages in listed companies. Although this decision does not apply to fi nancial institutions for the time being, there seems to be increas-ing uncertainties for securities fi rms to take advantage of backdoor listing.

It is not diffi cult to fi nd that institutional change has brought about self‐improvement and self‐growth of the Chinese securities fi rms. Because of strict regulatory endorsement and profi tability criteria for IPOs, securities fi rms qualifi ed for fl otation are usually in better business conditions. This is also true in backdoor listing, in which a restructuring plan is also subjectto the CSRC’s examination and approval. As public companies, securities fi rms could further increase net assets and improve corporate governance structure, incentive mechanism, and business performance, thus helping bet-ter the services offered. Therefore, fl otation can help securities fi rms enhancetheir reputation and help the cause of goodwill.

Classifi ed Oversight and the Impact According to the CSRC’s Classifi ed Over-sight Regulations for Securities Firms (revised in 2010), securities fi rms are classifi ed according to risk management capabilities, market competitive-ness, and ongoing compliance. Specifi cally, securities fi rms are subject to the assessment of risk management capabilities in terms of capital adequacy,corporate governance, risk monitoring, information system security, client protection, and information disclosure. They are subject to the assessmentof market competitiveness in terms of brokerage, underwriting and sponsor-ship, asset management, cost control, and innovation. They are assessed for ongoing compliance and are subject to criminal penalties and regulatory enforcement or disciplinary sanctions.

Securities fi rms are classifi ed on an annual basis into 11 grades of fi ve categories, as follows:

1. A (AAA, AA, A) 2. B (BBB, BB, B) 3. C (CCC, CC, C) 4. D 5. E

The CSRC assessment adds or subtracts points from a benchmark score of 100 points based on the performance of the securities fi rm in eachsubassessment. The 100 point benchmark is, supposedly, what a normally functioning fi rm would receive in the assessment. The assessment results


indicate which category and grade the fi rm will receive. In terms of risk management capabilities, a category A fi rm is among the most competitive, well able to control the risks of new business or products. A category B fi rm fallsabove the industry average, well able to control the risks of business expansionin a changing market. A category C fi rm has risk management capabilities that match its existing business. A category D fi rm is less capable, exposedto potential risks that may be above the fi rm’s risk tolerance. A category E fi rm faces real risks, more than just potential ones, and measures of risk disposition have been taken.

Such classifi cation helps goodwill serve its purpose for securities bro-kers in the following two aspects:

1. CSRC differentiates between securities fi rms according to risk manage-ment capabilities. It takes different regulatory measures and exercises diffe rential oversight accordingly. Rational allocation of regulatory resources and improvement of regulatory effi ciency contributes to the sustainable growth of securities fi rms. This helps boost the image of the industry and promotes goodwill to the benefi t of brokers in all categories.

2. Classifi cation based on risk management capabilities and market com-petitiveness provides an objective assessment of all securities fi rms. Afi rm in a better category and grade can benefi t in corporate image and reputation, allowing goodwill to quickly fulfi ll and improve.

Functional Evolution—An Analysis with Particular Interestto the Function of an Underwriter’s Goodwill

How the Function of Goodwill Is Shaped The functionality of a market is closely related to its information dissemination mechanism. A great deal of information asymmetry exists between the issuer and investors in the securities‐issuing market, particularly in the IPO market. Booth and Smith( 1986 ) discussed the subject and presented a “certifi cation hypothesis.” They believe that the issuer owns real information about fi nancial andbusiness performance, and therefore has a more accurate expectation of future growth prospects and cash fl ows. However, investors do not haveaccess to such information. As a result, if the issuer announces an issue priceon its own, the information asymmetry between investors and the issuerleads to “adverse selection.” To reduce information asymmetry, the issuer needs a trustworthy third party to disseminate information to investors and make them see that the price set by the third party refl ects the true value of the issuer’s securities. As the third party, an underwriter is an information producer who fulfi lls due diligence, completes corporate valuation, and passes such information to investors. The underwriter has some information


superiority over investors and helps reduce information asymmetry betweenthe issuer and investors.

However, a credibility problem with the underwriter as a third party may still exist. A goodwill mechanism plays an important role here to help reduce moral hazard and improve the credibility of the underwriter, whois responsible for participating in the IPO/issuance, valuing the company, and determining an appropriate issue price. Under such a mechanism, areputable underwriter would feel more favorably disposed toward reaching a price that better refl ects the true value of the company. Overvaluation could lead to failure in subsequent underwriting activities and damage to goodwill for investors, who would learn from their mistakes and only buy low in the future.

If the function of goodwill is sound, the management of an IPO com-pany that anticipates good business performance in the foreseeable future will likely hire a reputable underwriter at a relatively higher price for bet-ter information accuracy. Management would feel that such an underwriterwould send a positive signal to investors. An underwriter of good reputa-tion, for the good of its own goodwill, would also choose high performance companies as clients. On the other hand, an IPO company with low antici-pation of business performance in the foreseeable future would be reluctantto hire a reputable underwriter, worrying that the information revealed by the underwriter could tell an unpleasant truth. The reputable underwriter would also be less motivated to take the offer for his or her own reasons. In the end, a high performance IPO company would hire a reputable under-writer, knowing that investors would be able to judge a company’s invest-ment value by the goodwill of the underwriter the company hires.

Historical Performance of the Function of Goodwill Existing studies show that goodwill does not serve Chinese securities fi rms well in their underwrit-ing activities. An underwriter’s goodwill can effectively help the underwriterrefrain from opportunistic behavior and improve its credibility. Chinese researchers have studied the link between the performance of IPO compa-nies and the goodwill of their underwriters in both Shanghai and Shenzhen stock markets. The following is a sample of their fi ndings:

■ Tian Jia and Zhan Weihua ( 2000 ) formed their studies on almost all the IPO data available to them and found that there is no signifi cant rela-tionship between the goodwill of underwriters and IPO pricing.

■ Hu Xuyang ( 2003 ) selected a sample of 578 listed companies at the end of the fi rst half of 2001 for a study of the relationship between the goodwill of underwriters and IPO pricing. They found that goodwill does not play a signifi cant role in the relationship.


■ Based on the data of IPO companies that went public in the A‐share markets between July 1994 and October 2003, Liu Jianghui and LiuXiaoliang ( 2004 ) conducted an empirical study of the relationship between the goodwill of underwriters and IPO underpricing and found that there is no signifi cant relationship.

■ Based on the data of IPO companies between 1991 and 2003, Liu Jianghui, Yin Bocheng, and Yi Xingjian ( 2005 ) studied the performance rankings of the underwriters and the quality of the IPO companies and found that there is no signifi cant relationship between the goodwill of underwriters and the quality of IPO companies.

■ Guo Hong and Zhao Zhenyu ( 2006 ) conducted a period study with stock data between 2000 and 2003 and found that the goodwill of underwriters has no signifi cant infl uence on IPO pricing and initial returns. There is, however, a signifi cant positive correlation between thegoodwill of underwriters and long‐term IPO returns. Xu Haoping and Luo Wei ( 2007 ) studied the relationship between the goodwill of under-writers and the IPO underpricing between 2002 and 2004 and found that an underwriter of good practice and a high market share can helpsignifi cantly reduce the IPO underpricing.

■ Huang Chunling and Chen Zhengrong ( 2007 ) conducted a period study on goodwill mechanism and found that the quality of IPO companiesand their IPO initial returns are not signifi cant explanatory variables for the goodwill of underwriters.

■ Guo Haixing, Wan Difang, and Wu Zuguang ( 2011 ) studied the IPOs of 82 GEM listed companies and found that the goodwill of underwritersstill does not play a signifi cant role in the GEM.

Most early studies show that there is no signifi cant relationship between the goodwill of underwriters and the quality of IPO companies. Based on the mechanism behind how the function of an underwriter’s goodwill isshaped, goodwill seems to serve its purpose in a sound market mechanism. At the very beginning, the Chinese securities market and securities fi rms were still under the shadow of a planned economy. Along with institutionalchanges, the Chinese market mechanism has been improving. It would seem that the absence of any signifi cant evidence in early times has to do with the Chinese market system and the corporate institution of securities fi rms.

Effective fulfi llment of the function of an underwriter’s goodwill depends on the evolution of the market system and corporate institution. Before 2001, IPOs in the Chinese securities market were subject to administrative approval. Back then, the securities market was something new with green participants and a spotty mix of listed companies, and without sound legislation. Under the administrative approval system, the government exercised administrative


quota allocation. The central government dictated the quota of issuance or target number of IPO companies. Local government recommended candidates accordingly. The government also determined the number of shares to be issued and the issue price. As for pricing, the CSRC defi ned the price based on earnings per share (EPS) and a price‐to‐earning (P/E) ratio, choosing the specifi c P/E ratio. Under this system, it was the government that allocated resources and underwriters were functionally distorted. The P/E ratio for IPOs was no longer fi xed after March 1999, when the CSRC released the Guidelines for IPO Pricing Analysis Report (trial version). The guidelines specifi ed that a pricing analysis report agreed to by the issuer and the underwriter would provide an important basis for IPO pricing.

Since 2001, IPOs have become subject to regulatory endorsement other than administrative approval. Under the regulatory endorsement system, government approval is no longer a prerequisite for IPOs. A company canapply for an IPO having satisfi ed requirements of the Securities Act and Companies Act. An issuer arises from an underwriter’s recommendation,instead of from an administrative process. The regulatory agency specifi es eligibility criteria and IPO requirements in regulatory laws and rules. Anunderwriter selects and recommends an eligible IPO company. The IPO review panel examines and endorses an IPO application as appropriate.

Before 2004, each underwriter would have access to a certain number of “channels” and could use a channel to recommend only one company ata time. Such a process helped put the IPO number and tempo under control. The regulatory agency also kept a rein on each underwriter by keeping score of irregularities, suspending services, and decreasing the number of chan-nels, among other ways.

After 2004, sponsorship came about. A sponsor is required to assist an IPO company through the issuance and underwriting process. The spon-sor verifi es the information provided by the company for authenticity and integrity. The sponsor also helps the company establish appropriate disclo-sure rules and continues to offer sponsorship service afterward. The sponsoreven accepts joint and several liability in case of a problem.

When IPOs were subject to administrative approval, whether an IPO company was allowed to go public depended on whether the IPO was in line with the interest of local government. The quality of the company didnot seem to matter. Therefore, underwriters mainly competed in how to get a bigger quota and more projects.

Once IPOs became subject to regulatory endorsement and availability of channels, regulatory measures such as scorekeeping of irregularities, suspen-sion of service, and reduction in number of channels compelled underwriters to concentrate on the quality of IPO companies. This helped underwriters to some extent refrain from opportunistic behaviors and improved the


underwriting practice. Due to limited availability of channels, however, underwriters were less motivated to expand their business.

After sponsorship was introduced, underwriters as sponsors became responsible for the quality of IPO companies. They now accept liability over a long period. Any opportunistic behavior with intent to mislead investors leads to huge business risk. Therefore, sponsorship is an effective constraint mechanism. In its early stages, the Chinese sponsorship system had many defects, including fl aws in sponsor eligibility audit and a low level of mar-ketization for securities issuance. Those defects placed some obstacles in theway of goodwill to serve its purpose. Today’s sponsorship system is much better, and actually facilitates the fulfi llment of the function of goodwill.

Does goodwill serve any purpose in the Chinese stock market with the development and improvement of the securities market system? The follow-ing empirical study focuses on the function of an underwriter’s goodwill and builds on the latest market data. It may provide an answer.

An Empirical Study of the Function of a Securities Underwriter’s Goodwill

Hypothesis and Sampling

Regression Model The following model is designed to check, by regressiontesting, the functional activeness of an underwriter’s goodwill:

IPO b b GoodwillVariables b ControlVariables= + + ∑∑0 i j* *

The function of an underwriter’s good-will is mainly refl ected in the accuracy of the valuation of an IPO company,which can be checked with the fi rst‐day IPO premium rate. The lower the premium rate, the better the valuation. A low premium rate could indicate that the underwriter is good at disseminating information to investors and its valuation is well‐accepted by investors. On the other hand, a high premiumrate would mean unsatisfactory fulfi llment of the function of goodwill.

In the following formula, IPO represents the fi rst‐day premium rate, P Tthe fi rst‐day closing price, and P t the issue price:

IPO 1n /T= ( )P Pt

The following fi ve indicators are selected as goodwill variables in this study:

1. Region: Underwriters are divided into nationwide and regional busi-nesses based on the location of their registered offi ces. An underwriter


with a registered offi ce in Beijing, Shanghai, Guangzhou, or Shenzhen is considered a nationwide business and is assigned a value of 1. An underwriter whose registered offi ce is anywhere else is considered a regional business and is assigned a value of 0. A nationwide business has a valid reputation, while the reputation of a regional business is not signifi cant.

2. Listing: Underwriters are divided into listed and nonlisted compa-nies. A value of 1 is assigned to a listed company and 0 to nonlisted company.

3. Ranking: An underwriter in category A (AAA, AA or A) according to theCSRC’s Classifi ed Oversight Regulations for Securities Firms (revised in 2010) has a valid reputation and is assigned a value of 1. Any othercategory is assigned 0.

4. Securities underwriting volume: According to the Securities Associa-tion of China’s (SAC) underwriting‐volume‐based annual underwriter rankings (2008 to 2010), the top 18 in each of the three years (about one‐third of the total of 55 on annual average) are selected. By cross referencing, we cross out the same underwriter when it shows up for the second or third time, to reduce the fi nal number to 28. We believe that the 28 underwriters have an advantage over the others in regard to goodwill, and therefore a value of 1 is assigned to them, and 0 to others.

5. Market share: We work out the subtotals of all lead underwriters for sample listed companies. We believe that an underwriter whose under-writing is above the average in regard to the number of IPO companieshas a market share that may contribute to its goodwill and therefore has a reputation. A value of 1 is assigned to these underwriters and 0 is assigned to the others.

All the goodwill variables are dummy variables. An underwriter that is assigned a value of 1 is considered to have a reputation and the capabilities to make an effective valuation of an IPO company. The IPO premium rate on the securities of an underwriter should be lower than the premium rates on other securities. For the purpose of explaining the IPO premium rate, wealso select the following four control variables:

1. Previous year’s return on equity (ROE) 2. Size of public offering 3. Number of years between incorporation and IPO 4. First day’s logarithmic return (calculated the same way as the IPO pre-

mium rate)


In addition to these four variables, we also add to the control variables the two dummies: “year” and “industry” (as per the CSRC’s industrial clas-sifi cation standards). See Table 2.4 for details.

Sample and Data We split the A‐share market into the main board, small and medium‐sized enterprise (SME) board, and GEM and then create three subsamples for respective regression testing in the following two periods: one period between October 30, 2009 (the offi cial launch of the GEM)and November 25, 2011, for the GEM sample; and one period between

TABLE 2.4 Table of Independent Variables

Independent Variables Abbreviation Defi nition

GoodwillVariables

Region DISTRICT Underwriters divided intonationwide and regionalbusiness, according to thelocation of registered offi ce

Listing PUBLIC Divided into listed and nonlistedcompanies

CSRC Ranking

LEVEL As per the CSRC’s securitiesbroker rankings (2010)

UnderwritingVolume

AMOUNT As per the SAC’s securities underwriting volumes (2008 to2010)

Market Share MS As per the number of IPOcompanies an underwriterprovides underwriting services toin each market (boards)

ControlVariables

PreviousYear’s ROE

ROE An IPO company’s return onequity in the previous year

Size of PublicOffering

VOLUME The total shares of the initialpublic offering

Years betweenIncorporationand IPO

TIME The number of years betweenthe IPO company’s incorporationand IPO

First‐day LogReturn

MR The fi rst‐day logarithmic returnin the market

IndustryDummy

INDUSTRY As per the CSRC’s industry classifi cation for listed companies

Year Dummy YEAR As per the IPO year


June 19, 2006 (the restart of IPOs) and November 25, 2011, for the main board and SME board. The descriptive statistics of the three subsamplesmentioned previously are as follows: For the GEM, the sample size is 259(excluding those without available data for the variables, similarly from here on). A hypothesis test was done on sample data for the mean IPO pre-mium rates of different variables. The results are shown in Table 2.5 .

We can see at this point that considering all the goodwill variables, the mean IPO premium rates on securities underwritten by reputable underwrit-ers are all lower than the rates on securities underwritten by underwritersthat are considered to have no reputation. The p ‐values of the ranking andunderwriting volume variables are signifi cant at the 5 percent confi dence level, which indicates that there is a signifi cant difference between the mean values of 0/1 variables. The p ‐value of the market share variable is also signifi cant at the confi dence level slightly above 10 percent. We can at thispoint conclude that the goodwill mechanism works for reputable underwrit-ers in the GEM.

For the Small and Medium‐Sized Enterprise (SME) Board, the sample size is 523. The results of the hypothesis test for the mean are shown inTable 2.6 .

We can see at this point that there is no real difference between the mean of goodwill variables for the IPO premium rates on securities under-written by underwriters who have a reputation and those who do not. The mean of all variables also failed in the T‐tests for variance. We may therefore

TABLE 2.5 Results of Hypothesis Test for the Mean in the GEM

District Public Level Amount MS

Goodwill variable = 0 0.305 0.301 0.358 0.355 0.330


P ‐value ( T≤ TT t) (2‐ttailed)

0.591 0.375 0.015** 0.011** 0.105

Note: ***, **, and * denote signifi cance at the respective confi dence level of 1 percent, 5 percent, and 10 percent.

TABLE 2.6 Results of Hypothesis Test for the Mean in the SME Board Market




P ‐value ( T≤ TT t) (2‐tailed)t 0.706 0.951 0.966 0.579 0.828


conclude that the goodwill mechanism does not work in the SME board market.

For the Main Board, the sample size is 90. The results of the hypothesis test for the mean are shown in Table 2.7 .

We can see at this point that the mean IPO premium rates on securities underwritten by underwriters that have a reputation is higher, rather thanlower, than such rates on securities underwritten by underwriters that do not have a reputation. In particular, the mean of the listing and underwrit-ing volume variables are signifi cant at the 10 percent confi dence level in the T‐tests for variance. Therefore, we preliminarily conclude that the goodwill TTmechanism increases, rather than lowers, the IPO premium rates in the mainboard market.

Empirical Tests and Results

Correlation Test and Results According to the descriptive statistics above,we may preliminarily conclude that an underwriter’s goodwill could serve itspurpose in the stock market, especially in the GEM, where the mean shows satisfactory results in the variance test. Therefore, we further use a multipleregression test to check the functional activeness of goodwill. Before regres-sion modeling, we check the correlation among the variables and fi nd that the results in the three markets are respectively similar, as shown in Tables 2.8 , 2.9 , and 2.10 .

Generally, there is a negative correlation between goodwill variables and IPO premium rates, which falls in line with our hypothesis that thegoodwill of reputable underwriters can help reduce the IPO premium rates. The correlation between the variables at the highest level (0.740) is found between the underwriting volume and market share variables. There is anatural connection between an underwriter’s underwriting volume and its market share, which is logical. Strong correlation (0.650) is also foundbetween the ranking and underwriting volume variables (see Table 2.9 ).

In the SME Board Market, there is a positive correlation between the underwriting volume and market share variables. Among all the correla-tions between the variables, the highest level (0.707) is found between the

TABLE 2.7 Results of Hypothesis Test for the Mean in the Main Board Market




P ‐value ( T ≤TT t ) (2‐tailed)t 0.258 0.063* 0.588 0.075 0.515

131

TABL

E 2.

8 C

orre

lati

on C

oeffi

cie

nts

amon

g V

aria

bles

in t

he G

EM

IPO

RO

EV

OL

UM

ET

IME

MR

DIS

TR

ICT

PU

BL

ICL

EV

EL

AM

OU

NT

MS

IPO

1.

000

−0.0

10−0

.127

−0.0

170.

086

−0.0

34−0

.055

−0.1

52−0

.158

−0.1

01

RO

E

1.00

0−0

.131

−0.0

28−0

.079

0.02

00.

060

0.18

50.

038

0.05

4

VO

LU

ME

1.

000

0.00

50.

054

0.02

60.

030

−0.0

05C

.074

0.02

1

TIM

E

1.00

0−0

.067

0.01

20.

011

0.02

6−0

.004

0.00

1

MR

1.

000

0.00

2−0

.047

−0.0

190.

001

−0.0

58

DIS

TR

ICT

1.00

0−0

.158

0.44

10.

326

0.26

2

PUB

LIC

1.

000

0.15

50.

324

0.37

9

LE

VE

L

1.00

00.

650

0.54

3

AM

OU

NT

1.

000

0.74

0

MS

1.00

0

Not

e: I

PO d

enot

es t

he fi

rst

‐day

IPO

pre

miu

m r

ate;

RO

E t

he p

revi

ous

year

’s r

etur

n on

equ

ity

prio

r to

IPO

; VO

LU

ME

the

siz

eo f

init

ial p

ublic

off

erin

g; T

IME

the

num

ber

of y

ears

bet

wee

n in

corp

orat

ion

and

IPO

; MR

the

fi rs

t‐da

y lo

gari

thm

ic r

etur

n in

the

m

arke

t; D

IST

RIC

T t

he r

egio

n va

riab

les;

PU

BL

IC t

he li

stin

g va

riab

les;

LE

VE

L t

he r

anki

ng v

aria

ble;

AM

OU

NT

the

und

erw

riti

ng

volu

me

vari

able

; and

MS

the

mar

ket

shar

e va

riab

le.

132

TABL

E 2.

9 C

orre

lati

on C

oeffi

cie

nts

amon

g V

aria

bles

in t

he S

ME

Boa

rd M

arke

t

VIP

OR

OE

VO

LU

ME

TIM

EM

RD

IST

RIC

TP

UB

LIC

LE

VE

LA

MO

UN

TM

S

IPO

1.

000

−0.1

43−0

.159

−0.1

940.

108

−0.0

17−0

.003

−0.0

020.

024

0.01

0

RO

E

1.00

0−0

.051

−0.0

19−0

.053

0.06

3−0

.003

0.11

80.

121

0.07

0

VO

LU

ME

1.

000

0.01

30.

029

0.06

60.

035

0.06

00.

039

0.02

7

TIM

E

1.00

0−0

.031

−0.0

090.

047

0.03

90.

083

0.05

3

MR

1.

000

−0.0

350.

023

0.04

30.

062

0.03

5

DIS

TR

ICT

1.00

0−0

.016

0.46

30.

369

0.30

3

P UB

LIC

1.00

00.

281

0 43

40.

392

LE

VE

L

1.00

00.

707

0.50

2

AM

OU

NT

1.

000

0.65

9

MS

1.00

0

133

TABL

E 2.

10 C

orre

lati

on C

oeffi

cie

nt a

mon

g V

aria

bles

in t

he M

ain

Boa

rd M

arke

t

IPO

RO

EV

OL

UM

ET

IME

MR

DIS

TR

ICT

PU

BL

ICL

EV

EL

AM

OU

NT

MS

IPO

1.

000

−0.3

400.

314

−0.1

280.

196

0.12

10.

197

0.05

80.

189

0.07

0

RO

E

1.00

0−0

.347

−0.0

16−0

.093

0.15

9−0

.063

−0.0

72−0

.029

0.08

3

VO

LU

ME

1.

000

−0.2

47−0

.037

0.21

4−0

.106

0.19

40.

238

0.32

8

TIM

E

1.00

0−0

.034

0.07

5−0

.049

0.05

5−0

.114

−0.0

92

MR

1.

000

−0.0

82−0

.130

−0.0

59−0

.043

0.06

0

DIS

TR

ICT

1.00

0−0

.220

0.39

70.

381

0.56

9

PUB

LIC

1.

000

0.09

60.

126

−0.3

05

LE

VE

L

1.00

00.

559

0.32

5

AM

OU

NT

1.

000

0.51

3

MS

1.00

0


ranking and underwriting volume variables. Strong correlation (0.659) is also found between the underwriting volume and market share variables (see Table 2.10 ).

In the Main Board Market, there is a positive correlation between the IPO premium rates and all variables. Among all correlations between the variables, the highest level (0.569)—which is in the medium range in regard of the degree of correlation—is found between the region and market share variables. The one at the second‐highest level (0.559) is between the under-writing volume and ranking variables. There is some correlation (0.513), although no longer at the highest level, between the underwriting volume and market share variables.

Regression Test Results Building on the preceding regression models,we use a multiple regression test to check the functional activeness of an underwriter’s goodwill in the three markets and get the results shown in Tables 2.11 , 2.12 , and 2.13 .

Regression Analysis The results of the regression test for the GEM sample(2009–2011) show that two goodwill variables—ranking and underwrit-ing volume—are signifi cant at the 5 percent confi dence level, and the coef-fi cients for all the goodwill variables are negative. This indicates that an underwriter’s goodwill works for the GEM. That is, a reputable underwriter is more capable of fi nding and disseminating to investors the valuation information, and therefore reduces the IPO premium rate of an IPO com-pany. In the test for the SME Board Market sample (2006–2011), negativecoeffi cients for all the goodwill variables except the market share could indi-cate that a reputable underwriter could help reduce the IPO premium rate. However, the absence of signifi cance makes the conclusion weak, since all the goodwill variables fail in the T ‐test. In the test for the Main Board Mar-TTket sample (2006–2011), the coeffi cients for all the goodwill variables arepositive. The listing and underwriting volume variables are signifi cant at the confi dence level of 5 percent and 10 percent, respectively. Such signifi cance, although not very strong, could still be used to illustrate that in the MainBoard Market, a reputable underwriter increases, rather than lowers, the IPO premium rate.

For the purpose of further analysis and comparison, we split the SME Board Market and Main Board Market samples into two subsamples each for 2006 to 2008 and for 2009 to 2011. Regression tests have been done foreach subsample and the summary results are detailed next.

In the test for the SME Board Market sample (2009–2011), there is a lack of signifi cance since all the goodwill variables fail in the T ‐test. Also, the TTcoeffi cients for all the goodwill variables except for the listing are positive.


TABLE 2.11 Results of Regression Test for the Functional Activeness of Goodwill inthe GEM (2009–2011)

Model 1 Model 2 Model 3 Model 4 Model 5

Coeffi cient( T value)T


Coeffi cient(T value)T



Constant 0.862 0.854 0.864 0.843 0.869

3.183*** 3.159*** 3.231*** 3.149*** 3.222***

District 0.008

0.270

Public −0.030

−1.049

Level −0.075

−2.421**

Amount −0.067

−2.290**

MS −0.041

−1.388

ROE −0.001 −0.001 −0.001 −0.001 −0.001

−1.023 −0.957 −0.588 −0.934 −0.946

Volume −0.089 −0.087 −0.086 −0.082 −0.087

−2.653*** −2.607*** −2.593*** −2.462** −2.606***

Time 0.003 0.003 0.003 0.003 0.003

0.878 0.910 0.986 0.897 0.914

MR −0.190 −0.209 −0.147 −0.131 −0.212

−0.211 −0.232 −0.165 −0.147 −0.236

Industry

Year

ADJ R2 0.332 0.335 0.348 0.346 0.337

F ‐valueF 10.873*** 10.998*** 11.575*** 11.500*** 11.098***

Note: Industry denotes the industry dummies; Year denotes the year dummies; ***, **, and * denote signifi cance at the respective confi dence level of 1 percent, 5 percent, and 10 percent.


TABLE 2.12 Results of Regression Test for the Functional Activeness of Goodwill inthe SME Board Market (2006–2011)







Constant 1.188 1.194 1.197 1.192 1.187

3.058*** 3.074*** 3.082*** 3.069*** 3.056***

District −0.002

−0.072

Public −0.009

−0.347

Level −0.019

−0.626

Amount −0.008

−0.263

MS 0.006

0.186

ROE −0.006 −0.006 −0.006 −0.006 −0.006

−4.102*** −4.118*** −4.012*** −4.056*** −4.114***

Volume −0.095 −0.095 −0.094 −0.095 −0.096

−3.310*** −3.303*** −3.280*** −3.295*** −3.327***

Time −0.002 −0.002 −0.002 −0.002 −0.002

−0.794 −0.771 −0.763 −0.763 −0.804

MR 1.324 1.331 1.344 1.337 1.320

2.134** 2.144** 2.164** 2.148** 2.126**

Industry

Year

ADJ R2 0.542 0.542 0.542 0.542 0.542

F ‐valueF 29.028*** 29.040*** 29.068*** 29.035*** 29.031***



TABLE 2.13 Results of Regression Test for the Functional Activeness of Goodwill inthe Main Board Market (2006–2011)







Constant 0.600 0.523 0.602 0.570 0.604

1.738* 1.561 1.736* 1.679* 1.701*

District 0.067

0.852

Public 0.142

2.372**

Level 0.016

0.217

Amount 0.132

1.754*

MS 0.001

0.013

ROE −0.004 −0.003 −0.004 −0.004 −0.004

−1.605 −1.373 −1.436 −1.649 −1.383

Volume −0.047 −0.030 −0.045 −0.052 −0.044

−1.735* −1.117 −1.627 −1.936* −1.486

Time 0.000 0.002 0.001 0.001 0.001

−0.003 0.304 0.113 0.170 0.163

MR 3.863 4.492 3.826 3.782 3.833

2.815*** 3.319*** 2.773*** 2.803*** 2.747***

Industry

Year

ADJ R2 0.570 0.599 0.566 0.584 0.565

F ‐valueF 6.362*** 7.042*** 6.267*** 6.688*** 6.261***



In the test for the Main Board Market sample (2009–2011), some signifi -cance is discovered. The region and listing variables are signifi cant at the10 percent confi dence level and the underwriting volume variable is signifi -cant at the 5 percent confi dence level. And the coeffi cients for all goodwill variables are positive. Such results indicate that in the Main Board Market, a reputable underwriter increases a company’s IPO premium rate.

In the test for the SME Board Market sample (2006–2008), there is a lack of signifi cance since all goodwill variables fail in the T ‐test. But in this TTperiod, the coeffi cients for all goodwill variables except the listing are nega-tive. In the test for the Main Board Market sample (2006–2008), the fi nd-ings are similar to those discovered in the test for the SME Board Market sample for the same period. There is a lack of signifi cance as a result of thefailure of all goodwill variables except the market share (which is signifi cant at the 10 percent confi dence level) in the T ‐test. Also, the coeffi cients for allTTgoodwill variables except the listing are negative.

See Table 2.14 for a summary of the infl uence of an underwriter’s good-will on IPO premium rates and the statistical signifi cance.

As for the SME Board Market subsamples, there is no satisfactory sta-tistical signifi cance. Such absence would do no good for any estimation of the impact of an underwriter’s goodwill on a company’s IPO premium rate in those periods. So we can only feel comfortable to state that the underwrit-er’s goodwill mechanism works in an insignifi cant way in the SME Board market.

As for the Main Board Market, there is some signifi cance discovered in all goodwill variables for the Main Board Market subsample (2009–2011), and the same is true for the SME Board Market subsample (2006–2011).

TABLE 2.14 Impact of Goodwill and Signifi cance for Each Subsample

Impact of Goodwill Level of Signifi cance

GEM (2009–2011) Lower (IPOpremium rates)

Signifi cant

SME Board Market (2006–2011) Lower Not signifi cant

Main Board Market (2006–2011) Higher Weak

SME Board Market (2009–2011) Higher Not signifi cant

Main Board Market (2009–2011) Higher Weak

SME Board Market (2006–2008) Lower Signifi cant

Main Board Market (2006–2008) Higher Not signifi cant

Note: See earlier regression test results for supporting data and explanation for the above summary.


The coeffi cients for goodwill variables are mostly positive. This indicates that in the Main Board Market, especially between 2009 and 2011, the underwriter’s goodwill mechanism fails to help investors determine the value of an IPO company. In fact, it increases the IPO premium rates.

As for the GEM, there are signifi cant results in all goodwill variables and the coeffi cients for such variables are all negative. This indicates thatthe underwriter’s goodwill mechanism works greatly and helps lower the IPO premium rates.

Conclusions On the subject of whether an underwriter’s goodwill helps lower a company’s IPO premium rate in China, many studies have been done and most have arrived at the conclusion that in China, such goodwillcould not serve its purpose to lower the IPO premium rates. However, as the Chinese securities market continues to improve in the regulatory and institutional framework, especially with the improvement of sponsorship and after the creation of the GEM, could an underwriter’s goodwill serve the purpose?

Our study shows that the underwriter’s goodwill mechanism works in the GEM. A reputable underwriter can successfully disseminate to the mar-ket information of the true value of an IPO company and cause such valua-tion to be well‐accepted by investors, helping lower the IPO premium rate.This is the most important fi nding in our study, which means that along with the regulatory and institutional improvement of the Chinese securitiesmarket, the underwriter’s goodwill mechanism can work. This helps an IPO company get what it is worth and reduces IPO premium rates. It also helpsthe securities market reduce volatility and fi nancial risk, while maintaining stability.

However, the goodwill tests do not satisfactorily prove true on the Main Board and SME Board market samples. For the SME Board Market sample,there is a lack of statistical signifi cance of almost all goodwill variables, which makes a weak explanation. For the Main Board Market sample, the test results of goodwill variables seem promising, but the coeffi cients for such variables are positive, which indicates that a reputable underwriter increases, rather than lowers, the IPO premium rate. This is an interest-ing outcome that needs to be explored. But at least it is safe to say that anunderwriter’s goodwill does not serve its purpose well enough in the Main Board Market.

We believe that the underwriter’s goodwill mechanism works in the GEM for the following two reasons:

1. The market is a new arena where the goodwill mechanism works better because there are fewer complicated elements to suppress the negative


impact of an underwriter’s goodwill on a company’s IPO premium rate.Investors can also obtain and identify more easily the value signal from reputable underwriters.

2. The market mainly serves high‐growth companies, most of which are new businesses of high growth, high risk, and less sound management.Such elements could cause great information asymmetry between such companies and investors. Investors have less access to true informa-tion and are therefore more inclined to trust the valuation of reputable underwriters. This makes it easier for an underwriter’s goodwill to serve its purpose and for the valuation to be accepted by investors, therebyhelping reduce an issuer’s IPO premium rate.

REFERENCES

Booth , J. , and R. Smith . 1986 . “ Capital Raising, Underwriting and the Certifi cation Hypothesis .” Journal of Financial Economics 15 : 261 – 281 .

Fabozzi , F., and V. Kothari . 2008 . Introduction to Securitization . Hoboken, NJ : John Wiley & Sons .

Geisst , Charles R. 1998 . Investment Banking in the Financial System . Upper Saddle River, NJ: Prentice-Hall .

Goldman Sachs Annual Report . 2010 . Retrieved from www.goldmansachs.com/investor‐relations/financials/current/annual‐reports/2010‐ar‐pdf‐files/GS_AR10_Allpages.pdf.

Greenberg , Maurice. 2010 . “Prime Brokers and Derivatives Dealers.” Squam Lake Working Papers.

Guo , Haixing , Difang Wan , and Zuguang Wu . 2011 . “ Are Underwriters Trustwor-thy? Data from the GEM .” Nankai Business Review 3 .

Guo , Hong , and Zhenyu Zhao . 2006 . “ An Empirical Study on the Impact of an Underwriter’s Goodwill on IPO Pricing and Initial and Long‐Term Returns .” Management World 3 .d

Hou , Wailin , Lijuan Qian , and Xiaoxian Zhu . 2007 . “ On Escrow Arrangement for Security Deposits .” Journal of Shenzhen Stock Exchange 3 .

Hu , Xuyang. 2003 . “ On Goodwill of Financial Intermediaries and Information Quality in the Stock Market .” Market Herald 2 .d

Huang , Chunling , and Zhengrong Chen . 2007 . “ On the Underwriter’s Goodwill Mechanism in the IPO Market and an Empirical Study .” Market Herald 2 .d

Ling , Jia . 2005 . “ Investors Saved by a CNY 68 Billion Loan .” Beijing Modern Busi-ness , December 13.

Liu , Jianghui , Bocheng Yin , and Xingjian Yi . 2005 . “ An Empirical Study of the Rela-tionship of the Goodwill of Chinese Securities Underwriters and the Quality of IPO Companies .” Finance and Trade Economics 3 .

Liu , Jianghui , and Xiaoliang Liu . 2004 . “An Empirical Analysis of the Relation-ship between an Underwriter’s Goodwill and IPO Underpricing in China.” SNUBusiness School Working Papers.

http://www.goldmansachs.com/investor-relations/financials/current/annual-reports/2010-ar-pdf-files/GS_AR10_Allpages.pdf




Merrill Lynch . 2007 . “2007 Factbook.” Retrieved from www.ml.com/media/92209.pdf. Morrison , A. , and W. Wilhelm . 2006 . Investment Banking: Institutions, Politics and

Law. Oxford : Oxford University Press . ———. 2007 . “ Investment Banking: Past, Present and Future .” Journal of Applied

Corporate Finance 19 : 42 – 54 . Securities Association of China . 2011 . Securities Market Basics . Beijing : China

Financial and Economic Publishing House . Tang , Song . 2011 . “ Brokers and Three Kingdoms in the World of Wealth Manage-

ment Services .” Securities Times , November 5. Teng , Tai . 2010 . Investment Banking . Shanghai : Shanghai University of Finance andg

Economics Press . Tian , Jia , and Weihua Zhan . 2000 . “ An Empirical Study of the Relationship between

the Goodwill of Investment Banks and the IPO Underpricing .” CASS GraduateJournal 4 .l

Wu , Xiaoqiu . 2010 . Two Decades in the Chinese Capital Market . Beijing : ChinatRenmin University Press .

Xia , Feng . 2006 . “ 30 Brokers That Received Administrative Disposition Will All File for Bankruptcy .” Shanghai Securities News , November 13.

Xin , Qiaoli . 2010 . The Shadow Banking System . Beijing : China Economic Publish-ing House .

Xu , Haoping , and Wei Luo . 2007 . “ On the Effectiveness of the Goodwill Mechanism of Investment Banks .” Economic Research Journal 2 .l

http://www.ml.com/media/92209.pdf

143

CHAPTER 3 3 Analysis of the Management Model

of Chinese Securities Companies

In this chapter we systematically describe the historic shifts and currentstatus of the global investment banks management model. We begin by

investigating their business division and functional orientation from the per-spective of fi nancial institutions and fi nancial functions. Then we theoreti-cally and empirically analyze the management model of foreign investmentbanks in the last century.

The long‐term development of investment banks in the United Statesand Europe is market oriented. However, Chinese securities companies, inthe context of the profound fi nancial transformation and development, havetheir own unique management model. Beginning with 1987, this model canbe divided into the following three phases:

1. Primarily mixed operation phase2. Stringent separated operation phase 3. Coexistence of the mixed and separated operation phase

This section also comprehensively introduces today’s management modeland characteristics of Chinese securities companies. It clarifi es the history of that management model, which has signifi cantly been subject to the overallpolicies of China’s fi nancial reform. In addition, it has been closely relatedto the competitive landscape and market demands.

We then conclude that it is imperative for major investment banks toprefer the model of the fi nancial holding company, which is a conglomerateorganizational management model. However, the independent brokeragewill not likely disappear in China’s future. Also likely to remain in place fora long time are medium‐ and small‐sized securities companies, which are anecessary complement to the fi nancial holding company model. Even theprivate investment banking institutions with their partnership model will exist for a long time.


Finally, we look at an overall policy framework based on the forward transformation of Chinese securities companies. The choice of different mod-els of various securities institutions will depend on their nature, strategic plans, and professional focus. All of these should be considered for regu-latory policy making, which should coincide with different disciplines and characteristics in order to ensure that regulatory resources are well allocated.

INTRODUCTION

Investment banks (independent), also known as securities fi rms in China, build their fundamental business on the capital market. They are fi nancialinstitutions with a special functional purpose for conventional activities. They are very different from other fi nancial intermediaries, such as com-mercial banks and insurance companies.

The Glass‐Steagall Act of 1933 is regarded as a major contributing fac-tor to the emergence of modern investment banking. Historically, investment banks were fi nancial institutions that specialized in securities‐related activi-ties, as prescribed by the Glass‐Steagall Act. They were limited to securities underwriting, brokerage, proprietary trading, and M&A advisory services,among others. They were not allowed to enter into deposit taking, loans, insurance, and other fi nancial services. However, in a changing internal and external economic climate and at a time of deregulation, ICT development, and fi nancial innovation, the lines between investment banks and commer-cial banks, insurance companies, and other fi nancial intermediaries became blurred. Faced with intense market competition and driven by innovation for profi t, investment banks entered into a wider range of activities. They diverted their business focus from low‐risk conventional activities (such as consulting and intermediary services prior to the early 1980s) to high‐risk activities (such as proprietary trading and wealth management). In fact, by the year 2000, independent investment banks in the United States had evolved into full‐service fi nancial institutions. They derived more than half of their revenues from technical trading businesses that came into existencein the 1980s (Morrison and Wilhelm 2008 ).

This shift in business focus plus increased leverage brought about a fun-damental change to the business and revenue models. This was more thantwo decades before the outbreak of the fi nancial crisis in 2007. This alsocontributed to a very high return on capital over a long time in large inde-pendent investment banks. Inevitably, such a transformation also caused the banks to incur huge business risks together with high profi ts. Therefore, in the global fi nancial crisis triggered by the collapse of the USD 500 bil-lion subprime mortgage market in 2007, Morgan Stanley, Goldman Sachs,

Analysis of the Management Model of Chinese Securities Companies 145

Merrill Lynch, Lehman Brothers, Bear Stearns, and other giant U.S. invest-ment banks suddenly found that the risk they had been taking resulted in a loss far beyond what their own capital could cover.

In order to help themselves out of the crisis, rather than fi le for bank-ruptcy or accept an acquisition offer, the investment banks reorganized into bank holding companies for the U.S. federal bailout. Strictly speaking, investment banks with an independent corporate personality have arisen in the United States. Bank/fi nancial holding companies or full‐service banksare the mainstream institutions in today’s international investment banking(Zhanyu 2009 ).

Unlike their American and European counterparts, the Chinese securities fi rms that were subject to dual constraints of planned economy and govern-ment‐run economy in the early years have not been exposed to the cruelty of fi erce market competition. For a fairly long period of time after the incorpo-ration of the Shenzhen SEZ Securities Co. (the fi rst securities fi rm in China)in 1987, Chinese securities fi rms were in a “greenhouse,” where they spent their start‐up and growth periods without diffi culty. They enjoyed greatreturns by taking advantage of monopolies and other protection policies. In the new century, along with the change of climate in the market and the change of policy for the industry, profi ts fl attened as a result of increas-ing competition. Chinese securities fi rms now faced an industry‐wide sur-vival crisis in a market downturn. However, after some housecleaning and an overall improvement initiative, Chinese securities fi rms did not take asbad a hit as their American and European counterparts in the international fi nancial crisis. This was due to high growth, high speculation, and board participation in the Chinese capital market, as well as limited exposure in international banking.

According to statistics released by the Securities Association of China (SAC), the number of Chinese securities fi rms remained basically the same after 2007 at 106 (107 in 2008), but the number of business offi ces increased from 3,060 at the end of 2007 to 4,498 at the end of 2010. By theend of 2010, the 106 securities fi rms had total assets of CNY 1.97 trillion(0.06 trillion less than the 2009 value), net assets of CNY 566.359 billion (82.489 billion more than the 2009 value), and a net capital of CNY 431.928 billion (48.746 billion more than the 2009 amount). The aggre-gate principal amount for the funds under management increased by CNY 38.297 billion to CNY 186.629 billion.

From a realistic perspective, operations and oversight based on separa-tion of activities is the mainstream model in China. Despite a few fi rms that are part of some fi nancial holding groups, most Chinese securities fi rms still adhere to their independent corporate personality and a one‐dimensional management model. Today, globalization goes further in economy and


banking. And in this fi nancial crisis, there is a tendency for convergent evo-lution in the organization and management of international investmentbanks for the purpose of conglomeration (or universal banking).

How should Chinese securities fi rms respond to such convergence (in particular, to the change in the United States)? Should Chinese securities fi rms choose to embrace such change? How should the Chinese securities regulatory authorities adjust existing policies and regulations to respond to the change in climate in domestic and international investment bank-ing, and help Chinese securities fi rms through the transition? The list of questions goes on and on. In recent years, such questions have become unavoidable and strategically important for Chinese securities fi rms as the Chinese capital market expands and becomes more market oriented and internationalized.

This chapter analyzes the general infl uencing factors and international practices of the management of investment banks by combining institutional banking and functional banking. It also reviews the change of management models in Chinese securities fi rms over the past 20 or more years. This isdone in an attempt to fi nd an ideal management model that builds on therealities in China and satisfi es all the needs of Chinese securities fi rms. Italso aims to offer some ideas of the general policy for the reorganization of Chinese securities fi rms.

ORGANIZATION AND MANAGEMENT IN INVESTMENT BANKS: A GENERAL ANALYSIS BASED ON INSTITUTIONAL BANKINGAND FUNCTIONAL BANKING

Investment banks (securities fi rms) are a particular type of fi nancial institu-tion, a particularity largely determined by their functional orientation and corresponding business activities. Historically, this particularity determinedthe specifi c initial organization and management, or partnership. Along with the changing internal and external climate in the economy and in banking, the organization and management of investment banks has been one of the most frequently discussed topics in fi nancial theory around the world overthe past 30 years.

Investment Banks in the Financial System: Defi nition and Functional Orientation

Investment Banks: A Brief Survey from the Perspective of Separation of Activities From the perspective of separation of activities, investment banks are fi nancial intermediaries that use the fi nancial market as a business platform and


specialize in securities services. From a realistic perspective, today’s invest-ment banking can be divided into the following three categories:

1. Investment banking (conventional): Investment banking includes ser-gvices for corporate and government fi nancing activities (e.g., equityissuance and issuance of bonds, debentures, or convertible bonds) aswell as M&A advisory services.

2. Trading (including client trading and proprietary trading): g Client tradingrefers to securities brokerage services (including research reports and invest-ment advice) offered by an investment bank as an intermediary to its clients and also includes equity, fi xed‐income, commodity, and currency trading. Proprietary trading refers to an investment bank’s investment activities that ghave a bearing on its own balance sheet. Such activities exclude the invest-ment on behalf of clients. They largely occur in equity (including public offering and private placement), bonds and debentures, convertible bonds, derivatives, private equity funds, and hedge funds, among others.

3. Asset management: Asset management refers to a range of investmentproducts an investment bank offers retail or institutional clients, suchas equity investment, fi xed income investment, alternative investment and money market investment products. Generally, investment banks and their clients invest in alternative investments such as hedge funds, private equity funds and other marketable fund products.

Functional Orientation of Investment Banks In the modern market economy, an investment bank operates in an information marketplace. For investment banks with information superiority, it effectively creates that marketplace, providing a service contract with a self‐implementation mechanism. It provides principal economic participants with a variety of fi nancial services that are related to highly information‐sensitive securities and assets (Zhanyu 2009 ).

Historically, investment banks in the early years of investment banking fi t that functional orientation best. In the nineteenth century, however, when the concept of banking was much broader than it is now, many large banks emerged, offering both banking and securities services. Investment bankers in merchants banks in the United Kingdom or private banking partnerships in the United States engaged in a small range of activities, generally focusing on conventional investment banking (securities underwriting1 and M&A

1 Back then, the main job of investment bankers was to assist companies in designing transactions and securities for the purpose of fi nancing. Once an issuance plan was completed, investment bankers hired brokers to sell securities publicly to retail and large investors. Such practices enabled the investment banking industry to build a“clean” image and leave the dirty jobs (sales) to others (Geisst, 1998).


advisory services were the core activities) until the 1920s and 1930s. The information superiority that built on long‐term relationships between banks and clients became the key for those investment bankers to expand the market.

The Glass‐Steagall Act of 1933 specifi cally provides, for the fi rst time, a separation of commercial banks from investment banks. Due to this separa-tion, the fi nancial giant dominating the U.S. fi nancial industry at that time, J.P. Morgan, was confi ned to commercial banking and was forced to split its securities department and convert it into a new company, Morgan Stanley, which concentrated on stocks and bond‐related activities. Dismemberment of large banks helped lay a foundation for the rise of investment banking. This became a match for large banks in New York in terms of economic and politi-cal infl uence in the 1970s and also in terms of a market‐oriented fi nancial sys-tem that enjoys the highest level of fl exibility, innovation, and effi ciency. The separation also helped investment banks further consolidate in practice their particular institutional and functional orientations. This enabled investment banks to focus more on innovation, professional skills, and information, sig-nifi cantly differentiating themselves from commercial banks (see Figure 3.1 ).

FIGURE 3.1 The Information Marketplace around Investment Banks Source: Morrison and Wilhelm ( 2007 ).

Info ProducersSellers of

InformationLarge Investors

Sellers of Liquidity

InvestmentBank

Secondary MarketBuyers of Liquidity

Aggregate Demand InfoBuyers of Market

Expertise

IssuersBuyers of

Information

Retail InvestorsSupply Some Liquidity

Aggregate Demand Info


Overall, the Glass‐Steagall Act, which separated securities business from commercial banking in an attempt to keep commercial banks away from risks, greatly constrained the business development of commercial banks and made them victims. The Act cost American commercial bank-ing dearly, but it benefi ted investment banking. After a relative stagnation period between the 1940s and 1970s, American investment banking expe-rienced a fast growth through the 1980s and almost controlled the market after the 1990s. Profi tability in investment banking was much higher thanthat in commercial banking. Considering this situation, commercial banksput persistent effort into lobbying after the 1970s, requesting deregulationand business crossover to enable them to return to investment banking. After the 1980s, the regulatory authorities (the Federal Reserve) gradu-ally eased the regulation and allowed commercial banks to participate in securities‐related activities through bank holding companies. In 1989, J.P. Morgan was allowed to return to the securities industry, which set off anew wave among big commercial banks for limited crossover. The FinancialServices Modernization Act of 1999 basically abandoned the “separation of activities” that the Glass‐Steagall Act had emphasized, bringing the U.S.fi nancial system into a new stage of crossover.

After commercial banks returned to the securities industry via bank/fi nancial holding companies, independent investment banks such as Morgan Stanley, Goldman Sachs, Merrill Lynch, Lehman Brothers, and Bear Stearns faced a competition that was never before seen. They began to adjust their business activities for a fundamental change. While maintaining conven-tional activities (e.g., securities underwriting, M&A services, and securities brokerage), investment banks caused asset management and proprietary trading to take a larger proportion of their business and revenue. As a result, U.S. investment banks were no longer confi ned to the functional orienta-tion of a fi nancial institution that mainly takes up low‐risk activities and simply relies on relationships. They engaged heavily in asset management and proprietary trading activities on leverage and became fi nancial inter-mediaries that take high risks. Due mainly to a range of creative “shadow banking” or “securitized banking” systems accompanied by securitiza-tion (see Figure 3.2 ), the line between investment and commercial bank-ing became extremely blurred. Prior to the outbreak of the 2007 fi nancial crisis, it was very diffi cult to determine with any accuracy, theoretically or practically, the institutional and functional orientation of the independent investment banks.

It is due to that change in business activities and institutional and func-tional orientation that when the U.S. subprime mortgage market collapsed in 2007, both independent investment banks (e.g., Morgan Stanley, GoldmanSachs, Merrill Lynch, Lehman Brothers, and Bear Stearns) and commercial


banking conglomerates (e.g., Citigroup and J.P. Morgan Chase) were unable to avoid the impact of the run on the repo market. As the value of assets slumped and liquidity dried up, they were all caught in unprecedented distress.

Organization and Management in Investment Banks: A Global Perspective

Determinants of Organization and Management For any investment bank, the choiceof management model depends on external factors as well as internal ones.

FIGURE 3.2 The Securitized Banking System: Basic Architecture

InvestorsTranching

Funds

ABS

Funds

Funds

Hypothecation(Repo Market)

Funds

Funds

Funds

Mortgages

Mortgages

Mortgages

Borrowers

Direct Lenders

Banks (Commerical/Investment

Bank-Led SPV or SIV)

Securitization

CDO Tranches

CDO Owns ABS Asset

Pool

AAA

AA

ABBBEQ

AAA

AA

ABBB

SPV’sLoan Pool

EQ


External factors include historical and cultural background and the fi nan-cial market and regulation of the country or region where the bank runs its business. Internal factors include the bank’s industrial positioning, business activities, and others.

External Factors Market Environment Market environment factors have a wide reach. They include economic structure and total economic output of a country orregion, level of development, application of information technology in the fi nancial market, competition between different types of fi nancial institu-tions, and competition among investment banks.

Regulatory System Regulatory system factors include choice and regu-lation of separation or crossover in fi nancial institutions across different countries or regions, plus the fi nancial innovation‐related legislation and law enforcement in different legal systems.

Internal Factors Attributes Much like form is decided by content, the particular manage-ment model of an investment bank is determined by its attributes and divi-sion of work. A simple comparison of investment banking and manufactur-ing and commercial banking provides an intuitive understanding.

Unlike physical products manufactured by a manufacturer, the “products” offered by an investment bank are nonmaterial services. The “production” of such services is an advanced process that combines capital, knowledge, wisdom, and experience rather than a process that involves physical tools and their movement.

Unlike commercial banks, investment banks offer a wide range of cre-ative products in their underwriting, consulting, and other services. Such activities are more risky and challenging. It is these attributes that lead to the particular choice of management model in an investment bank.

Institutional Positioning and Business Activities Globalization enablesan investment bank to offer its services in different countries or regions and to satisfy the needs of a variety of trades and customers. There are in-vestment banks of different positioning, such as international banks with a global presence, large banks that do regional business, small banks that offer specialized services, and securities companies. Obviously, investment banks of different positioning choose their management models much differently.

Given that the range of investment banking is quite wide, fi nancial institutions engage in different series of activities for market competition,


historical reasons, or competitive edge in a particular expertise. Considering the huge characteristic difference of activities (such as brokerage and M&A advisory services), the choice of management model may vary among invest-ment banks.

Organization and Management in Investment Banks: Continental Europe, the United States, and Japan Historically, in the process of integration and separation of their fi nancial activities, investment banks in developed economies estab-lished the following three mainstream management models at the end of the twentieth century:

1. Continental European model (full‐service German banks) 2. American model (crossover of activities) 3. Japanese model (interlocking shareholding among fi nancial corporations)

The Continental European Model (Universal Banking) In ContinentalEurope, full‐service banks may be a single corporation with multiple licenses pursuing a variety of activities. They are directly engaged in a full range of fi nancial services, including banking, securities, insurance, trust, fund, leas-ing, derivatives, and other emerging business. In a full‐service bank, several departments are set up and each takes charge of a particular type of activity.Although each department works as a relatively independent subsidiaryunder the central leadership of the headquarters, there is no fi rewall between departments. To a considerable extent, all the departments share customers. Target customers often overlap, with many new business opportunities being available in cross‐selling.

The Deutsche Bank is a typical example of the Continental European model. Its investment banking division is owned by a global company and is responsible to the company’s headquarters. It provides a full range of services in consulting, fi nance, research, risk management, and investmentto individual, corporate, and government clients, as well as other fi nancial institutions.

Organizationally, the universal banking model is clearly customer driven. A full‐service bank aims to offer a “one‐stop shopping” experience with a full range of fi nancial services to retain as many quality custom-ers as possible while expanding the customer base. This model enables a fi nancial institution to integrate multiple fi nancial services and allows much openness and freedom. Its fl exible arrangement facilitates the shar-ing of resources and the fl ow of information and enables the institution to benefi t from information superiority. Diversifi cation allows the institu-tion to have better stability or protection from the impact of an external


incident while achieving economies of scale and scope to improve interna-tional competitiveness.

A full‐service bank usually holds corporate equity by a large propor-tion and enjoys internal information superiority. However, it often disre-gards and even damages the interest of outside shareholders. For purposesof monopoly and information superiority, the bank is often less driven for innovation. It is diffi cult to reconcile internal confl icts between different interest groups in the bank. Therefore, in real‐world practice, this model normally requires strict internal control and has demanding requirements of the members in the management at the headquarters (as to business skills, coordination skills, and professional ethics, etc.).

The American Model Quite different from the Continental European model, the management models in the American investment banks were deeply infl uenced by the separation of activities legacy of the Glass‐Steagall Act of 1933. This resulted in the emergence of independent investment banking. After the 1980s, commercial banks marched into investment banking as a result of deregulation. In the competitive landscape of American investment banking, there are independent investment banks, bank holding companies, and small specialized investment banks. Because of the differencein institutional positioning and business activities, management models varyin different investment banks.

The Citigroup Model This model is commonly found in a typical bank holding company, such as Citigroup. A group company controls one orseveral banks and companies. There are strict legal restrictions (fi rewalls) between banking and nonbanking subsidiaries. The banking part offers se-curities and insurance services. For example, Citigroup consists mainly of Citicorp and Citi Holdings. Citicorp is further divided between RegionalConsumer Banking and the Institutional Clients Group. Citi Holdings has brokerage, asset management, and local consumer lending divisions.

The Morgan Stanley Model Before reorganizing into a bank holding com-pany in 2008, Morgan Stanley was one of the leading independent invest-ment banks in the United States. Organizationally, Morgan Stanley regroups activities and customers together and sets up divisions to satisfy the needs of customers or business operations. There are divisions for institutional securities, asset management, and global wealth management. The institu-tional securities department is responsible for investment banking, equity,and fi xed‐income securities services. The investment and asset management department has a wide range of activities, including conventional mutual


fund management, alternative investments, retirement services, as well asfi nancial and estate planning, trust services, securities transfer, and other general activities. The global wealth management department serves high‐net‐worth clients and earns fees and commissions.

The Model of Specialized Investment Banks In addition to bank holding companies and independent investment banks that provide a full range of investment banking services, within the American fi nancial system there aremany boutique investment banks that specialize in some particular activi-ties, have particular expertise, and specifi cally target niche markets, such as customers and business opportunities in specifi c industries (see Table 3.1 ).

Unlike large investment banking corporations, these small investment banks are mostly limited partnerships, which is the conventional organiza-tional model for investment banks. They have super‐fl at management and rely deeply on incentives and restraints on partners (Zhanyu, 2009 ).

The Japanese Model The post–World War II Japanese fi nancial model islegislatively a duplicate of the American model. However, the special “mainbank” system has resulted from the fact that operational and management models in Japanese fi nancial institutions had been different from Ameri-can models for quite a long period of time. Corporate cross‐shareholding among fi nancial institutions is the main feature of such a system, under which securities fi rms and commercial banks hold a large number of shares of each other. As a result of this governance arrangement and long‐termrestrictions on fi nancial business, most Japanese securities fi rms adopt “ac-tivity‐driven” organizational and management models, in which a securitiesfi rm focuses on the activities, highlights the importance of each activity in

TABLE 3.1 Particular Activities and Expertise of Some Typical American Specialized Investment Banks

Company Sandler O’Neill Greenhill Lazard

Expertise Provide other fi nancialinstitutions and insurancecompanies with servicessuch as organizationaltransformation,strategic planning, loanrestructuring, interestrate risk management(balance sheet riskmanagement), and others

M&A advisoryservices andfi nancial reorganization;special committeeadvisory services

M&A advisoryservices; assetmanagement


the organizational design, and sets up functional departments according to its category of activities.

Post-1980 Tendency and the Latest Developments of Organization and Management in Investment Banks around the World The great changes around the world sincethe 1980s have driven investment banks (especially American and British banks) to major changes in institutional positioning, business models, and management models. There has been a noticeable trend toward integration, internationalization, and enhancement by knowledge and electronic means.However, the 2007 fi nancial crisis shook the ground of investment banking. It posed a threat to their existence, causing a sudden, major change to man-agement models in investment banks.

Change in Organization and Management in Investment Banks around the World between 1980 and 2007 Integration (Universal Banking) Integration refers to a tendency of invest-ment banks to attempt, by means of organizational restructuring, to inte-grate commercial banks, insurance companies, trust companies, and other fi nancial institutions into large or super‐large fi nancial conglomerates (i.e., the so‐called one‐stop shop of fi nancial services). Such change responds to an internal need for more funds and a better cushion against risk as wellas to the competitive pressure from commercial banks in the context of deregulation.

Internationalization As globalization made its way into the economy andfi nance over the past 40 years, investment banks around the world began seeking an international presence by going across regions and markets for a broader global business development. Obviously, business expansion re-quires more from the management model, and investment banks have had to change their organizational framework and management philosophy. In-ternational depository receipts, global bonds, and many other new products have been developed while investment banks enter into foreign markets by means of branch offi ces, joint ventures, or equity participation.

Enhancement by Digital/Electronic Means The era of the digital economybuilt on the Internet, computers, and information technology has brought afundamental change to service in the banking industry. It has also posed anew challenge to the management of fi nancial institutions. For investment banks, the high speed of information transmission and the rise of e‐trade and other new transaction means in the digital era have changed market competition to some extent. These innovations have also created a chancefor readjustment of some investment banking activities (such as securities


brokerage). This has forced investment banks to adjust their managementmodels to adapt to the new business environment.

Engineering/Knowledge‐Based Enhancement In recent years, competitionhas further affected conventional investment banking and reduced profi t. In-vestment banks around the world now pay more attention and concentratemore closely on research and innovation. In a sense, investment banking hastransformed from conventional to knowledge‐enhanced services. A variety of fi nancial engineering technologies has become the primary means of in-vestment banks to expand business and increase profi t margins. Objectively, such a new business landscape has set higher requirements of management (e.g., a rising status of the R&D department in an investment bank) and has also become the main driving force for management remodeling.

Organizational and Management Models and Distribution in Today’s Invest-ment Banks in This Global Financial Crisis The fi nancial crisis that began inthe summer of 2007 has had a huge impact on investment banking, especially on the form and existence of the U.S. independent investment banks. Realistically, the fi nancial crisis continues to exist and fi nancial institutions around the world are still facing much uncertainty as a result of the market turmoil. As far as the investment banking is concerned, organization and man-agement have changed considerably across the industry. Global independent investment banks have gone out with the fall of the fi ve Wall Street titans. All nine investment banks that have a global presence have turned into conglomerates. All large regional investment banks (such as HSBC), except for three Japanese securities fi rms, have also done the same. For small specialized investment banks and retail brokerage fi rms, the crisis has had limited impact on their organization and management. Most small specialized investment banks remain as partnerships, while retail brokerage fi rms remain independent companies in which multiple management models coexist (see Table 3.2 ).

ORGANIZATION AND MANAGEMENT IN CHINESE SECURITIESFIRMS: A HISTORICAL AND THEORETICAL REVIEW

Unlike American and European investment banks that have a long history of market‐based evolution, Chinese securities fi rms, as nonbank fi nancial insti-tutions, have a brief history. They came to the attention of regulators and market participants in China after the economic reform in 1978, especially after the reinstitution and development of capital markets in the 1980s. The absence of any clear institutional positioning for a long period, as well as the many restraints as a result of systematic defects of the Chinese capital


market, made the change of management model in Chinese securities fi rms particularly Chinese in character. After the year 2000, Chinese securitiesregulatory authorities made several attempts to restructure the securitiesindustry and enhance its competitiveness. But although the Chinese capi-tal market is among the top markets around the world in terms of market value, Chinese securities fi rms still remain far behind their American and European counterparts with respect to business capability. They have alsonot found a suitable management model yet.

Change of Activities and in Organization and Management inthe Chinese Securities Firms

From an objective point of view, institutional change over more than 20 years after 1987 has resulted in profound changeover in the system structure of the Chinese securities fi rms. A system has taken shape that

TABLE 3.2 Investment Banks and Distribution in Global Investment Banking (2010)

GlobalInvestment Banks

Large RegionalInvestment Banks

Small SpecializedInvestmentBanks

RetailBrokerage Firms

Bank of America BNP Paribas Broadpoint Gleacher Charles Schwab

Barclays CIBC Evercore Partners CommonwealthFinancial Network

E* Trade

Edward Jones

LPL Financial

Royal Alliance

Scottrade

TD Ameritrade

Citigroup HSBC Greenhill and Co.

Credit Suisse Macquarie Houlihan Lokey

Deutsche Bank Mizuho Jefferies and Co.

Goldman Sachs

J.P. Morgan

Morgan Stanley

UBS

MUFG

Nomura

Royal Bank of Canada

Royal Bank of Scotland

StandardChartered Bank

Wells Fargo

Sumitomo Mitsui

Société Générale

Keefe Bruyette andWoods

Lazard

Moelis and Co.

Perelia Weinberg Partner

Rothschild

William Blair

Note: Generally, retail brokerage fi rms do not offer a full range of investment bank-ing services or products.


consists of market‐oriented fi nancial institutions offering securities ser-vices. And there is a tendency for diversifi ed ownership as a result of the general company to corporation conversion and the infl uxes of privatecapital and foreign funds. During this process, Chinese securities fi rmshave been expanding their business activities, changing their institutionalpositioning, and adjusting organization and management through the fol-lowing three stages:

1. Primary crossover 2. Strict separation of activities 3. Concurrence of separation and crossover

Primary Crossover (1987–1994) The Chinese securities industry started to take off in September 1987, when Shenzhen SEZ Securities Co. was incor-porated with the permission of the People’s Bank of China and with theinvestment of 12 local fi nancial institutions. After the landmark incorpora-tion of Wanguo, Shenyin, and Haitonog securities companies in Shanghai in the following year, securities fi rms emerged around the country and shortly thereafter grouped together, playing an important role in China’s nascentsecurities market.

During this period, most Chinese securities fi rms were wholly owned by the government. In fact, they lacked any independent institutional position-ing and could be simply regarded as subsidiary fi nancial institutions affi liated to their charter members (most were special‐purpose banks). Most Chinesesecurities fi rms were part of the planned economy and were deeply affected by the “fragmentation in administration” due to the dual leadership of the central and local authorities. As a result, regional and nationwide securitiesfi rms were “all‐inclusive” in business territory, organizational structure, and business activities and had similar HR management policies. However, the Chinese capital market was still in its infancy and the securities business was small and relatively simple. As a result, Chinese securities fi rms were less concerned about development strategies and corporate culture and had a loose organizational structure and ineffi cient management. A securities fi rm of that time had extensive organization and management. The fi rm wouldset up and manage business offi ces that focused on counter‐based activities. And as an affi liate of a special‐purpose bank, the fi rm was also an extensionof the bank’s activities and management.

In terms of change in management, the period can be further divided into the following two phases according to difference in business focus:

1. Brokerage phase (1987–1990) 2. Brokerage, issuance, and proprietary trading (1990–1994)


Brokerage Phase (1987–1990) Between 1987 and 1990, government bonds and corporate debentures were mostly traded in the Chinese securities market, and securities fi rms did not participate in the issuance of such bonds and debentures. In addition to the rare services in the issuance and sales of bonds (after 1988) and stocks in the primary market, securities fi rms were mostlyengaged in securities brokerage. This included securities trading, registra-tion and custody, dividend payment, principal repayment and interest pay-ment, and other rather simple services as per instructions.

Consequently, management was extremely simple. The location of busi-ness offi ces and the fi nancial strength of charter members had direct bearingon a securities fi rm’s competitive edge. Securities fi rms were hence highly dependent on their charter members (mainly special‐purpose banks).

Brokerage, Issuance, and Proprietary Trading (1990–1994) In the 1990s,after the establishment of the Shanghai and Shenzhen stock exchanges, stocks replaced government bonds and corporate debentures as the most commonly traded products in the Chinese securities market. Back then, high speculation and turnover in the stock market attracted a large number of retail investors. Obviously, as high turnover resulted in huge trading volume, securities bro-kerage remained a business focus in securities fi rms at that time and for a long period after. Due to limitations of trading technologies at the time, the number and location of business offi ces were the most important factors for business growth. Therefore, large securities fi rms rapidly increased the number of their business offi ces and adopted fl at management.

Chinese securities fi rms kept their focus on brokerage. They discovered that in the Chinese securities market, demand exceeded supply. There wasa tendency toward a seller’s market with the possibility of huge speculation and even price manipulation. The spread between primary and secondarymarkets was huge, and the number of publicly tradable shares was relativelylimited in the secondary market. Chinese securities fi rms were also making a concentrated effort to promote securities issuance services and proprietary trading. From an objective perspective, this helped securities fi rms out of overreliance on brokerage and on the right track to balanced growth.

Thanks to business diversifi cation and improvement of competitiveness, Chinese securities fi rms became more independent and started to adopt line or line‐function management along with business expansion, increase in business income, and increase in number of business offi ces. However, theywere still highly dependent on the charter members’ fi nancial support.

Strict Separation of Activities (1995–1999) After the 1990s, the Chinese specialpurpose banking system was exposed to serious misappropriation problems. A large number of special purpose banks misappropriated credit funds or


borrowed from the interbank lending market to invest in the securities or real estate market via their wholly owned or partially held securities fi rms and trust and investment companies. This exposed the banks to a bigger business risk, facilitated speculation and a bubble economy, and caused a series of adverse effects on the macro economy. It was in such a context that China enacted in 1995 the People’s Bank Act, Commercial Banking Act, and Insurance Act, which established the basic landscape of the Chinese fi nancial system on the principle of “separation of activities” in banking, securities, and insurance. After commercial banks withdrew, securities fi rms obtained an independent institutional positioning and adopted new management, having been brought to regulatory compliance in an overall improvement initiative. In terms of organization, after the enactment of the Companies Act of 1994 and Financial Institutions Regulations, most securities fi rms converted from wholly govern-ment‐owned fi rms to companies of limited liability. After 1998, some fi rms began converting from companies of limited liability to corporations in order to increase capital and shares in a fast growing capital market (Zhanyu 2009 ).

Subject to the regulatory separation of activities and by means of sepa-ration of affi liations or shareholding structure makeover, fi rewalls were built among banking, securities, insurance, and trust activities. Firewalls serve many purposes, such as cutting off capital fl ows between banks and secu-rities fi rms. Chinese securities fi rms therefore faced different competition, which required higher technical skills. As a result, competition grew moreintense in the three main conventional activities. Faced with limited spacefor business growth in those activities, securities fi rms had to try something new. They adapted business and management models to the needs of emerg-ing business, such as corporate fi nance advisory services.

Hoping to get more customers, securities fi rms attempted to integrate investment banking activities (e.g., securities issuance, corporate restruc-turing consulting services, and fi nancial advisor services) while improving facilities in business offi ces, expanding consulting services to investors, and promoting the brokers’ system. However, as the fund‐related services, M&A services, and international activities became new growth points, securities fi rms further expanded the then popular line management. For example, securities fi rms turned investment banking divisions into one of the integral parts of business departments. They also attempted to build a sound man-agement system based on hierarchical delegation and changed the undertak-ing division‐based management model to adapt to the needs of international business and customers.

In line with such changes, Chinese securities fi rms broke down the previ-ous one‐dimensional organizational framework and management structure, and began conducting multiple business activities within existing offi ces. They established specifi c activity categories such as single‐level or multilevel


frameworks and structures that embraced diversity and relied on multide-partmental collaboration. Management also focused on business risks. Secu-rities fi rms at large established internal control mechanisms that included audit committees, risk control committees, and oversight departments. They also took back autonomy in business offi ces.

Concurrence of Separation and Crossover (Since 2000) The Chinese banking industry has now entered a “concurrence of separation and crossover” after the enactment of several game‐changing regulations. The regulation that enables qualifi ed securities fi rms and fund management companies to have access to the interbank lending market was enacted by the People’s Bank of China (PBC) in August 1999. The regulation that enables qualifi ed securities fi rms to hypothecate proprietary stocks and securities investment funds (SIF) bonds and borrow from commercial banks was enacted by the PBC and CSRC in early 2000. In particular, the amendment to the Commercial Banks Act became effective in February 2004, where the supplementary words “except as otherwise provided by the Chinese law” were added to Section 43. This means that commercial banks may, if in compliance with the Chinese law, deal in trust, investment, and stocks via fi nancial holding companies or others.

The change did not come easily. After a bullish market at the turn of the twentieth century, the market experienced a severe downturn as a resultof the reduction of the state’s stake in listed companies in 2001. And in thisdownturn, multiple risks accumulated over years posed a real threat to the securities industry by the end of 2003. Consequently, the regulators stepped in and called for an overall improvement initiative for brokers, which lasted four years beginning in 2004. Such an initiative helped maintain the number of securities fi rms in China at a relatively stable level. More importantly, it helped cause operating resources and main business to quickly fl ow to large, high‐performance fi rms of sound management, resulting in higher industrial concentration. The concentration ratio was 23.95 percent in the top 5 fi rms and 41.15 percent in top 10 fi rms in respect to operating revenue in 2009.

Due to existing separation restrictions, most Chinese securities fi rms still stick to the one‐dimensional organization and management model. However, for the purpose of market competition as well as regulatory com-pliance, after the year 2000 some securities fi rms made some major changes to their organization. The number of corporations is increasing and a con-siderable number of companies have gone public. By the end of 2010, 33 of the 106 securities fi rms had converted into corporations, and 15 of the 33 went public (there were 17 listed securities companies by October 2011).

A survey of organizational framework and management structure on a company‐by‐company basis shows that despite some difference in the design of departments and divisions, Chinese securities fi rms share a similar


FIGURE 3.3 Haitong Securities Company’s Organizational Framework andManagement Structure Source : The listed company’s annual report.

Shareholders’Meeting

Supervisory Board Board Office

Board of Directors

GeneralManager’s

Office

Board Office

Brokerage Committee

Int’l Business CoordinatingCommittee

Strategic Development andIT Governance Committee

Affiliates

Haitong Int’lHolding Co.,

Ltd.

Haitong-Kaiyuan

InvestmentCo., Ltd.

HaitongFutures Co.,

Ltd.

ITManagement

Dept.

ResearchCenter

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HRHeadquarters

Planning andFinancial

Dept.

BrokerageOperations

Center

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ManagementHeadquarters

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AnhuiSubsidiary

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EquityInvestment

andCooperation

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EquityManagement

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Subsidiaries

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Dept.

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HeilongjiangSubsidiary

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JiangsuSubsidiary

GansuSubsidiary

ZhejiangSubsidiary

ShenzhenSubsidiary

GuangdongSubsidiary

HubeiSubsidiary

IBCommittee

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Nominations and CompensationEvaluation Committee

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Dept.

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SecuritiesInvestment

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InstitutionalInvestorServices

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Headquarters

InvestmentBankingOffice

Haitong-FortisPrivate Equity

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HFTInvestment

ManagementCo., Ltd.

Fullgoal FundManagement

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organizational framework and management structure. It consists of business divisions, functional departments, and regional headquarters. As for the separation of powers and responsibilities, centralism prevails in most fi rms and delegation varies greatly under the infl uence of geographic and economic environment, management awareness, and others (see Figure 3.3 and 3.4 ).

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Despite the still existent separation line between commercial banks and securities fi rms, there is a tendency toward diversifi cation and conglomeration in the management of securities fi rms. A number of securities fi rms have been included in some fi nancial holding companies,2 which is an inevitable outcome of an attempt of Chinese mainland fi nancial institutions for integration of activities. According to Xia Bin ( 2001 ), despite the fact that there were many quasi‐fi nancial companies in China before 2000, fi nancialholding companies that are related to investment banking emerged after the overall improvement initiative in the securities industry. The CITIC fi nancial holdings company (incorporated in 2002) is the fi rst large fi nancial group by the name of fi nancial holding company, as approved by the State Council (see Table 3.3 ).

Internal Logic for Organizational and Management Evolutionin Chinese Securities Firms

To a considerable extent, the change of organization and management in Chinese securities fi rms is subject to the general policy for the Chinese fi nancial system reform, and is therefore politically sensitive. Such change is also closely related to competition in a changing internal and externalenvironment and the underlying demand in the market. From the perspec-tive of historical evolution, the emergence of Chinese securities fi rms (as an outcome of the change of the Chinese fi nancial system) and the choice of

2 In general, Chinese fi nancial holding companies in a conglomerate arrangement can be divided into the following three groups:

1. China Construction Bank (CCB), Bank of China (BOC), Industrial and Commer-cial Bank of China (ICBC), Bank of Communications (BoComm) and the big four asset management companies, which, despite the absence of the word “holdings”in their names, can be regarded as fi nancial holding companies, with companies actually engaging in fi nancial services–related activities as parent companies.

2. CITIC Group, China Everbright Group, and Ping An Group, in which parent companies, as pure investment holding institutions that work out strategies andoversee the management, do not directly engage in banking operations and have no fi nancial services–related activities in primary business.

3. China Merchants Group, Shanghai International Group, State‐Owned Assets Operation Co., Ltd. (SSAOCORP), Baosteel Group, and the like, in which par-ent companies are nonbanking economic entities holding nonbanking‐institution licenses and pursuing nonbanking activities in the primary business, which is “fi nancial holding groups coming into being out of industrial capital–related investment activities” as mentioned in the Memorandum on Cooperation and Separation of Duties in Financial Regulation.


TABLE 3.3 Chinese Securities Firms Affi liated to Financial Holding Companies

Name of Organization Financial Subsidiaries and Affi liates

China ConstructionBank (CCB)

CICC, CCB Asia, CCB Int’l (Holdings), SGB (Sino‐German Bausparkasse), CCB Financial Leasing, CCBTrust, CCB Principal Asset Management

CITIC Group CITIC Bank, CITIC Securities, CITIC Trust, CITICTrust Holdings, CITIC‐Prudential Life Insurance, CITICInt’l Financial Holdings, China Securities Co. (CSC), CITIC Bank International (former CITIC Ka Wah Bank), CITIC‐Jintong Securities

China EverbrightGroup

Everbright Bank, Everbright Securities, Sun Life‐Everbright Life Insurance, Everbright PramericaFund Management, Shenyin and Wanguo Securities,Everbright Futures

Ping An Group Ping An Bank, Shenzhen Development Bank, Ping AnProperty and Casualty Insurance, Ping An Securities, Ping An Trust, Ping An Life Insurance

China MerchantsGroup

China Merchants Bank, China Merchants Securities, Wing Lung Bank (Hong Kong), China Merchants FundManagement

Shanghai InternationalGroup

Shanghai Pudong Development Bank, Guotai JunanSecurities, Shanghai Rural Commercial Bank, ShanghaiSecurities, Shanghai International Trust, Hua An Fund, Haitong Securities, China International FundManagement, Changjiang Pension Insurance

Shanghai State‐Owned AssetsOperation Co., Ltd. (SSAOCORP)

Guotai Junan Securities, Shenyin and Wanguo Securities, China Pacifi c Insurance (Group), Eastern Life Assurance

China Huarong AssetManagement

Huarong Xiangjiang Bank, Huarong Securities, Huarong Financial Leasing, Huarong Int’l Trust, Huarong Futures, Huarong Zhiyuan Investmentand Management, Huarong Yufu Capital, HuarongRongde Asset Management, Huarong Huitong AssetManagement

China Cinda AssetManagement

Cinda Securities, Happy Life Insurance, Cinda Propertyand Casualty Insurance, Cinda Futures, Huida AssetTrust, First State Cinda Fund Management, Cinda Financial Leasing

China Orient AssetManagement

Dongxing Securities, Bangxin Asset Management, Dongyin Development (Holdings), Daye Trust

Source: Websites or annual reports of the companies listed.


organizational and management models are closely related to the functional orientation of the Chinese fi nancial market (the stock market in particular). They both relate to an inherent call of the great change in Chinese economicand fi nancial environment over the past 30 years.

In the early 1990s the ideological dispute about the choice of “planned economy” or “market economy” remained a highly sensitive topic. From a macroscopic point of view on market positioning and functional orienta-tion, the Shanghai and Shenzhen stock exchanges were created such that they did not entirely apply proven economic theory to practice for market‐based optimization of resource allocation. To a considerable extent, this waspart of the exploration of a new system in an attempt to fi nd a way to make a strategic change of fi nancial support strategies (i.e., a shift from mon-etary fi nancial support to monetary and securities‐based support). This was a period of economic transition, when the monetary revenue was drying up and the state‐owned banking system was carrying a huge economic burden. It was exposed to increasing risk as a result of massive bad debts accumu-lated over the years. The government allowed diversifi cation of promoters of a securities fi rm. For example, special purpose banks, insurance compa-nies, or other fi nancial institutions at the central level could be accepted as charter members. Local fi nancial institutions and even departments of fi nance could subscribe to capital contributions or shares. National or local trust and investment companies, which were quite new in the market, couldalso be allowed to set up a securities fi rm.

Therefore, even though the government was not very strict with the restrictions on market access, it was clearly a reasonable outcome that promoters chose a wholly government-owned company as the only organi-zational model either for institutional controllability or for exclusive owner-ship of returns. The market was in its infancy, securities fi rms were engaged in extremely simple and simplifi ed activities, and fi nancial institutions had much crossover in their activities due to the lack of regulatory constraintsand sound institutional settings. Promoters did not defi ne particular institu-tional positioning and functional orientation for securities fi rms. As a result,the management in securities fi rms was usually a natural extension of that of parent companies, which inherited the characteristics of a planned economy. There was little difference between securities fi rms and other fi nancial insti-tutions in China, in terms of management.

However, things changed after 1993. Landmark events in the reform included the stripping of nonperforming assets and the establishment of three policy‐oriented banks. Along with the reform in state‐owned special purpose banks, the Chinese government seemed more clear and deter-mined about the commercialization and market‐oriented reform in fi nan-cial institutions. In that context, another proposal came to the attention


of policymakers. This was for a market‐oriented reform in securities fi rms that were inferior to special‐purpose banks in terms of assets, capital, and infl uence. The moment came along with the enactment of the Companies Act of 1994 and Financial Institutions Regulations. Financial institutions in securities‐related activities were brought to compliance. During the process, limited liability companies became the preferred organizational model for securities fi rms and most of them completed conversion within two to three years.

Along with the rapid development of the fi nancial market, there was an increasing demand for diversifi ed securities services. There was also increasing competition between fi nancial institutions. For the purpose of enhancing core competencies and expanding market share, securi-ties fi rms began to review their management models. They replaced the one‐dimensional model, building on business offi ces in multiple activi-ties with single‐level or multilevel management systems that built on the classifi cation of activities, embraced diversity, and relied on multidepart-mental collaboration.

New legislation, including the People’s Bank Act, the Commercial Banking Act, and the Insurance Act of 1995, established legislatively the fi nancial model based on separation of activities. The institutional inde-pendence of Chinese securities fi rms was thus confi rmed. Satisfying the increasing need of money for a new technology‐enhanced makeover, this went beyond the capital restrictions in companies of limited liability, where there was only a single type of shareholder and most equity was in the hands of the controlling shareholders. After 1997, some Chinese securities fi rms further converted from companies of limited liability to corporations. This was in compliance with relevant regulations to sepa-rate from banks and other controlling shareholder, and it consolidated institutional independence and improved corporate governance. By the end of 1998, 29 of the 90 Chinese securities fi rms had completed such conversions.

While working on the organizational transformation, many large Chinese securities fi rms started to focus on business risks. Generally, they established internal control mechanisms that included audit committees, risk control committees, and oversight departments. They also took backautonomy in business offi ces. Individuation and diversifi cation started toappear in organizational structure and business mix. The Securities Act of 1999 legally differentiated the securities fi rms that offered brokerage ser-vices from the ones that offered general services. This improved or brought a change to the market operation system. Such changes included adminis-trative approval to regulatory endorsement for IPOs and the launch of a sponsorship system.


At the beginning of the new century, there was another major change of climate for the Chinese fi nancial system reform. China’s accession to the WTO in 2001 required the Chinese fi nancial system to be integrated into the global system as soon as possible. Opening up, accompanied by marketization and internationalization, became a driving force push-ing forward the fi nancial system reform and the change of organization and management in Chinese securities fi rms. After China’s accession to the WTO, Chinese fi nancial institutions would be faced with increasing competitive pressure from foreign competitors. To help Chinese securi-ties fi rms prepare for possible competition against foreign competitors in regard to capital, business, human resources, and others, the CSRC released in July 2006 the Risk Control Indicators‐Based Regulatory Mea-sures for Securities Firms and the Circular on Release of Net Capital Calculation Standards for Securities Firms. These regulations defi ned risk control indicators and determining net capital as the core indicator. The Provisional Assessment Measures for Securities Firms in Creative Activi-ties, which had been amended twice, also made the size of net assets one of the qualifying criteria for securities fi rms to carry out creative activi-ties. Net assets became a prerequisite factor for the operation and expan-sion of brokers. They also determined their market standing in the years to come. Many Chinese securities fi rms that had already diversifi ed their investors by conversion into corporations now dreamt of becoming pub-lic companies. Within a few years, dozens of securities fi rms had their IPO plans. There was a tendency of organizational transformation across the industry between 2006 and 2007 just before the fi nancial crisis. By that time, 17 securities fi rms became public companies through IPOs or back-door listing (Zhanyu 2009 ).

While Chinese securities fi rms were lining up to become corporations and then public companies, other fi nancial institutions (e.g., commercialbanks) brought major changes to their business activities. Chinese fi nan-cial reform went further, with the development of the fi nancial market, improvement of regulatory practice, change of regulatory philosophy, and changeover of the competitive landscape due to the advancement of tech-nology and innovation. A considerable number of banks or other eco-nomic entities then started to target an “integration” model, whereby a fi nancial institution could use a fi nancial holding company to segregate some activities and cause different activities to complement each other. This resulted in some securities fi rms becoming a part of conglomerates, subject to conglomeration management. However, despite the group‐like organizational framework and management structure, Chinese fi nancialholding companies have not yet brought noticeable synergies between dif-ferent business divisions/subsidiaries (e.g., banking, securities, insurance,


and trust). Those synergies would be far less signifi cant than the practical effect of synergies found in full‐service banks in the Continental Europe or even in American bank/fi nancial holding companies. 3 The lack of syn-ergies is due to the existing regulatory system as well as the realities of fi nancial development.

SELECTION OF MODELS (GOALS) FOR CHANGEOF ORGANIZATION AND MANAGEMENT IN CHINESE SECURITIES FIRMS

As fi nance penetrates further into China’s economic development and the Chinese fi nancial reform accelerates its pace, it is inevitable for fi nancial institutions, especially large ones, to follow the tendency toward integration.Therefore, for large investment banks, it is the trend of the times to choose the organizational and management model of fi nancial holding companies.As conglomerates, these holding companies have some protection of sepa-ration of activities and also enjoy the effi ciency of integration of activities. Independent brokers, however, will not die out in the foreseeable future. Small and medium‐sized securities fi rms (and even private partnerships ininvestment banking) will survive and grow for a long period of time, as a necessary complement to fi nancial holding companies. This is due to the following two reasons:

1. Financial holding companies are and will be limited by the develop-ments of the Chinese fi nancial market. They are also faced with some constraints of the existing regulatory system.

2. The independent model will be encouraged for innovation and continu-ity of expertise.

3Conglomeration is one of the most‐discussed topics in the Chinese academic circle. Many scholars believe that conglomeration, a highly specialized and centralizedorganizational structure, could help securities fi rms promote business and controlrisks. Currently, some large and medium‐sized securities fi rms are trying to build such a structure by transforming into holding companies. However, such companies are not real fi nancial holding companies. They simply build segregation between dif-ferent securities‐related services. They hold no bank assets and engage in no otherfi nancial activities than securities‐related services. Therefore, such a model would not be the goal of Chinese securities fi rms in their development and would not becomethe mainstream model in investment banking. It is nothing but some advanced formof independent securities fi rms.


Financial Holding Companies: Defi nition

Financial holding companies, bank holding companies, securities holding companies, full‐service banks, and other similar terms are often regardedas equivalent. But a clear understanding and distinction of these terms willhelp defi ne more clearly the future management model for Chinese securi-ties fi rms.

Generally, investment banking management models can be divided into the following three models:

1. Independent investment banks: In the independent investment bankmodel, an investment bank not affi liated to any fi nancial holding com-pany. It carries out investment banking activities on its own for the pur-pose of better decision making and effi cient operation. Morgan Stanley, Goldman Sachs, and Merrill Lynch before the fi nancial crisis are typical examples. 4

2. Affi liates to fi nancial holding companies: In the affi liate model, an investment bank is an affi liate to a fi nancial holding company and does business in a relatively independent manner in the capital market.

3. Subsidiaries of bank holding companies: In the subsidiary model (cross-over in all activities), an investment bank has no independent legalcapacity and is merely a business division of a bank holding company (full‐service bank). Typical examples include the Deutsche Bank and the Union Bank of Switzerland in Continental Europe.

Heterogeneous Financial Conglomerates (HFC) The Principles for the Supervision of Financial Conglomerates was jointly released in 1999 by the Basle Committee on Banking Supervision (Basle Committee), the International Organization of

4 In the independent business model, a securities fi rm (investment bank) conducts business on its own and is not affi liated to any fi nancial holding company. As per ownership and liability, this model can be further divided into partnership and corporate models. Investment banks, the American ones in particular, were allfamily‐controlled partnerships. Generally, large investment banks have experiencedthe conversion from partnerships into corporations. Today, only a small number of investment banks remain as partnerships, while most have been acquired by or merged into fi nancial holding companies or have become public companies. But even if an investment bank has completed the conversion from a partnership into apublic company, such as Goldman Sachs becoming a public company in 1999 andconverting into a bank holding company after the fi nancial crisis. We still view it tobe in an independent business model because such conversion is merely an internalownership arrangement and does not result in any change in business and manage-ment models.


Securities Commissions (IOSCO), and the International Association of Insur-ance Supervisors (IAIS). According to the defi nition of heterogeneous fi nan-cial conglomerates (HFC) in the Principles for the Supervision of Financial Conglomerates, a fi nancial holding company refers to fi nancial conglomerates with regulated entities under the same control that offer fi nancial services (as sole or primary business) in at least two businesses: banking, insurance, and securities. For such a conglomerate, fi nancial services are the primary busi-ness and its regulated entities engage to a signifi cant extent in at least two of the activities of banking, insurance, and securities business, and the capital adequacy requirements vary for each type of business.

According to the European Commission’s Financial Conglomerates Directive (released in 2003), a fi nancial conglomerate is a group that meetsthe following fi ve conditions:

1. A regulated entity is at the head of the group or at least one of the sub-sidiaries in that group is a regulated entity.

2. If there is a regulated entity at the head of the group, that entity is a par-ent undertaking of an entity in the fi nancial sector, an entity that holdsa participation in an entity in the fi nancial sector, an entity linked with an entity in the fi nancial sector by a relationship in which they are man-aged on a unifi ed basis pursuant to a contract concluded between them or provisions in their memorandum or articles of association, or wheretheir administrative, management, or supervisory bodies consist for themajor part of the same persons in offi ce.

3. If there is no regulated entity at the head of the group, the group’s activi-ties occur mainly in the fi nancial sector.

4. At least one of the entities in the group is within the insurance sector and at least one is within the banking or investment service sector.

5. The consolidated or aggregated activities of the entities in the group within the insurance sector and of the entities within the banking and investment services sector are both signifi cant.

As per the defi nition, a subgroup that meets these conditions should also be considered a fi nancial conglomerate. This defi nition is the most com-plete and legally binding defi nition ever made for fi nancial conglomerates.

So far, there is no specifi c defi nition of fi nancial holding companies in any Chinese laws and regulations. The Memorandum on Cooperation and Separation of Duties in Financial Regulation5 created between the China Banking Regulatory Commission (CBRC), the China Securities

5 The Memorandum on Cooperation and Separation of Duties in Financial Regulation is available on the CBRC website.


Regulatory Commission (CSRC), and the China Insurance Regulatory Commission (CIRC) in June 2004 is the only government paper in which “fi nancial holding companies” are referred to. In Section 8, it states the following:

For the purpose of regulation of fi nancial holding companies, regu-latory authorities should comply with the principle of operations and oversight based on separation of activities: bring the group company of a fi nancial holding company under the supervision of appropriate regulatory agencies according to the nature of the pri-mary business of such a group company and cause affi liates and activities of the fi nancial holding company to be supervised sepa-rately according to the nature of activities.

The memorandum also brings under regulation the fi nancial holding groups coming into being out of industrial capital‐related investment activi-ties and urges effort in control, coordination, and studies (on regulatorypolicy, standards, and practices) for such fi nancial holding groups. But this document neither gives any defi nition of fi nancial holding companies nor deliberates how to regulate the fi nancial holding groups coming into beingout of industrial capital‐related investment activities.

The institutional and regulatory framework remains on the principle of operations and oversight based on separation of activities. A fi nancial holding company serves the purpose of diversifi cation and integration of activities in the framework of a group. In reference to the internation-ally accepted defi nition, and in consideration of the realities in China, fi nancial holding companies are expected to engage in at least two kinds of activities in the fi nancial sector. Therefore, the defi nition of fi nancial holding companies should be as follows: Conglomerates that, in the form of holding companies, have their principal assets to a signifi cant extent in at least two of the banking, insurance, securities, trust, and other fi elds in the fi nancial sector. Specifi cally, such a conglomerate is a bank holding company (BHC) if all its subsidiaries are commercial banks; a securities holding company, if all its subsidiaries are engaged in investment bank-ing; and an insurance holding company if all its subsidiaries offer insur-ance services. Strictly speaking, bank or securities holding companies are not fi nancial holding companies. For example, conglomeration occurs in a securities fi rm if it establishes multiple subsidiaries and engages them separately in securities brokerage, asset management, investment con-sulting, venture capital, and other services. The emerging conglomerate, referred to as a securities holding company, is merely an advanced formof an independent securities fi rm.


Criteria for an Ideal Future Management Model for Chinese Securities Firms

Financial Holding Companies: The Best Model for Large Investment Banks in the Tendency toward Integration The Inevitability of Integration: An Analysis that Builds upon the Driving Forces of the Development of Investment Banking and the Logic of Institu-tional Change We can learn from the change of the fi nancial system and thehistorical evolution of investment banking in developed countries around the world that the fi nancial industry in most of these countries has under-gone changes from crossover through separation to re‐crossover. Either the crossover or the separation model is an outcome of the evolution that helps the industry adapt to the inherent requirements of economic development. The change of investment banking business model results from market ori-entation and institutional reasons.

The endogenous forces that drive investment banking to integration come from the following four areas:

1. Increasing public consumption of fi nancial services: As the primarycause, this pushes commercial and investment banking to integration. Companies and families want convenient fi nancial services and requestfi nancial institutions to be one‐stop shops. As a result, “fi nancial super-markets” and like institutions that offer integrated fi nancial servicescome into being. If a provider can offer complete fi nancial services, companies save trouble in fi nding fi nancial counterparties.

2. Market competition: As the capital market develops, the portion of conventional commercial banking shrinks in commercial banks whose growth is also limited due to separation of activities. Therefore, for commercial banks, the realistic way out is to explore new business and break through the limitations of separation of activities. Driven bycompetition, investment banks also desire to become stronger. In otherwords, there is a strong demand for crossover between commercial and investment banking and between money and capital markets.

3. Rapid development of information technology: This allows for con-venient and effi cient connection and interaction between capital and money markets and also results in inevitable interpenetration betweencommercial and investment banking.

4. Financial liberalization and internationalization: This accelerates the integration of commercial and investment banking.

If the change of business model in investment banking is endogenously driven by the development of fi nancial markets, such change surely cannot


happen without the change of a regulatory model that allows for, or adapts to, a new business model. Within less than a century, the law of the negation worked on the American fi nancial system. The institutional evolution seemsto be a simple cycle, but in fact it has its own laws. As economy develops, the system may not maintain equilibrium and players who desire to maximizeexpected revenue have motives to cause the system to be changed. When itcomes to integration, if revenue is expected to exceed costs, there is a possible systematic change, bringing about a tendency to equilibrium. 6 The currentglobal trend of crossover into the fi nancial industry is an inevitable result of market development, as the comparative cost advantage of competitionworks its way into the reconstruction of the fi nancial market. Although it isgovernment that pushes the change of the fi nancial system, the government would have to cave in to the demands of the market if the relations of pro-duction did not facilitate the development of productive forces. The market,competition, external environment, and other factors jointly result in anirresistible trend from separation to integration of activities.

In the United States, the Financial Services Modernization Act of 1999 came into existence to remove constraints imposed on the fi nancial industry by the former fi nancial system and regulation. In the United Kingdom, the Big Bang reform in 1986 allowed commercial banks to merge with invest-ment banks into fi nancial conglomerates, offering a variety of fi nancialservices. In 1998, Japan implemented a fi nancial system reform package that deregulated the banking, securities, and insurance businesses; repealedthe ban on banks in securities and insurance businesses; and allowed the crossover of fi nancial institutions. Globally, the fi nancial industry in theUnited States, the United Kingdom, and some other countries has gone fromcrossover through separation to integration. Germany, France, Italy, The

6 From the perspective of functionality, both fi nancial intermediaries and market‐based instruments are the carriers that help deliver basic fi nancial functions. As for the delivery of fi nancial functions, players compete against each other and the change of competitive cost is the key to decide competitive advantage. In the sce-nario of optimal arrangement, fi nancial functions are delivered by players who can do it at the lowest cost. This process, known as competitive arrangement of fi nan-cial functions, has a bearing on the change of structure and the development of the fi nancial system. We can learn from the current trend in the fi nancial industry that the boundaries between conventional activities are blurring, and it is hard to catego-rize some new fi nancial products into a specifi c category of conventional activities.Therefore, the separation of activities is a relative concept, and crossover is a more effi cient separation of duties that replaces the previous one. The change in fi nancialfunctional arrangement results in a change of separation of duties in the fi nancialsector, helping improve the effi ciency of the fi nancial system. This is how the separa-tion of duties goes further in the fi nancial sector.


Netherlands, Switzerland, and others disagree that banking crossover is thecause of the Great Depression of the 1930s. They have no legislation similarto the American one on separation of fi nancial activities, and they have been following the “universal banking system,” which is a crossover model thatintegrates banking and securities.

In China, the integration in investment banking is also an inherent requirement for the development of the capital market and commercialbanks. As integral parts of the modern fi nancial system, the capital market and commercial banks have some natural connections. The capital marketneeds the banking system as a necessary fi nancing channel and also pro-motes the asset and liability growth in commercial banking. Due to someinherent defects such as the mismatch of assets and liabilities regarding returns and risks, commercial banks have to rely on the capital market for asset, liability, and liquidity management. As China keeps moving toward a market economy and increasing its economic aggregate, rapid accumula-tion of social wealth leads to an increasing demand for diversifi ed fi nan-cial services. This is resulting in declining conventional commercial bankingin terms of business functionality. And as the capital market is becoming increasingly important in the macro economy, commercial banking has touse the platform for business innovation. For both the capital market and commercial banking, cooperation and integration are necessary at certainstages as the only path to further development.

The transition to integration in investment banking is also an inevi-table choice for the Chinese fi nancial system to improve its international competitiveness. Chinese securities fi rms will face double competitive pressures from foreign investment banks as well as other Chinese fi nan-cial institutions, which penetrate into investment banking and move toward integration. Overly strict regulation and separation of activi-ties continue to exist. A sound capital fl ow mechanism continues to be absent. Tools and activities continue to be infl exibly confi ned. If these conditions continue against a backdrop of fi nancial globalization where competition is fi erce, the Chinese commercial banking and securities markets will be severely limited in competitive strength and will be much less motivated to develop.

After the year 2000, in the global trend of fi nancial liberalization and deregulation, China became the last “fortress” of all market economies for the separation of activities in the fi nancial industry. From the regulatory perspective, the separation policy has become fl exible in recent years. As the Chinese fi nancial system reform goes further, the walls that keep com-mercial banks, insurance companies, and trust and investment companies from the securities business are crumbling and integration would be the ultimate choice.


Therefore, integration is an inevitable result of historical development. This is because of the global trend and an inherent requirement of the Chinese fi nancial industry. In the fi nancial market, large investment banks are driven by profi t and under the pressure of intense competition. They diversify activities and change their business model from the one that servesone particular kind of activity and independence to the one that serves inte-gration. Such change in business models would certainly cause change to organizational models.

Financial Holding Companies Are the Best Model for Large Investment Banks to Achieve Integration For investment banks, the change of businessmodel would certainly lead to the change of organizational model. In thedevelopment trend of fi nancial globalization and conglomeration, crossoverwould clearly be the future of the Chinese fi nancial industry. But considering the realities of the Chinese fi nancial sector, it would be a gradual process of development from separation to integration of activities. 7 During the transi-tion, fi nancial holding companies would be the choice that has the lowest cost and the highest return, and also the choice that best meets real‐worldconditions and needs.

After the outbreak of the fi nancial crisis, following the acquisition of Merrill Lynch and Bear Stearns and the bankruptcy of Lehman Brothers,Goldman Sachs and Morgan Stanley chose to convert into bank holding companies and submitted themselves to more stringent regulation by the U.S. federal government. The conversion of the big three U.S. investment banks into bank holding companies is a historic incident of the global fi nan-cial industry. It means to some extent that the mainstream independent investment banking model started to change, and the fi nancial holding com-pany model started to take over.

The Financial Services Modernization Act of 1999 was mainly intended “for the affi liation of banks, securities fi rms, insurance companies and other

7 In general, the evolution of the Chinese fi nancial system is a progressive reform. Since it is the government that pushes the reform forward, the evolution has the characteristics of mandatory change. Regulators make some arrangement for a newfi nancial system out of the old one, instead of destroying the core of the latter. Such an arrangement paves the way for reform, so regulators push the reform further. While such a shift maintains stability and continuity and also reduces friction costs, it costs time in the reform. According to the logic of a progressive reform, it wouldtake some time, even a very long period of time, for the Chinese investment banking system to shift from operations and oversight based on a separation of activities tooperations and oversight based on an integration of activities. But crossover in fi nan-cial services and related legislation will be necessary elements in the future reformof the fi nancial sector.


fi nancial service providers.” Considering the fact that investment banks gener-ally do not engage in the business of savings banks, fi nancial holding companies and national banks are the main fi nancial institutions that cross over activities at large. The Act allows qualifi ed bank subsidiaries to engage in securities and insurance business. It also allows banking, securities, and insurance companies to penetrate into each other’s territories for the purpose of affi liation via fi nan-cial holding companies—a typical model of such a crossover system.

Along with the increasing popularity of crossover in fi nancial services around the world in recent years, many countries have started to encourage the affi liation of fi nancial institutions, and some fi nancial mega‐conglomerates have emerged. Financial holding companies became the fi rst choice for large fi nancial institutions. In 1998, Citigroup started to take control of Citibank (commercial banking), Solomon (securities business), and Travelers Group (insurance business). Although the three wholly owned subsidiaries are engaged in different activities respectively, Citigroup has established the structure of a fi nancial holding company. HSBC Holdings (incorporated in 1991) has whollyowned subsidiaries in different regions. They run independently and engage in commercial banking, investment banking, asset management, insurance,and trust business, among others. Mizuho Holdings (incorporated in 2002) owns Mizuho Bank, Mizuho Corporate Bank, Mizuho Securities, MizuhoTrust, and other subsidiaries in fi nancial services. After three major mergers and reorganizations in 1995, 1998, and 1999 respectively, UBS now owns UBS Warburg (investment banking), UBS Global Asset Management, and UBS Swiss Bank.

In China, despite an investment banking history of only more than 20 years, independent investment banks have been dominant due to the legal restrictions of separation of activities. However, the growth model and com-petitive landscape are not stable. After the overall improvement initiative for securities fi rms, the organizational model in Chinese investment banking is quietly experiencing some change along with the Chinese fi nancial system reform and under the infl uence of the trend in the international fi nancial market. Some large fi nancial holding companies have started to give strong support to investment banking by making use of the business and network advantages of the commercial banks under their control. The number of independent investment banks will likely decrease, and more large invest-ment banks will likely embrace the fi nancial holding company model.

Financial Holding Companies Are the Best Choice for Large Chinese Investment Banks, Subject to the Constraints of the Current Financial System

The Financial Holding Company Model: Enabling Crossover under the Regu-latory Framework That Is Based on Separation of Activities In the second


half of 1992, there was a rush in real estate and securities investment. Byway of the interbank lending market, a great amount of credit funds fl ooded into the stock market, causing chaos and disorder across the entire fi nancial system. Consequently, the government worked to bring order to the fi nan-cial sector, and the central leadership required strict legislation on operations and oversight based on separation of activities. Such a principle was put for-ward offi cially at the national fi nancial work conference in early 1995. Sub-sequently, the enactment of the Commercial Banking Act, Securities Act, and Trust Act laid the legal foundation for operations and oversight based on separation of activities in the fi nancial sector.

Clearly, such an arrangement is an effective institutional arrangement that has worked in the realities of Chinese economic development and fi nan-cial operations. Integration in the fi nancial industry brings positive effect only on the premise that the regulatory authorities have enough authority, experience, and skills to regulate and supervise such integration at a low cost. Financial institutions must also have effective internal risk control, sound rules and regulations, professional staff, and enough management skills to manage the business at a low cost. Otherwise, any hasty move to integration of fi nancial services would likely lead to excessive speculation, uncontrol-lable risk, and an overheated market, among others. The fi nancial history of other countries indicates that the decision to separate fi nancial activities was mostly for the purpose of strengthening regulation and preventing risks.

Financial holding companies, as a new management model for cross-over, are in fact the result of organizational innovation by banking and other fi nancial institutions under the legal framework of separation of activities to bypass the legal obstacles and expand their business territories. The reasonfi nancial holding companies emerged in the United States is that American banking (commercial banking in particular) made an organizational innova-tion to bypass the regulation on separation of activities when competitiongot intense and business was tough. It is safe to say that in the institutionalcontext at that time, fi nancial holding companies built a bridge for Ameri-can banking to complete a smooth transition from separation of activities to crossover. 8

Although a fi nancial holding company is allowed to engage in at least two of the activities of fi nancial business, it does not cross over such activi-ties directly by itself. Instead, it uses subsidiaries as business platforms, andseparation of activities remains among subsidiaries. The fi nancial holding

8 The current crossover in American banking is mostly within fi nancial holding com-panies, where subsidiaries are engaged in different activities respectively, and each is relatively independent in legal capacity and management. The current crossover is not a simple recurrence of the pre‐1930 crossover.


company can benefi t from the economies of scale by creating complemen-tary activities, making money arrangements, and attracting and retain-ing employees with expertise in or between subsidiaries. It can also avoid the spreading of risk among subsidiaries by building a fi rewall between subsidiaries.

Therefore, fi nancial holding companies smoothly combine the safety provided by separation of activities and the effi ciency accompanied by inte-gration of activities. Like a ferry or bridge to integration of activities in theChinese fi nancial sector, such a model can enable integration within the current Chinese legal framework based on separation of activities. In China,the emergence of fi nancial holding companies is not the start of overall crossover, but merely an innovation, in a sense, under the separation‐based fi nancial system.

Chinese Financial Holding Companies: Emerging to the Surface Although in the Chinese legislative and regulatory landscape operations and oversight are based on separation of banking, securities, insurance, and trust business, such a model proved to be defective in practice. Under strict regulatory separation of activities, the banking and securities businesses are almost likewater and oil. They make it impossible for fi nancial institutions to carry out some activities that could benefi t economic growth and the public. The People’s Bank of China released the Provisional Regulations on Intermedi-ate Business of Commercial Banks in July 2001, allowing commercial banks to engage in some nonbanking activities. PBC also issued the Circular onHow to Implement the Provisional Regulations on Intermediate Business of Commercial Banks in April 2002, requiring commercial banks to categorize their intermediate business. (In fact, such classifi cation helps commercial banks engage in securities‐related activities.)

Financial holding companies are not expressly prohibited in existing laws and regulations. A fi nancial holding company actually engages in “fi nancial services‐related management and activities” instead of directly in fi nancial services itself. It does not cross over fi nancial activities directly. Instead, it uses subsidiaries as business platforms and separation of activi-ties remains among subsidiaries. This does not contradict the regulatoryprinciple that is based on separation of activities. Therefore, there is nolegal obstacle for the incorporation of a fi nancial holding company. TheChinese Commercial Banking Act (revised in 2003) provides in Section 43 that “within the People’s Republic of China, commercial banks shall not engage in trust investment and securities business. They shall not invest in non‐owner‐occupied real estate or non‐banking fi nancial institutions and business, except as otherwise provided by the Chinese law.” The Securities Act (revised in 2005) provides in Section 6 that “securities, banking, trust


and insurance are subject to operations and oversight based on separation of activities. Securities fi rms, banks, trust and insurance companies shall be incorporated separately, except as otherwise provided by the Chineselaw.” Legislatively, such provisions allow for integration. In fact, no Chinese law expressly bans an entity from holding shares in a commercial bank, aninsurance company, and a securities fi rm at the same time.

In the suggestion on the 11th Five‐Year Plan, which was adopted at the Fifth Plenary Session of the 16th CPC Central Committee in October2005, the CPC Central Committee made a point to speed up the fi nan-cial system reform and steadily push forward pilot programs and schemesfor integration of activities in the fi nancial sector. In recent years, a series of reformative measures have been taken, which are designed to push the fi nancial market reform further and deregulate the fi nancial industry. Some of them have relaxed the strict restrictions of separation of activities. These major breakthroughs in policy indicated a systematic market change in the Chinese fi nancial system, and the change did happen (as shown earlierin Table 3.3 ).

Coexistence of Independent Business and Financial Holding Company Models: Competitive Landscape for the Ideal Investment Banking Model in the Future The growing and all‐embracing international fi nancial market pushes investment banking to integration, leading to the emergence of “fi nancial supermarkets or depart-ment stores” and a dazzling variety of innovative products and fi nancial derivatives. However, quite a number of investment banks stick to special-ization, which makes the best of their advantages and gives prominence to particular services they offer. Integration is the trend of the investmentbanking development, and it usually suits large investment banks only. Infact, there is always a place for small and medium‐sized investment banks, regardless of how the investment banking market changes and how the industrial concentration improves. This is also an important criterion, tosome extent, for a sound and reasonable capital market structure.

The Independent Business Model Suits Small and Medium‐Sized Investment Banks Independent, specialized investment banks, a product of the separa-tion of fi nancial activities, can be found everywhere around the world. They are completely independent and are not controlling or being controlled by commercial banks or other fi nancial institutions. This independent business model helps small and medium‐sized investment banks in market segmenta-tion and functional orientation.

Independent investment banks are most endogenously motivated. Such a bank can make a decision on its own for the purpose of maximizing long‐term benefi ts and maintaining goodwill. Such a bank in partnership can


especially avoid the behavior that benefi ts group interests at the cost of investors. This could be very good for the long‐term development of invest-ment banking. On a run for profi t, investment banks also keep searchingconstantly for profi t‐making opportunities and developing new products and services, which signifi cantly boosts their innovative power.

Small and medium‐sized investment banks also work on segmentation and compete against large investment banks on the basis of staggered com-petition. The history of the U.S. stock market indicates that regardless of the swing between separation of activities and crossover, small and medium‐sized investment banks that are unable to diversify their activities have been sticking to characteristic, specialized services as the only way to survive and grow in the margins of the market. It is these small and medium‐sized investment banks that make the piece that completes the competitive land-scape in the securities market. For example, the American commission rateliberalization reform after the 1970s was largely due to small and medium‐sized investment banks in competition. Because small and medium‐sized investment banks work on specialization and segmentation more than large investment banks do, small and medium‐sized banks can offer products andservices at a relatively lower cost and have their own customer base and market infl uence in the capital market.

Alternatively, the development of large investment banks may be limited by the independent business model for the following reasons:

■ Small asset size: A relatively small amount of capital is the biggestfl aw in an independent investment bank. Although some major invest-ment banks around the world (such as Merrill Lynch, Goldman Sachs,Lehman Brothers, and Nomura Securities) have tens of billions of U.S. dollars in net assets and hundreds of billions in total assets, such amounts are still small compared with their competitors in the form of multibusiness fi nancial conglomerates, such as Citigroup, J.P. Morgan, Deutsche Bank, ABN Amro, Credit Suisse, and HSBC.

■ Lack of information superiority: Among all fi nancial intermediaries,commercial banks are considered to have information superiority. Usually, a commercial bank has already established a capital settle-ment relationship with a company before its IPO, and therefore has a lot of information about the client. A fi nancial holding company that integrates multiple activities can maximize the value of information, while an independent investment bank that cannot get client informa-tion from a commercial bank does not have the information superi-ority for its business. This could also prove from another angle the inevitable choice for large investment banks to convert to fi nancialholding companies.


Private Investment Banks Can Adopt the Independent Business Model Therewill be an increasing number of private quasi‐investment banking compa-nies. In the future competitive landscape in Chinese investment banking, private investment banks or quasi‐investment banks will constitute a special competitive group. There will be an increasing number of private companiestaking up some investment banking activities (including fi nancial consult-ing fi rms and consulting and management companies)—essentially quasi‐investment banking companies.9 These companies are mostly incorporatedby returnees who have accumulated during overseas studies or employmentquite a lot of advanced management experience and business skills and also have sharp eyes for market opportunities and a quick mind for creativemeans. They may also be professionals who, with working experience at securities or other companies and established connections, offer on their own some investment or M&A advisory services and even some project fi nancing and wealth management services.

In recent years, many professionally capable private consulting com-panies have enthusiastically played a part in corporate restructuring andmergers and acquisitions in the capacity of fi nancial advisors. And they havesuccessfully helped clients complete some notable mergers and acquisitions. For example, Unisplendour Investment Consulting Co. helped TEDA takecontrol of Meilun by way of backdoor listing, Beijing Xinmin Financial Advisors brought Xidan Shopping Mall and Beijing Friendship Store Group to a merger agreement. Shanghai Asian Business Investment Consulting Co. Ltd. helped COSCO Group take control of Zhongcheng, and Shangfang Group take control of Jiafeng in the capacity of fi nancial advisor. Such cases have a great impact on state‐owned‐enterprises (SOE) restructuring. Such private quasi‐investment banks have also brought along creative business reorganization models and demonstrated how listed companies can success-fully complete mergers, acquisitions, and reorganization.

Partnership is probably the preferred form of such quasi‐investment banks. For the purpose of business growth, most private investment banks choose to be independent entities. Some may choose to be companies, but most choose to be partnerships. After all, partnership is the independentbusiness model admirably suitable for those quasi‐investment banks. Part-nership has existed since the very beginning of the investment banking his-tory of more than 100 years and has the natural inherent rationality.

9 Although these management or fi nancial consulting fi rms cannot obtain from theregulatory authorities licenses for IPO underwriting, brokerage, and other business,they can still be regarded as investment banks because of the services they offer totheir clients, such as M&A and IPO consulting services, project fi nancing, fi nancial advisory services, company research, and venture capital services.


As a typical intelligence‐intensive business, investment banks require high business skills, innovation capability, and professional ethics of theiremployees, and they regard human capital and intelligence resources as the most important capital and resource. In some professional services, such as law, accounting, auditing, tax accounting, and management consulting, partnership or independent practice has been a tradition. In a partnership,equality, cooperation, and personal responsibility have been deeply rooted in the moral values of each partner. The long popularity of partnership in investment banking is also proof that partnership once was the most effec-tive organizational model for investment banks.

Along with the development of the capital market and the diversifi -cation and expansion of investment banking, large investment banks have converted into companies or corporations. 10 Such change seems to indicatethat notwithstanding many merits, and due to some inherent characteristics,partnership may also hinder the development of large investment banks to some extent. For example, there is some internal instability with respect tocapital size and structure. When a senior partner retires, the partner takesaway a share of capital, causing a signifi cant reduction in available corpo-rate capital. Such impact on the business can be devastating in a year whenthe partnership is not doing well. The limitation of partnership on the busi-ness is not signifi cant if an investment bank is small and mainly engages in activities that require a small amount of capital. However, as investmentbanking keeps pushing the bar higher and higher as to the size of capital and the speed of expansion, it is challenging for partnerships to meet the huge capital requirements for some businesses.

Along with the business expansion of large investment banks, business risks increase. For example, there is a possibility of massive loss within a short period of time. When a partnership is faced with such high risks, it ispartners who have unlimited joint and several liability for debts. The mecha-nism seems to be deeply fl awed. Unlike a public company, a partnership does not have to disclose its operating status and fi nancial position. In ahighly competitive capital market activity, the lack of suffi cient transpar-ency, market surveillance, and public oversight leaves risk management sus-picious in a partnership. This would impose greater pressure on the internal control mechanism.

Currently, most American investment banks are companies or corpora-tions. However, there are quite a few small and medium‐sized investment

10 In August 1998, 188 Goldman Sachs partners voted for selling some shares to public investors. This indicated that the partnership model, which had been widely accepted in investment banking for centuries, seemed to be no longer popular or tohave been abandoned by the mainstream investment banks.


banks in partnerships. In China, partnership never existed in investmentbanks. However, partnership is far too outmoded for investment banks, because investment banking cannot shake off individual character and skills. Business forms vary to fi t different sizes and activities, and each form has a specifi c orientation. This means that regardless of partnerships or compa-nies/corporations, independent, private quasi‐investment banks that adopt the competitive strategies for differentiation and specialization will achieve success in the competitive landscape in the Chinese securities market, thanksto a particular competitive advantage in human capital.

Criteria for an Ideal Future Management Model for Chinese Securities Firms:Factors Within Firms Advantages of Financial Holding Companies: Help Build up Competitive-ness in Investment Banks Financial holding companies are an advanced micro‐organizational form and a product of sustainable development of the fi nancial industry. They are an organizational innovation by fi nancial institutions helping to adapt to, survive in, and grow with the development and transformation of the fi nancial system. Compared to an independentfi nancial institution, a fi nancial holding company has the following core strengths:

■ Capital intensifi cation: A fi nancial holding company can raise capitalby issuance of stocks, bonds, debentures, notes, and other securitiesand invest money in subsidiaries under its control. It can also manageand employ the assets of subsidiaries in a centralized manner. Through equity operations at different levels (a subsidiary can use the same hold-ing strategy), the fi nancial holding company can control a large businessfamily and double the capital utilization ratio and assets in its actual control. Capital‐intensifi ed management is the fundamental operationaladvantage of a fi nancial holding company.

■ Diversifi cation‐induced coupling effect: The advantage of businessdiversifi cation is one of the goals of fi nancial capital operations. A fi nancial holding company serves a purpose to break through restric-tions on business activities and pursue a variety of fi nancial services in hopes of building up operational advantages such as economies of scale and scope, synergies, and spread of risk. This model can bring to investment banks synergies, economies of scale and scope, cross‐selling, information sharing, fi nancial innovation, and so forth. Once having been incorporated into a fi nancial holding company, an investment bank has a boost to grow, thanks to the homogeneity of fi nancial ser-vices. Enlarged business network coverage, diversifi ed services, and one‐stop fi nancial services help an investment bank attract more customers,


increase market share, or further explore the needs of the established customer base.

■ Effective spread of business risk: A fi nancial holding company has a broad range of business. It can arrange different activities into a variety of business mixes at different risk levels. Therefore, it is less exposed tothe risk of bankruptcy. A fi nancial institution that chooses or is limited to a certain line of business, on the other hand, has a narrow range of options of asset combinations and business mixes. Therefore, it is highlyexposed to the risk of bankruptcy. Learning from how the American investment banks responded to this fi nancial crisis, the fi nancial hold-ing company model seems to be the optimal organizational model that provides shelter for investment banks. In Europe, the fact that many investment banks have chosen the fi nancial holding company model suffi ciently indicates the vitality of this organizational model that helps multibusiness investment banks survive and grow. In the United States, after the outbreak of the fi nancial crisis, some large independent invest-ment banks went bankrupt or were sold to commercial banks and became part of bank holding companies. Goldman Sachs and MorganStanley were converted into fi nancial holding companies. In Japan and South Korea, investment banks controlled by fi nancial holding compa-nies dominate the securities market. From historical facts and currenttrends, we can conclude that although the fi nancial holding companymodel might not be the only option for investment banks, it is at leastan important organizational model that combines effi ciency and risk control. Its vitality proves its importance in the development of invest-ment banking. The high stability of German full‐service banks over a long period of time and the bankruptcy of more than 1,000 single‐line American banks since the 1980s seem to confi rm both positive and negative conclusions.

■ Market power: Thanks to the economies of scale, a fi nancial holdingcompany expands quickly. It takes a huge chunk of market share and gains a monopoly. By taking advantage of such infl uence in the market, the company earns excess profi ts. Such a natural monopoly that empowers a fi nancial holding company for further growth is the main enticement for investment banks to choose this organizational model.

Financial Holding Company–Backed Investment Banks Are Stronger inRespect to Overall Competitiveness: Chinese Practice An analysis of the 2009 performance of Chinese securities fi rms leads to the encouraging dis-covery that investment banks controlled by fi nancial holding companies have strong competitive advantages (see Table 3.4 ).

186

TABL

E 3.

4 M

arke

t C

ompe

titi

on P

erfo

rman

ce o

f Fi

nanc

ial H

oldi

ng C

ompa

ny–B

acke

d Se

curi

ties

Fir

ms

Item

Num

ber

of

FH

C‐

Back

ed S

ecu

riti

esFir

ms

in t

he

To

p 1

0N

am

es o

f FH

C‐B

ack

ed S

ecu

riti

es F

irm

s in

t he

Top 1

0N

am

es a

nd N

um

ber

of

the

Oth

ers

in t

he

To

p 1

0

Top

10 (

2009

) by

un

derw

riti

ng (

RM

Bam

ount

)

8C

ICC

, CIT

IC S

ecur

itie

s, B

OC

Inte

rnat

iona

l, U

BS

Secu

riti

es, C

hina

Se

curi

ties

(C

SC),

Chi

na M

erch

ants

Secu

riti

es, P

ing

An

Secu

riti

es, U

BS

Secu

riti

es

Gal

axy

Secu

riti

es, G

uoxi

n Se

curi

ties

(2)

Top

10 (

2009

) by

un

derw

riti

n g (

cont

ract

s)8

CIT

IC S

ecur

itie

s, C

ICC

, Guo

tai J

unan

Secu

riti

es, C

hina

Sec

urit

ies

(CSC

), C

hina

Mer

chan

ts S

ecur

itie

s, P

ing

An

Secu

riti

es,

BO

C I

nter

nati

onal

, UB

S Se

curi

ties

Guo

xin

Secu

riti

es, G

alax

y Se

curi

ties

(2)

Top

10 (

2009

) by

pr

opri

etar

y tr

adin

g re

venu

e

6G

uota

i Jun

an S

ecur

itie

s, C

ITIC

Sec

urit

ies,

Hai

tong

Sec

urit

ies,

She

nyin

and

Wan

guo

Secu

riti

es, C

hina

Mer

chan

ts S

ecur

itie

s,C

hina

Sec

urit

ies

(CSC

)

Gal

axy

Secu

riti

es, G

F Se

curi

ties

, Guo

xin

Secu

riti

es, H

uata

i Sec

urit

ies

(4)

Top

10 (

2009

) by

m

arke

t sh

are/

reve

nue

5C

ITIC

Sec

urit

ies,

Guo

tai J

unan

Sec

urit

ies,

Hai

tong

Sec

urit

ies,

Chi

na M

erch

ants

Se

curi

ties

, She

nyin

and

Wan

guo

Secu

riti

es

GF

Secu

riti

es, G

alax

y Se

curi

ties

, Hua

tai S

ecur

itie

s,

Guo

xin

Secu

riti

es (

4 )

Top

10 (

2009

) by

net

ca

pita

l6

CIT

IC S

ecur

itie

s, H

aito

ng S

ecur

itie

s,E

verb

righ

t Se

curi

ties

, Guo

tai J

unan

Se

curi

ties

, Chi

na M

erch

ants

Sec

urit

ies,

Shen

yin

and

Wan

guo

Secu

riti

es

GF

Secu

riti

es, G

uoxi

n Se

curi

ties

, Gal

axy

Secu

riti

es,

Qilu

Sec

urit

ies

(4)

Top

10 (

2009

) by

ass

et

size

6C

ITIC

Sec

urit

ies,

Hai

tong

Sec

urit

ies,

Guo

tai J

unan

Sec

urit

ies,

Chi

na M

erch

ants

Se

curi

ties

, She

nyin

and

Wan

guo

Secu

riti

es,

Chi

na S

ecur

itie

s (C

SC)

Gal

axy

Secu

riti

es, G

F Se

curi

ties

, Hua

tai S

ecur

itie

s,

Guo

xin

Secu

riti

es (

4)

187

Firs

t qu

alifi

ed s

ecur

itie

s fi r

ms

for

pilo

t m

argi

ntr

adin

g an

d sh

ort

selli

ngpr

ogra

m

3 in

6 (

tota

l)C

ITIC

Sec

urit

ies,

Guo

tai J

unan

Sec

urit

ies,

Eve

rbri

ght

Secu

riti

esG

F Se

curi

ties

, Hua

tai

Secu

riti

es, G

uoxi

n Se

curi

ties

Firs

t qu

alifi

ed s

ecur

itie

s fi r

ms

for

pilo

t di

rect

inve

stm

ent

prog

ram

2 in

2C

ITIC

Sec

urit

ies,

CIC

C

Qua

lifi e

d as

QD

II7

in 9

CIT

IC S

ecur

itie

s, G

uota

i Jun

an S

ecur

itie

s,H

aito

ng S

ecur

itie

s, C

hina

Mer

chan

ts

Secu

riti

es, S

heny

in a

nd W

angu

o Se

curi

ties

, C

ICC

, Eve

rbri

ght

Secu

riti

es

Hua

tai S

ecur

itie

s, G

uoxi

n Se

curi

ties

Secu

riti

es fi

rms

rate

d A

A

(201

0) (

no fi

rm r

ated

AA

A)

8 in

12

Eve

rbri

ght

Secu

riti

es, G

uota

i Jun

an

Secu

riti

es, H

aito

ng S

ecur

itie

s, C

hina

M

erch

ants

Sec

urit

ies,

CIC

C, C

hina

Secu

riti

es (

CSC

), C

ITIC

Jin

tong

, CIT

IC

Secu

riti

es

Ori

ent

Secu

riti

es, G

uoxi

nSe

curi

ties

, Hua

tai S

ecur

itie

s,G

alax

y Se

curi

ties

Not

es:

1. A

ll th

e fi n

anci

al h

oldi

ng c

ompa

ny–b

acke

d se

curi

ties

fi rm

s in

Tab

le 2

.2 a

ppea

r in

Tab

le 3

.1. U

BS

Secu

riti

es is

add

ed fo

r U

BS

Gro

up (U

BS)

and

is t

he c

ontr

ollin

g sh

areh

olde

r. 2.

Alt

houg

h G

alax

y Se

curi

ties

is

cont

rolle

d by

Chi

na G

alax

y Fi

nanc

ial

Hol

ding

s L

td.,

who

se p

rim

ary

busi

ness

rem

ains

to

be i

nves

tmen

tba

nkin

g, G

alax

y Se

curi

ties

is r

egar

ded,

for

the

tim

e be

ing,

as

a se

curi

ties

hol

ding

com

pany

‐bac

ked

secu

riti

es fi

rm (

an in

depe

nden

t bu

sine

ssm

odel

in a

n ad

vanc

ed f

orm

) ra

ther

tha

n a

fi nan

cial

hol

ding

com

pany

–bac

ked

secu

riti

es fi

rm.

Sour

ce: W

ind

Info

rmat

ion

Co.

, the

Sec

urit

ies

Ass

ocia

tion

of C

hina

(SA

C),

and

the

Chi

na S

ecur

itie

s R

egul

ator

y C

omm

issi

on (C

SRC

) web

site

s.


Considering the status quo of Chinese securities fi rms, the regulatory authorities will generally select a small number of securities fi rms on the basis of their risk management capability and industrial infl uence for pilot programs of innovative activities. On the principle of “pilot arrangement before extended practice,” the regulatory authorities will consider a series of indicators (such as net capital requirement, regulatory compliance, andnet capital risk control) and pilot program implementation plans and selecthigh‐performing and prudent securities fi rms for the fi rst pilot program. If the fi rst one goes well and the market response is satisfactory, the authori-ties will extend the pilot program. Based on the lists of qualifi ed securitiesfi rms for pilot programs of direct investment, QDII, margin trading and short selling, and stock‐index futures, fi nancial holding company–backedsecurities fi rms can better meet the CRSC requirements and have a bet-ter chance to fi rst participate in new activities. This is thanks to signifi cant advantages brought about by economies of scale. Therefore, fi nancial hold-ing company–backed securities fi rms have a natural competitive advantage in qualifying for new business.

Once qualifi ed, a securities fi rm has a starter’s advantage to get access to the new business market in advance and leave other securities fi rms far behind in the competition for new customers. Such an advantage is path‐dependent. In the long run, this advantage will help enhance overall compet-itiveness and the strong will get stronger. Innovative products and services, which will be crucial for the upgrade of profi t model and future competi-tiveness, will be a game for the strong, and will signifi cantly widen the gap between competitors.

Net capital is at the core of investment banking oversight around the world. In China, regulators are working on the improvement of the risk con-trol system in securities fi rms, with net capital as the core indicator. The CSRC released in July 2006 the Risk Control Indicators‐Based Regulatory Measures for Securities Firms and the Net Capital Calculation Standards for Securities Firms. It imposed more stringent requirements in the revisions of June 2008, which provide that with the net capital requirement at the core, the regula-tory system must directly keep a rein on securities fi rms as to the scale and structure of each business. Capital strength determines the future. A securities fi rm can use a fi nancial holding company as a platform to reinforce capi-tal strength for the securities fi rm to build on the advantages of the holding company and to have easier access to fi nance by means of IPOs, issuance of debentures, or others. According to the 2009 Chinese securities fi rm ranking by net capital, all the top six fi rms are backed by fi nancial holding companies.

Financial holding company–backed securities fi rms have strong com-petitive advantages in the aspects of business capacity, profi tability, risk control, and innovation capability, among others. And such dominant or


potential competitive advantages will turn into overall competitiveness along with future business growth. This will be determined by the overallcompetitiveness and platform resources of the fi nancial holding companies.

The Choice of a Future Growth Model for Investment Banks Should Com-ply with the Financial Services Framework That Leans toward Commer-cial Banking After the post‐crisis reorganization, mainstream Wall Streetinvestment banks did not disappear; they were integrated into a new busi-ness and regulatory system. In fact, among more than 880 mergers andacquisitions in investment banking in the past fi ve years, more than 260,or 30 percent, involve commercial banks acquiring investment banks. This indicates that in the United States, commercial banks have been the mainbuyer in the purchase of investment banks. We cannot deny that the fi nan-cial crisis has provided a business growth opportunity for the American bank‐backed fi nancial holding companies. In the fi nancial crisis, as assetvalue rapidly shrank and bank runs escalated, investment banks sufferedmassive losses and could barely survive without external help. This pavedthe way for a series of mergers, acquisitions, and reorganization in theAmerican fi nancial industry. Major commercial banks were active in M&As and reorganization. In particular, several large commercial banks seized arare opportunity and quickly divided up most of the assets in the Americansecurities industry.

The fi nancial crisis showed that the single‐line business model does not perform as well as the crossover model does in respect to resilience to a fi nancial crisis. The crossover model proves to be more risk‐resistant.11 Gen-erally, in commercial banking, business management is more transparent. Risk management and control systems are also better. Together with strictregulatory oversight, diversifi ed business activities, and other factors, theyhelp stabilize sharp fl uctuations in operating income.

Along with increasing competition and deregulation, commercial bank‐controlled fi nancial holding companies in China over the long run will havemore vitality in the future competitive landscape. The reasons for this are discussed next.

The Chinese banking sector has access to most fi nancial assets and cus-tomers. In the Chinese fi nancial industry, the majority of capital, fi nancial

11 Compared with independent American investment banking, conventional Euro-pean banking (especially German banking) took a relatively smaller hit in the crisis.The German universal banking model may not necessarily be superior to the inde-pendent American investment banking model, lacking theoretical proof and practi-cal evidence. However, full‐service banks are clearly exposed to less risk and aremore robust.


assets under management, and fi nancial services customers are concen-trated in the banking system. According to a study of Qian Xiao’an (2006),93 percent of all the Chinese fi nancial assets are controlled by the bank-ing sector. Less than 7 percent are in the insurance and securities sectors. Because commercial banks have most of the assets and customers and can easily offer one‐stop services, they have both a subjective impulse and objec-tive facilities to convert into fi nancial holding companies. The asset andcustomer structure in the Chinese fi nancial industry determines that com-mercial banks will be at the core of fi nancial holding companies. All subsid-iaries in a fi nancial holding company can share information and customers. Therefore, an investment banking subsidiary can expand its business and improve the quality of service.

Investment banks need liquidity. In the existing Chinese system, all fi nancial institutions except commercial banks are unable to create liquidity on their own. However, they all have a strong need for liquidity,12 invest-ment banks in particular. A review of the Chinese securities industry and the U.S. fi nancial crisis shows that both Wall Street banks and Chinese securities fi rms are highly dependent on liquidity. The difference is that due to insti-tutional dissimilarity, Wall Street investment banks can create liquidity and increase fi nancial leverage by the so‐called fi nancial innovation. Before the fi nancial crisis, the fi nancial leverage ratio was up to 30 to 1 in the majority of Wall Street investment banks. This means that even if the total return on assets (ROA) dropped by only 3 percent, it could devastate these fi nancial institutions.

Before the overall improvement initiative across the industry in China, securities fi rms had no legitimate fi nancing channels. Some turned to ille-gal means for liquidity, such as misappropriation of clients’ money in their securities trading settlement accounts, issuance of over‐the‐counter bonds, and wealth management contracts. Such means led to bankruptcy and shut-downs. After the overall improvement initiative, the regulatory authorities have enabled some high‐performing and prudent securities fi rms to have access to some legitimate fi nancing channels, such as IPOs and issuance of corporate debentures. For most securities fi rms, however, along with increas-ing innovative products and services and expanding asset services, the prob-lem of liquidity shortage still remains. If an investment bank becomes a

12 Lloyd Blankfein, Goldman Sachs chairman and CEO, once said: “When Goldman Sachs was a private partnership, we made the decision to become a public company, recognizing the need for permanent capital to meet the demands of scale. While accel-erated by market sentiment, our decision to be regulated by the Federal Reserve is based on the recognition that such regulation provides its members with full prudential supervision and access to permanent liquidity and funding” ( Goldman Sachs, 2008 ).


subsidiary of a fi nancial holding company, the commercial bank in the same fi nancial holding framework could provide liquidity support by means of business coupling, banking‐securities cooperation, and others.

Investment banks also need public credit. Credit is the foundation of the fi nancial industry and is usually divided into commercial credit and pub-lic credit (also referred to as government credit). Unlike general industrialcompanies, fi nancial companies do not rely solely on their own commercialcredit; they also need public credit. In China there is no investor protection law, deposit insurance system, or fi nancial consumer protection system. This makes the need for public credit even more important for fi nancial compa-nies. Due to the public ownership and other historical reasons, the public credit of Chinese commercial banks is better than that of insurance com-panies and securities fi rms. Except for commercial banks, the public credit of Chinese fi nancial institutions cannot serve its purpose. This is particu-larly true in the securities sector, where problems exposed during the over-all improvement initiative dragged the public credibility of securities fi rms down to the bottom in the whole fi nancial industry (even though the inves-tor protection mechanism has been established). Defi nitely, an investment bank being a part of a fi nancial holding company would greatly improve its public credit.

SOME IDEAS OF OVERALL POLICY FOR FUTUREORGANIZATIONAL AND MANAGEMENT TRANSFORMATION IN CHINESE SECURITIES FIRMS

After more than 20 years, the Chinese securities industry has become pre-liminarily functional in the service to the capital market and the improve-ment of capital effi ciency. As the core service agency in the capital market, Chinese securities fi rms have also made their own way to growth and gainedexperience. They are increasingly clear about their operating models in bro-kerage, underwriting, proprietary trading, and consulting services. They are also very active in innovation. By either international experience or Chinesepractice, the securities industry is, relatively speaking, strictly regulated by policy and regulations because of its signifi cant impact on economic stabil-ity, public wealth, fair competition, and market speculation. Therefore, the management model in securities fi rms is the result of legislative and regula-tory control as well as market competition for effi ciency.

The same is true of the Chinese securities industry and the principal parties of securities fi rms. The exploration, change, and innovation of the management model in Chinese securities fi rms will continue to be policy oriented, path dependent, and market‐demand driven. To some extent, this


is subject to the effect of multiple factors such as economic and institutional features, capital market maturity, and historical experience. Financial hold-ing companies, independent securities fi rms, and emerging private securities institutions will also be driven by policy and market in further development, differentiation, and growth. They may, however, vary greatly in terms of dependence on policy or market factors.

Operations and Oversight Based on Separation of Activitiesand the Financial Holding Model

Currently, there are clear and complete industrial boundaries plus a regula-tory framework under the established Chinese fi nancial management sys-tem, which builds on the principle of operations and oversight based onseparation of activities. The National People’s Congress has promulgatedthe Commercial Banking Act , the Securities Act, the Insurance Act, andthe Banking Oversight Act. It has defi ned basic industrial connotations, setbasic regulatory rules, and delegated regulatory powers to regulatory agen-cies under the State Council for banking, securities, and insurance sectors, respectively. How to introduce the fi nancial holding model to the current legal framework is a project that requires the effort of both policymakers and market participants.

Some Experience Gained from Undergoing Pilot Programs of the Financial Holding Model and Integration of Activities The historical evolution of the Chinese fi nancial industry and some pilot programs approved by the State Council have pro-vided some fi nancial conglomerates or institutions that engage in activities or hold shares in companies in activities across different fi nancial sectors. Such conglomerates and institutions can be broadly grouped under four basic groups plus two special additions, as follows:

Basic Groups

1. The fi rst group consists of conglomerates approved directly by the cen-tral government, such as CITIC Group, China Everbright Group, and China Merchants Group. Besides fi nancial services, they are also widelyengaged in industrial activities. Because of current franchise manage-ment system in the Chinese fi nancial industry, these conglomerates make an effort to expand the scale of fi nancial activities. As a result, the assets of fi nancial subsidiaries constitute a large chunk of the total assets of conglomerates.

2. This is business created by a fi nancial institution engaged in activi-ties in another fi nancial sector under a pilot program or crossover, as a result of equity investment. This includes a fund management


company incorporated by a bank under a pilot program, a bank’s investment and equity participation in an insurance company under a pilot program, the acquisition of a trust company by a bank, or an insurance company’s investment or equity participation in a com-mercial bank.

3. These are emerging fi nancial asset management companies (AMC) that have created or acquired banking, securities, insurance, and other subsidiaries.

4. This last group is nonbanking conglomerates holding shares of fi nancial institutions in different types.

Special Additions

1. The fi rst special addition is the China Investment Corp. (by direct investment or investment via the Central Huijin Investment Ltd.) as (controlling) shareholder in domestic fi nancial institutions of different kinds.

2. The second is banks or other fi nancial institutions that have incorpo-rated, acquired, or invested in overseas subsidiaries engaged in activities across different sectors (there is no separation of activities in the host countries), such as ICBC (Asia) and BOC International.

The above classifi cation indicates that the existing Chinese fi nancial holding model is clearly policy oriented. Because the need for reform and development policy varies in different historical periods, the corresponding fi nancial holding model refl ects different values and practice characteristics. Unlike similar foreign models, the Chinese fi nancial holding model is usu-ally a derivative product of China’s foreign strategy or fi nancial reform, rather than a natural outcome of the effort to adapt to the development of fi nancial markets and to integrate fi nancial resources.

Selection of Landing Site for Financial Holding Model Chinese fi nancial policy that targeted different problems at different periods of time has resulted in many rudimentary, policy‐oriented fi nancial holding models with dif-fering focuses. For the argument that the future fi nancial holding model has the advantage of economies of scale and synergies to be tested and confi rmed, another important question needs to be answered: How to develop the fi nancial holding model, or what kind of model needs to be developed. Based on realistic options of policy, this question would lead to a discussion on how to choose between further development with modifi cation based on existing rudimentary models and exploration of a new model based on the evolution of market demands. Judged from the Chinese fi nancial history and industrial practice, further development


seems a reliable and pragmatic way for the design of policy for the fol-lowing three reasons:

1. Under the current legal framework on the principle of operations and oversight based on separation of activities, the constraints on marketbehaviors are strong. Crossover is subject to offi cial examination and approval/endorsement on a case‐by‐case basis. This usually requires coordination and franchise by the central government. In the short andmedium run, the current framework will remain the suitable one forthe development and regulation of the Chinese fi nancial industry, andit will continue to improve and consolidate. Exploring and testing the fi nancial holding model under the current framework can reduce the direct impact on the present status, unnecessary cost of change, anduncertainty. It can also help keep the systemic risk under control.

2. The existing crossover model can indicate a successful combination of fi nancial practice and policy framework, to some extent. Despite vari-ous crossover models, such exploration of diversifi cation offers more options and test perspectives for the selection of the future fi nancial holding model, without the extra cost.

3. The Chinese fi nancial industry is still growing and reengineering itself. The industrial landscape is changing. Inertia is being replaced by newmarket‐oriented competitiveness. The banking sector, as the conven-tional fi nancing channel, remains dominant in the fi nancial industry.Securities and insurance sectors have more motivation and vitality for innovation during the exploration. When exploring the fi nancial hold-ing model, the competitive landscape and established strength of thethree sectors must be considered. In fact, the single‐line, market‐orientedpractice actually acquiesces in the arrangement that the conventional banking sector has for the resources endowment. The securities andinsurance sectors have an innate disadvantage. There is no natural spacefor them during the development of the fi nancial holding mode. There-fore, policy coordination and institutional design will be important in the process.

Among the existing fi nancial holding models in China, the trial model, in which commercial banks are the main parts in holding companies, is directly subject to the provisions of Section 43 of the Commercial Banking Act. It states that “within the People’s Republic of China, commercial banks shall not engage in trust investment and securities business; shall not invest in non‐owner‐occupied real estate or non‐banking fi nancial institutions andbusiness, except as otherwise provided by the Chinese law.” This refl ects how stringent legislative requirements are on separation of banking from


other fi nancial sectors. It also indicates how diffi cult it will be if policy chal-lenges the law by allowing banks to establish affi liates that engage in the activities of another fi nancial sector.

Nonbanking companies that buy into fi nancial institutions usually have the purpose of fi nancial investment and local resources integration. They are not actually involved in fi nancial business and specialized decision‐makingintervention. Therefore, the China Investment Corporation, conglomeratesapproved directly by the central government, and fi nancial asset manage-ment companies seem closer to the path of substantive exploration of the fi nancial holding model. A further comparison of these three fi rms follows.

Both the China Investment Corp. and national conglomerates (such as CITIC Group, China Everbright Group, and China Merchants Group) have important economic functions. These include foreign investment, cross‐border economic exchanges, equity management, and the management of state‐owned fi nancial assets for the purpose of infl ation proofi ng and pos-sible appreciation. Their participation in fi nancial business is a means toexercise such functions, rather than an end. They aim to carry out the gov-ernment‐defi ned functions, rather than become fi nancial holding companies.In the course of business development, such duality in development orienta-tion, in a particular environment and for a particular issue, may internalize goals and means into a unifi ed business motive. It may also generate fric-tions and confl icts.

In contrast, fi nancial asset management companies (AMC) that have accomplished the historical mission to dispose of nonperforming loans are in need of new functional orientation. They also need a development path to build on their relatively pure fi nancial background, keep sources of assets,carry on asset management experience, and expand into a new category of fi nancial institutions.

In real‐world practice, Huarong and Cinda asset management compa-nies are becoming such an embryonic form. Their subsidiaries have alreadyobtained multiple licenses, respectively for banking, securities, futures,insurance, trust, leasing, and others. Their headquarters have full strate-gic decision‐making power over subsidiaries. To transform into a fi nancial holding company under the existing policy framework, a fi nancial assetmanagement company would not have to break through strict legislative and regulatory restrictions and spend extra money to build a new fi nancialinstitution. For such policy‐oriented fi nancial institutions, it would be a dis-creet transformation in a particular historical background, which does not require a new regulatory framework. In this sense, it is a reformative design that has relatively low market, policy, and institutional costs. Of course,this is based on the premise that the Chinese fi nancial market really needsfi nancial holding companies.


Regulatory Framework for Financial Asset Management Company–Based Financial Hold-ing Model In China, fi nancial asset management companies are fi nancialinstitutions that exist in certain realities and are running well. Subject to the defi nition and constraints provided in the State Council’s Financial Asset Management Companies Regulations, the Ministry of Finance shall be the promoter and the China Banking Regulatory Commission (CBRC) the over-sight agency. With the approval of the State Council, fi nancial asset manage-ment companies have converted into corporations. In regard to a tendency for conglomeration, the CBRC released the Guidelines for Oversight Based on Consolidation of Financial Statements in Financial Asset ManagementCompanies (on trial), making a point of regulatory oversight based on con-solidation of fi nancial statements of the headquarters and subsidiaries.

It is safe to say that such an institutional arrangement lays down basic regulatory principles and mechanisms for fi nancial asset management com-panies. In particular, regulatory oversight based on consolidation of fi nan-cial statements targets the goal and serves the purpose to monitor, curb, and control the systemic risk in conglomerates, in general. Meanwhile, under the current framework on the principle of operations and oversight based on separation of activities, there is clear separation of duties for industrial regu-lation. Subsidiaries of a fi nancial asset management company are subject to appropriate regulatory authorities in their respective fi nancial sectors. For future institutional improvement, further efforts may be put into the follow-ing three areas:

1. Strengthen the consolidation of fi nancial statements‐based oversight at the headquarters level. The global fi nancial crisis raised particular con-cerns about the contributing causes of a fi nancial system that is “too big to fail” and “too complicated to fail.” Appropriate guidance should be offered to the design of the fi nancial holding model, helping enablea fi nancial holding company to integrate resources and cause different activities to complement each other effectively and effi ciently. This alsohelps prevent intricate and intractable connections between the fi nan-cial market and fi nancial institutions. From the perspective of a securi-ties fi rm as a subsidiary, it is supposed to combine its own strengths in capital market information, product design, asset portfolios, and sys-tem network with the strengths of a sister subsidiary in customers, riskcontrol, physical outlets, funds in custody, and specialization. It alsoneeds to establish an appropriate and necessary fi rewall mechanism, and prevent connected transactions that cause damage to the interestsof customers and fair competition in the market.

2. Consolidate the regulatory coordination mechanism. More effortsshould be invested in consolidating the banking, securities, and insurance


regulatory coordination under the framework that builds on separa-tion of activities. By now, the China Banking Regulatory Commission (CBRC), the China Securities Regulatory Commission (CSRC), and theChina Insurance Regulatory Commission (CIRC) have established a joint mechanism. The CBRC and CIRC have entered into a regulatorycooperation memorandum. But such institutional arrangement is stillin principle. In the context that crossover behaviors become increas-ingly frequent and the business model becomes increasingly diversifi ed, it is more important to have a more concrete, workable institutional arrangement among the CBRC, CSRC, and CIRC. This will help to further explore regulatory practice in statistics, joint on‐site inspection and non‐on‐site monitoring, and market access cross‐checking, amongothers. It will ensure effective oversight that is adapted to the marketdevelopment. It will also ensure against regulatory arbitrage by way of crossover.

3. Revise as appropriate the Financial Asset Management Companies Regu-lations. Along with the accumulation of market experience, the StateCouncil is expected to defi ne new institutional attributes and functional orientation, strengthen legal constraints, and provide a clearer regula-tory basis, based on the characteristics of fi nancial asset management companies.

Multilevel, Diversifi ed Independent Securities Firms

For securities fi rms, the fi nancial holding model is the path to upsizing, inte-gration, and conglomeration. The independent model leads to specialization (specifi c activities, specifi c territories, and specifi c customer groups). Theindependent model is also indispensable. Market experience shows that asa result of competition between conglomerates, some will win and become stronger, whereas others will lose and die. Eventually, as the number of play-ers decreases, only a few will remain in the market. However, the reality isthat China has administrative divisions subject to multilevel, cross‐regionalgovernance. Resource‐intensive fi nancial conglomerates are unable to offerservices that cater to all needs. Financial conglomerates also lack fl exibility and adaptability. Independent securities fi rms are therefore necessary to fi ll the gaps. According to current policy, independent securities fi rms will, in fact, continue to be the most common securities fi rms.

After years of effort, the CSRC has established a relatively complete securities fi rm regulatory system with a full range of regulatory tools. With the Securities Act as the framework and the Securities Firms Regulations and Regulatory Measures as pillars, such a regulatory system has also been constantly supplemented and improved to meet regulatory requirements of


the behavior of securities fi rms. The Risk Control Indicators‐Based Regula-tory Measures for Securities Firms and Guidelines on Dynamic Risk Control Indicators Monitoring System for Securities Firms (on trial) clearly set out basic prudential management requirements for securities fi rms and establish the capital constraint‐based regulatory means. They also confi rm the size of net capital as one of the criteria, and set different net asset‐size thresholdsfor different basic activities and their combinations. Such basic activitiesinclude securities brokerage, underwriting, sponsorship, proprietary trad-ing, and securities asset management.

The Securities Firms Classifi cation Regulations build upon the behavior assessment of securities fi rms and establish a quantitative evaluation system, thereby causing securities fi rms to be regulated according to their classi-fi cation. All these institutional arrangements lay an institutional basis for the differentiation of securities fi rms in market positioning, business size, key activities, risk tolerance, and others. Considering the diversifi ed investor groups in China, and its geographical vastness, policymakers should also be concerned about securities fi rms that can meet the needs of differentcustomers, adapt to local conditions, and provide fl exible fi nancial services.

Independent Securities Firms Must Find Their Competitive Advantage over Financial Holding Company–Controlled Securities Firms by Differentiation Financial holdingcompany–controlled securities fi rms have advantages in crossover exper-tise, information, channel network, economies of scale, market infl uence, and others. They would certainly focus on strategic arrangement and con-solidation of strengths in the activities of relatively high returns, such as underwriting and proprietary trading. Subject to existing securities issuanceregulations, IPOs remain under strict policy control. Qualifi ed IPO compa-nies that have real prospects to go public are a scarce resource. As a result, the competition is intense in related investment banking services. It is nei-ther necessary nor economical for independent securities fi rms, especially small and medium‐sized ones, to choose such activities strategically. For the purpose of effi ciency in the arrangement of fi nancial service resources,policymakers should encourage independent securities fi rms to focus on the fi nancial needs of regional or particular investor groups and work on seg-mentation, targeting, and positioning.

The Policy Orientation to Classifi cation-Based Market Access and Oversight Greatly Supports Independent Securities Firms in Diversifi cation Compared with com-mercial banks, securities fi rms produce fewer economic externalities and are faced with less policy control as to market access. Therefore, there is noshortage of securities fi rms in the market. However, further policy guidanceis needed to avoid homogeneous competition and promote differentiated


services. In particular, independent securities fi rms should be encouraged to make the best of their advantages to better meet the needs of more investor groups for differentiated, customized, and diversifi ed services. Their advan-tages include strong local presence, closeness to investors, better under-standing of underlying needs, and fl exible services.

Regulators are urged to build upon the existing market access system and explore a more specifi c limited licensing system. In this way, regulators can use subdivision and restriction according to the connotation of a license to create specifi c licenses for underwriting, brokerage, asset management,and other activities. They could guide independent securities fi rms to clearlydefi ne their main activities and specialize in a particular fi eld. This wouldbring about a range of specialized securities fi rms that belong to differentclasses, have different expertise, have clear positioning, and also comple-ment each other. It would also help securities fi rms reduce homogeneouscompetition and improve specialization. In addition to net capital, regula-tors could also require securities fi rms to include their risk indicators, stra-tegic positioning, target customers, geographic coverage, and other factors.Small or medium‐sized specialized securities that focus on particular areas, customer groups, and activities (such as brokerage and asset management) should be encouraged to meet the multilevel needs for securities services.

Marketization and Emerging Private Securities Firms

Recently, some privately owned securities fi rms have emerged in the market. This is an important symbol of marketization of the Chinese securitiesindustry. It is a logical demand and outcome of the market‐oriented mecha-nism exploration by professional groups. For a long time, the Chinese secu-rities industry has been a highly regulated and policy‐oriented industry. Theemergence of private securities fi rms is the beginning of pure marketization under the existing business model in the securities industry. Although suchfi rms are still in the early stage, it is a worthy attempt that is highly corre-lated with the existing system. For the strategic purpose to promote vibrant,market‐oriented development of securities fi rms, regulators should monitor and protect private securities fi rms. They could even create a special policy for pilot programs.

Regulators Should Establish a Sound Regulatory Policy Framework for Private Secu-rities Firms For the purpose of institutional design, regulators should lay down appropriate regulatory principles. They should lower market access requirements and simplify or even cancel the administrative examination and approval process, while specifying regulatory principles and require-ments of the behavior of private securities fi rms. Because such securities


fi rms are still in the early stage, they cannot take too much of a regulatory load. In the framework of the guidance principles of regulatory policies, regulators should bring private securities fi rms under strong market disci-pline and to full and complete disclosure of information. They should causeprivate securities fi rms to build goodwill with word of mouth and compete fairly in the market.

Regulators Should Provide Necessary Protection of Private Securities Firms’ Rights and Interests on the Principle of Fair and Equitable Treatment Small business size, little market infl uence, and weak bargaining power of private securities fi rms in a buyer’s market make them vulnerable. Their legitimate rights and interests are often violated and ignored. When making a supporting policy, regulators should cause customers and private securities fi rms to honor abusiness agreement or a contract relationship. This should have reciprocal rights and obligations, making it clear that the policy would give reasonablefair and equitable treatment to each business contract. It would create a stimulating market environment for natural growth and rational develop-ment of private securities fi rms.

Regulators Should Also Create Conditions for the Growth of Private Securities Firms As a possible path to diversity and specialization, private securities fi rms are more market‐oriented than other types of securities institutions. For fair treatment, private securities fi rms that can weather through mar-ket change and value effi ciency and core competitiveness deserve help to step up. This requires clear qualifying criteria and thresholds for private securities fi rms to convert into or upgrade to other conventional securities institutions. Regulators should make an effort to boost the expectation thatprivate securities institutions would have a sound and stable growth. Theyshould channel vigorous capital fl ows and professionals into private securi-ties fi rms.

In summary, affected by policy orientation, historical heritage, market demand, and many other factors, the business model of Chinese securities fi rms will diversify as the economic reform goes further into the capital mar-ket and the Chinese economy further moves toward a market economy. Dueto inherent endowment, strategic planning, and expertise, different secu-rities fi rms may choose different organizational and management models. Regulators should create policies that respect such a choice, fi t the regularpatterns and characteristics of different models, and have rational regu-latory focus and allocation of regulatory resources. Successful regulatory policy is expected to enable different securities fi rms to grow on their own merits and in their own ways. It should meet the demands of customers andthe fi nancial market with maximum effi ciency and at optimal cost in their


own areas of strength. Successful regulatory policy should bring ultimately diversifi ed, specialized, and market‐based prosperity to securities fi rms.

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203

CHAPTER 4 4 Analysis of the Profi t Model ofChinese Securities Companies

The importance of the profi t model for businesses is unquestionable; generating profi ts is the objective and responsibility of the enterprise.

Therefore, the profi t model is the enterprise’s business structure, which has evolved through market competition and is dependent on making profi ts. Particularly for business, it implies the specifi c operation mode of investingless and earning more.

The profi t model of Chinese securities companies has great peculiarities. This is due to the following factors:

■ The Chinese securities industry is relatively new compared to ordinary Chinese industries.

■ The “strong regulation” regime of the Chinese securities sector has cre-ated a monopoly situation for securities companies.

■ With increasing competition, securities companies will continue to con-solidate or restructure, and their division based on different profi t models is becoming visible.

Securities companies are required to move from an opportunity‐oriented model to a strategy‐oriented model so that the position of the profi t model will appear more clearly, with more intensive attempts or explorations forthat model. Overall, profi t models of securities companies are becomingdifferentiated.

Research for the profi t model in Chinese securities companies helps to make policy, fl ourish the industry, and boost securities companies to growand build their core competitiveness.

Over the past two decades, Chinese securities companies have been improving as China’s capital market has developed rapidly. However, a number of institutional reforms, including the introduction of the customer


margin system, share price index futures, and securities margin trading, havenot allowed the profi t model of Chinese securities companies to transformsignifi cantly. Despite changes in revenue and profi t structures, the profi tmodel of securities companies has always generally been the “channel” model, with the added features of quasi‐banking and “similarity.” All of this has made Chinese brokerages face the embarrassment that services offeredare a mix of strong and weak, and that the capacity of securities companies to offering services is at a low level overall.

In terms of the historical record of brokerage, their future profi t models may be diverging. The regional medium and small brokerages will make impressive strides in upgrading traditional business and innovating new business. However, several major companies will be on their way to internalization based on nationwide operation in China’s future. In terms of business, however, the profi t model will transform from the channel mode to the service mode, innovating traditional business and expanding innovative business.

THEORETICAL ANALYSIS OF PROFITABILITY MODELS

Background and Signifi cance of Studies on Securities Company Profi tability Models

Profi tability models are of great importance to a business because its primary goal and duty is to generate profi t. A profi tability model is a business structure established gradually by the business to gain profi t in the process of market competition. For a specifi c type of business, it is a certain operational approach that generates relatively greater sales and profi t with relatively less input.

One key idea of the “golden rules for investment” proposed by the Paris School of Business maintains that the most important thing for a business is not capital, nor is it talent—it’s the profi tability model. The absence of a profi tability model that is clear and reasonable would make it diffi cult for a business to survive and grow. Some scholars believe that a common business has a common profi tability model, while a successful business always has an extraordinary profi tability model behind its miraculous fortune. 1 A uniqueprofi tability model is an integral part of the core competitive strength of a business, and the source of its competitive advantages.

The following three reasons make the profi tability models of Chinese securities companies very special:

1. The securities industry is an emerging industry in China, compared to ordinary businesses. It has strengthened and expanded parallel to the

1 Junjie (2009).

Analysis of the Profi t Model of Chinese Securities Companies 205

birth, growth, and development of the capital market in China. As the capital market emerged and increased in size, the number of investmentand fi nancing participants has grown, and the demand for fi nancial services has been rising and changing. Accordingly, fi nancial products and transactions are increasingly diversifi ed. Against this backdrop, some uncertainties have emerged in the profi tability model of securitycompanies.

2. The highly regulated system and regime of the Chinese securities industry made Chinese securities companies monopolistic in nature. However,stringent regulation has made the profi tability models of securitiescompanies closely connected to the policies made by regulators, leav-ing securities companies little room to develop new forms of business. Currently, most profi tability models are essentially identical.

3. As competition intensifi es, consolidation and restructuring of secu-rities companies will continue. A labor division between securities companies based on different profi tability models will gradually take shape. It is inevitable and necessary that securities companies shift from being opportunity oriented to strategy oriented. The position-ing of profi tability models will become clearer. Profi tability models will become more intensely explored and sought after. Differentia-tion of profi tability models will gradually take place among securities companies.

Generally, studies on profi tability models for Chinese securities com-panies are helpful to policy making, development, and growth of securities companies and the establishment of their core competitive strength.

The Meaning of Profi tability Model for a Securities Company

Until now, a precise and uniform defi nition of the profi tability model of a securities company has not existed. However, the profi tability model can bedescribed in two dimensions, as follows:

1. The profi t structure of the securities company 2. The profi t methods of the securities company’s business

Profi t Structure of the Securities Company The profi t structure of a businessrefers to the components of total profi t, each with its unique derivation andnature. It also refers to the percentage in the total profi t, as manifested in the types of business (products/projects) that contribute to the profi t of the business and their respective effects on the profi t. Qualitatively speaking,it is refl ected by the profi t‐making projects that account for the profi t and


the effect of each profi t‐making project on the enterprise’s ability to make aprofi t. The profi t structure of a business is the manifestation of its business structure. The projects are the cause and the results are the effect. The busi-ness structure of an enterprise has been a long‐standing topic in corporate strategy theories. From related diversifi cation to unrelated diversifi cation, from vertical integration to horizontal integration, from diversifi ed expan-sion to returning to the core business, extensive and in‐depth studies have been carried out by scholars. Practical business structure models, such as the GE Matrix and the BCG Matrix, have played a major guiding role in theoperation practice of a business.

Currently in Chinese securities companies, the business structure mainly consists of the brokerage business, underwriting business, proprietary busi-ness, and asset management business. Of these, the brokerage business is dominated by the sale of securities, which accounts for 50 percent of total revenue. The investment banking business focuses on stock fi nancing, which accounts for 10 percent of total revenue. The proprietary business is closely related to the secondary market, marked by relatively large fl uctuations. Theasset management business is slow‐developing and accounts for a relatively small percentage. The basic rationale for such a combination of these busi-ness types is the stock generation services, trading services, and investmentservices.

Profi t Methods of the Securities Company The second dimension relates to ana-lyzing the profi t method of each business type of a securities company. The profi t method of each type of business is essentially synonymous with its business model. The profi t model is the core of the business model. In recent years, business models have become a hot topic in corporate strategy theo-ries, and various defi nitions have been proposed. 2 In layman’s terms, thebusiness model answers such questions as “What kind of value does the enterprise provide for its clients?” and “By what means does it gain profi t(make money)?” The profi t model or business model of the various business types of a securities company is simple and clear‐cut: Gain revenues by pro-viding fi nancial services for different types of clients.

Factors Affecting the Profi t Model of a Securities Company

External and internal factors affect the profi t model of a securities com-pany. External factors include demand, market environment, and policies. Internal factors include strategies and capabilities. For Chinese securities

2 Peterovic, Kittl, and Teksten (2001); Linder and Cantrell (2000); Weiwei (2003, 77–84).


companies, external factors are the primary factors, while internal factors are secondary.

External Factors From the day a Chinese securities company is fi rst founded,external factors will always have the greatest infl uence on the profi t model. External factors dictate the business composition of a securities company.They are the main reason behind the identical profi t models across the secu-rities industry (see Figure 4.1 ).

Demand Helping with the market fi nancing efforts of those who needcapital is a mission of securities companies and most investment banking businesses. A huge demand for direct fi nancing is an important driving forcefor the expansion of the securities market. In 2010 and 2011, boosted by government policies that encouraged direct fi nancing, equity fi nancing madea great leap forward. The investment banking business has since been grow-ing in securities companies.

From a different perspective, the factor of investor demand is the basis and source of such buyer business as brokerage, asset management, invest-ment consultancy, and securities margin trading. The main motivation anddriving force for the deployment, expansion, and growth of the various linesof business in a securities company are the needs of different investors, dif-ferent needs of the same investor, and various needs of an investor in dif-ferent locations and stages. These are the major factors dictating the profi t methods of the corresponding business in a securities company.

Market Environment The market environment refers to the condition of the tChinese securities market. The brokerage business is the mainstay of Chinese securities companies, and commission fees for the active purchase of securities are the major source of their revenues. Brokerage commissions account for 50 percent of the business revenues of securities companies. These business and

FIGURE 4.1 Framework for Analyzing Factors Affecting Securities Company Profi tability Models

Profitability Model Demand Factor

Policy Factor

MarketEnvironment

Factor


revenue patterns lead directly to the fact that the profi tability of a securities company depends on the condition of second‐tier markets to a great extent.In addition, the proprietary business of securities companies is subject to even greater constraints and infl uence of the secondary market. In 2007, when the condition of the securities market was good, proprietary business accounted for more than 30 percent of total revenues of securities companies. Too much reliance on the condition of the secondary market means the Chinese securitiesmarket is somewhat at the mercy of something beyond its control.

Policies Policies are the most important exogenous factors affecting the prof-itability model of securities companies. The profi tability models of Chinesesecurities companies are different from those in foreign markets as a result of a different formation process. From its beginning, the securities market has been bearing an unmistakable mark of policies, to which each majorchange in the profi tability models of securities companies is closely related. Policy factors mainly include macroeconomic policies and policies specifi c to the securities industry.

■ Macroeconomic policies: The effects of macroeconomic policies are indi-rect. They fi rst affect the securities market by infl uencing the demand of investors or fundraisers, which in turn affects the development of thesecurities industry and the profi tability models of securities companies. For the securities industry, the most infl uential macroeconomic policies include fi scal policies, monetary policies, and tax policies. The promot-ing or inhibiting effects of fi scal policies and monetary policies on theeconomy affect the overall performance of public companies. The riseor drop of liquidity affects the inward and outward capital fl ows in the securities market. The increase or decrease of taxes changes the invest-ment cost, affecting the investor’s investment demand.

■ Policies specifi c to the securities industry: Specifi c to the securities indus-try are mainly regulatory policies and approval policies. A securitiescompany is a fi nancial institution in the capital market. Therefore, it is vital to subject it to risk management. Oversight of the securities indus-try is mainly focused on operation protocols of securities companies, practice of professionals, and investment behaviors of market partici-pants. Regulatory policies provide a background and platform of rules, and thus affect the profi tability model of securities companies.

Unlike the registration system in the U. S. securities industry, an approval system has been adopted in China for industrial accession, conduct of busi-ness, and outlet deployment. So far, the approval policies focus on the fi eld of innovative business. Some insiders of the securities industry maintain that


overly prudent regulatory and approval policies have impeded the develop-ment of innovative business of securities companies.

Internal Factors Strategies The choice of strategies is the key internal factor affecting the profi tability model of a securities company. It directly decides the profi t-ability model of the company. The business scope of securities companies is fairly wide, covering multiple segments of the fi nancial market. However, it’s not necessary or possible for every securities company to engage in all business categories. A general rule of market competition calls for special-ized division of labor between securities companies. Therefore, securitiescompanies inevitably have to make strategic choices on business composi-tion and profi t methods based on external market opportunities, as well as consideration of personal history, development path, and unique resources and capabilities.

Learning from major events overseas, securities traders tend to base their roles in the market on their specifi c conditions and their own advantages, while solidifying, strengthening, and improving their advantages and mar-ket status through clear business positioning. For example, some research-ers believe the strength of Merrill Lynch lies in its brokerage business, while Goldmann Sachs excels as the fi nancial advisor for acquisition of target com-panies. Domestically, China International Capital Corp. Ltd. (CICC) stands out above many other securities traders with its focus on the investment bank-ing business. CITIC Securities, however, develops in a more comprehensive manner, maintaining or acquiring a leading position in many business fi elds.

Capabilities Capabilities are another important internal factor affectingthe profi tability model of a securities company. They are the basis for anysecurities company’s capability choice, and they independently affect the profi tability model of a securities company.

Competitive capability refers to the competitive strength of an enter-prise, by which the enterprise acquires competitive advantages. Its ingredi-ents include not only resources such as land, capital, technologies, and labor, but also structural factors that consolidate and confi gure various resources, such as property rights relationships, governance structure, process systems, management systems, and corporate culture, as well as unique entrepreneurcapabilities.3 The capability factors of securities companies are the basisand source of the differentiated values they provide to the clients. Therefore,these factors affect a securities company’s revenue and composition, as wellas the added value of its various lines of business.

3 Wei (2003).


PROFITABILITY STRUCTURES OF CHINESE SECURITIES COMPANIES

Overall Profi tability Structure

Over the last 20 years or more, Chinese securities companies have been growing in parallel to the fast development of the Chinese capital market. However, the many institutional reforms (such as the introduction of the cli-ent margin system, stock index futures, and securities margin trading) haveso far failed to bring about a fundamental change in profi tability models(as shown in Figure 4.2 and Table 4.1 ). The few changes in the revenue structure and profi tability structure of securities companies can hardly be considered qualitative. The source of profi t is relatively stable and consists mainly of the following six parts:

1. Revenues from brokerage commissions 2. Revenues from the underwriting business 3. Revenues from the asset management business 4. Revenues from proprietary business 5. Interest revenues 6. Revenues from other types of business

Table 4.1 and Figure 4.3 show the revenue structure of listed Chinese securities companies from 2007 to 2011. It is clear that the brokerage com-mission business is a dominant part of the revenue structure of Chinesesecurities companies, accounting for half of the total revenue in the fi rstthree quarters of 2007, 2010, and 2011 and more than 60 percent of thetotal income in the fi rst three quarters of 2008 and 2009. Counting in the

FIGURE 4.2 Revenue Structure of Publicly Listed Securities Traders in Quarters 1through 3 of 2011 Source: Wind Information Co.

Other Types of Business(13.48%)Proprietary

Business(14.11%)

Interest Income(16.12%)

Asset ManagementBusiness

(4.19%)Securities Underwriting

(14.18%)

BrokerageCommission(47.62%)


TABLE 4.1 Revenue Structures of Publicly Listed Securities Traders in 2007 through 2010 and Quarters 1 through 3 of 2011 (CNY in millions)

Year 2007 2008 2009 2010Quarters

1–3 of 2011

Brokerage commissionrevenue (CNY)

50,241 30,698 48,144 41,705 21,393

Brokerage commissionrevenue (%)

49% 60% 61% 46% 48%

Securities underwritingrevenue (CNY)

3,666 2,990 5,025 10,637 6,504

Securities underwritingrevenue (%)

4% 6% 6% 12% 14%

Asset managementrevenue (CNY)

2,339 1,592 1,832 2,142 1,883

Asset managementrevenue (%)

2% 3% 2% 2% 4%

Interest income (CNY) 3,326 5,278 5,476 7,508 7,241

Interest income (%) 3% 10% 7% 8% 16%

Proprietary businessrevenue (CNY)

36,385 3,467 9,607 19,456 1,845

Proprietary businessrevenue (%)

36% 7% 12% 22% 4%

Revenue from othertypes of business (CNY)

6,472 6,999 8,204 8,797 6,055

Revenue from othertypes of business (%)

6% 14% 10% 10% 13%

Total revenue 102,429 51,024 78,288 90,245 44,921


undertaking business and the asset management business, more than half of the revenues of Chinese securities companies come from provision of conduits.

Since the introduction of the GEM board in late 2009, the number of small and medium public companies has been growing. Listed securities traders have seen the percentage of their underwriting business rising con-stantly. The percentage reached 15 percent in 2011.

Percentages of the asset management business and the proprietary busi-ness change with the fl uctuation of the secondary market. The bull market in 2007 drove the percentage of proprietary business up to 35.52. In contrast,


the percentages were merely 6.79 and 4.11 in the fi rst three quarters of 2008 and 2011, respectively.

With the deployment and expansion of innovative business lines such as stock index futures, securities margin trading, and direct investment, alter-native business types have shown a steady upward trend, accounting for 13.48 percent in the fi rst three quarters of 2011. Clearly, the revenue struc-ture of listed Chinese securities companies is quietly changing.

The Effect of an Enterprise’s Scale on Its Profi tability Structure Figure 4.4 shows the revenue of 17 listed securities companies ranked by scale in descendingorder (based on their operating revenues in the fi rst quarter of 2011).

All of the 17 listed securities traders are comprehensive securities companies engaging in six categories of business. From the perspective of revenue structure, securities traders with a larger operation scale, such as CITIC and Haitong Securities, enjoy a relatively well‐rounded devel-opment pattern and a more balanced revenue structure. This is thanks to an abundant supply of capital and satisfactory revenues from all lines of business. Small‐scale securities traders, on the other hand, are rela-tively more reliant on brokerage commission business and proprietary business.

Figures 4.5 and Figure 4.6 show the results of a comparative case study of CITIC and Northeast Securities that analyzed the impact of operation scale on the revenue structure of a securities trader. The two fi gures show

2007

49%60% 61%

46% 48%

4%22%12%7%

36%

Brokerage CommissionSecurities UnderwritingAsset Management

Interest IncomeProprietary BusinessOther Types of Business

0%10%20%30%40%50%60%70%80%90%

100%

2008 2009 2010 2011Q1−3

FIGURE 4.3 Revenue Structures of Publicly Listed Securities Traders in 2007 through2010 and Quarters 1 through 3 of 2011 Source: Wind Information Co.

213

FIGUR

E 4.

4 R

even

ue S

truc

ture

s of

Pub

licly

Lis

ted

Secu

riti

es T

rade

rs in

Qua

rter

s 1

thro

ugh

3 of

201

1 So

urce

: Win

d In

form

atio

n C

o.

Bro

kera

ge C

omm

issi

on

Sec

uriti

es U

nder

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ing

Ass

et M

anag

emen

t

Inte

rest

Inco

me

Pro

prie

tary

Bus

ines

s

Oth

er T

ypes

of B

usin

ess

0%20%

–20%

–40%

CITIC

Haitong

Huatai

GF

China Merchants

Everbright

Hong Yuan

Industrial

Changjiang

Guoyuan

Founder

Sinolink

Sealand

Shanxi

Southwest

Northeast

Pacific

40%

60%

80%

100%

1%

12%

31%

11%

37%

66%

16%

14%

59%

22%

45%

17%

44%

17%

49%

15%

40%

50%

16%

7% 71%

26%

52%

15%

77%

6% 62%

40%

60%

85%

43%

25%

76%

7%


2007



0%10%

43%

7%

35%

10%

42%

10%

18%

20% 17% 15%27%

17%

12%

31%

41%

10%

28%

16%

11%

50%20%30%40%50%60%70%80%90%

100%

2008 2009 2010 2011Q1−3

CITIC Securities Revenues Structure in 2007 through 2010 and Quarters 1 through 3 of 2011 Source: CITIC Securities Quarterly Report 2011.

that CITIC Securities has a business structure that is very different from that of Northeast Securities. The differences have become increasingly apparent with time. Due to its large size and considerable strength, CITIC Securities has an increasingly balanced and rational business structure, as manifested in the declining percentage of brokerage business and the trend toward bal-anced proportions of various lines of business. The small and relatively weak Northeast Securities, on the other hand, has a business structure dominated

2007



0%

20%

–20%

–3%

64%

1%7%

6%

18%1%

10%

7%9%

65% 85%

−20

4%

15%

70%75%

23%

9% 12%

40%

60%

80%

100%

2008 2009 2010 2011Q1–3

FIGURE 4.6 Northeast Securities Revenues Structure in 2007 through 2010 and Quarters 1 through 3 of 2011 Source: Northeast Securities Quarterly Report 2011.


by brokerage, with other business lines suffering from slow growth and lowpercentages.

The Effect of Location on the Profi tability Structure

Based on their registered addresses, listed securities companies were classi-fi ed by province (see Table 4.2 ) and by east, central, and west region (see Tables 4.3 , 4.4 , and 4.5 and Figure 4.7 ). The results show the east having the most listed securities companies with seven (41.18 percent), followed bythe central region with six (35.29 percent), and the west with the fewest atfour (23.53 percent).

As shown in Tables 4.3 , 4.4 , and 4.5 and Figure 4.7 , the total revenue of securities traders in the eastern region is markedly higher than those in the central and western regions. Specifi cally, the revenue of the eastern regionis three times the combined revenue of the central and western regions. Thebusiness structures of securities traders in the east are also more balanced

TABLE 4.2 List of Publicly Listed Securities Companies by Province

Number Province Short Name of Company

1 Shanghai Haitong Securities, Everbright Securities

2 Chongqing Southwest Securities

3 Yunnan Province Pacifi c Securities

4 Xinjiang UyghurAutonomous Region

Hong Yuan Securities

5 Sichuan Province Sinolink Securities

6 Shanxi Province Shanxi Securities

7 Jiangsu Province Huatai Securities

8 Jilin Province Northeast Securities

9 Hunan Province Founder Securities

10 Hubei Province Changjiang Securities

11 Guangxi ZhuangAutonomous Region

Sealand Securities

12 Guangdong Province CITIC Securities, GF Securities, Merchants Securities

13 Fujian Province Industrial Securities

14 Anhui Province Guoyuan Securities

Source: 2010 Annual Report of Publicly Listed Securities Companies.


TABLE 4.4 Total Revenues in Different Regions (2007–2010 and Quarters 1–3 of 2011) (CNY in millions)

Year East Central West

2007 79,985 15,433 7,011

2008 40,941 7,368 2,715

2009 58,868 12,197 7,223

2010 70,959 11,725 7,561

Quarters 1–3 of 2011 34,625 6,240 4,057

TABLE 4.3 Geographical Distribution of Sampled Companies

Region Short Name of CompaniesNumber of Companies

Percentage of the Total Number of Publicly Listed

Securities Companies

East Haitong Securities, EverbrightSecurities, CITIC Securities, GFSecurities, Merchants Securities, Industrial Securities, HuataiSecurities

7 41.18%

Central Changjiang Securities, Northeast Securities, Sealand Securities, Guoyuan Securities, FounderSecurities, Shanxi Securities

6 35.29%

West Southwest Securities, Pacifi cSecurities, Hong Yuan Securities,Sinolink Securities

4 23.53%

Note: The categorization into the east, central, and west is based on the defi nition set by the Seventh Five‐Year Plan passed at the fourth session of the sixth People’s NationalCongress. East refers to Beijing, Shanghai, Tianjin, Guangdong, Zhejiang, Fujian, Jiangsu, Shandong, Liaoning, Hebei, and Hainan. Central refers to Hubei, Anhui, Henan, Shanxi, Hunan, Guangxi, Jiangxi, Jilin, Inner Mongolia, and Heilongjiang. West refers to Sichuan Yunan, Xinjiang, Shaanxi, Guizhou, Chongqing, Qinghai, Ningxia, Gansu, and Tibet. At the fi fth session of the eighth National People’s Con-gress in 1997, Chongqing was elevated to a municipality directly under the central government and included into the western region, raising the number of provincialregions in the west to 10. Source: 2010 Annual Report of Publicly Listed Securities Companies.

217

TABL

E 4.

5 R

even

ue S

truc

ture

s in

Dif

fere

nt R

egio

ns (

2007

–201

0 an

d Q

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ers

1–3

of 2

011)

Yea

rR

egio

n

Per

centa

ge

of

Bro

ker

age

Com

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n

Per

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ge

of

Sec

uri

ties

U

nder

wri

tin

g

Per

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ge

of

Ass

etM

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ent

Per

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rest

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com

e

Per

centa

ge

of

Pro

pr i

etary

B

us i

nes

s

Per

cen

tage

of

Oth

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yp

esof

Bu

sin

ess

2007

Eas

t48

.88%

4.14

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81%

3.38

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6.88

%

Cen

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50.6

7%1.

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0.58

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1.31

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2.93

%44

.38%

3.96

%

2008

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6.25

%3.

80%

10.6

2%7.

37%

14.5

3%

Cen

tral

71.9

3%2.

80%

0.49

%9.

14%

6.28

%9.

36%

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t69

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8.38

%0.

00%

9.39

%−0

.54%

13.3

2%

2009

Eas

t59

.04%

7.03

%2.

91%

7.17

%11

.55%

12.3

1%

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tral

72.0

9%3.

52%

0.84

%6.

82%

11.7

1%5.

02%

Wes

t63

.65%

6.34

%0.

23%

5.85

%19

.13%

4.79

%

2010

Eas

t43

.94%

11.3

2%2.

67%

8.36

%23

.04%

10.6

7%

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tra l

57.5

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1.58

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16.3

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20.5

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81%

6.47

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6.46

%

2011

Q1–

3E

ast

43.4

2%14

.25%

4.85

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.06%

7.20

%14

.21%

Cen

tral

68.8

2%9.

56%

2.36

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.67%

−10.

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10.8

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24.0

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and rational, in comparison to their counterparts in the central and westernregions.

PROFIT METHODS OF THE MAIN BUSINESS OF SECURITIES COMPANIES

Analysis of Traditional Business

Brokerage Commission Business The brokerage commission business hasalways been the major source of revenue for Chinese securities companies. The profi tability model of the brokerage business has the following major characteristics:

■ The brokerage business still makes profi t mainly through the channel system resource of the securities trader’s trading seat. There are certain barriers to the industry.

■ Due to the simplicity of the profi tability model of the business, competi-tion inside the industry is increasingly intensifi ed, and profi tability of the industry is inescapably at the mercy of market conditions.

According to data from 2007 through the fi rst three quarters of 2011, the percentage of brokerage commission business in the total revenues of listed Chinese securities companies showed a declining trend, although the business maintained its core business status (as shown in Table 4.6 ).

FIGURE 4.7 Percentage Revenue Structures in Different Regions (Quarters 1–3 of 2011) Source: Wind Information Co.

Brokerage Commission

East Central West

Securities UnderwritingAsset Management


0%

20%

–20%

40%

60%

80%

100%

43.42%68.82% 50.88%


In 2007, fueled by an extraordinarily booming secondary market, the Shanghai composite index hit the highest record in history with 6,124 points. Revenues from the brokerage commission business made up nearly 50 percentof the total revenues of securities companies. In 2008, the secondary marketslid continuously, bringing about a signifi cant decrease in brokerage com-mission revenues. However, other types of revenue, especially proprietarybusiness revenues, also dropped dramatically, leaving the brokerage com-mission business accounting for 60 percent of the total revenues. In 2009, the secondary market recovered slightly, and the brokerage commissionbusiness expanded somewhat. However, due to slow growth of other types of business, brokerage commission still accounted for 61 percent of the total revenues. The secondary market was volatile in 2010, which led to aslight contraction of the brokerage commission business. Combined withsignifi cant growth of proprietary and underwriting business, the percentageof brokerage commissions as a component of total revenues dropped rap-idly. The situation in the fi rst three quarters of 2011 was similar to that of 2008. The secondary market continuously declined and the percentage of brokerage commission business remained stable, as compared to 2010.

Investment Banking Business The investment banking business has a very wide scope. Based on the practice of international securities companies, itmainly includes securities underwriting and issuance, mergers and restruc-turing, and fi nancial consultancy.

In China, the current profi tability models of investment banking have the following three features:

1. Sponsors remain unavoidable for companies wanting to go public. The sponsor system is yet another manifestation of the channel system prof-itability model of securities traders.

TABLE 4.6 Revenue of Publicly Listed Securities Traders’ Brokerage Business in 2007 through 2010 and Quarters 1 through 3 of 2011 (CNY in millions)

Year 2007 2008 2009 2010Quarters1–3, 2011

Brokerage commissionbusiness revenue

50,241 30,698 48,144 41,705 21,393

Percentage 49% 60% 61% 46% 48%

Average concessionaire commission rate

0.157% 0.134% 0.17% 0.094% 0.079%



2. IPOs are still the most important source of revenues for the investment banking business. Mergers, targeted issuance of new shares, share place-ment, and bond underwriting are still relatively underdeveloped.

3. Due to the impact of secondary market fl uctuations combined with pol-icy factors such as IPO suspension, the investment banking business is constantly weathering market conditions.

Table 4.7 shows the revenues from securities underwriting business in 2007 through 2010 and in the fi rst three quarters of 2011. Over those years, the revenues from securities underwriting business of listed Chinese securi-ties companies have been steadily rising, with an increasing percentage inthe total revenue, jumping from 4 percent in 2007 to 14 percent in 2010. The underwriting business has become an important revenue source among traditional business lines. To some extent, it may serve as one of the triumvi-rate of securities trader revenues, attenuating revenue fl uctuations.

A major change in the investment banking fi eld is that the securities issuing market has transformed from a market dominated by oligarchic monopolies to a market with more widespread competition between many contenders. Against this backdrop, the overall underwriting business pat-tern of listed securities trades has undergone signifi cant changes. The per-centage of the main board in the total fi nancing amount has dropped from 70 percent in 2008 to 36 percent in 2011 while the percentages of the GEM board and the SME board have both reached 30 percent, respec-tively, giving rise to a trichotomous pattern (see Figure 4.8 ). In addition, as the number of big projects decreased, the average IPO fi nancing amount has dropped from CNY 3.7 billion in 2007 to CNY 1 billion in 2011 (see Figure 4.9 ).

An explosion of small and medium projects has brought good oppor-tunities to small and medium securities trades, which were excluded from large projects. Securities traders specializing in small and medium proj-ects have a signifi cantly increased share in the underwriting business. Large

TABLE 4.7 Revenue of Publicly Listed Securities Traders’ Underwriting Business in 2007 through 2010 and Quarters 1 through 3 of 2011 (CNY in millions)

Year 2007 2008 2009 2010Quarters1–3, 2011

Securities underwritingbusiness revenue

3,666 2,990 5,025 10,637 6,504

Percentage 4% 6% 6% 12% 14%



FIGURE 4.8 Market IPO Financing Structure in 2008 through 2010 and Quarters 1 through 3 of 2011

200

Main Board SME Board GEM

2009 2010 2011Q1–30%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

30%

70% 65%

23%

12%20%

40%

40%

30%

34%

36%

securities traders, which previously benefi ted from large project issuance and were far ahead, now face great challenges. At the same time, with increased scale and scope of corporate bond issuance, as far as bonds underwritten by securities traders go, the monopoly by a few securities traders is also affected. First‐tier markets have undergone a transition from oligarchic monopoly to competition among a number of powerful players. According to statistics from Wind Information Co., the combined market share of the top fi ve traders in the industry dropped from 71 percent in 2008 to 36 percent in 2011. The same is true with bond underwriting. The combined market share of the top fi ve traders has dropped from 65 percent in 2008 to 48 percent in 2011. (For consistency, only the amount of bonds underwritten by securities traders is included in these statistics.) CITIC Securities was the top-ranking securities trader in 2008, with a 24 percent share in the IPO underwriting market and a 26 percent share in the bond underwriting markets. However, its market share signifi cantly decreased in the fi rst three quarters of 2011, down to 11 percent in the IPO underwrit-ing market and 14 percent in the bond underwriting market. By the third quarter of 2011, CITIC still ranked number one in revenues from securities


underwriting business, Merchants Securities had risen to second place, and Everbright Securities and GF Securities saw their underwriting business revenues increase markedly. Figure 4.10 shows that the distance between the several securities traders near the top is no longer signifi cant. Against the background of high and stable levels of fi rst‐tier market issuance, the competition between securities traders over the underwriting business will intensify going forward.

Asset Management Business The asset management business refers to a secu-rities company’s practice of operating the client’s assets and providing the client with investment management services for securities or other fi nan-cial products. The securities company does this in the capacity of asset manager under requirements of relevant laws, regulations, and provisional measures. It also follows the manner, terms, requirements, and restraints prescribed by the asset management agreement it has entered into with the client.

FIGURE 4.9 Average Market IPO Financing Amount in 2008 through 2010 andQuarters 1 through 3 of 2011 Source: Wind Information Co.

13

37

18

14

10

2009 2010200820070

5

10

15

20

25

30

35

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Profi tability models of the asset management business have the follow-ing features:

■ Limited by the lack of variety in investment targets and fi nancial prod-ucts, profi t from products in the asset management business mainly depends on the profi t from stock in the secondary market. As a result, although the management fee is not all pegged to the secondary market, the revenue is still decided by the performance of the secondary market through factors such as scale of issuance.

■ Compared with funds and wealth investment products offered by banks, the asset management business is constrained by a variety of fac-tors such as channel, customer base, and investment capability. It still lacks a conspicuous profi tability model that enables it to exceed funds, trust products, and wealth investment products.

After six years of development, the asset management business of domestic securities companies is only similar to the sunshine private fund business in scale, far below the open‐ended fund business. In the second half of 2009, the regulator started implementing less stringent approval proce-dures for securities trader asset management and gradually increased sup-port for the asset management business of securities companies. For securi-ties companies with a history of two years or more, the restrictions on the validity period and scale of newly established products was lifted, and the

FIGURE 4.10 Revenues of Publicly Listed Securities Traders’ Securities Underwriting Business and Its Percentage in the Total Revenue in Quarters 1 through 3 of 2011 Source: Quarterly reports of publicly listed securities companies in 2011.

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approval waiting period was cut to two months. In the fastest instance of collective fi nancial product approval, the process from case acceptance to offi cial response took only 12 days.

Table 4.8 and Figure 4.11 show the asset management revenue of listed securities companies and its percentage in the total revenue in 2007 through 2011. The revenue from the asset management business is shown to be rela-tively stable among listed securities traders. In particular, in the bear marketof 2011, it was one of the few growing business lines in securities companies.

Figure 4.12 shows the asset management revenue of listed securities trad-ers and its percentage in the total revenue in the fi rst three quarters of 2011.

TABLE 4.8 Revenue of Publicly Listed Securities Traders’ Asset Management Business and Its Percentage in the Total Revenue in 2007 through 2011 and Quarters 1 through 3 of 2011 (CNY in millions)

Year 2007 2008 2009 2010 Quarters 1–3, 2011

Revenue from assetmanagement business

2,339 1,592 1,832 2,142 1,883

Percentage 2% 3% 2% 2% 4%


FIGURE 4.11 Revenue of Publicly Listed Securities Traders’ Asset ManagementBusiness and Its Percentage in the Total Revenue in 2007 through 2011 and Quarters1 through 3 of 2011 Source: Wind Information Co.

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Clearly, the revenue from the asset management business is still a small part of total revenues among securities traders. The overall performance of collective fi nancial products is not satisfactory. In the revenue structure of American exchange members, asset management fees account for over 10 percent. Besides external factors of the securities market environment, the growth of securities companies’ asset management business is affected by a lack of experience and internal capabilities. However, compared with public and private funds, securi-ties traders have certain advantages in terms of operation mechanism and man-agement level. Therefore, the asset management business has bright prospects.

Proprietary Business Proprietary business refers to the type of business inwhich a securities company engages in securities transactions for profi t in its own name with its own capital or legally raised funds. In China, proprietarybusiness refers specifi cally to a securities company’s behavior of buying andselling securities precuts for itself.

The major features of the proprietary business profi tability model are as follows:

■ Due to restrictions on investment scope and investment leverage, pro-prietary business is mainly based on the securities company’s own capi-tal. It is impossible to leverage using methods similar to those of U.S. investment banks.

■ Due to a lack of variety in investment targets and risk hedging means, the revenue is subject to large fl uctuations as the secondary market fl uctuates.

FIGURE 4.12 Revenues of Publicly Listed Securities Traders’ Asset Management Business and their Percentages in the Total Revenue in Quarters 1 through 3 of 2011 Source: Wind Information Co.

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As one of the traditional business lines of securities companies, propri-etary business has always been an important source of revenue. In particu-lar, when the secondary market is doing well, proprietary business tends to account for a large portion of total revenue. The secondary market in China has been weak since 2011, as shown by a trend of unilateral decline. For that reason, listed securities traders saw their revenues from proprietarybusiness drop by a signifi cant 60 percent year after year to CNY 1.845billion. Only fi ve traders (CITIC, China Merchants, Everbright, Sinolink, and Pacifi c) made any profi t from their proprietary business. Southwest,Sealand, and Northeast suffered great losses equal to 50 percent, 22 percent, and 20 percent of their respective total revenues. With a weak market in the third quarter of 2011, all of the 17 listed securities traders suffered losses in their proprietary business, which totaled CNY 3.5 billion collectively (see Figure 4.13 ).

Table 4.9 shows the listed securities traders’ revenue from proprietary business and as a percentage of total revenue in 2007 to 2011. There isa strong correlation between listed securities traders’ proprietary business revenues and the condition of the secondary market. In 2007, the secondary market almost doubled in size, boosting listed securities traders’ revenuesfrom proprietary business to CNY 36.4 billion, or 36 percent of total rev-enue. The slump in the secondary market in 2008 cut proprietary business revenues to a mere CNY 3.4 billion, or 7 percent of the total. The second-ary market improved in 2009 and proprietary business of listed securities

FIGURE 4.13 Publicly Listed Securities Traders’ Revenues from Proprietary Business in the First Three Quarters of 2011 Source: Wind Information Co.

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traders yielded CNY 9.6 billion in revenue, accounting for 12 percent of thetotal. In 2010, the market showed uneven signs. The Shanghai composite was weak but the SME board did well. Although their brokerage commis-sion business declined, listed securities traders made CNY 19.4 billion fromtheir proprietary business, which accounted for 22 percent of their totalrevenues. In the fi rst three quarters of 2011, the secondary market was slug-gish. The Shanghai composite was struggling and the SME board was even worse. Listed securities traders only managed to make CNY 1.8 billion from their proprietary business. The decrease, combined with the rising securitiesunderwriting revenues and interest revenues, brought down the percentageof proprietary business to 4 percent.

Analysis of Innovative Business

Innovative business of Chinese securities companies mainly includes secu-rities margin trading, securities trader direct investment, and investmentbanking (IB) business. Being relatively new, innovative business only has asmall percentage of the total revenues of securities companies. However, itsappearance has diversifi ed the profi tability model of securities traders.

Securities Margin Trading Business Securities margin trading business, also knownas securities credit trading, refers to the practice by investors of providing

TABLE 4.9 Revenues of Publicly Listed Securities Traders from Proprietary Business in 2007 through 2010 and the First Three Quarters of 2011 (CNY in millions)

Year 2007 2008 2009 2010Quarters1–3, 2011

Revenue fromproprietary business

36,385 3,467 9,607 19,456 1,845

Percentage 36% 7% 12% 22% 4%

Shanghai CompositeIndex (closing price)

5261.56 1820.81 3277.14 2808.08 2359.22

Magnitude of increase/decrease

97% −65% 80% −14% −16%

SME Board Index(closing price)

6247.56 2863.99 5631.76 6828.98 4990.43

Magnitude of Increase/Decrease

153% −54% 97% 21% −27%



collateral to a securities company with membership on the Shanghai Stock Exchange or the Shenzhen Stock Exchange. They do this in order to borrow capital to buy securities listed in the same exchange before reselling them, or to borrow securities listed in the same exchange before reselling them.

The securities margin trading business has the following features:

■ Through free capital and securities, it provides customers with trading resources and then collects fees that are higher than in the brokerage business.

■ After the realization of refi nancing, it provides customers with trading resources through leverage, thus extending the operation leverage of thesecurities trader.

■ The bilateral trade profi tability model to some extent enables the securi-ties trader to be in better market conditions.

On March 30, 2010, the Shenzhen Stock Exchange issued a notice about a securities margin trading pilot run, which was launched the next day. The fi rst batch of securities companies designated for the pilot included Guotai Junan, Guosen, CITIC, Everbright, Haitong, and GF. The introduction of the securities margin trading business could magnify securities supply and demand, invigo-rate securities market trading, increase transaction volume, and enhance mar-ket liquidity, thereby bringing about more brokerage and interest revenues for securities companies. Product innovation opportunities can also derive from securities traders’ engagement in securities margin trading, which makes it pos-sible to lower the cost of proprietary business and carry out hedging operations.

The securities margin trading business has experienced stable operation since its introduction in 2010. The balance of securities margin trading roserapidly. As of September 30, 2011, the balance reached CNY 33.591 billion, accounting for 0.145 percent of the total market value. Most transactions were margin buying (see Figure 4.14 ).

On November 25, 2011, the Shanghai Stock Exchange and the Shenzhen Stock Exchange offi cially released the Detailed Rules for Securities Margin Trading Operation, marking the familiarity of the securities margin trading business. The pool of underlying assets for margin trading was expanded to include 285 stocks from the Shanghai Stock Exchange and the Shenzhen Stock Exchange, up from 90. Of those stocks, 70 were exchange‐traded funds (ETFs). The China Securities Regulatory Commission also promulgated the Provisional Regulations on the Oversight and Management of SecuritiesFinancing Business, and securities fi nance companies have been offi ciallyfounded. The promulgation of the series of policies implies further opening of the securities margin trading business and gradual establishment of sup-porting mechanisms.


As of 2011, the average daily fi nancing purchase amount was only over CNY 1 billion, or 0.5 percent of the average daily market transaction amount (see Figure 4.15 ). With the familiarity of the securities margin trading busi-ness and further opening of the securities fi nancing business, the transaction amount of securities margin trading saw a constantly rising percentage. (In the U.S. and EU markets, the amount of transactions made by fi nancing

FIGURE 4.14 Growth of Securities Margin Trading Source: Wind Information Co.

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FIGURE 4.15 Securities Margin Trading Volume Source: Wind Information Co.


traders accounts for 18 to 20 percent of total stock market transactions. Inthe Taiwan market, the percentage sometimes rises to 40 percent.)

Direct Investment The direct equity investment business of securities compa-nies is investment in private equity (PE). From an investment perspective, it refers to equity investment in nonpublic enterprises in the form of private equity. The transaction execution process gives consideration to future exit mechanisms, such as profi ting from selling the equity through public listing, merger, or management buy‐back.

The profi tability model of the direct investment business has the follow-ing features:

■ It allows fi nancial capital to continue extending to industrial capital and realizes the transformation from industrial capital to fi nancial capital through fi nancial platforms.

■ It disperses the risk of revenue fl uctuations brought to securities compa-nies by the secondary market.

In September 2007, CICC and CITIC became the fi rst companies quali-fi ed to conduct direct investment business on a pilot basis. They established their direct investment subsidiaries in October 2007. Thereafter, other securities traders established their own direct investment companies, one after another. According to data from the securities industry association, 34 securities companies had been qualifi ed for direct investment business by mid‐2011. The direct investment subsidiaries of 28 of these companies had made a total investment of CNY 10.2 billion in 229 projects, 29 of which had gone public. The remaining six companies were going through the prep-aration or screening process. By 2011, the lead underwriters of more than300 companies that had made their IPO were direct‐investment‐qualifi ed securities traders. Obviously, the investment bank strength of securitiescompanies had signifi cant impact on their direct investment business. Based on the human and other resource advantages of their investment banks, many direct‐investment‐qualifi ed securities traders were rapidly expanding their direct investment business, vying to make deployment ahead of each other to gain a head start.

In order to strengthen oversight and management control in relation to direct investment of securities traders, the regulator made the following stipulation:

If a sponsor and its controlling shareholder(s), de facto controller(s) and major affi liated persons together hold in excess of 7 percent of the issuer’s shares, or if the issuer holds or controls more than


7 percent of the sponsor’s shares, the sponsor shall, when spon-soring the offering and listing of the issuer’s securities, bring in anunaffi liated sponsor to jointly perform the sponsorship duties and such unaffi liated sponsor shall be the lead sponsor.4

While controlling risks, this restriction also brings down the scale and profi t margin of the securities trader direct investment business. In order to gain greater profi t margins in the PE market, a large number of securities traders have started exploring equity participation in industrial funds or raising funds on their own, thus creating new operational models for the secu-rities trader direct investment business. By the end of May 2011, the direct investment company of CICC had gained approval from the China Securities Regulatory Commission for its fi rst fundraising pilot, CICC JIATAI Industrial Integration Fund, which was expected to raise CNY 5 billion, according to the plan. The opening of the fl oodgates through this project suggests that direct investment companies themselves would be able to raise funds from external sources and hopefully become yet another important force in the domestic PE market as specialized government procurement (GP) organizations.

The direct investment business of securities companies is special in nature. It takes a minimum of several months to go through the process of investigation, screening, and investment realization. It is hard to have a defi -nite timetable once the listing application is fi led for the investment project.Lock‐up periods vary from one to three years after the listing of the invest-ment project. Finally, the profi t is then realized. The payback period of thedirect investment business is about three to four years. Securities companies entering into the profi t‐making phase in 2012 or 2013 were mostly founded before 2010. The major companies in this group included CITIC, GF, andGUOSEN (see Table 4.10 ).

4 Retrieved from http://wenku.baidu.com/view/2dcfc069011ca300a6c390fa.html.

TABLE 4.10 Publicly Listed Securities Traders’ Expected Profi ts from Direct Invest-ment Business

Number of Freed ProjectsExpected Profi t

(CNY 100 million)

CITIC Securities 5 5.4

GF Securities 5 3.3

GUOSEN Securities 2 1.5

Source: GUOTAI JUNAN Securities 2012 Securities Industry Investment Strategy Report, 14.

http://wenku.baidu.com/view/2dcfc069011ca300a6c390fa.html


According to statistics from China Securities Research, as of May 2011, the average book rate of return of the direct investment business of securi-ties traders was 5.10, which was higher than the 3.78 rate in 2010 and the4.12 rate in 2009. In comparison, the book rate of return for securities trad-ers’ direct investment in industrial funds was even higher. As of late May 2011, the Chinese private equity market had disclosed 16 equity invest-ment funds in which securities traders participated, with the disclosed tar-get amount of fund raising reaching CNY 60 billion. The most active ones include the China–Belgium Direct Equity Investment Fund, the MianyangScientifi c and Technological City Industrial Fund, and the Xiangjiang Indus-trial Investment Fund. Of the projects they invested in, 14 were listed in thestock market, and their arithmetic average rate of return on book reachedas high as 7.68.

Stock Index Futures The effect of stock index futures on the profi tability of securities companies is manifested in two major ways:

1. Commission income through the IB business 2. Provision of hedging room and diverse choice of investment strategies

for proprietary business and asset management business

The introducing broker (IB) business refers to the practice of securities companies introducing customers to future brokers at the brokers’ requestfor a certain amount of commission fees. The IB business originated in the United States and is now widespread and successful in other countriesand regions with developed fi nancial and future transaction markets (UK, Korea, Taiwan). On April 15, 2007, the promulgation of the Rules on the Administration of Future Trading marked the fi rst time the existence of thefuture intermediary business was confi rmed in a law or regulation. The Trial Measures for the Provision of Intermediary Introduction Services to Futures Companies by Securities Companies promulgated later that year included detailed provisions concerning qualifi cations for the IB business, business scope, business rules, and supervision systems. In early 2008, the SecuritiesSupervision Commission started verifying securities companies’ qualifi ca-tions to provide intermediary services to futures companies. The IB busi-ness of securities companies still has a relatively small transaction scale andmarket share.

For the proprietary business and asset management business of secu-rities traders, the effect of stock index futures is manifested mainly in the management of stock investment risks through hedging and profi t drawn from stock index futures based arbitrage and leveraged invest-ment instruments.


A year after stock index trading was offi cially launched in China on April 16, 2010, the development of the Chinese stock index futures market was generally stable without signifi cant fl uctuations. Since May 2010, the stock index futures trading volume has hovered around the CNY 3 trillion mark (see Figure 4.16 ).

As a type of innovative business, stock index futures carry relatively large risks due to the leveraged transactions involved. In order to avoid dramatic market fl uctuations, the regulator has enforced stringent criteria for stock index investment. In addition to individual investors, institutionalinvestors still face a high degree of restriction on their participation in thestock index futures business. Stock index futures trading is now carried out by securities investment funds.

Procedure fees for the stock index futures business were typically 0.01 percent to 0.015 percent in 2011. Of this, 0.005 percent went to the China Financial Future Exchange, while the rest went to futures companies and securities companies proportionately. There is no uniform regulation on the distribution of procedures fees between futures companies and securities companies. Instead, the proportions are negotiated between them and are often closely related to their equity relationships. If the futures company is wholly owned by the securities company, the latter may possibly extract a smaller proportion of procedure fees. If the securities company is just an abso-lute or relative controlling shareholder, the proportion extracted is likely to be higher. With recent annual trading volume, the IB business generated for secu-rities companies about CNY 1 to 2 billion in revenue from procedure fees.

FIGURE 4.16 Securities Margin Trading Volume Source: Wind Information Co.

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CHARACTERISTICS OF THE PROFITABILITY MODEL OF SECURITIES COMPANIES

Channelized

Over more than 20 years in development, the profi tability model of Chinese securities companies has been a channel profi tability model. Securities gain income and realize profi ts by providing clients with special channels. Evenwith the appearance of innovative business, such as direct investment, secu-rities margin trading, and stock index futures, the channel profi tabilitymodel remains dominant in Chinese securities companies. (The percentageof the brokerage commission business and the securities underwriting busi-ness has always been over 60 percent.)

The special channels in the channel profi tability model of Chinese secu-rities companies mainly include trading channels and issuance channels. Trading channels mainly relate to the brokerage business of securities com-panies, while issuance channels correspond to the securities underwriting business. The channel profi tability model is by nature a type of market monopoly model in a planned economy system. These channels are granted by the regulators, rather than acquired through market competition. Techni-cally, there is no barrier in the channel profi tability model. Whoever gets the channel privilege can engage in the securities service business.

As a result of this traditional profi tability model, the revenue and profi t of the securities market are closely related to the market trend, mak-ing them highly unstable and cyclic. In particular, when the market goes down, securities companies lack effective means to increase their busi-ness revenues. The channel profi tability model also causes the revenue of securities companies to be reliant on the number and utilization rate of channels. To some extent, this suppresses the creativity of securities com-panies since they lack the internal motivation for business and product innovation.

From a historical perspective, the channel profi tability model has certain historical inevitability and justifi cation. In the context of the original indus-trial pattern and rules, it was a reasonable choice for securities companiesto gain revenues by expanding their customer base and improving the uti-lization effi ciency of channels. However, with recent loosening of securities market policies, improvement of infrastructure and increasing competition, the channel profi tability model can no longer fi t in the current development situation. With the liberalization of brokerage commission rates, a declin-ing percentage of the brokerage commission business in the total revenuewill become one of the signs of the transformation of securities companies’profi tability model.


Pan-Banking Characteristics

Since the very beginning, all Chinese fi nancial institutions have been showing pan‐banking (or quasi‐banking) characteristics. Such character-istics are even more prominent when it comes to securities companies. A considerable part of the revenues of earlier securities companies came from interest income, generated from the interest spread arising when securities companies deposit customer margins in a bank. Interest income accounted for over 30 percent of the business revenues of earlier securi-ties companies.

According to 2011 statistics, interest income in the overall securi-ties industry accounted for 15 percent of total revenue, becoming the second-largest revenue contributor. In 2010, securities companies (on a pilot basis) started engaging in the securities margin trading business, which brought about certain changes in the interest income structure of securities companies. However, interest income due from banks and other fi nancial institutions still makes up over 95 percent of the total interest income. In 2011, the sluggish market and persistently low commission rates further accentuated the pan‐banking characteristics of securities companies. Interest income accounted for 16 percent of the total revenue in the fi rst three quarters of 2011. It can be seen from mature markets overseas that interest income is ubiquitous in securities companies. How-ever, it mainly exists in the form of securities‐margin‐trading‐based inter-est income, which accounts for over 10 percent, or even 30 percent of the total revenue. Therefore, to avoid the same fate of the trust industry, Chinese securities companies have to rid themselves of the pan‐banking characteristics.

Uniformity

Chinese securities companies are characterized by a dull uniformity in their profi tability models. Specifi cally, they are uniform in the following two aspects:

1. Identical business structures: The profi tability models of major securities companies are extremely similar. They basically focus on four traditional business lines: brokerage commission business, securities underwriting business, proprietary business, and asset management business. Thebrokerage business mostly involves acting sale of securities. The invest-ment banking business mainly focuses on stock fi nancing. The propri-etary business has a relatively small percentage. The asset management business is growing very slowly. Some securities companies have gained


qualifi cations for innovative business such as securities margin trading, stock index future trading introduction, and direct investment. How-ever, innovative business accounts for no more than 10 percent of total revenue, at most.

2. Identical forms of services in each business line: The business of Chinesesecurities companies is highly homogenous, essentially without any dif-ference and distinction in terms of service forms, service means, and ser-vice contents. Identical profi tability models and homogenous business have made it impossible for any effective means of competition among securities companies to exist, with the only exception being price. The uniformity of profi tability models impedes the establishment of the core competitive strength of a securities company and negatively affects thehealthy development of the securities industry as a whole.

Varying Service Capabilities and Overall Need for Improvement With the profi t-ability model of Chinese securities companies characterized by conduits, uniformity, and pan‐banking features, securities traders are in an awkward position with varying service capabilities and generally low‐quality services.

Against the backdrop of channel‐based services, the business expan-sion is often dependent on the channel resources of the securities trader. Compared with monopolistic channel resources, the abilities of the staff to serve and innovate, and its work capacity, become less and less of a determinant. For example, the trading seat of a securities trader is the core resource of the service channel. The pricing of the service—the commis-sion rate—is simply reduced to the pricing of the trading channel. This means that the question of how to improve service quality is replaced by the question of how to reduce the commission rate. The information, advice, and wealth management services provided by securities traders totheir brokerage business customers cannot be priced through the commis-sion rate. A lack of pricing in the market inevitably leads to poor quality of services.

However, against the backdrop of identical services, competition in business tends to come from competition for resources. During this process,greater importance than the actual operation of business is attached to the competition for resources (such as big clients in the brokerage business, high quality companies ready to go public in the investment banking business and fund resources in the asset management business). Therefore, resources acquisition and business operation become two discrete facets. In the invest-ment banking business, the sponsor representative may not know much about the project, while the transactor understands the project but bears nosponsorial responsibilities after the issuance of the project. As a result, thetransactor has little incentive and the sponsor representative is not attentive


enough. In practice, this leads to a low level of service capability due to the staffi ng mismatch.

Signs of a Transition in the Profi tability Model

The direct investment business of securities companies was fi rst piloted in September 2007. By July 2011, a total of 34 securities companies hadestablished their own direct investment subsidiaries, with a total registered capital of CNY 21.6 billion. Six direct investment companies invested in and were managing seven industrial funds. The direct investment business of securities companies usually has a payback period of three to four years.This means that the securities traders had to wait until after 2012 to gain a return from their direct investment business.

The securities margin trading business of securities companies started in 2010. It made only a small contribution to total revenue—about 1 percent on a monthly basis. With the familiarity of the securities margin trading business, the expansion of target securities, and the introduction of refi nanc-ing business, income from securities margin trading business was expected to live up to the levels of securities traders in the United States and other mature international markets (about 10 percent of the total income) within the following fi ve years.

The stock index future business not only brings IB business commis-sions to securities companies, but also provides hedging room and diversi-fi ed strategic options to their own proprietary business and asset manage-ment business. It even promotes comprehensive innovation in other types of derivatives.

Table 4.11 shows that securities traders such as CITIC and HAITONG, despite the low percentage of innovative business in their total revenues, have a relatively well‐rounded business development pattern and reasonable revenue structure, compared with others in the industry. Their profi tabilitymodels have started a transition process.

CONSTRUCTION OF NEW PROFITABILITY MODELS

Differentiation of Profi tability Models among SecuritiesTraders as Larger Ones Become More Well-Roundedand Internationalized

Judging from the development history of securities traders, their profi tability models are poised to differentiate further with each passing day. Mediumand small regional securities traders will speed up their development


by upgrading traditional business and introducing new business through innovation—an approach discussed earlier. A few large securities traders will also emerge in China, building upon their existing nationwide operation, and will gradually go international.

International vision and internationalized capability will become the core demand in the development of Chinese securities companies. In the future, the demand for internationalized fi nancial services will be driven by the following two forces in China: (1) the internationalization of fi nancing for domestic companies, which primarily takes Chinese enterprises over-seas and brings in international fi nancial capital; and (2) the internation-alization of resource allocation in the domestic capital market, which pri-marily takes Chinese fi nancial capital overseas and brings in international enterprises.

How International Demand Gives Rise to Internationalized Vision and Raises the Bar for Service Capability From the angle of domestic enterprises raising funds inter-nationally, due to the internationalization of business, client population, and management, the large number of domestic enterprises can reap both fame and benefi ts by raising funds through international fi nancial markets. Thisrequires Chinese securities companies to have an internationalized vision and become familiar with the complete host of systems and rules on the international capital market, as well as the characteristics of various com-plex fi nancial instruments in the international market.

Capital market systems and rules vary greatly from country to country. The forms of products are even more diverse and complex. Although, after

TABLE 4.11 Innovative Business Revenues of Some Securities Companies (CNY 100million)

Securities CompanyCITIC

SecuritiesHAITONGSecurities

GFSecurities

MerchantsSecurities

Securities margin trading 0.77 0.37 0.25 0.9

Direct investment 5.82 1.72 0.05 0.16

Futures business 1.5 2.46 2.91 0.93

Stock index futures hedging 4.3 0.5 1.6 Not disclosed

Total of innovative business 12.39 5.05 4.81 1.99

Total revenue 277.95 97.68 102.19 64.86

Percentage in the totalrevenue 4.46% 5.17% 4.71% 3.07%

Source: The 2010 annual report of the company.


years of relatively rigorous regulation, the products in the Chinese fi nancialmarket suffer a lack of variety and rigidity in product forms. Chinese enter-prises and securities traders are partially constrained in their fundraising efforts by noncitizen treatment in international capital markets. Althougha number of Chinese securities companies conduct international business, most of their overseas bases are concentrated in Hong Kong, Macao, andsimilar places. Few have really gained accession into the U.S., European,and Japanese markets. Only a handful of companies are able to get corecustomer resources locally. Therefore, the challenge facing Chinese securi-ties companies is to fi gure out how to grasp the systems and rules of inter-national capital markets and familiarize themselves with diverse fi nancial products and their rules.

From the angle of internationalized resource allocation in the domestic capital market, an important function of China’s international fi nancial center is to attract international enterprises and investors to the Chinese capital market for investment and fundraising and to allocate capital globally based on the Chinese capital market. This proposition has given Chinese securities companies a broader market and a larger customer group. For securities companies, specifi c requirements include the ability to serve international customers, promote the internationalization of the Chinese capital market, and develop measures to respond to various international risks.

How to Effectively Draw on the Comparative Advantages of the Domestic Capital Market, Identify International Customers, and Raise Service Levels All internationally well‐known investment banks promote the internationalization of their domesticcapital markets. By “going out” and “bringing in,” these banks enable the capital market of one country to allocate global fi nancial resources. Chinesesecurities companies need to take hold in the domestic capital market and satisfy the international fi nancing demand of domestic customers. They alsomust integrate going out with bringing in, understand the trend of the inter-national fi nancial market, grasp the tendency of international macroeco-nomic policies, draw on the comparative advantages of the domestic capitalmarket, and realize their own quantum leap while promoting the interna-tionalization of the Chinese capital market.

China’s construction of the International Finance Center is expected to be completed in Shanghai by 2020. The construction process will provide securities companies with a broad space for development, at least in the twoaspects discussed next.

The fi rst aspect involves a series of deeply rooted issues in the con-struction of the International Finance Center that cannot be addressed with policies alone. These issues include the diversifi cation of products,


the deepening of services, and the scaling up of platforms. In order to promote the internationalization of the capital market, securities com-panies need to constantly explore customer needs, consolidate customer resources, and come up with innovative fi nancial products. They must also attract international enterprises and encourage them to conduct restruc-turing and stock market listings in China. Attracting international busi-ness requires various means, including deepening the integration of in‐depth M&A, consultancy, industrial chain integration, and stock market listings. This will expand and solidify the capital market, promoting its internationalization.

Specifi cally, the reform and opening up over the past 30 years has realized a migration of the secondary industry from overseas to coastal regions of China. A multitude of international enterprises have relocated their manufacturing, R&D, and sales business to coastal cities in the Pearl River Delta and the Yangtze River Delta through foreign direct invest-ment (FDI) or similar arrangements. The rise of the secondary industry in the east brought labor and other resources from the countryside to the cities, from the west to the east. With the approach of the Lewis Turning Point, the Chinese economy is facing yet another transformation in its growth pattern as bottleneck factors such as land, electricity, and minerals resources become increasingly prominent. This means broad prospects for securities companies.

The current transformation includes deepening fi nancial services, opti-mizing fi nancial products, replacing direct industrial investment migration with fi nancial capital migration, and replacing migration from overseas to China with migration from eastern China to western China. Over the past 30 years, the China’s relatively monotonous fi nancial system, unduly domi-nated by banks, has been suffering from substantiated fi xed stock quantity risks and a lack of product variety in the process of resource allocation. Ser-vices dominated by simple loan fi nancing, international foreign exchange,and settlement are not able or capable of satisfying the customers’ demand for deeper value, let alone innovation in fi nancial products and services.Looking forward, securities companies should enhance the role of entry through fi nancial capital in international capital circulation. Acquisition, mergers, restructuring, and similar means, as well as fi nancial forms such as equity participation, shareholding, and share swap, draw on resourcesfrom upstream and downstream of the industrial chain. They give full playto their resource integration capabilities so as to improve capital utilization effi ciency.

The second aspect for development is to help the customer grasp both domestic and international platforms and realize optimum international allo-cation of resources. Since the establishment of the Chinese capital market,


it has been increasing in size and innovative products have been emerging. Since the Asia fi nancial crisis, the capital markets of emerging market coun-tries have been getting increasingly rational and mature. Following the sub-prime crisis in the United States and the still unfolding European Union debt crisis, the rationale for a development model of developed capital markets in Western countries has been increasingly called into question and subject to criticism because of its high degree of leverage. Thus, it seems the table has turned to some degree in the development of the capital markets in emergingmarkets versus that in developed countries. On the other hand, mergers and splits of international enterprises have been emanating from inside devel-oped economies to developing economies. With two major developments in the background as a clear guidance for the development of securities com-panies, they should appropriately take advantage of multiple domestic and international capital market platforms, combine the two trends of “going overseas” and “bringing in,” and fulfi ll their function of expanding the Chinese capital market and strengthening the Chinese market.

A Transition from Channels to Services

As a typical sector of the service industry, securities companies help investors make transactions in the capital market. They provide investors with con-sultancy and advice and come up with custom‐made fi nancial products for them, thereby satisfying the investor’s fi nancial demand in various aspects. The current operation models of Chinese securities companies are domi-nated by the provision of transaction for investors, which gives rise to a typ-ical channel profi tability model. With increasingly intense competition, it’s an inevitable trend for Chinese securities companies to shift from a channelprofi tability model to a service profi tability model. With a service profi tability model, years of business development endows securities companies with acute insight and the ability to discover customer demand. It enables them to accomplish a profi tability model transformation through innovative solu-tions for customer needs, based on persistent pursuit for innovation that iscentered on the customer, oriented toward customer needs, and manifestedthrough innovative products. For example, in the brokerage business, the investment consultancy business can be enhanced to meet investor demand for fast and convenient trading of securities, while providing customers witha higher level of services.

Innovation in Traditional Business

Traditional business is the core business of securities companies as capi-tal market intermediaries. The innovation of traditional business is vital


to the transformation of securities companies’ profi tability models. For traditional business, therefore, new profi t‐making channels should be constantly explored. Efforts should be made to come up with new ways of making profi t, and professional and specialized services should be provided.

Brokerage Business—Specialized Operation The current brokerage commissionbusiness demonstrates the following trends:

■ Revenues from brokerage commission business remain important to Chinese securities companies. However, with the constant introduc-tion of new innovative business, the percentage of the brokerage com-mission business in the total revenue will drop to a reasonable level, probably around 25 percent, as in major international investment banks.

■ With the loosening up of the minimum commission rate and more relaxed requirement for new operations, as the business is highly homogenous among securities companies, cost control and trading scaleexpansion will become the means for a securities company to become awinner in the brokerage business competition.

■ Securities companies will implement specialized brokerage commission business based on their own characteristics and advantages.

■ Policies made by regulators on the opening of small operations will have a profound impact on the brokerage commission business.

As the regulatory philosophy that advocates “regulation by category, support for over‐performers and elimination of under‐performers” takeshold, the brokerage business of securities companies will inevitably follow a differentiated and specialized operation path. Innovation in the brokerage business will be made in the following directions:

■ Securities companies will establish a differentiated strategic orientation appropriate for the development of the brokerage business, based on their own resources and the environment. The following three patterns will apply: 1. All-around comprehensive fi nancial service providers: These are ba-

sically relatively large securities companies with a comprehensive business scope.

2. Specialized service providers targeting specifi c markets or investors:These are basically securities traders with distinctive features, such asCICC and GUOTAI JUNAN.


3. Small and medium securities companies with geographical advan-tages: These companies enjoy certain resources and advantages dueto their locations, providing differentiated services for customers insmall and medium-sized cities.

■ Securities companies will perfect the customer relationship management (CRM) system and enhance services for various customer segments. Theconstruction of the CRM system is the basis for gathering suffi cient cus-tomer information, understanding customer needs, and ensuring excel-lent work in customer exploration and services. Dynamic analysis of customer information should be realized through the CRM system. Thisshould serve as the basis for customer service segmentation, leading todifferent pricing strategies and customer services strategies for custom-ers with different characteristics. Diversifi ed charging models should beutilized to satisfy individual and institutional investors’ demand for all‐around, diversifi ed, and comprehensive fi nancial services, thus reducing reliance on commission fees.

■ Securities companies will provide differentiated for‐fee services. Consul-tancy services are vital to fee differentiation based on the subject matters in the brokerage business of securities companies. With the enrichment and deepening of service means, investment consultancies services have broad prospects and are insulated from market conditions. Therefore, they could help reduce the brokerage business’s current dependence on good conditions. On the other hand, the absence of a uniform business model for investment consultancy services is conducive to business differ-entiation. Investment consultancy operations with competitive strength can effectively stabilize existing customer resources while attracting new customers with similar commission rates. Therefore, the heterogeneity of the investment consultancy service is key to the competitive strength of the brokerage business of securities companies in the future.

■ Securities companies will diversify marketing channels and marketing strategies. In terms of marketing channels, existing channels should be optimized and consolidated, and strategic alliances with other institu-tions should be thoroughly utilized to diversify marketing channels. Interms of marketing strategies, successful experience from other indus-tries should be suffi ciently studied to strengthen service marketing and realize diversifi cation of promotion methods.

Investment Banking Business—Transitioning toward Equal Importance for Securities Issuance and Financial Consultancy The underwriting business currently hasa favorable return and the issuance business has few risks. Therefore, the investment banking business of Chinese securities companies is dominated by issuance, while other types of business are left in the cold. However,


with the arrival of the full circulation era in the Chinese capital market, the investment banking business has to break with the traditional securities‐underwriting‐dominated frame. It must explore market space for invest-ment banking services, cultivate new profi t growth areas, and shift towardattaching equal importance to securities issuance and fi nancial consultancy. Chinese securities companies should provide listing sponsor services and also use that as a breakthrough point to provide follow‐up fi nancial consul-tancy and M&A services. Great efforts should be made at the same time toexplore business with private companies, so as to generate resources for the direct investment business of securities companies.

As the most basic business of investment banks, the securities under-writing business can make various innovations in issuance pricing, issuance methods, and issuance venues. Issuance price can be made more market driven, so that it transitions toward the globally practiced book‐building pricing mechanism. The confi guration of extra issuance targets and sell-ing schemes can be more fl exible. Constant efforts should be made to get accustomed to issuance provisions that require improvement of convertiblebonds. More fl exible coupon rates for corporate bonds should be designed. Help should be provided for small and medium enterprises to raise funds by issuing shares or bonds in the GEM board.

Financial consultancy is another important business line of investment banks. It generates bountiful revenues by providing enterprises with advice concerning M&A development, working as M&A transaction intermediar-ies, and making overall planning. While making innovations in fi nancial consultancy business, securities companies should break through the con-straints of traditional channel fi nancial consultancy business. In parallel, they should expand the scope of services and come up with in‐depth and innovative contents of fi nancial consultancy to establish their own featuresin terms of technical skills and specialties, thereby gaining differentiated competitive strength.

Proprietary Business—Actively Taking Part in Market Transactions Proprietary business is one of the traditional business lines of securities companies. Compared with other types of business, the revenue of proprietary business bears an unmistakably positive correlation with the revenues of the second-ary market. Therefore, the performance of this business is subject to large fl uctuations. For a long time, Chinese securities companies have been paying great attention to short‐term profi ts, providing considerable input into theproprietary business. Indeed, this business has generated bountiful revenues for securities companies when the market is in good condition.

Active participation in market transactions should be an important direction of securities companies’ innovation in proprietary business.


It mainly refers to the constant scaling up of proprietary business and the implementation of more investment means and instruments. One factor isthe need for capital to be constantly enriched. From the perspective of regu-latory requirement, the expansion of proprietary business is constrained by the abundance of a company’s capital. The more abundant the capital, thegreater the opportunity for expanding proprietary space. Another factor is fl exible allocation of assets. The lack of variety in investment means and instrument is the major reason behind the large fl uctuation in proprietary business. Based on market conditions, securities companies should adjust the asset portfolio of the proprietary business in a timely manner, enrichasset variety, and avoid models that rely solely on equity assets. They shouldalso actively implement derivative instruments in proprietary asset portfolio to effect risk control.

The Guidelines on the Participation in Stock Index Futures Trading by Securities Companies promulgated in April 2011 explicitly state that the proprietary business and some asset management business of securi-ties companies can take part in stock index futures trading. Normally, proprietary business is only allowed for hedging purposes. The participa-tion in stock index futures trading by securities companies for the purpose of hedging could effectively hedge against losses from unilateral market declines and control the risks of proprietary business. Therefore, it is of great signifi cance for making proprietary business a stable revenue source for securities companies.

Asset Management Business—Product Innovation The asset management busi-ness of securities companies falls into the category of wealth management. Thirty years after the end of World War II, the new middle class emerg-ing in the United States and Europe created favorable opportunities for the development of the wealth management business. It has been 30 years since China started reforming and opening up, and the rich class of the societyhas already taken shape. Their demand for wealth management will also promote the growth of the wealth management business in China.

Due to policy restrictions, the asset management business of securities companies is limited in various aspects such as issuance, promotion, scale,and investment means. As a result, the development of the asset manage-ment business of securities companies is delayed. There is little room forproduct innovation. Neither the scale nor the revenue can be effectively improved.

The loosening of policies is essential for the development of the asset management business of securities companies. Regulators are speeding up policy loosening. By 2010, the product approval procedure had been reformed to make the process from over six months to within three months.


The issuance of collective wealth management products is evidently faster, with rising scale. In September 2011, the China Securities Regulatory Commission circulated to the asset management division of each securities company an outline of the revision of the Trial Implementation Measures for the Customer Asset Management Business of Securities Companies (for solicitation of opinions). This opened up new space for innovation in asset management. After the adoption of the fi ling system, the asset man-agement business of Chinese securities companies was expected to make great breakthroughs and reenact the development speed of their American counterparts. The establishment of their asset management companies by Orient Securities and Everbright Securities refl ected the importance attached to the asset management business by the management of these securities companies.

With the gradual loosening of regulation, making a great effort for product innovation is the way forward for the asset management business of securities companies. Securities companies should strengthen customer resources sharing between different business divisions so that key custom-ers of the investment banking, brokerage, and other divisions also becomethe customers of the asset management division. Based on diversifi ed andindividualized needs of investors and guided by market demand, securities companies should enhance product development and innovation in the asset management business and design wealth management products with vary-ing risk and return characteristics.

Cultivation and Growth of Innovative Business

As China loosens its regulation on securities companies, cases of institu-tional innovation emerge one after the other. The depth and breadth of secu-rities companies’ engagement in innovative business and their innovative capability will accelerate the transformation of the profi tability model of securities companies. In 2011, the regulators sped up the promulgationof provisions concerning innovative business of securities companies. Theconstant development and deepening of innovative business of Chinesesecurities companies in the future will surely change the profi tability model of Chinese securities companies. Table 4.12 highlights major events that took place in 2011.

Profi t Growth Points Brought about by Innovative Business Securities Margin Trading One year after the introduction of the securities margin trading, listed securities traders already started reaping some profi t from the business. From the perspective of absolute numerical value, therevenue from securities margin trading was still only a small part of the total

247

TABL

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TABL

E 4.

12 (C

onti

nued

)


revenue of the securities industry. In the long run, with a rising proportionof securities trading in the A‐share market, and combined with the mag-nifying effect of the establishment of refi nancing companies on the securi-ties margin trading, the securities margin trading business had an appealinggrowth space.

The establishment of China Securities Finance Corporation Ltd. in October 2011 signifi ed that the refi nancing business had entered into a substantial preparatory stage. The establishment of refi nancing companiesmade it so that the conduct of the securities margin trading business could break through the constraint of the securities trader’s own capital and secu-rities. For the conduct of the “two‐fi nance” (securities and capital) business, it could magnify the effect of leverage. Although the refi nancing businesswas yet to be introduced by the end of 2011, the introduction of refi nanc-ing companies was seen as a vital step toward making routine the securities margin trading business.

As the securities margin trading business develops and matures, the participation of long‐term capital, such as insurance companies and funds for social security funds in the securities borrowing practice, will furtherincrease the balance of securities margin trading, according to experience from overseas. Hopefully, this will boost its proportion in the total revenue of the industry to over 10 percent. For most securities traders, that is equiva-lent to creating yet another investment banking division, while allowing thesecurities trader to play just the role of the capital intermediary in the securi-ties margin trading business. The stability of revenues and the relatively lowrisks are indeed very appealing.

Direct Investment The fi rst pilot for direct investment business of securi-ties companies was launched in September 2007. As of July 2011, a total of 34 securities companies had set up their direct investment subsidiaries, totaling CNY 21.6 billion in registered capital. Six of the direct investmentsubsidiaries had invested in and were managing seven industrial funds.

The signifi cance of the direct investment business lies in its ability to expand investment channels for securities companies, improve capital uti-lization effi ciency, and enable securities companies to participate in mar-ket transactions more effectively. However, the development of the direct investment business requires well‐standardized operation as a fundamental prerequisite.

In terms of the future development of the direct investment business, the direct investment business realized the integration of industrial capi-tal and fi nancial capital. But the relationship of the two is likely to bring about issues such as interest transmission. This problem is worth paying special attention to. The industrial fund essentially represents the securities


trader’s own interest. After making investment in an enterprise, it becomes the best choice for the securities trader to have the enterprise listed in the stock market for maximum profi t.

After having its interest tied to that of the investment company, the securities trader ought to be the impartial intermediary. The overturned roletends to make it possible to skew the securities trader’s criteria, which isexpected to be impartial and objective. From the perspective of image‐build-ing, there are risks of fi nancial statement whitewash, cover‐up of connected transactions, and exaggeration of profi tability. From the perspective of list-ing price, however, the higher the issuing price of the listed company in the fi rst‐tier market, the better. This is because the price directly determines the fundraising scale of the listed company, thereby determining the issuance income for the securities trader.

The direct investment business may bring about progress in many respects, such as changing the pan‐banking and overly homogenous profi t-ability models, curbing fl uctuations in revenues, and expanding the scope of fi nancial services. However, the associated problem of interest transmission is still worth paying attention to.

Stock Index Future Business The stock index future business has greatdepth and breadth for exploration. Building upon the introduction of theShanghai–Shenzhen 300 Stock Index Future pilot, the regulators will deepenand widen their exploration. They will launch other types of stock index futures, as well as mini‐futures. Futures companies with a securities trader background may benefi t from stock index futures in various aspects. Theycan share the fruit of improved performance of their affi liated futures com-panies and also acquire commission revenues through the IB business. Theycan attract new customers while maintaining existing customers and pro-vide hedging and strategic diversity for their own proprietary business and asset‐management business. In addition, stock index futures are conducive to innovation in the structure of invested products and industries. Theyinclude strategy diversifi cation, product diversifi cation, the exploration anddevelopment of arbitrage systems, and across‐the‐board innovation of otherderivatives.

The development of stock index futures can directly bring to a securities company procedure fees from the IB business and revenues form propri-etary business. Based on the current volume of stock index futures transac-tions and the depth of securities companies’ involvement, the stock indexfuture business is bringing CNY 1 to 2 billion to the securities industry.As the depth and breadth of stock index futures business increase, it will become an important revenue source and investment instrument for securi-ties companies.


“New Third Board” Business The “new third board” is the colloquial name of the private company agency share transfer system. It is yet anotherboard launched in the Chinese capital market, following the main board,the SME, and the GEM. Most companies listed on this board are small and medium tech companies. It’s an important component of China’s multilayer capital market system framework.

The new third board expansion was the focal point of the OTC mar-ket reform, which was launched as a pilot on the original agency share transfer system. The year 2011 witnessed rapid expansion of the third board. In November, the number of chief agency brokers increased to 58 from 44 one year earlier, while the number of listed enterprises increased from 82 to 148.

For securities companies, profi ts from the new third board business mainly include the following:

■ Acquiring investment bank income from listing and private placement ■ Acquiring commission income through transaction matchmaking ■ Acquiring income as underwriters or sponsors from board‐switching enterprises

■ Price arbitration between the third board and the GEM and SME boards after board‐switching

The fi rst two types of profi ts are currently regular income sources for chief agency brokers. However, due to the small overall size of the thirdboard market, the revenues are limited and even negligible compared withrevenues from the main board and the GEM board.

The plan for the new third board expansion was under discussion in 2011, without a defi nite launch date. Once launched, all‐inclusive expansion was planned with many more listed enterprises, chief agency brokers, andinvestors. Following the introduction of the securities margin trading busi-ness, the new third board is likely to become yet another feel‐good factor for the securities industry.

Client Margin Management The China Securities Regulatory Com-mission approved a pilot project, Cinda XIANJINBAO, in which Cinda Securities is allowed to engage in the business of client margin cash man-agement at a scale of up to CNY 7 billion. This is the fi rst time the regulators allowed a securities company to include client margin into the scope of securities management since 2004, when a comprehen-sive purge of securities traders was conducted. This pilot is signifi cant because the business will become yet another stable source of income for securities companies.


The fee structure of the Cinda XIANJINBAO set up by Sinda Securi-ties includes the following items: management fee (annual rate 0.7 percent), custodian fee (payable to the custodian, annual rate 0.05 percent), and per-formance fee (given that the annualized profi t rate of the product exceeds0.7 percent, Cinda Securities may extract 30 percent). The management feeand performance fee are the major profi t sources of securities traders. The securities trade can also get the performance fee as long as the operation of this part of capital by the securities trader yields a profi t rate higher than the low‐hanging 1.45 percent. Once the business is opened up, it can bring a new and stable profi t source for securities traders. According to incomplete statistics, as of the end of June 2011, the total amount of customer deposits in the securities industry was about CNY 800 to 1,000 billion. Assuming 50 percent of the deposits in the entire industry can be included into the scope of the cash management business, based on the 3.5 percent interest rate, itwill bring at least CNY 5 billion for the industry. This is equivalent to about 3 percent of the industry’s total revenue in 2010.

Synergism between Innovative Business and Traditional Business The conduct of innovative business brings new profi t points and incremental revenuesfor securities companies. It also optimizes traditional business, realizing synergism between innovative and traditional business. For example, the proprietary business may offset some losses in self‐operation by hedging with instruments such as stock index futures (see Table 4.13 ). The broker-age business, investment consultancy business, and research business mayjointly ensure an obstruction‐free industrial chain. This is also an important

TABLE 4.13 Some Publicly Listed Securities Companies’ Return on Investment through Derivative Financial Instruments (CNY in 10 thousands)

Name of SecuritiesTrader

Net Profi t of Investment through Derivative Financial Instruments

in the First Half of 2011(changes in fair value

included)

Net Profi t of Investmentthrough Derivative Financial

Instruments in 2010(changes in fair value

included)

CITIC Securities 60847.03 43235.41

Haitong Securities 9001.94 7694.63

GF Securities 29341.07 16397.84

Everbright Securities −356.23 29.27

Source: The companies’ annual reports in 2010 and mid‐year reports in 2011.


part of transformation of profi tability models experienced by Chinese secu-rities companies.

The following measures are designed to exploit synergies between the innovative business and the traditional business of securities companies:

■ Greater resource input: Increase HR input from investment banks. Speed up the construction of light operations. Enhance input into assetmanagement product innovation.

■ Transition from seller business to buyer business: The key factor for a securities trader to win the competition in the future is its investmentcapability. This includes the capability to invest in various types of sellerbusiness such as self‐operation, asset management, direct investment, PE funds, cash management, securities margin trading, agreement‐based share buy‐back, and other types of capital operation business.

■ Encouragement of innovation: Specialized operation can be realizedthrough innovation in product design, sale, and service. Business inno-vation is also encouraged. Through customer‐oriented business suchas fi xed income business, equity business, and securities margin trad-ing business, new business fi elds can be created and explored and new growth points can be cultivated.

■ Optimization of traditional business by innovative business: The stock index future business is conducive to sharing customer resources, exten-sion and expansion of operation outlets, and improvement of customer services, even more so to the optimization of the proprietary business and asset management business.

■ Building up customer resources and encouragement of customer‐oriented business development: Based on customer experience, various business lines should be encouraged to improve their product and ser-vice innovation capabilities from the perspective of customer needs, so as to fi nd great space for development.

CASE STUDIES

For the future development of small and medium securities traders, the right way forward is regionalization and market segmentation. For large securities traders, the right choice is to become more internationalized and comprehen-sive in business scope. The following two cases studies were selected from the 18 listed securities traders in China in 2011, CITIC Securities and Soochow Securities. Large securities traders such as CITIC are likely to take the lead in the competition to become more internationalized and comprehensive.


Small and medium securities traders, represented by Soochow Securities, may stand out in the process of regionalization and specialization.

CITIC Securities—Equal Importance to Tradition and Innovation, Firm Foothold in China, and Aggressive Exploration Overseas

As an industrial leader, CITIC Securities has traditional advantages in such business lines as brokerage and investment banking, in addition to the fre-quent breakthroughs it has been making in direct investment and securitiesmargin trading. The focus of CITIC’s development has been on both tra-dition and innovation, and maintaining a strong presence in China, while exploring growth opportunities overseas.

Development of Both Wholly Owned and Equity-Controlled Business; Taking Rootin Beijing, Guangdong, Shanghai, Zhejiang, and Shandong; Brokerage Accounting for Half of the Revenues

Fifty‐Five Proprietary Business Units Taking Root in Beijing, Shanghai, Guangdong, and Jiangsu Figures 4.17 through 4.19 show the distribution of CITIC’s business channels.

The brokerage business is the main source of revenues for CITIC Securities, as it is for all securities traders. As a large securities company with nationwide presence, CITIC Securities owns 55 operations distributed over 13 provinces.

In addition to the 55 operations of its own, CITIC Securities also indi-rectly owns 91 operations distributed closely in Shandong and Zhejiang through securities companies such as CITIC JINTONG and CITIC WT.

Equity Control of JINTONG and WT, Prominent Geographical Advantages in Zhejiang and Shandong With 46 of its 52 operations located in Zhe-jiang, CITIC JINTONG has absolute dominance in the region, providing strong support for the brokerage business of CITIC in the Zhejiang region.

With 37 of its 39 operations located in Shandong, CITIC WT has abso-lute dominance in the region, providing a strong support for the brokeragebusiness of CITIC in the Shandong region.

The Brokerage Business Remains to Account for Nearly Half of the Revenues in 146 Operations Nationwide With 146 operations nationwide, includ-ing those of its own and those owned through CITIC JINTONG and CITIC WT, CITIC Securities is able to maintain the brokerage business revenue at about 30 to 40 percent of the total average revenues (see Figure 4.20 ).


FIGURE 4.17 Distribution Pattern of CITIC Securities’ Proprietary Business Source: Wind Information Co., public information of the company, iFinD Database.

Xinjiang

Inner Mongolia

Gansu

Qinghai

Tibet

Yunnan

Hainan

Macao

Hong Kong

Taiwan

Fujian

Zhejiang

Shanghai

Jiangsu

Shandong

Tianjin

LiaoningJilin

Anhui

Beijing

Shanxi

Shaanxi

Ningxia

SichuanChongqing

Guizhou

Guangxi

Hunan

Jiangxi

Hebei

Henan

Hubei

High

Low

Branches

So

uth

Ch

ina

Se

a Is

lan

ds

Heilongjiang

Guangdong

Investment Banking Business Even with the resources of nearly 150 opera-tions distributed across the country, CITIC Securities is still making a great effort to develop the investment banking business, in order to expand rev-enue sources and curb income fl uctuations. Figure 4.21 shows the revenue generated by the Investment Banking division within CITIC Securities.

Thanks to the great strength of its investment banking team, the securi-ties underwriting business made up an average of more than 10 percent of CITIC Securities’ total revenues over the past few years.

Although the investment bank of CITIC Securities didn’t issue the most IPOs, due to the fact that most of the IPOs are large‐cap or mega‐cap,CITIC’s revenue from its investment banking business far exceeds any other company with the same number of IPO issuances (See Table 4.14 ).

Investment Business The investment business is another bright spot in CITICSecurities, and an important factor that keeps the percentage of the bro-kerage business in the total revenue below 50 percent. Statistics show that over the years the profi t rate of CITIC’s investment business averaged about 28 percent. In particular, against the backdrop of a securities market slump in


TABLE 4.14 Top‐Five Securities Traders in Terms of the Number of Investment Banking Projects Since 2006

Issuance and UnderwritingStatistics Since 2006 Number of Underwriting Projects

Name of Organization Total IPO Added Allotment TransferableBonds

BondIssuance

CITIC Securities Company 295 50 43 6 7 189

Ping An SecuritiesCompany

204 111 35 1 1 56

China International CapitalCorporation Limited

198 26 20 6 9 137

GUOSEN Securities CO.Ltd.

188 105 49 3 5 26

GUOTAI JUNANSecurities Co. Ltd.

174 16 30 2 6 120

Source: Wind Information Co., public information of the company, iFinD Database.

XinjiangInner Mongolia

Gansu

Qinghai

Tibet

Yunnan

Hainan

Macao

Hong Kong

Taiwan

Fujian

Zhejiang

Shanghai

Jiangsu

Shandong

Tianjin

Liaoning

Jilin

Anhui

Beijing

Shanxi

Shaanxi

Ningxia

SichuanChongqing

Guizhou

Guangxi

HunanJiangxi

Guangdong

Hebei

Henan

Hubei

High

Low

Branches

So

uth

Ch

ina

Se

a I

sla

nd

s

Heilongjiang

Distribution Pattern of CITIC JINTONG’s Securities Operation Outlets Source: Wind Information Co., public information of the company, iFinD Database.


recent years, CITIC has been able to maintain a high level of income by sell-ing its equities in CITIC Construction and China AMC. Figure 4.22 showsthe revenue generated by the Brokerage division within CITIC Securities.

Firm Foothold in China, Aggressive Exploration Overseas With the fast develop-ment of the brokerage, investment banking, and investment business, CITIC Securities is wasting no time and exploring internationalized business while strengthening its foothold in China.

Investment in Overseas Securities Traders On June 9, 2011, the board of the company considered and passed a proposal about the acquisitionof 19.9 percent equity interest in CLSA and Cheuvreux by wholly owned subsidiary CITIC Securities International. (See Figure 4.23.) It allows its subsidiary in CLSA and Cheuvreux for USD 374 million. The acquisitionwas still in progress in late 2011.

Overseas Financing On April 13, 2011, the fi rst provisional shareholdersmeeting of the company considered and passed proposals including the

FPO


Gansu

Qinghai

Tibet

Yunnan

Macao

Hong Kong

Taiwan

Fujian

Zhejiang

Shanghai

Jiangsu

Shandong

Tianjin

Liaoning

Jilin

Anhui

Beijing

Shanxi

Shaanxi

Ningxia

SichuanChongqing

Guizhou

Guangxi

HunanJiangxi

Hebei

Henan

Hubei

High

Low

Branches

So

uth

Ch

ina

Se

a I

sla

nd

s

Heilongjiang

Guangdong

Hainan

FIGURE 4.19 Distribution Pattern of CITIC WT’s Securities Operation Outlets Source: Wind Information Co., public information of the company, iFinD Database.


0

10

20

30

40

50

60

44.28

2006

43.33

2007

42.11

2008

49.63

2009

28.09

2010

Percentage of Securities Brokerage Business in the Total Revenue

FIGURE 4.20 Percentage of Securities Brokerage Business in the Total Revenue in CITIC Securities Source: Wind Information Co., public information of the company, iFinD Database.

FIGURE 4.21 Percentage of Investment Banking Business in the Total Revenue inCITIC Securities Source: Wind Information Co., public information of the company, iFinD Database.

16.3

7.11

10.0710.91 10.45

0

2

4

6

8

10

12

14

16

18

2006 2007 20092008 2010

Percentage of Securities Brokerage Business in the Total Revenue


FIGURE 4.22 Percentage of Investment Business in the Total Revenue in CITICSecurities Source: Wind Information Co., public information of the company, iFinD Database.

26.1124.54

36.43

15.81

39.43

0

5

10

15

20

25

30

35

40

45

2006 2007 2008 2009 2010

Percentage of Investment Business in the Total Revenue

FIGURE 4.23 Internationalization of CITIC Securities Source: iFinD Database.

Internationalization of

CITIC Securities

Investment

inOverseas

Securites

Traders

Plan toacquire

19.9 percent

equity inCLSA

Plan toacquire

19.9 percent

equity inCLSA

H Share

Financing

Plans

Cultivation

of Cross-

Border

Business

CITIC

Securities

Brokerage

(Hong

Kong) Ltd.

CITIC

Securities

Futures

(Hong

Kong) Ltd.

CITIC

Securities

Finance

(Hong

Kong) Ltd.

CITIC

Securities

International

Company Ltd.,

CITIC


issuance of H shares and listing in the main board of the Hong Kong Stock Exchange. Related work was in steady progress later in 2011.

Cultivation of Cross‐Border Business With Hong Kong as the startingpoint, CITIC is actively gaining experience for development overseas and gradually tapping into overseas markets by establishing CITIC SecuritiesBrokerage (Hong Kong) Ltd., CITIC Securities Futures (Hong Kong) Ltd., CITIC Securities Finance (Hong Kong) Ltd., and CITIC Securities Interna-tional Company Ltd.

Soochow Securities—Brokerage Supplemented with Investment Banking, Firm Regional Foothold,and Nationwide Exploration

Soochow Securities, formerly known as Suzhou Securities, is a securities company with regional dominance in Suzhou. It does not stand out in theindustry in terms of its overall strength. In 2011, Soochow Securities held the following rankings out of the 107 securities companies in China: thir-tieth in business revenue, thirty‐fi rst in net asset, thirty‐second in net profi t, twenty‐fourth in brokerage revenue, twenty‐sixth in investment banking revenue, and thirty‐fi fth in proprietary business revenue.

However, as a regional and specialized securities trader, Soochow Secu-rities differentiated itself in the industry with some distinctive features. Ithad typical Soochow characteristics. In terms of the number of operations,the company had the most operations in the Suzhou region with 22. It comfortably enjoyed the largest share of the brokerage business in Suzhou. According to data disclosed by the company, the market share of the com-pany reached over 45 percent in 2010. Soochow Securities owned 7 of the top 10 operations in the Suzhou region.

With these distinctive features, the brokerage business was persistently responsible for a large portion of the company’s revenues. According toavailable data, even in 2011 when the investment banking business was growing rapidly and the brokerage business was shrinking dramatically,brokerage still accounted for 50 percent of the company’s total income. That fi gure was as high as 96.7 percent in 2008.

In comparison to CITIC Securities, Figure 4.24 shows Soochow Securi-ties’ distribution pattern; and in contrast, Figure 4.25 shows its transactionvolume relative to the other major securities fi rms.

Thanks to its fi rm foothold in Suzhou, Soochow Securities enjoyed great competitive advantages and certain monopoly in the brokerage securitiesbusiness in the entire Suzhou region. Since 2006, Soochow Securities made an effort to thoroughly tap into the Suzhou market and expand its presence


FIGURE 4.24 Distribution Pattern of Soochow Securities’ Proprietary Business


Gansu

Qinghai

Tibet

Yunnan

Hainan

Macao

Hong Kong

Taiwan

Fujian

Zhejiang

Shanghai

Jiangsu

Shandong

Tianjin

Liaoning

Jilin

Anhui

Beijing

Shanxi

Shaanxi

Ningxia

SichuanChongqing

Guizhou

Guangxi

HunanJiangxi

Guangdong

Hebei

Henan

Hubei

High

Low

Branches

So

uth

Ch

ina S

ea Isla

nd

s

Heilongjiang

Total Transaction Volumes of Soochow Securities (equity fund) in theSoochow Region since 2006 Source: Wind Information Co., public information of the company, iFinD Database.

Unit: CNY 100 billion Total Transaction Volume—Equity Fund

Soochow Securities

7,605.3433

27,854.1352

2,609.4774

2,290.1935

1,850.7568

1,344.0611

1,283.6619

1,241.9686

1,187.7014

0 4,643 9,286 13,929 18,572 23,215 27,858

2,500.9316

Huatai Securities

Haitong Securities

Nanjing Securities

Xintai Securities

CITIC Securities

GF Securities

CITIC Construction

Shenyin Wanguo Securities

China Investment Securities


75.7570.59

96.72

77.964.59

49.94

0

20

40

60

80

100

120

2006 2007 2008 2009 2010 2011Mid−Year

ReportPercentage of Brokerage in the Total Revenue

FIGURE 4.26 Percentage of Securities Brokerage in the Total Revenue in SoochowSecurities Source: Wind Information Co., public information of the company, iFinD Database.

3.21 2.160.17

5.81

13.73

33.32

0

5

10

15

20

25

30

35

20072006 20092008 2010 2011 Mid−YearReport

Percentage of Securities Underwriting in the Total Revenue

FIGURE 4.27 Percentage of Securities Investment Banking in the Total Revenue in Soochow Securities Source: Wind Information Co., public information of the company, iFinD Database .


in regional markets in Jiangsu. As a result, the brokerage business constantly made up 50 percent to 96.7 percent of its revenues.

Based on the vibrant regional economic atmosphere in Suzhou in recent years, Soochow Securities started focusing on the development of high quality regional enterprises as potential targets for public listing sponsor services. In 2010, the percentage of the underwriting business in the total revenue exceeded 10 percent for the fi rst time. By the fi rst half of 2011, thepercentage had risen to 33.3 percent.

According to a list of companies whose IPOs were sponsored by Soochow Securities since 2006, a majority of them were based in the areascovered by the operations of Soochow Securities. Of the 16 companieswhose IPOs were sponsored by Soochow since 2006, 13 (81 percent) were based in the Yangtze River Delta, 11 (69 percent) were based in Jiangsuprovince, and 3 (20 percent) were based in Suzhou.

Because regionalized brokerage business and investment banking busi-ness are the cornerstone of the development of Soochow Securities, thegrowth of its asset management business and investment business is rela-tively slow. According to data disclosed by the company, during the period 2008 to 2010, equity and derivative-related proprietary business only

FIGURE 4.28 Percentage of Return‐from‐Investment in the Total Revenue inSoochow Securities Source: Wind Information Co., public information of the company, iFinD Database.

5.38

14.9

6.32

11.55 11.51

−0.13−2

0

2

4

6

8

10

12

14

16

2006 2007

2008

2009 2010 2011Mid−Year

ReportPercentage of Return from Investment in the Total Revenue


involved 17 percent of the company’s net capital, far below the 45 percent level of the average securities trader. The asset management business is stillin its infant stage. According to statistics from Wind Information Co., as of 2011, when Soochow Securities went public, it had only two asset manage-ment products with a total net asset value of less than CNY 500 million, ranking in the middle among over 100 securities traders in China.

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Wei , Shi. 2003 . Corporate Strategic Thinking—The Key for Victory in Competition. Beijing : China Times Economics Press .

Wu , Xiaoqiu. 2008 . “ The Chinese Capital Market in the Global Vision: LeapfrogDevelopment and Policy Transition .” Finance and Trade Economics 4 .

Wu , Xiaoqiu , Qiqing Chen , and Hongling Mao . 2004 . “ The Chinese Securities Indus-try: Development and Road for the Future .” Economic Theory and BusinessManagement 1 .t

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Wu , Zhifeng . 2004 . “ Business Exploration and Innovation of Securities Traders Viewed from the Perspective of Income Structure .” Market Herald 3 .d

Yao , Lushi , Liling Huang , and Lisheng Pan . 2005 . “ On the Causes and Governance of the Failure of Some Chinese Securities Companies .” Review of Investment Studies 11 .

Yao , Lushi , Ren Liu , and Zhuyun Zhang . 2007 . “ A Study on the Profi tability of Chinese Securities Companies and the Restructuring Thereof .” Journal of Hefei University of Technology (Social Science) 10 .

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Zhang , Junjie . 2009 . The US Profi tability Model. China Economics Press . Zhang , Xuefeng. 2007 . “A Study on Problems Associated with the Transition and

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267

CHAPTER 5 5 Analysis of Risk Management in

Chinese Securities Companies

A securities company’s ability to survive is based on its ability to protectagainst and control risks. Strict and effi cient risk management is the

basic condition for the company’s development. The global fi nancial crisiswas precipitated by a high leverage and overuse of derivatives by majorglobal investment banks such as AIG, Lehman Brothers, and Merrill Lynch. Chinese securities companies have experienced fallout from their miscon-duct due to out of control risk management. These problems for securitiescompanies have accumulated to the point of complete exposure by 2003. Therefore, the China Securities Regulatory Commission (CSRC) made prominent the comprehensive reordering of securities companies in 2004. After that, the sense of compliance management and ability in risk manage-ment was clearly strengthened. This established a system for institutions tomonitor risk gradually and enhance business risk management.

After the global fi nancial crisis, the risk‐management model of foreign securities companies, that was once regarded as the example for the wholeworld, was reexamined. An urgent hope arose to fi nd a new solution for a risk‐management system that could be suitable for indigenous Chinese securities companies. The process was simply to develop successful or useful strategies and discard those that were not.

This chapter details the research on the current status and development trends for risk management of Chinese securities companies. It emphasizesthe management of traditional risks and business innovation risks and puts forward the standards for risk management in terms of future developmenttrends.


STATUS QUO AND TREND ANALYSIS OF RISK MANAGEMENT IN SECURITIES COMPANIES

All securities companies are marked by high risks. How well they manage risks is often indicative of their performance and even their survival. Com-prehensive and effective risk management and control can promote the stable and healthy running of a securities company and of a securities indus-try as a whole. It can enhance the confi dence of a vast number of investors and thereby invigorate market transactions. After going through such stages as internal checks, internal control system, internal control structure, andinternal control integrated framework, risk management in Western secu-rities companies entered into the comprehensive risk‐management stage. Comprehensive risk management emphasizes full coverage of risks, partici-pation of the entire staff, and control of the entire process. It means setting a new standard for risk management. In this comprehensive risk‐management stage, securities traders position themselves as organizations that operate risks and gain profi ts from doing so. Some Chinese securities traders learnedfrom the advanced experience of risk management overseas and constructedtheir own risk‐management system earlier than others. Due to infrastructuredefi ciencies, however, a number of risk‐associated incidents have been trig-gered by a collapse of the risk management and control system or inappro-priate operations. One example of such collapse was China Eagle, the fi rst Chinese securities companies to come up with the idea of risk management. It was forced to shut down and was placed in trust. Since 2004, there has been a purge of comprehensive securities companies occurring in the Chinese securities market. The purge may provide opportunities that will promote the establishment of internal control and risk‐management mechanisms in securities companies.

The fi nancial crisis that swept the world in 2008 forced the fi nancial industry in various countries to elevate the status of risk management and control. In China, however, it called into question the effectiveness of the risk‐management systems used overseas. In light of that, it is necessary tostudy the risk‐management practices of both Western and Chinese securities companies and learn from their successes and failures. Risk managementthen needs to be optimized for the special environment of Chinese securitiescompanies and the characteristics of the risks they face.

Sources of Risks Facing Securities Companies

Market Risks Market risks are the most basic. They are the major risks facingsecurities companies. Due to a long‐standing lack of variety in profi tability models, various business lines have shown a tendency toward synchronized

Analysis of Risk Management in Chinese Securities Companies 269

movement. When market risks increase, the brokerage business of securities companies faces contraction. This in turn leads to lackluster performanceof the proprietary business and the asset‐management business. When the market rallies, the proprietary business and asset‐management business grow, leading to an increase of transaction volume. This directly drives up revenues from the brokerage business and boosts the underwriting business. Therefore, the various traditional business lines of Chinese securities com-panies are highly dependent on the condition and trend of the market. Theyare very vulnerable to instability of income and profi t in the face of market risk impacts.

Liquidity Risks With lower issuance premiums, overall profi t goes down,reducing the ability of securities companies to attract capital. Increas-ing capital by issuing new shares used to be the major fi nancing channel of securities companies. However, with the gradual decline of return on invested capital, fewer means are available for increasing capital through new shares. This undermines the capital adequacy ratios of securities com-panies. Chinese securities companies dedicate too much of their capital to proprietary business. Compounded by their weakness in fund‐raising abili-ties, this will accentuate the liquidity problem once market risks increase. During the comprehensive purge of securities companies led by the CSRC, most securities companies subjected to administrative liquidation were punished. Suffering from fund defi ciency, they appropriated customer assets and funds through institutional loopholes and, fi nally, exposed themselves to liquidity risks.

Operational Risks Operational risks refer to losses caused by inappropri-ate operation of the transaction or management system, or the lack of indispensable background technological support. Specifi cally, they includeoperation/settlement risks and loss‐of‐internal‐control risks. These are risks caused by such things as undetected, over‐the‐limit risk taking, unauthor-ized transactions, fraud committed by the transaction division or the back-ground division, and unskillful or unstable staff compounded by easy access to computer systems.

Policy Risks Policies have always been an inescapable factor in the develop-ment of the Chinese securities market. The functioning of the securities mar-ket and the operation of securities companies are not standardized enough. Therefore, regulators frequently resort to administrative means. Whenever a major change of policy takes place or an important measure or regula-tion is enacted, the securities market tends to swing drastically, bringing about violent fl uctuation in the performance of securities companies. The


development of the Chinese securities market is also changing. Standardiza-tion is an increasingly urgent requirement for the development of the market. Major policies and administrative means affecting the development of the securities market are gradually adjusted. Changes of policies will change themode of competition in the Chinese securities market and are likely to have major impact on various business lines of securities companies.

Compliance Risks In the past, compliance risks were the most common risks facing Chinese securities companies. Typical breaches of law and regulations included false information in the fi nancial statement, preva-lent off‐the‐book operation, illegitimate entrusted wealth management and high interest fi nancing, appropriation of customer assets, illegal bond issuance, bulk‐holding and market manipulation, and control of large shareholders.

Financial Risks Due to unvarying profi tability models of securities companies,fl uctuation of the securities market often leads to the risk of income and profi t instability. The growth of a company’s business exposes it to such risks as small amounts of cash holding, low net capital, and weak risk resistance. In daily operation, a variety of factors may lead to large amounts of underwrit-ing, embezzlement of funds, and other activities in the investment banking business. Without timely and suffi cient fi nancing funds, this may bring liquid-ity risks to the company. An oversized line of business may lead to fi nancial losses by reaching the thresholds set out by the Administrative Measures on Risk Control Indicators of Securities Companies. In conducting new busi-ness, the failure to maintain a healthy capital structure and keep high‐risk business in proportion may pose certain risks to the safety, liquidity, and profi tability of the company’s capital operation.

Risk Management of Overseas Securities Companies

Advanced Risk-Management Concepts Foreign investment banks’ understanding of risk management and the importance they attach to it are fi rst refl ected in their risk‐management concepts and principles. How do they properly and effectively recognize, assess, test, and control each type of risk? This issuebears heavily on the operation performance and long‐term development of Western investment banks as they face various risks in their operational activities. Clear relationships of rights and interests give rise to strong inter-nal demand for risk prevention. To withstand risks is an integral part of thecore business of securities companies. The desire to control risks comes from within. Thus, mature concepts of risk management have been established.


Well-Rounded Organizational Structure for Risk Management Investment banks in Western countries usually have a well‐rounded internal organizational struc-ture for risk management. In a nutshell, such a structure typically includes an audit committee, a risk monitoring committee, a risk policy team, a risk‐management committee, and others. The risk‐management committee inturn consists of a market risk team, a credit risk team, a portfolio risk team,and a risk infrastructure team. All of these components come together to form a comprehensive and closely organized management system.

The risk‐management architecture of Western investment banks has played an important role in risk management. Well‐established corporate governance ensures that the risk‐management arm has an important sta-tus and role in the entire operation process. Enough attention is paid torisk control, and views and suggestions from the risk‐control division arereceived. The architecture has also designed relatively well‐rounded risk‐management systems and mechanisms that are effectively enforced.

Effective Risk-Management System and Mechanism Rigorously designed risk‐management systems govern every activity. They establish relevant stan-dards in operational practice. Rigorous systems follow these standards inhandling business related report forms, business procedures, and variousissues, as well as the designing of promotional materials. Business‐related communication and linguistic expression should be as standardized as pos-sible. The information system should be fully utilized in monitoring risk exposures at various business levels.

Quantitative Risk-Management Method In managing risks, Western investmentbanks use various fi nancial instruments such as futures, options, and fi nan-cial swaps to avoid or reduce investment risks. Based on their own advan-tages, they come up with various permutations of products, interest rates,exchange rates, terms, share prices, indexes, and agreement provisions. These derivatives are also used in hedging, risk mitigation, and asset‐liabilityoptimization. The focus of risk‐management techniques varies from oneinvestment bank to another. For example, major methods include value atrisk (VaR), risk‐adjusted return on capital (RAROC), enterprise‐wide risk management (ERM), and scenario analysis.

Risk Management in Chinese Securities Companies

Post Purge Institutional Environment for Risk Management in Securities Companies Post‐Purge Policy Environment Characterized by Classifi ed Regulation After the purge of securities companies, a classifi ed regulation system


was established by the Regulation on the Supervision and Administration of Securities Companies promulgated by the CSRC. It functions throughfi nancial risk regulation and compliance regulation, and emphasizes both standardization and development. By changing the mechanism, approaches, and means of regulation, it guides and promotes the establishment of risk monitoring and control mechanisms with both self‐discipline and checksand balances within the company.

Major Contents of Classifi ed Regulation Securities company classifi ca-tion refers to the evaluation of securities companies and their classifi cation into fi ve categories and 11 levels by the CSRC based on the risk‐management capability of each securities company. This is done in consideration of the company’s market infl uence and in accordance with the provisions of the Securities Companies Classifi ed Regulation Guideline (Trial), informally re-ferred to as “the guideline.” The CSRC and its regional branches conduct classifi ed regulation of securities companies based on the result. The classi-fi cation results also serve as the basis for determining the scope and priority of new business or product pilot projects.

Assessment Procedure In light of their own conditions, securities com-panies make self‐evaluation according to the Securities Companies Risk‐Management Capability Evaluation Indexes and Standards. Then, based on the assessment made by the securities company itself, a contingent sent by the CSRC will conduct a preliminary review and give evaluation scoresaccordingly. The preliminary review results will then be submitted to theCSRC, which revisits the review results from the contingent and determines to which category the securities company belongs.

Evaluation Factors Risk‐management capability is the determinative factor in the classifi cation of securities companies. The guideline has estab-lished 69 evaluation indexes in the following six categories: capital strength, customer interest protection, compliance management, legal person gover-nance, internal control, and corporate transparency. This represents a secu-rities company’s ability to control and withstand potential risks.

Risk‐Control Systems The Administrative Measures on Risk Control Indi-cators of Securities Companies encompasses liquidity risks, market risks,operation risks, and various business risks. Of these, the provisions on the absolute and relative indexes of net capital and their standards ensure that the business scope of a company is commensurate to its net capital level.The provisions on the calculation of risk capital requirement ensure that each business line of the company is supported by corresponding net capital.


This enables indirect control of the scale of each business and direct control of the scale of some high‐risk business. It also establishes a mechanism that dynamically pegs the scale of each business line to the net capital level. In terms of routine supervision, capital suffi ciency is emphasized to strengthen inspection of the securities company’s risk control index generation process. Monitoring and warning are strengthened in relation to the implementa-tion of risk control indexes by establishing a monitoring system. Regulatory measures are taken in a timely manner against companies whose risk‐control indexes fail to meet requirements, thus forcing them to meet the risk‐control index standards on a consistent basis.

Compliance Management System The Provisions for Trial Implementation of the Compliance Management of Securities Companies call on securitiescompanies to establish such concepts as compliant operation, whole‐staff compliance, and compliance from senior management. They advocate andpromote compliance culture construction and raise compliance awarenessamong all employees. The provisions require securities companies to setup a compliance director position. This person is in charge of the review, supervision, and inspection of the company and its employees in terms of operation management and professional practice compliance. Securities companies are also required to establish a compliance assessment mechanism and a breach reporting mechanism and submit an annual compliance report to the regulators. The provisions make it clear that the result of the compliance management effectiveness evaluation conducted by the CSRC shall serve asan important basis for the classifi cation of securities companies. A securities company that faces a breach of law or regulation should uncover the illegalor illegitimate act through effective compliance management, take positivecorrective measures, hold the perpetrators accountable, improve its internal control mechanism and business process, and report the issue to the localsecurities regulatory commission in a timely manner. That company will then be exempted from liabilities or given a lesser punishment pursuant to law.

Analysis of the Status Quo of Risk Management in Chinese Securities Companies

Risk‐Management Philosophy and Compliant Operation Awareness To date, domestic securities companies have signifi cantly improved their gov-ernance, established preliminary risk management control systems, and improved their risk management frameworks. However, the current compli-ance management systems of securities companies were formed passively in a rigorous external regulatory environment. Securities companies fall short in terms of identifying risks in their practice, voluntarily raising risk awareness,and establishing a risk‐monitoring philosophy. Most securities companies


still fail to improve their ability to innovate, while facing market risks in a proper way. Some compelling questions still remain: How do securities companies sense the necessity of a scientifi c corporate governance structurefor the long‐term stable development of the company? How do they fi nd the necessity of risk monitoring in the survival and development of the com-pany? How do they fi nd the motivation to constantly improve internal riskmonitoring?

Construction of Risk‐Management Organizational Systems Currently, risk‐management organizational systems of domestic securities companies are largely identical. They basically adopt a centralized, top‐down management model consisting of various levels of risk‐management units that are inde-pendent of the business system. These risk‐management units usually include the board of directors (risk‐management committee), board of supervisors, compliance director (risk‐management director), internal review divisions, compliance management divisions, and risk‐management divisions. Usually, the board of directors is ultimately responsible for risk management. Under the board of directors, a risk‐control committee may be set up to take charge of specifi c risk‐control issues in relation to the board of directors. An audit committee may be set up to take responsibility for the review and supervision of internal and external auditing. In practice, the control and prevention of various risks in operation are managed by the risk‐management committee in some companies, and by the operation staff in others. The board of trustees supervises the exercise of duty by the fi nancial division, directors of the company, managers, and other senior executives to ensure its legality and compliance with regulations. This safeguards the rights and interests of the company and its shareholders.

Since the adoption of the compliance management system, the CSRC requires each securities company to appoint a compliance director. The com-pliance director takes responsibility of compliance issues of the company.The director examines and monitors the legality and compliance of opera-tional and managerial behaviors in the company according to the Provi-sions for Trial Implementation of the Compliance Management of Securities Companies, and has the right to report directly to the regulators. In somesecurities companies, the compliance director is also the risk‐managementdirector. In other companies, the position of risk‐management director is taken by a separate person. An independent risk‐management director is more focused on the aspect of business risk control and usually reports directly to the general manager. The board of directors, the board of supervi-sors, the operational staff, the compliance director, and the risk‐management director together form the highest management tier of the risk‐management system of a securities company.


The internal audit division is the earliest supervisory division to be set up by securities companies as a division independent of the business system. The division is usually directly under the leadership of the audit committee of the board of directors. The internal audit division is independent of variousbusiness divisions and branches of the company. Independently, it performs its duties of auditing, inspection, assessment, report, and advising in relation to the implementation of internal control systems. The risk‐managementdivision is set up by securities companies for the independent client margin deposit period as required by the regulators. It is responsible for monitoringfi nancial indexes and the running of business through technical means and management systems.

Because the regulators have raised dynamic management system require-ments, the current risk‐management divisions of most securities companies mainly focus on the construction of dynamic risk‐management systems and the real‐time management of risk control indexes and warning systems. The compliance division helps the compliance director fulfi ll the duty of compliance management. Usually, it is responsible for establishing compli-ance systems and processes and also for conducting compliance reviews on systems, contracts, and new business, in addition to compliance supervi-sion and inspections. The divisions that actually fulfi ll the duty of risk man-agement are the internal audit division, the risk‐management division, andthe compliance‐management division. Together they form the intermediatemanagement tier of the risk‐management system of a securities company. Inorder to extend risk management to the foreground business end effectively,some securities companies have set up risk‐management positions within their business divisions. The heads of various business divisions and thedivisional risk‐management positions together form the front end of the risk‐management system of a securities company.

The current risk‐management architecture of securities companies is essentially complete in form; however, higher‐level managing units in particu-lar, such as the board of directors, the risk‐management committee, and the audit committee, usually fi nd it hard to play their roles. The reason has to do with the basic principle of the risk‐management system’s independence from the business system. From the perspective of institutional design, the opera-tional staff is not fi t to serve in the highest tier of the risk‐management system. However, due to governance defi ciency in securities companies, the opera-tional layer and the decision‐making layer are often controlled by the same person. Therefore, the risk‐management system is actually inseparable from the business system. Although the risk‐management divisions of most securi-ties companies are able to fulfi ll their duties properly, these divisions can only address some specifi c and trivial issues. They can do little to infl uence risk‐management strategies, principles, and other across‐the‐board deployments.


Whether a securities company is equipped with effective risk manage-ment is not determined by whether the organizational system is reasonable, oreven the construction of the divisions performing specifi c risk‐management duties. It is determined by whether the top‐level units that manage risk‐management policies, such as the risk‐management committee, are able to effectively fulfi ll their duties.

Risk‐Management System and Process Client Fund Safeguard Systems Have Been Established Currently, most client transaction settlement funds are transferred upward from the opera-tion outlet to the headquarters. Risk management through such means as stress tests and sensitivity tests can provide a preliminary protection for the safety of client funds. Through the realization of third‐party deposits, securities companies have completely blocked the channels for client fund appropriation, suffi ciently safeguarding client funds.

Relatively Standardized Brokerage Business and Operation Outlet Man-agement Securities companies now have multilayer control over their op-eration outlets. In terms of organizational systems, the headquarters of thecompany directly appoints and vertically instructs the manager, fi nancialdirector, and computer director. It establishes mechanisms for assessment, post shifting, furloughs, and resignation. The conduct of business refl ects the separation of foreground and background services, approval and execution,execution and supervision. A double‐responsible‐persons‐at‐the‐countermechanism is adopted for key business in which one person conducts the business while the other reviews the process. In terms of the system of ac-counts, a collective account management system is designed and the third‐party deposit mechanism is adopted for client funds. The account openingprocedure is relatively well‐established. Account standardization is essen-tially accomplished. A centralized transaction system is implemented, andmeasures for administration of transaction system authorization have been formulated. Through the centralized transaction system platform, central-ized management and hierarchical authorization are applied for transaction authority. A system review mechanism is applied to key operation, and cen-tralized storage and remote back up are implemented for transaction data.

Compliance Management System The compliance management system was preliminarily established in securities companies in late 2008. It mainlyincludes setting up the position of compliance director, setting up independentcompliance divisions, independent fulfi llment of compliance managementduties, establishing basis compliance management systems, compliance as-sessment systems, and breach reporting systems.


Risk‐Monitoring System In the aspect of risk monitoring, most securitiescompanies currently conduct basic work such as monitoring risk control index thresholds through a monitoring system based on the AdministrativeMeasures on Risk Control Indicators of Securities Companies. Domesticsecurities companies seldom engage in risky business and rarely use fi nancial leverage. They therefore usually have a high capital adequacy ratio. Few of them have established a risky budget restriction mechanism. However, withthe constant capacity expansion of the securities market and the gradual loosening up of qualifi cations for securities company business, the capital adequacy ratios of many securities companies will soon face challenges. Inaddition, the dramatic fl uctuation of the stock market has brought great risk exposures to proprietary business. Therefore, it will be a foresightedmeasure for securities companies to establish a risk‐restricting mechanismto control business scale. A lack of control over the total volume makes it impossible to get in‐depth analysis of business risks. Attaching risk moni-toring to the development of the company greatly undermines risk manage-ment in terms of the little importance attached to it.

Insuffi cient Coverage of Risk Management Complete risk monitoring re-quires coverage of all business, divisions, branches, and the entire staff. It should be able to reach every step of a process, from decision making, ex-ecution, and monitoring to feedback. The achievement of that task depends on the authority the operational layer grants to the risk‐monitoring division. Given that the role of internal risk monitoring is hardly recognized by the operation layer in a securities company, it is very diffi cult to change the real-ity that there are blind spots in risk monitoring.

Business Innovation Risk Management Innovation will be an impor-tant fi eld for Chinese securities companies in the future. In the process of exploring for fi nancial innovation, a lack of in‐depth research on innova-tive products or defi ciencies of the design of new products may lead to disputes with clients, bringing about economic loss, legal problems, or reputation risks to the company. Factors that may result in great losses of funds include incomprehensive understanding of the risks associated with innovative business, underestimation of risks, incomplete risk controlmechanisms, and insuffi cient innovative business risk control measures, as well as poor execution of risk‐control measures or innovative business. However, business qualifi cation constraints currently limit most securities companies from carrying out innovative business. Those with the willing-ness to engage in innovative business tend to focus on the market develop-ment of innovative business and fail to come up with strategic risk‐control planning and deployment.


Utilization of Risk‐Monitoring Techniques Market risk‐control techniques commonly used internationally fall into the following three categories:

1. Index control systems, including economic indexes and regulatory indexes, sensitivity analysis, and fl uctuation analysis

2. Risk measurement, including extreme value theory, value at risk (VaR), and stress test

3. Risk‐based performance evaluation, including economic value added (EVA) and risk‐adjusted return on capital (RAROC)

Securities companies currently use index control systems and risk‐measurement methods most frequently. Risk‐based performance evaluation is less used. This refl ects the fact that Chinese securities companies still have a long way to go before achieving delicate management. The most widely used risk‐control technique right now is the regulatory index method. This is the risk‐control index, such as net capital, required by the CSRC. Because of their compulsory nature, risk‐monitoring efforts of Chinese securities companies are almost exclusively focused on regulatory indexes. Such efforts include estab-lishing centralized monitoring systems and realizing dynamic monitoring. The system solutions currently provided by software companies for securities companies are also tailored, with few exceptions, for regulatory indexes. The monitoring systems of current securities companies are essentially able to meet regulatory requirements by collecting real and complete operational data in a timely manner. The sensitivity analysis and stress test was used in client fund safety monitoring in the independent deposit period. Its two types of techniques have been rarely used since the implementation of third‐party deposits. The Guideline for Risk Control Index Dynamic Monitoring System of Securities Companies (Trial) states that the risk‐monitoring division of a securities com-pany conduct sensitivity analyses and stress tests on net capital and risk control indexes. Companies should also carry out predicative analyses based on busi-ness plans and come up with business scale adjustment proposals.

Value at risk (VaR) has been the most popular worldwide risk‐measurement method over the past few decades. In practice, however, the Chinese securities market does not quite fi t the basic premise of VaR due to high regulatory intensity and low effi ciency. A lack of securities product varieties, however, makes for a very small number of securities products created based on modern asset portfolio theories. As a result, VaR and similar risk‐measurement techniques still do not have much of a role to play in China.

Risk‐based performance evaluation is the risk‐monitoring technique that securities companies urgently need to introduce. This technique can be a breakthrough point for risk monitoring to gain greater attention from


the operation layer of securities companies. The operation layer is oftenresistant to risk monitoring. This is because it often appears to hinder the business in day‐to‐day operation, and the benefi t from risk monitoring isdiffi cult to put in numerical terms. Through RAROC and similar risk‐based performance evaluation techniques, however, the risk/profi t ratios of differ-ent business lines can now be quantifi ed. This makes a clear and convincingargument for risk monitoring in front of the operation layer and the man-agement layer. However, due to the high technique requirements associated with risk‐based performance evaluation, there is still a gap in terms of the acquisition of empirical data and its specifi c application.

Risk Management in Securities CompaniesPost Financial Crisis

In August 2007, the outbreak of the subprime mortgage crisis in the United States dealt a severe blow to investor confi dence in the value of mortgage‐backed securities, which in turn triggered a liquidity crisis. The crisis then spread to the common credit market, which has little to do with the real estate industry, and directly affected large securities‐holding fi nancial institu-tions. Bear Stearns went bankrupt, Lehman Brothers shut down, and Morgan Stanley and Goldman Sachs were converted to bank holding companies.

Lehman Brothers was a 158‐year‐old Wall Street company. It was the fourth‐largest investment bank in the United States, a leader in the fi xed‐income product market, and the top‐ranking company in the mortgage‐backed securities business in the United States for 40 years in a row. OnSeptember 15, 2008, the world’s consummate player in the fi xed‐incomeproduct market applied for bankruptcy.

In contrast, with its acute foresight and resolute measures, Goldman Sachs dodged a severe blow from the subprime mortgage crisis, which testi-fi es to the effectiveness of its risk‐management system. Of the USD 1 trillion on Goldman Sachs’ balance sheet, only USD 28 billion was illiquid assets. Of this, only USD 1.7 billion was subprime mortgage‐related assets. Goldman Sachs was the fi rst fi nancial institution to foresee the subprime mortgage crisis and actively took preventive measures. It had a very advanced risk‐monitoring system in place that had been conducting risk tests based on 25,000 data entries each day collected from major transaction markets and business activities around the world. Goldman Sachs foresaw the high riskof subprime mortgage. The system had issued warnings before the risks of subprime mortgage loans were fully exposed. Goldman Sachs held a meet-ing to discuss the topic of mortgage risks, and decided to reduce its holdingsof mortgage‐backed securities. It instead purchased expensive insurance policies. While its rivals were busy expanding their mortgage bond business,


Goldman Sachs started short selling mortgage‐backed securities and going long on crude oil, in a bid to protect itself against possible losses.

Analysis of Problems in Risk Management of U.S. Investment Banks during theFinancial Crisis

Defi ciencies in Corporate Governance Mechanism A lack of effective restrictions on agents gave them too much power and led to a decision‐making crisis. The equities of American investment banks are usually very widely distributed. Their corporate governance is distinctively marked by man-agement control and market orientation. Shareholders cannot effectively exercise their decision‐making rights through the board of shareholders. They can buy or sell shares to affect the fl uctuation of share prices, which sends warning or admonition signals to the management. However, they can by no means affect any preemptive restrictions. Overly concentrated power improves management effi ciency, but it tends to lead to decision‐making risks.

A defi cient compensation system undermined risk‐management vigilance and triggered a moral hazard. In the compensation structures of U.S. invest-ment banks, equity incentives make up the better half of the total income, which causes people to pursue short‐term interest. The best way to get high incomes at the end of a year is to make the company’s share price soar. This became the goal shared across the board at Lehman Brothers. They would take high risks in order to rapidly expand their business, giving rise to a purely profi t‐oriented corporate value. Subprime mortgage securities enabled the staff in the housing loan division of Lehman Brothers to rake in bonuses of over four times their salaries. It also brought in a great amount of revenues for the company. However, when the real estate bubble burst, the subprime mortgage crisis became widespread and took its toll on Lehman Brothers.

Too Much Speculation and Leverage in Operation Led to an Explosion of Risks Investment banks generally have a capital adequacy ratio. Lured by high profi t and driven by fi erce competition, Lehman Brothers started investing in the subprime mortgage market and complex fi nancial products.This had the effect of turning investment banks into hedge funds, going after high risks. These investment banks, however, had borrowed a large amount of funds. The debt had been driving up the leverage ratio and constantly increasing the risks of the operation, without putting suffi cient risk control mechanisms into place. Due to the high leverage ratio, once something went wrong, the loss would far exceed the capital fund.

Overly Concentrated Asset Allocation Lehman Brothers’ assets were overly concentrated on bonds. They were holding a large amount of real


estate–related bonds and derivative instruments. As a result, their risks were overly concentrated. According to Lehman Brothers fi nancial statements, as of the second quarter of 2008, the total amount of the company’s bond holdings was USD 516.7 billion, accounting for 80.8 percent of its total assets. What used to be the major income source for Lehman Brothers fi nally brought the company down.

Inspirations Drawn from the Financial Crisis for the Risk Management ofSecurities Companies Corporate Governance Standardization Good corporate governance is keyto proper functioning of the risk‐management system. The excellent perfor-mance of Goldman Sachs during the crisis was closely related to its sound corporate governance. The management was willing to listen to lower rank-ing employees and discuss related issues in a timely manner. During the fi nancial crisis, two obscure traders of the Structured Product Transaction Team of the Housing Loan Division of Goldman Sachs realized in 2006 that the housing loan lending criteria in the United States was too low. Theydecided that the default rate of high‐risk housing loans would inevitably surge. They took their case against future risks to the management of the company and were supported by the fi nancial controller. After discussions,management recognized their views and came up with a series of protectivemeasures.

Current equity structures of domestic securities traders are relatively con-centrated and equities are relatively homogenous in nature. Most shareholders set somewhat low bars for securities companies in terms of risk identifi cation and risk control. Some shareholders use their share‐controlling status to hold sway in the board of directors and management, turning securities traders into a fi nancing and capital operation platform for large shareholders. In the future, the governance structure should be optimized through acquisition and restructuring. It should attract the participation of foreign fi nancial institu-tions with advantages in risk management and control, and actively promote the listing effort. In addition, the structure of the board of directors should also be optimized to give prominence to the role of independent directors.

Building up a Comprehensive Risk‐Management System Securities com-panies should fi rst study and formulate risk‐management strategies. Theyshould then establish and build up a comprehensive risk‐management sys-tem and, based on their respective business deployment, risk conditions, and control level, improve their development strategies, business deployment,corporate governance, and risk control systems. The institutional systemshould be continuously improved and implementation strengthened to con-trol the safety, stability, and reliability of the entire risk‐management system,


as well as the composite risk caused by combining it with operational risks. With the development and change of business, various risk‐control mecha-nisms should be correspondingly improved. Such mechanisms include the fi rewall, authorization management, risk report, risk disposition, and risk accountability.

The Establishment of One’s Own Internal Risk Measurement Model Based on Practice Advanced techniques are handy tools for risk management and control. Securities traders in developed countries are good at conducting, monitoring, and assessing with quantitative tools. However, risk manage-ment of domestic securities traders is still, to a large extent, dominated by the traditional qualitative analysis, suffering a shortage of scientifi c man-agement and control models, and advanced risk‐monitoring information systems. Investment banks in the United States have come up with an entire set of risk‐monitoring systems by combining quantitative techniques with advanced information systems. Such systems are mainly used to conduct real‐time monitoring over the compliance of the business, risk exposures, and major day‐to‐day business transaction data. With very powerful statistical analysis functions, they are able to effectively meet the needs of managers by processing multidimensional quantitative risk information based on various risk management needs. In comparison, Chinese securities companies cur-rently have only various fi nancial warning indexes, most of them manually operated. Information technology is underutilized. As a result, risk monitor-ing suffers from small coverage and low work effi ciency.

The fact that the risk models of some securities traders failed to work during the fi nancial crisis shows that although risk‐measurement modelsshould play an important role, they should not be relied on with blind faith.

A risk model that fi ts one’s specifi c conditions should fi rst be con-structed and continuously improved based on the changing situation. The model should go through the risk identifi cation and assessment processes, and be compatible to new business, including the design of units of mea-surement and risk‐measurement models for various types of risks. Then, thelegitimacy and accuracy of the parameters, data sources, and quantitativeanalysis procedures should be confi rmed through tests and other methods. As the environment and regulatory requirements change, relevant param-eters should be adjusted and improved. Improvements should be based on a comparison between the result of the quantitative analysis and the actual result. For risk indexes that cannot be quantifi ed, such as operation risks and policy risks, risk control can be conducted through standardized busi-ness process and internal control mechanisms.

The risk‐control system must then be built up, and risk models must be given full play. The occurrence of the subprime mortgage crisis caused major


investment banks to call into question the risk models they had used as a trump card. The VaR model had been most frequently used to predict the maximum loss of a transaction, but it failed to predict the USD 130 billion loss brought on by the subprime mortgage crisis. The success of GoldmanSachs lies in its huge internal control division and internal control mecha-nism, which gave actual full play to the risk model. Its internal control staff, 1,100 strong, gathers 25,000 data items from major transaction markets and business activities across the globe through the company’s risk‐monitoring system on a daily basis. It monitors, assesses, and controls various risks fac-ing the company. It identifi es problems and addresses them in a timely man-ner. If a disagreement arises between the internal control division and the transaction divisions, the view of the internal control usually prevails. Theinternal division has great authority and is directly affi liated with the board of directors. It has formed a core risk team, the approval of which must be acquired for any high‐risk project to be implemented.

Further Improvement of the Net Asset Regulatory System As a fi nancial institution operating and managing risks, a securities company can effec-tively reduce the occurrence of risks. It lowers risk‐associated losses throughsuch measures as constructing rigorous internal control mechanisms, standardizing business operation procedures, adopting distributed opera-tion, and hedging against risks. However, risk events cannot be completely avoided. Therefore, there must be suffi cient capital commensurate with the risk level to absorb potential losses that might be brought about by risk events. This prevents the stability and continuity of operations from being affected. A net capital regulatory system has been established for Chinese securities companies. And, based on net capital deduction ratios and calcu-lated risk capital requirement ratios, a series of regulatory indexes such as“net capital/the sum of all risk capital requirements” has been established.It is required that “net capital/the sum of all risk capital requirements” shall not be lower than 100 percent.

The current net capital supervision system has yet to be improved. The quality of regulatory capital is still low. For example, the tangible common equity ratio in the regulatory capital is too low, the risk capital is under-rated, regulations on the capital adequacy ratio are too rigid, and the inter-nal risk‐control indexes of securities companies are not binding enough. Thenet capital regulatory system needs further improvement in the future.

Risk Management Should Manage the Accumulated Amount of All the Individual Risks During the fi nancial crisis in the United States, securities traders did pretty well in terms of preventing individual risks, but somedetailed isolation and labor division measures lacked effi ciency. Reports and


feedbacks thus failed to reach the senior management in a systematic way. The management may have known about individual risks, but a description of the accumulative effect of all these individual risks was missing. There-fore, risk management should not only quantify individual risks, but also manage the sum of these risks.

Attach Importance to Coordination in Risk Management Risk manage-ment is a complex and onerous system project. There is a practical need for coordinated management of risks. In order to effectively prevent andsolve risks, securities companies must coordinate their management of risks, including different typs of risks, and profi ts. Doing so enables managementin different dimensions, such as the internal control mechanisms, auditing,and inspecting, to function in a synergic fashion.

Strategic Risks and Risk-Management Strategies of Securities Companies

Strategic risk management refers to the effective management of the risks facing a securities company in a comprehensive and systematic way. It involves risk control in work plans and work measures, as well as effectivemanagement of risks at a strategic level. Not only localized risks, but alsorisks with systematic implications should be managed effectively. Not only should risks be identifi ed and controlled, but the balance between risks and profi ts should also be analyzed. A securities company’s ability to withstand various risks is analyzed to ensure comprehensive and effi cient developmentin an environment in which risks are controllable.

The Meaning of Strategic Risk Management Management of Risks in Strategic Planning The survival and developmentof a securities company is affected by multiple internal and external factors, which fall into the following three categories:

1. The ch aracteristics of the securities company itself 2. The characteristics of the securities industry 3. The overall external environment

Strategic risk management systematically identifi es potential risks resid-ing in the external environment, internal resources, strategic goals, devel-opment planning, and implementation plans for a certain period in the future. It avoids or reduces risks associated with strategic decisions through scientifi c decision making and risk‐management measures. Risk‐oriented


strategic planning and implementation plans are the most effective strategicrisk‐management methods.

Strategic Planning for Risk Management Risk management and system construction should be properly planned from a long‐term and strategic per-spective. Economic capital allocation should be utilized to enhance competi-tive advantages, thus ensuring the fulfi llment of the strategic planning goals.The risk‐management strategy of securities companies is now to implementcomprehensive risk management over the next three years.

Strategic Risk-Management Tactics Risk‐management tactics are the specifi c ways to implement the risk‐management strategy. They should have well‐defi ned risk appetite and risk tolerance; they should determine risk costs, such as economic capital costs; and they should establish basic principles and methods for the identifi cation, appraisal, and quantifi cation of various risks. They should also specify the methods and application principles for economic capital allocation.

An important part of risk-management tactics is economic capital alloca-tion and assessment. This is an important method of strategic risk manage-ment for capital, a major resource of the company. In order to allocate capital reasonably, growth opportunities facing each business line, as well as risks associated with such opportunities, must be analyzed. Potential losses that could be brought about by these risks should be analyzed next. Then, the bal-ance between the growth opportunity and the cost of risk should be analyzed.Finally, reasonable allocation is made among various lines of business, in view of the risk cost, opportunity cost, and operational cost. A certain busi-ness line may undergo rapid growth in a short period. However, the growth opportunity might be largely limited in a long‐term perspective. Therefore, the idea of reasonable capital allocation must be represented in the guideline for strategic planning so that it can be implemented in specifi c work plans.

Economic capital is the capital prepared to make up for unexpected losses that are possible at a certain confi dence level. Its quantity should equal the value at risk in a securities company’s overall loss distribution ata given level of confi dence. The allocation of economic capital should be adjusted and assessed according to risk‐adjusted return on capital (RAROC). RAROC refers to the ratio of the expected return from certain investment to the amount of economic capital it takes. The basis of the RAROC criteria isthe return on investment the shareholder asks for in order to take the risk. When it comes to economic capital allocation, the maximum profi t can-not be generated by allocating all the capital to the asset with the highest RAROC. Requirements related to extreme risks, systematic risk prevention, and risk distribution dictate that changes in marginal profi ts and marginal


risks should also be considered, in addition to the value of RAROC, whileassessing the effect of economic capital allocation. The capital allocation with the smallest risk is identifi ed for a fi xed expected rate of return, whilethe capital allocation with the highest expected rate of return is identifi ed for a fi xed risk tolerance.

Assessing the various business divisions based on RAROC tends to make the business divisions unwilling to develop business or products with great strategic importance in favor of a relatively low return in the shortterm. Therefore, a revision is needed, with the main basis being the cost of the economic capital taken up by each individual business line.

MANAGEMENT OF RISKS ASSOCIATED WITH TRADITIONAL BUSINESS OF CHINESE SECURITIES COMPANIES

The risks of securities companies are mostly concentrated in business opera-tion. The risks are generated as securities companies engage in each of the main business lines. The various business centers are not only the manage-ment and profi t centers for securities companies, but also the cradle of risks. Therefore, securities companies should conduct risk management around their various main business lines.

Securities Proprietary Business Risk Management

Securities proprietary business refers to the operational practice by securi-ties companies of trading securities for profi t in the securities market using capital or securities that are in their exclusive control.

Major Sources Risks in Securities Proprietary Business Risks associated with theproprietary business of securities companies are mainly market risks, oper-ational risks, and compliance risks. The proprietary business of securitiescompanies takes up a large amount of funds, and thus leads to risks for securities companies in the event of market price fl uctuation. Regulatory agencies have therefore been paying great attention to the proprietary business. The following risks are associated with the proprietary business of securities companies:

■ Mistakes in choosing securities types and target companies ■ Misjudgment of the general trend or of price fl uctuation ■ Risks caused by poor timing of transaction or operational mistakes ■ Borrowing funds or buying securities in breach of quotas, plans, and proportion limits


■ Proprietary business operators manipulating market prices and transac-tion scales in violation of rules and regulations

■ Operation in violation of regulation or unauthorized acts while execut-ing directions as committed by investment decision makers or operators of securities companies

■ Conduct of proprietary business in another person’s name or with another person’s account

■ The amount or proportion of individual stock holdings exceeding the limits set by law

■ Mixed operation of proprietary business and brokerage business and other behaviors in breach of regulations

■ Large fl uctuation of Shanghai (SSE) or Shenzhen (SZSE) stock exchange indexes or individual stock prices

■ Inaccurate forecast of policy trends and policy fl uctuations

Management of Risks Associated with Proprietary Business of Securities Companies Construction of Risk‐Management Systems for Proprietary Business of Securities Companies The unique characteristics of proprietary business, as compared to other types of securities company business, require a risk‐management system that fi ts the business. Proprietary securities holdings,profi t and loss, risks, and transactions are effectively monitored mainly through dynamic tracking of business operation information and data. Focus is on the prevention of such risks as unchecked expansion of propri-etary business, decision‐making mistakes, unauthorized operation, disguisedproprietary operation, and insider trade.

An independent risk‐management division or team may be set up for securities proprietary business. With the support of IT staff, a risk‐control system can be developed. The planning and fi nance division is responsible for the management of equity‐type proprietary funds, trading seats, and accounts, as well as routine capital clearing and accounting. The risk‐management divi-sion or team helps calculate the maximum risk amount that the proprietary business can sustain, the formulation risk warning indexes, and the moni-toring of risks associated with proprietary business. The monitoring results and a risk‐assessment report are presented to the risk‐management division of the company on a daily basis. After categorizing and analyzing the infor-mation, the risk‐management division assesses the overall risk of the propri-etary business of the company and comes up with suggestions or comments before sending the assessment results to each member of the risk‐management committee. The risk‐management committee evaluates the risk‐management policies for securities proprietary business on a regular basis, and provides the board chairman and general manager with strategic advice.


The proprietary business unit should compile a securities proprietary report, which includes the following contents:

■ Information about the accounts and trading seats of proprietary business ■ Major decisions on the sale of proprietary business, risk limits, asset allocation, business authorization, and so forth

■ Proprietary business risk monitoring report ■ Other issues that should be reported

The responsible division, responsible persons, and process of propri-etary business reporting should be specifi ed clearly.

Risk‐Control System for Proprietary Business of Securities Companies The success of risk control for the proprietary business of securities companieshinges on establishing a series of proprietary business systems. The behavior of decision makers and operators of securities proprietary business is shaped and governed through these systems. In designing risk control sys-tems for proprietary business, the authorization system is the prerequisite and foundation. The investment decision‐making process for proprietary business is improved based on clear authorization rules. The incentive andconstraint systems are important means for ensuring the effective implemen-tation of risk management for proprietary business. And the communication system is the key factor for the dynamic circulation of proprietary business risk control.

Risk‐Management System for Proprietary Business Sound Internal Control Management System and Effective Risk Over-sight Internal control systems include proprietary trading management rules, proprietary investment decision making and risk control measures, operator management measures, proprietary account use managementrules, and proprietary fund allocation mechanisms. These should be formu-lated and earnestly implemented to prevent and solve irrational actions and improper operation caused by human mistakes, as well as to increase return from proprietary business and lower trading risks.

Once internal systems are implemented, strictly abiding by laws and regulations is imperative. Risks that might be caused by holding too muchof the same type of securities in the event of price fl uctuation should be prevented. An even greater effort should be made to avoid various law‐ or regulation‐breaching behaviors such as market manipulation.

Following this, in cooperation with other business divisions such as the investment bank division, the proprietary business division, and thebrokerage business division, the trade division should stick to a rigorous


internal insulation wall mechanism. This will maintain the separation of staff, fi nance, business management, and information. It effectively prevents connected transactions and insider trading from happening. Based on thecharacteristics of securities trading, the proprietary business may adopt an operation model with cascaded decision making, cascaded management, and cascaded control. An internal control process should be established forthe proprietary business of securities companies.

Construction of Risk Warning and Real‐Time Monitoring System Risk warning and monitoring is a fundamental and critical part of risk man-agement for the proprietary business of securities companies. Risks can be controlled and protected against only if they can be identifi ed. Riskwarning and monitoring is a comprehensive and complex system. Securi-ties companies need to accumulate empirical data and then construct and build up a risk warning and real‐time monitoring system based on their own risk‐control frameworks and systems. The following fi ve steps should be followed:

1. Select warning indexes in a scientifi c and sensible way: A comprehensive analysis of securities proprietary should be conducted to provide a basison which to forecast risks facing the business. The indices selected must be able to sensitively refl ect the change of risks in securities proprietary business. The criteria should include the ability to categorize risks bytheir importance and nature and to characterize the risks.

2. Gather and process risk signals: Signals gathered as warning signals should be those of signifi cance to the decision making in securities pro-prietary business. Interference from other factors should be avoided to prevent skewed or incomplete information gathering.

3. Identify and measure risks: Make judgments about risks in securities proprietary business based on existing knowledge and experience. Iden-tify risks through effective risk‐identifi cation methods, such as the sys-tem decomposition method and the scenario analysis method. Based on risk identifi cation, determine the weight and threshold value of each risk index and verify these in practice.

4. Assess and deal with risks: In the overall risk judgment and decision‐making process, the risk is rated using the identifi cation methods notedabove. If the risk is rated at or above the warning level, the risk warning division must immediately issue risk warning signals, so that the risk‐addressing division can enact remedies in a timely manner. Based on therisk warning signal level, the risk‐control division identifi es major riskfactors, comes up with timely solutions, and implements them to bringthe risks under control.


5. Receive risk control feedback: The securities propriety business riskcontrol division feeds the status of risk control back to the risk warn-ing, forecast, information gathering, and processing divisions. Risk‐management organizations for the proprietary business of securitiescompanies should also be notifi ed.

Real‐Time Monitoring System for Risks Associated with Securities Pro-prietary Business Risk management usually needs a series of quantitative techniques. The use of risk‐management techniques should follow the prin-ciples of easy operation, fl exibility, and convenience.

A risk‐management information database should fi rst be constructed. It should contain the amount of information needed to support the risk‐control process for securities proprietary business. The database shouldinclude various types of dynamic data such as transaction volume, current market prices, model‐supporting data, and major measurement results,such as risk exposure level and VaR. The database should also includevarious types of static information. Such information includes the scale of the proprietary business, the make‐up of the portfolio, restrictive rules onthe operation of proprietary business set by the securities company, and thesystem risk of the securities market. It also includes pre‐stored informationsuch as raw data, risk measurement standards, risk measurement model, and relevant parameters.

The next step is fast, reliable, and error‐free processing of information. This is a core link for realizing real‐time monitoring in securities proprietary business risk control.

At the core of risk information processing is a risk information inte-gration program. The integration program provides standard interfaces,intersystem communication, and transmits the source data to the databasesystem in a complete and safe manner.

Proprietary Business Risk‐Monitoring Report After calculating, analyz-ing, and summarizing risk information, the proprietary business risk con-trol staff proceeds to provide the latest risk‐control advice in the form of a risk‐monitoring information report for various tiers and levels. Risk reports for higher levels are sent to higher senior management of the securities com-panies through certain channels to serve as a basis for decision making.Risk‐monitoring reports for other levels can be accessed by other employeesthrough their respective user interface with a password, and serve as impor-tant guidance for proprietary business transactions or operation monitoring.

Implementation of Risk Transfer and Risk Disposition There are someeffective means for securities companies to transfer the risks of securities


proprietary business; for example, entrust specialized institutions with secu-rities investment with higher risks, transfer the risks to others through cov-enants, or laterally transfer the risks through various forms of economic cooperation.

Two securities proprietary business risk disposition methods are correc-tive risk disposition and emergency risk disposition. When there is regulation‐breaching operation or potential risks in the proprietary business of a securities company, the decision makers of the business use the corrective risk disposition method to correct their own behavior and prevent the risks from deteriorating. Emergency risk disposition measures are used in the caseof a sudden deterioration of or a temporary payment risk in the propri-etary business of a securities company. Remedial measures should be taken promptly to prevent the risks from further spreading.

Management of Risks Associated with the Brokerage Business of Securities Companies

Major Sources of Risks in the Brokerage Business Based on their sources, opera-tion risks in the securities brokerage business can be divided into the follow-ing three types:

1. From inside the securities company (failing to gain an expected market share or profi t due to the company’s misjudgment of the environment or low effi ciency in management)

2. From outside the securities company (as the result of intensifi ed compe-tition within the securities industry or mixed fi nancial operation)

3. Loss of a favorable living environment for the brokerage business (due to macroeconomic changes)

Competition Risks Outside the Industry Competition risks outside theindustry mainly come from other fi nancial institutions represented by banksand insurance companies. From a short‐term perspective, the expansion of the securities brokerage business has intensifi ed the competition for clients between securities companies and other fi nancial institutions. From a long‐term perspective, the fi nancial industry has shown a trend toward mixed operation, which is accentuated by the fi erce competition from the banking industry. The current business layout and competition pattern of China’s securities industry will change.

Innovation in securities brokerage business has, to some extent, sped up the trend of mixed operation. Current securities companies are far behind banks and insurance companies in terms of management level and scale. As a result, they are in a disadvantaged position in mixed operation.


For example, in the channel service fi eld and fi nancial product sale fi eld of product innovation, channel innovation will accelerate the pace at which other fi nancial institutions enter into the securities industry. When it comes to product innovation, banks enjoy the advantages of better access to mar-kets, foreign currencies, and other product fi elds. Therefore, compared to securities companies, they are able to provide brokerage products with a more competitive edge. Banks also have outlet and client resource advan-tages. In the consigned fund market, the share of banks is far greater than that of securities companies. In channel innovation, with the spread of cooperation products and the expansion of cooperation scope, higher lev-els of cooperation are, in turn, accelerating the formation of such outside competition.

Horizontal Competition Risks Securities companies were used to stableincome and low risks. However, faced with fi erce market competition,securities companies have seen the percentage of their traditional business decrease year by year, thus constantly raising risks to securities companies.In the fi rst half of 2011, for example, the decline of brokerage business and the increase of fees and taxes in the securities industry had a 15.1 percentand 13.8 percent negative effect on net profi t, respectively. The commis-sion rate of the brokerage business of securities traders dropped as much as 22 percent from 0.1054 percent in mid‐2010 to 0.0826 percent in mid‐2011. Homogenous competition in the securities industry has not fundamentally improved. Therefore, in order to maintain market share and commission rate for a period in the future, the decline of brokerage business’s percentage in the total revenue will become an irreversible trend.

The room for further commission rate reduction is limited. Some securi-ties traders have started trying to get off the hook of the vicious price war by means of diversifi ed competition. Brokerage business is shifting from being channel dominated to being added value services dominated. The increase of costs that comes along with added value services is also forcing securi-ties traders to proactively search for a competition model designed for thegrowth of profi t. However, innovation in the brokerage business is easily replicated, which undermines or even erases the value of innovation. The current protection of fi nancial, product‐related patents has not been recog-nized by all the parties concerned, and the awareness of patent protection has yet to be raised in China. Once a fi nancial product or innovative item of other types is introduced, it tends to be conveniently copied by other securi-ties companies, leading to a rapid decrease of the value of brokerage innova-tion. On the other hand, the brokerage business of securities companies is subject to many constraints, so the room for innovation is small. As a result, innovative products of securities companies are likely to be very similar to


one another. Therefore, securities companies should have a clear position-ing in innovation. Those positioning themselves as innovation leaders willbear a high cost and the possibility of being copied by other companies, but they will have certain advantages in terms of brand recognition and market share. Those positioning themselves as close followers pay a lower cost, but will face fi ercer competition.

Internal Management Risks Internal management risk in the brokerage business of securities companies refers to the possibility of the brokerage business suffering losses due to mistakes in management and operation pro-cesses caused by the uncertainty of some fi nancial factors. They are essen-tially risks caused by out of control operation and management, and aretherefore controllable. The operation division is the brokerage risk concen-trated spot. It is a weak link in risk control. The following actions by the operation division can all lead to potential risks:

■ Engagement in proprietary business in breach of regulations ■ Industrial investment without permission or provision of guarantee for others in their economic activities

■ Engagement in foreign exchange or overseas business in breach of for-eign exchange administration regulations of the country

■ Setting up “little coffers” or appropriating and dividing funds without permission

■ Fund merger or split ■ Setting up transaction rooms without permission

Internal management risk in the brokerage business of securities compa-nies falls under three main categories: (1) compliance risks, (2) credit risks,and (3) legal and policy risks associated with business expansion. These aredetailed next.

Compliance Risks Compliance risks refer to the possibility that incom-pliance with policies and procedures of an organization or with laws and regulations may lead to low effi ciency of work, high operation costs, loss inoperation revenues, unnecessary delay, punishment, or fi nes. This includes the following types of risks:

1. Market developing material breaches 2. Risks in securities margin trading for clients 3. Appropriating clients’ security deposits 4. Not using uniform account opening protocol of the company or the

protocol being in breach of laws or regulations 5. Incomplete or false account opening or closing information


6. Clients failing to go through the confi rmation process on time after commissioning through telephone

7. Failing to get the signature of a person receiving a payment 8. Skipping the authorization procedures or incomplete authorization pro-

cedures when a client appoints an agent

Credit Risks Credit risks of the brokerage business of securities compa-nies mainly include the risk of losses from overdraft by clients and the risk of losses from the absence of client confi rmation in an agency transaction. With the introduction of the securities margin trading business, credit risks will gradually increase.

Legal and Policy Risks Associated with Business Expansion Legal and policy risks have always been among the major risks facing the operation of Chinese securities companies. Innovation in brokerage business is somewhat constrained in terms of products, pricing, means of business expansion, andchannels. Business innovation is, to a great extent, made to circumvent con-straints of current laws, regulations, and policies.

Management of Risks Associated with Brokerage Business The Establishment of Three Lines of Defense for Risk Control The fi rst line of defense is made up of brokerage business headquarters and securi-ties operation outlets. The second line of defense is made up of the risk‐management division and the legal compliance division. The third line of defense is made up of the audit and supervision division.

The fi rst line of defense is responsible for setting up an independent electronic monitoring system to watch out for abnormal transactions of tar-get clients and organizing continuous risk screening and inspection efforts. On the second line of defense, the risk‐control division is responsible for assisting the operation management division in building and improving the target client abnormal transaction monitoring system and conduct-ing further analyses and assessments based on the results of risk screening and inspections. The legal compliance division is responsible for provid-ing compliance training and supervision and conducting investigations into incompliance events. The third line of defense, the audit and supervision division, organizes joint inspections by incorporating compliance contents into audit inspections.

Establishment of Examination Indexes During the process of risk man-agement, examination indexes should be established and constantly adjusted and improved. For example, compliance management indexes


for marking service staff can have the following parameters set up for monitoring:

■ Marketing service staff buying stocks in their own name ■ Marketing service staff working as agents of their clients ■ Logging on to the transaction system from a computer using the name of a marketing service staff

■ Phone number of the client being the same as the number of marketing service staff

■ Different clients under the name of a marking service staff member hav-ing the same telephone number

Monitoring Data‐Screening Procedures After analysis, data generated by themonitoring system enters into the screening procedure. A risk‐control team is set up under the brokerage business headquarters to take charge of fi nalizing a screening plan, analyzing data of suspected risks, supervising the screening process, and verifying screening results. The head of each operation outlet is the fi rst responsible person for the screening work. Chief operating offi -cers are specifi cally responsible for organizing their division to carry out the screening work and submit the screening report in a timely manner.

Reforming the Assessment System for Operation Outlets, Setting up Risk‐Control Management KPI Risk‐control management key performance indica-tors (KPI) are set up in addition to the general business KPI assessment system. The fi nal score is the product of the business KPI score and the risk control KPI score. Forefront operating units are therefore urged to make a continuous effort to prevent compliance risks associated with marketing services.

Punishment for compliance risks associated with marketing services of various operation businesses has been greatly strengthened. The strengthening was in response to such events as the company being subjected to regulatory measures by the regulators, the stock exchange, associations, or other authori-ties due to breaches of regulations in operation or due to human error. Other events included substandard accounts being created in violation of standard account management regulations. Severe punishment was dealt out for large and small risk events with bearing on compliant operation of the company.

Management of Risks Associated with Investment BankingBusiness of Securities Companies

The investment banking business mainly involves prelisting tutoring, sponsor-ship, and underwriting. It can also include consultancy for merger, acquisition, and investment. Policy risks can arise from changes in macropolicies, laws,


regulations, competition risks from Chinese and overseas investment banks, market risks due to market fl uctuations, and issuance risks under the approval system. In order to improve their overall competitive strength in the face of increasingly fi erce competition, securities companies must build up their risk management for the investment banking business.

Major Sources of Risks in Investment Banking Business Project Risks In order to issue securities, a company must go through sub-stantive examinations. If a restructuring enterprise tutored by a securitiescompany fails to successfully issue its securities, the securities company willsuffer losses in human and fi nancial resources. On the other hand, securi-ties companies have driven up project costs while fi ghting with each other for projects. Some even offer bridge loans or loan guarantees for compa-nies planning to issue securities. Once the project fails to gain approval for issuance, the securities company will face losses from bad debt or have to advance the fund needed to pay bank loans.

Compliance Risks In the stock underwriting business specifi cally, breachesof regulations occur if the securities company is involved in the following situations:

■ Continues to underwrite the stocks of the issuing company despite knowing that there are illegal practices, such as excessive packaging, oreven participates in the malpractice

■ Attracts underwriting business opportunities with illegitimate means ■ Fails to follow due procedures, perform due diligence during the issuing process, or provide suffi cient information in the public solicitation letter

■ Fails to perform due investigation when the issuing company attempts to get listed through fraudulent means and false information

Once any of the above events takes place, the securities companies will have to bear consequences. These may include equal or joint liabilities,punishment by the securities regulatory commission, and economic lossesand damage of reputation, which further poses potential risks for the stockunderwriting business.

Issuance Underwriting Risks Issuance risks of securities underwritinginclude the following three items:

1. Risks associated with means of issuance: Securities underwriting issu-ance risks refers to the risks of failing to issue shares or bonds at the


predetermined prices, or the issuer failing to raise the amount of fundsneeded from the market due to unexpected changes in the market. The three means of issuing securities underwriting are: sales by proxy,standby commitment, and standby underwriting. In their capacity asunderwriter, securities companies usually adopt the standby commit-ment approach. In the event of a misjudgment of the trend of the sec-ondary market, the standby commitment may become a heavy burden of risk for the securities company.

2. Issuing body risks: This refers to the possibility of losses or profi ts of the issuing body being directly impacted by relevant parties in the market. They include the issuing body’s operational risks, fi nancial risks, marketexit risks, legal risks, and agency risks.

3. Issuance project fi nancial risks: A delay of the share issuance project can be due to market or policy changes or other reasons. The issuer may not be able to raise the expected amount of funds, or the share issuance plancan be vetoed. These actions can all undermine the issuer’s ability to payback on time the bridge loan provided by the securities trader in order to land the project. They can even leave the issuer unable to pay the loan altogether, leading to the risk of bad debts.

Management of Risks Associated with Investment Banking Business of Securities Companies Establish Sound Internal Control Architecture, Mechanisms, and Procedures Improving Internal Architecture of Investment Banking Business Sound internal structures and internal control mechanisms must be established in order to shift the core competitive strength of investment banking business from the ability to communicate with the regulators to the ability to provide high quality execution in the early stage of the project and high quality is-suance and pricing in the late stage. Stock underwriting business involves not only the investment banking division and the capital market division, but also relevant divisions responsible for research, sales, risk control, and compliance. Labor division, coordination, and checks and balances betweenvarious divisions should be emphasized throughout project implementation. In order to maximize interdivision synergic effects, there must be a capital market division, research division, sales division, and trade division that cancooperate seamlessly with the investment banking division. In terms of en-hancing the internal control mechanisms and risk‐management constructionof the lead underwriter and intermediaries, the market mechanism shouldbe allowed to play its role. Internal control measures such as foreground/background separation and fi rewalls must be brought into full play.


The focus of division construction and HR resources allocation should be shifted from forefront divisions to middle and background divisions. These divisions mainly include the capital market division, the research divi-sion, the sales division, and the trade division. The capital market division is a very important forefront business division. It straddles the Chinese wall and is located between the investment banking project team at the front end and the sales, trade, and research divisions at the rear end. It plays a lead-ing and driving role in the project issuance phase. In the issuance pricingprocess, it controls corporate underwriting risks and effectively balances the interests of the issuer and the investors.

Investment Banking Business Internal Control Design Step OptimizationThe following are the major steps for internal control design:

■ Determine control targets ■ Integrate control processes ■ Identify control links ■ Determine control measures ■ Represent design result through process diagrams, survey forms, and internal control mechanisms

■ Finalize the internal control cycle

Construction of Full‐Coverage Risk Control Models Improving Early‐Stage Project Implementation Capability The executionability in the early phase of the project will become part of the core competi-tive strength in investment banking business. In addition to issues repeatedly emphasized by the regulators, such as due diligence and information disclo-sure in the prospectus, the investment bank also needs to dedicate more ener-gy into the preparation phase before the launch of the project. Before formally taking on the project, the investment bank should assess its own capability, making sure it has suffi cient human resources and experience in terms of early stage execution, research coverage, market promotion, sales, and post‐listing maintenance to ensure successful issuance. Improvement should be made as soon as possible when a weak spot has been found. A preliminary evaluation should also be made on the conditions of the company and the industry to determine whether the issuer meets the criteria for public listing, and whether its developmental stage is ready to enter into the capital market. The invest-ment bank should decide whether to formally launch the project based on considerations of the company’s positioning and its own strength, and pro-vide services that are designed specifi cally for the issuer.

Flexible Pricing and Selling Methods Helping the issuer come up with reasonable price expectations is step one. Suffi cient preparation is needed


before issuance, including materials such as PowerPoint slides for a seriesof investor presentations, often called the road show, to fully exploit the company’s bright spots and investment value. Before the road show, train-ing should be arranged for the management. Using road show rehearsals,management members learn how to conduct themselves with decorum and communicate with institutional investors in capital market language. Dur-ing the issuance stage, the communication strategies should be regularlyadjusted according to feedback from investors.

In order to avoid major disagreements, issuer expectation management should be strengthened ahead of time. It should be made clear to the issuer that the pricing of new shares must leave some room for second‐tier market trade prices. Financing effi ciency and post‐listing performance should beconsidered, so that there is room for growth after listing. Through evalu-ation models, peer comparisons, and similar methods, the issuer may havea more thorough and realistic understanding of its own value. The value of the issuer should be fully elaborated on in the prospectus and in other materials. Research reports from analysts and their views on comparable companies should be provided to help the issuer realize its own invest-ment value. The investment bank should convey investor’s feedback on theissuer’s investment value to the issuer in a timely fashion to enhance the issuer’s understanding of its own value, and to satisfy the need for reason-able self‐positioning. The investment bank should guide the issuer to look at new share pricing from a strategic perspective. It should also help the issuer maximize profi ts while respecting investor demand for reasonable returns and giving consideration to the company’s fi nancing needs.

Strengthening communication between the sponsor and inquiry recipi-ents and value guidance for the latter is critical. Great effort should be madeto build up the research team. The value exploration role of the investment value report should be accentuated in the issuance of new shares in the future. A high‐quality investment value report should be compiled to give a thorough description of the issuing company’s strategic positioning, profi t-ability, competitive advantages, and challenges to provide a basis for the inquiry recipient to give their quotations.

It is also very important to build up the sales team. Under the new share issuance system, there should be logical consistence between the inquiry quotation and the subscription quotation. To ensure successful subscription, institutional investors will communicate with the sponsor more actively. The sales team of the sponsor may help fi nd the point of market balance by communicating with institutional investors and providing reasonable price guidance.

Distributors should be rigorously vetted and controlled. Generally speak-ing, at the beginning of subscription, the lead underwriter signs a lock‐up


agreement with distributors and strategic investors with an allotment option. Selling securities within the lock‐up period (usually a half year) is prohibited. In order to prevent the opening of the fl oodgate, the underwriter may imple-ment “privilege abolishing” measures. This means that if an investor sells off its shares right after the issuance, its allotment option for future shares will be abolished. If a distributor engages in similar sell‐offs, the lead underwriter will apply “buy back punishment,” by reducing the distributor’s commission income based on the extent of the sell‐off.

The right selling points should be chosen to pique investors’ interest. In the U.S. and E.U. markets, investors are most interested in the market advantages and core technologies of the issuer. That was epitomized byChina National Offshore Oil Corporation’s (CNOOC) two attempts to get publicly listed overseas. The fi rst time, CNOOC’s selling point was its off-shore petroleum franchise, which in the eyes of overseas investors is the biggest risk; its monopolistic advantages will no longer exist in the event that the franchise is abolished. Therefore, in its second road show, CNOOC shifted the focus to the company’s core technologies in offshore exploration and production. Investors’ expectations for the company changed, and the shares were successfully issued.

Hedging with Derivative Instruments In overseas markets, people pay great attention to the use of corresponding methods to hedge risks in case the underwritten securities are not sold out. In particular, the use of deriva-tive instruments is extremely important to investment banking risk control. For example, the use of fi nancial futures and options may avoid potential price losses. In terms of allotment, when large cap stocks are expected to trend upward, underwriting risks are relatively low. When large cap stocks slump during the process of allotment implementation, underwriting risksare rapidly magnifi ed. As a high risk business, allotment deserves extra caution. In terms of allotment timing, the trend of large cap stocks should be carefully studied to implement share allotment while the large cap is on the rise, thus reducing issuance risks.

Management of Risks Associated with Asset ManagementBusiness of Securities Companies

Sources of Risks in Asset Management Business Legal and Compliance Risks Risks Associated with Guaranteed Return Because of inadequate inter-nal control systems, guaranteed return in entrusted wealth management has turned fi duciary wealth management into a high‐risk type of business. Al-though guaranteed return is explicitly prohibited in order to attract more


investors, wealth management products nevertheless frequently come with a promised return, as well as hidden “principal protecting” provisions to ensure so‐called low risk and high return.

Risks Associated with Malpractice in Investment Operation Chinese man-agers of entrusted assets fall behind professionals in overseas investmentbanks in terms of investment techniques, risk control capability, investment analysis, and judgment. Some of them are not conscientious enough in safe-guarding clients’ interests. This tends to lead to moral hazards in the asset management business of securities traders. It also leads to investment op-eration in breach of laws, regulations, or contracts, as well as engagement in high‐risk business with entrusted assets, concentrated share holdings, ormarket manipulation through illicit transactions.

Risks Associated with Connected Transactions and Interest Transmis-sion Due to loopholes in laws, asset owners are lacking in risk protection awareness. As long as they can get a certain amount of returns, they don’t particularly care about how the entrusted assets are specifi cally operated. This creates opportunities for “connected transactions” in the asset management business of securities companies. The securities companies can engage in con-nected transactions to transit interests by benefi ting their proprietary business at the expense of the client’s interests, and they create risks by doing so.

Contract Risks Currently, a distinctive feature of assets entrusted to securi-ties companies is that the amount is fi xed within the term of entrustment.That is, at the beginning the owner deposits the assets into a special account in full, and then withdraws the original amount plus the receivable profi ts by the end of the term. It is usually not allowed to transfer the entrusted fund during the entrustment period. For the owner, such a managementapproach poses a great fi nancial pressure because a large amount of funds have to be prepared in the early stage. In practice, however, due to consid-erations such as the timing of the initial investment, phased allocation of funds, and the timing of full‐amount liquidation, the securities trader tends to sit on part of the entrusted fund for a fairly long period of time, failingto fully realize the time value of money. The larger the entrusted fund, thelower the utilization effi ciency.

Assets are often entrusted on a short term basis, with quite concen-trated expiration dates. Therefore, securities companies face great opera-tional diffi culties. Most of the entrusted investment management contractssigned by securities companies have a term of half a year or one year. Great overall risks in the capital market, a lack of variety in investment products,and a shortage of effective hedging mechanisms and tools make it diffi cult


for securities companies to come up with robust and seamless investmentplans that can generate favorable returns in such short periods. Such hastyshort‐term investment can hardly secure stable returns and is often accom-panied by high risks. Once the poor performance of expiring funds leads to redemption diffi culties, bank runs tend to take place, bringing about the riskof capital chain disruption for securities companies.

Market Risks With limited investment choices available, return rates of bonds and notes can hardly meet the needs of wealth management. Most entrusted assets are invested in stocks. The stock market is marked by big risks and unstable returns. Due to insuffi cient investment capability, entrusted wealth management contracts usually have short terms. It is very tough to op-erate in a way that achieves anticipated return in a very short period of time. Faced with the return rate pressure, some securities traders resort to bulk holding. This has exacerbated market risks in the asset management business. For example, Zheshang Securities adopted a concentrated investment strategy in 2012, and their asset management business did very well. However, when shares of LUDADI, a company in China, which Zheshang Securities held in large amounts, continuously declined by their daily trade limit, Zheshang’s wealth management products were severely crippled. According to statistics from Wind Information Co., fi ve of the six collective wealth management products operated by Zheshang Securities recorded negative income by the end of 2010. The worst performing product, JINHUI 2, saw its net value de-cline by 11.42 percent.

Management of Risks Associated with Asset Management Business of Securities Companies Stringent Internal Management and Internal Control System Stringent Business Separation Mechanisms Securities companies should effectively separate their asset management business from securities pro-prietary business, securities underwriting business, securities brokeragebusiness, and other lines of business to prevent insider trading and avoid confl icts of interest. The same senior executive should not run asset manage-ment business and proprietary business at the same time. The same personshould not be the division head of two divisions that engage in both types of business. The same investment sponsor should not handle asset manage-ment business and proprietary business at the same time. An investment sponsor of collective asset management business should not assume the role of investment sponsor for other types of asset management business.

Relevant Accounting Systems Asset management plans should have inde-pendent and complete account, review, reporting, and archiving management


systems. Financing accounting of asset management plans should be the responsibility of dedicated personnel in the fi nance department. The set-tlement and custody department should take charge of the asset custody and clearing associated with asset management plans. It should be ensuredthat the risk‐management department and the supervision and inspection department can effectively monitor the operation and management of col-lective asset management business to effectively prevent off‐the‐book opera-tion, appropriation of collective asset management plan funds, and other illicit or illegal behaviors.

Provisions of Laws Observed and Responsibilities Clearly Specifi ed If asecurities company participates in a collective program, the fund owned bythe securities company itself in the program should not be more than 5 per-cent of the total amount of the program and should not exceed CNY 200 million. If a securities company participates in multiple collective programs, the total amount of funds owned by the securities company in these pro-grams should not exceed 15 percent of the company’s net asset. Throughoutthe term of the collective program, the number of clients should be no fewerthan two. The net asset value of the program should not be lower than CNY 100 million for 20 consecutive trading days. The securities of a single company held by a single collective program should not exceed 10 percentof the net asset value of the collective program. If a securities company isto invest client funds under its management in securities issued by a com-pany, the amount of securities purchased should not exceed 10 percent of the issued amount. In the special securities account managed by a securi-ties company, the shares of one single public company should not exceed5 percent of the total amount of shares in the company, unless explicitly authorized by the clients. When the clients’ holding of a public company’sshares reaches 5 percent, purchase of any more shares of the company bythe securities company for the clients through the special securities account should be subjected to approval of the clients of the asset management busi-ness before every transaction. Shares of the public company should not be transacted by the securities company without the clients’ permission.

Optimization of Contract Design, Standardization of Contract Management

Improving Capital Liquidity Design A comprehensive market is still miss-ing for the circulation of entrusted wealth management products. There is no way to base the price on market supply and demand or a price discov-ering mechanism. The precision pricing of products by the trustee during the circulation process is very costly. Therefore, asset management contracts should give consideration to the diversity of client needs, the limited term


of entrusted funds, and the balance of incomes. In entrusted fund liquidity management, it is advisable to fi rst sign a general agreement that specifi es the total amount of entrusted funds, and then sign various subagreements sepa-rately that require the fund owner to inject a certain amount of capital into a special wealth management account in each of the several phases as specifi ed. The capital will be invested in a phased manner. The assets will be gradually liquidated upon expiration of the entrustment term to pay the clients their money back. Based on the condition of the securities market, the expecta-tions of the two sides and the performance of previously entrusted capital, the two sides may reconsider or revise the conditions of the subagreements.

Optimizing Contract Term Structure: Design of Reload Option Models The asset management business in China is characterized foremost by a time limit on the use of entrusted capital. How to extend the operation cycle of the asset under management is an important aspect of risk management in this busi-ness. The design of reload option models refers to the design of a reasonable wealth management covenant about reload options based on the principle of the option contract, so that the securities trader can play the role of a buyer. If the return from the assets under its management meets certain criteria, the se-curities trader gets to decide when a new wealth management agreement goes into effect and whether an existing wealth management agreement will be renewed. The securities trader may exercise its right when market conditions are favorable or there is a capital crunch for follow‐up operations, or give up when the opposite is true. A precondition for the client to sign a reload op-tion agreement with the securities trader is that it has abundant idle funds. As the seller of options, the client will receive discounts on wealth management procedure fees, additional services, or a fi xed option premium.

Implementing Risk Evaluation and Monitoring Gradual Adoption of Risk Management Techniques Risk management techniques can be adopted gradually and implemented in a series of steps.A risk management department can start by determining the investment scopes and investment proportion of wealth management products based on a study on client risk and return preferences. Based on those results, calculate the probability distribution pattern of the return from a wealthmanagement product based on target market analysis and forecast. Depend-ing on the characteristics of wealth management products and clients’ devel-opment requirements, fi nalize elements of the wealth management product,such as call option scale and proportion and basic returns. Finally, calculate the management risk and expected return of the corresponding wealth man-agement products. Based on the risk‐return characteristics of the product


and the development plan for the asset management business, evaluate theoperation risks and expected return of wealth management products to de-termine the feasibility of the products.

If the product plan fails to meet the risk control requirement, the ele-ments of the products will have to be adjusted and revised. Quantitative analysis should be conducted to adjust and advise the proportions of vari-able return assets and fi xed return assets in the portfolio based on the fl uctuation of the market. This is to ensure that after a period of time, the investment portfolio won’t fall below a preset minimum target return forentrusted assets, which achieves the goal of maintaining and increasing the value of the portfolio.

Dynamic Monitoring of Risks Should Be Implemented Enhancing dy-namic monitoring of risks through the design of key indexes includes the following items:

■ Whether the asset management business is audited within the account ■ The scale of entrusted capital and the percentage of net assets ■ How well the entrusted capital is managed in a special account ■ How the funds are deposited ■ How the client and the company share risks, and the safety of the principal ■ Whether the fl oating profi t and loss of the entrusted asset are kept within the stop‐profi t/stop‐loss scope defi ned by the company

■ The percentage of the total amount of unsettled losses associated with the entrusted assets in relation to the net assets

■ Remedy channels for losses in the asset management business and their impact on the capital chain of the company

■ The way losses in the asset management business are processed by accountants

■ The operation of asset management business accounts and whether any operation or entrusted investment is made outside the system of the company

■ Guarantees offered to clients of the asset management business

When a relevant index reaches the level of a risk, the securities traders can identify the risk and reduce losses.

Management of Risks Associated with Research and Investment Consultancy Business of Securities Companies Confl ict of Interest Risks The core risks of the research and investmentconsultancy business of securities companies are those triggered by confl icts


of interests. The independence of securities analysts is severely underminedby the failure to effectively separate the research and consultancy division from the brokerage, investment banking, and proprietary business divi-sions. In a securities company, researchers get bonuses from the investment division and release reports in coordination with the proprietary busi-ness. The company seeking public listing reviews the research report, and cross‐divisional appointments are frequently made for some positions. As a result, confl icts of interest frequently occur, and a securities company may benefi t while sacrifi cing the rights and interests of its clients and investors. This gives rise to related risks. For example, analysts may exploit the release of securities research reports to unduly benefi t themselves and interestedparties. They may divulge contents or views of the securities research report before it is even released. During the processes of preparing and releasing securities research reports, the research division and its staff may be affected and interfered by interested parties such as other divisions and personnel of the company, the issuer of securities, the company seeking public listing,fund management companies, securities asset management companies, and certain clients. In order to gain undue profi ts, they may provide contents or views of the securities research report to divisions or personnel of the com-pany or individuals wanting the information before the report is formally released. In a securities company, rules relating to the quiet period may be violated by the sponsor, lead underwriter, or fi nancial consultant in charge of IPO issuance, additional stock issuance, and allotment or issuance of convertible bonds.

Other Behaviors in Violation of Laws or Duty of Care Due to the defi -ciency of securities companies in terms of R&D strength, staff capability,and market branding, behaviors such as fraud, misleading investors, dis-semination of false information, insider trade, or market manipulation may trigger risks.

Management of Risks Associated with Research and Investment Consultancy Busi-ness The purpose of establishing an insulation wall is to prevent confl icts of interest between securities companies and clients outside the company.The key is to maintain the independency of securities analysts. Measures to ensure independency mainly include the following activities:

■ Maintain the independence of the research and consultancy division from the proprietary and investment banking divisions in terms of staff, venues, business processes, and management systems. In particular,researchers and consultants in direct contact with investors from the public should not be controlled by the proprietary, investment banking,


and asset management divisions. Their compensation should be based on whether their investment advice is objective and accurate, ratherthan tied to the revenues of investment banking, proprietary banking, asset management, and other business.

■ Confl icts of interest should be disclosed in time. In the process of releas-ing a research report, researchers and consultants should disclose con-fl ict of interest issues that they know about, including the relationship between their own securities company and the research subject and whether the securities company, researchers, or consultants hold anystocks in the research subject.

■ Another measure has to do with setting a quiet period. Within the underwriting term or proprietary term of a certain stock, the research-ers and consultants of the securities company should not release any research report about the stock. For the time that the researchers andconsultant release their investment advice concerning a certain stock,the proprietary division of the securities company the researchers and consultants work for should not enter into transactions in a way that isagainst the investment advice.

■ All investors should be treated equally. The research and consultancy division should provide the same core contents of the research report at the same time without making distinctions between big investors and medium, small, or individual investors. However, variation is allowedin terms of the amount of detail and specifi c product recommendations to account for different preferences and risk tolerances among differentinvestors.

MANAGEMENT OF RISKS ASSOCIATED WITH INNOVATIVEBUSINESS OF SECURITIES COMPANIES

The securities industry overall is in a period of structural adjustment. Going forward, the decline of traditional business lines will accelerate in the face of fi erce competition. As the reform of the Chinese capital market deep-ens, institutional changes and changes of operational environment will be the major trends, creating room for the survival and development, productinnovation, and transformation/upgrade of domestic securities traders. Due to its sensitivity to both policies and the market, innovative business needsfavorable market environment and lax regulatory policies. The regulators will only prudently adjust regulatory policies in favor of the launch of inno-vative business when resistance to risks are enhanced, the overall classifyingand grading levels are improved, and the overall risk‐management quality


is raised. Currently, for innovation business, the regulators apply a policy of “piloting before spreading.” This means that companies with better overallstrength speed up the introduction of new types of business and gradually change the traditional profi t patterns and structures. The traditional over-reliance on brokerage business will be changed, and the income structure will gradually become more reasonable with diversifi ed sources of income. The profi t structure will become increasingly similar to that of establishedinternational investing banks, resulting in greater gaps between large securi-ties traders and small and medium ones.

Management of Risks Associated with Securities Margin Trading

Analysis of Risks Associated with Securities Margin Trading Risks of Runaway Business Scale Risks of runaway business scale mainlyrefer to situations in which the scale of securities margin trading business gets out of control. The fi nancing for an individual client is oversized and the term is too long, leading to the possibility of low asset liquidity or breaches of regulations concerning net capital scale and ratios. By providing clientswith securities margin trading services, securities companies can not onlycollect fi nancing fees, but also reap more commissions for the amplifi cation of transaction volume. In pursuit of higher profi ts, securities traders willexpand the securities margin trading business where possible. But as theyblindly increase the scale, the risks facing them also get bigger.

Credit Risks The securities margin trading business is conducted between the securities trader and the investor. When the client’s capital fi nancing or securities fi nancing effort results in losses, the remaining amount in themargin account can be used as a remedy. However, when the loss is so bigthat it exceeds the remaining amount in the margin account, there will be risks of breaches of contract. The characteristics of securities margin trad-ing amplify market fl uctuation and risks. When an investor breaches the contract in a securities margin trading transaction, the transaction will be canceled. But if the investor is unable to compensate the securities trader for the huge losses, the trader will bear the risks. In securities margin tradingtransactions in China, the accuracy of client credit risk evaluation directly affects the risks and benefi ts of the securities trader. Without enough inde-pendent credit evaluation companies, the securities traders have to take itupon themselves to evaluate the credit risks of their own investors. Creditrisks will arise if the investor fails to give the securities trader its capital or securities.


Market Risk Market risks of the securities margin trading business mainly refer to the possibility of losses in certain situations. Market fl uctuation caused by unforeseeable and uncontrollable factors can make it diffi cult to carry out securities margin trading business normally in a securities exchange. It can also threaten market security or lead to a depreciation of the value of collateral deposited by the client with the securities trader. Mar-ket fl uctuation can also cause a below‐the‐standard margin maintenance ratio, in which it is diffi cult for the securities traders to carry out forced liquidation or reclaim the borrowed capital (securities).

Securities Margin Trading Fuels Market Speculations Securities margin trading, combined by the short mechanism and stock index futures, will amplify risks. Given that the market and credit systems are not sound enough and the securities margin trading mechanism has yet to be improved, securities margin trading will have a large impact on market fl uctuation. When the market is low, the leverage effect of securities margin trading will exacerbate the decline and tend to cause a disruption of the investor capital chain. This brings about liqui-dation risks in the investor’s company and market fl uctuations.

Credit Risks Will Exacerbate Market Risks When the maintenance mar-gins are insuffi cient, if the client fails to provide additional margins in time,the securities trader will carry out forced liquidation on the collateral in its capital account and credit securities account. This will inevitably lead to a lack of liquidity for the investor. If most investors in the securities mar-ket are subjected to forced liquidation, there will be a panic in the market, bringing about serious market risks.

Exasperation of Market Risks by the Price‐Limit Mechanism If the inves-tor fails to meet the minimum margin ratio requirement while the securitiesplaced as collateral keep reaching their price limits, the securities trader willnot be able to carry out liquidation. Although securities traders have theright of recourse when the collateral is no longer suffi cient to ensure their interests as creditors, failure to dispose of the collateral in a timely manner will inevitably increase their own liquidity risks. This then leads to a short-age of capital, a lack of liquidity, and the cause of market risks.

Management of Risks Associated with Securities Margin Trading Business of Securities Companies Management of the Opening of a Margin Account for Investors Beforeopening a margin account for an investor, the securities company rigorously examines the investor’s credit history, income level, and real properties based


on a grading system. The identity, wealth and income, securities investment experience, risks and preferences, and specifi c needs of the investor will be studied thoroughly. A primary review of the investor’s credit and assets willbe conducted and a risk and qualifi cation review report will be produced.The report will show the extents of ethic risks and fi nancial risks associated with the securities margin investor. The trader must ask the investor to sign a risk alert letter and inform the investor about the risks of margin trading. This ensures that investors taking part in securities margin trading are high quality investors who are fully aware of the risks involved.

Margin Trading Account Risk Control The key to margin trading accountrisk control is to conduct real‐time monitoring of maintenance margin ratio and to respond in a timely manner. In order to ensure the effi ciencyand quality of risk control for margin trading accounts, securities tradersshould strengthen the application of information technologies, enablingthe system to automatically calculate risk levels of various margin trading accounts, identify abnormal accounts, and send processing alerts accord-ingly. Accounts breaking the prewarning account threshold must be frozen immediately. The securities margin trading account manager of the opera-tion division should immediately inform the account holder. Additional col-lateral is then required within a specifi ed period of time. If the investorneither deposits a suffi cient amount of collateral nor pays back the cor-responding part of debt, forced liquidation should be carried out and the collateral disposed of, according to the contract. For accounts breaking thehigh‐risk‐account threshold, forced liquidation should be carried out imme-diately, and the investor should be demanded to make up the shortfall.

Management of Securities Trader Margin Trading Limits Management of securities trader margin trading limits involves managing the following:

■ Limits of a securities trader’s involvement in the securities margin trad-ing business

■ Limits imposed by a securities trader on individual investors’ securities margin trading transaction amounts

■ Limits imposed by a securities trader on the amount of a single securi-ties margin trading transaction

The purpose of managing the margin trading scale of individual stocks is to prevent institutional or individual investors with abundant capital from manipulating the rise and fall of certain securities. This can occur by exploit-ing the effect of the securities margin trading business on the fl uctuation of the stock market, which will increase market risks and cause volatility in the securities market.


Integrated Utilization of Various Risk‐Control Measure Establish Scientifi c Profi t Models and Formulate Reasonable Capital Use Policies Securities companies should compare profi ts from the securities margin trading business and proprietary business under various market con-ditions to identify the optimal benefi t point by establishing scientifi c profi t models. Available capital should be allocated proportionally at the optimal benefi t point. The two business lines should be managed separately. By do-ing this, limited amounts of capital can be allocated rationally, and the capi-tal utilization effi ciency can be raised.

The pledge ratio, warning line, and liquidation line of a client’s account should be monitored constantly. This is done through concentrated moni-toring of and timely inquiries into various risk control indexes, the bal-ance and changes in the client’s credit capital account and margin trading account, and the market value of securities and changes thereof. The key to dynamic management of risks is to establish and build up the daily market‐to‐market system, the margin call system, and the forced liquidation system to minimize risks.

Standardize the Forced Liquidation System and Clarify Risk Liabili-ties In order to safeguard its own interests, a securities trader may carry out liquidation on entrusted securities to make up the shortfall of margin in the client’s credit securities account. Before carrying out liquidation, the securities trader has to fulfi ll its obligations accordingly, such as informingthe client about risks and requiring the client to increase the margin in a timely manner. A mechanism should be established to allow the securitiestrader to send risk forecasts, alerts, and warnings to the client before carry-ing out liquidation. Liquidation should stop when the income from liquida-tion equals the amount of the margin needed. It should not go beyond that extent. Agreement should be reached as to each party’s liabilities in the face of risks, so as to avoid unnecessary disputes. An agreement should be signed between the securities trader and the client that clearly defi nes each party’s rights and obligations, sets out detailed provisions about risk liabilities, and clarifi es specifi c operational issues such as liquidation notifi cation, liquida-tion scope, and liquidation timing.

Management of Risks Associated with Stock Index Future Business

Sources of Risks in Stock Index Futures Business Special Nature of the Trading Mechanism Stock index futures trading is a type of margin trading. Stock index futures contracts can be generated


infi nitely without any limit of amount. The stop‐loss transaction mecha-nism in stock index futures trading makes it so that the prices of stock index futures are marked by self‐enhancing fl uctuations. Stock index futures provide investors engaging in stock trading with fi nancial derivative instru-ments with transaction and risk‐management functions, such as risk man-agement, hedging, and long‐term price discovery. However, spread trading of stock index futures is not without risk. It faces certain risks relating tothe gap between futures and spot prices being convergent, calculation of relevant costs being accurate, dividends being accounted for, impact and wait costs, and liquidation being carried out smoothly. Pricing risks, execu-tion risks, and margin insuffi ciency risks are the major risks facing the stock index futures trading business of securities companies. How to measureand manage these risks is a question that must be addressed while conduct-ing spread trading of stock index futures. Risk management for securitiestraders traditionally focuses on the control of legal risks, moral risks, andoperation risks. It pays greater attention to the control of risks than to the management of risks. Securities companies should pivot toward managingthese market‐based risks. In particular, the management of market risks and credit risks is a concern.

Risk Control Systems for the Stock Index Futures Business of Securities Companies Currently, risk management of securities companies is mainlyimplemented according to the Administrative Measures on Risk Control Indicators of Securities Companies. However, these measures only make forstatic management of risks through position limits. Dynamic management for market risks and credit risks is still missing. Position limits, intra‐day risks, margins, and policy risks should be brought under collective man-agement. A collective risk‐management system should be established and a risk‐management organization comprised of relevant authorities should be set up.

Constructing Solid Risk‐Management Processes Language and standards used in risk management should be unifi ed. Standardized procedures and steps covering all aspects of risk management must be established. Before engaging in stock index futures trading, the company must organize risk management–related divisions to conduct market risk analyses and to construct risk models designed to examine relevant risks. Management should be strengthened during the trading process. Using real‐time moni-toring and after‐hours trading, transactions, capital, positions, losses, and profi ts need to be monitored on a real‐time basis. Compliance risks are then assessed, and performance risks are regularly evaluated.


Management of Risks Associated with the Direct Investment Business of Securities Companies

The direct investment business of securities companies refers to a practice by securities companies to search for and identify high‐quality investmentprojects or companies using its own expertise. The company then makesequity investments with its own raised capital or funds in order to gain a return on equity.

In March 2008, the CSRC started allowing qualifi ed securities companies to apply for direct investment pilot projects. In July 2011, it subjected the direct investment business of securities companies to routine regulation, wid-ening the space for the growth of the direct investment business. By the fi rst half of 2011, 18 direct investment projects of securities traders had gone pub-lic successfully. Three direct investment projects were cleared by the issuance examination committee. The book return of direct investment projects stood at CNY 2.591 billion, with an average return rate of 432.68 percent. By that time, 34 securities traders had been qualifi ed for direct investment, and almost all set up their direct investment subsidiaries. The total registered capital was CNY 23.5 billion, an average of CNY 712 million for each company. Based on the 15 percent net capital upper limit, the amount of directly investable capital was expected to reach up to CNY 46.9 billion.

Risks Associated with the Direct Investment Business Liquidity Risks The direct investment business of securities companies usu-ally has a long investment cycle. The operation term is typically 3 to 5 years, or even 7 to 10 years. It is very diffi cult to transfer the investment within the operation term. Poor liquidity is a sign of long risk cycles. If the important fi nal exit step is not carried out smoothly, there will be high liquidity risks. The fi nancial structure of a securities trader is highly leveraged. The sources of capital include not only capital owned by the securities trader itself, but also debts. If those sources are to be used as long‐term capital, the liquidity risks of the capital must be constantly controlled. Otherwise, fi nancial crises will become extremely likely, leading to the spread of risks.

Profi t Fluctuation Risks Risks facing the direct investment business of securities traders are a combination of technical risks, market risks, and fi nancial risks. They are characterized by the possibility of a highly risky scenario in which a small risk eventually leads to the failure of the entire project. Without an existing market for the equity assignor to reach a trans-action agreement directly with the investor, it is impossible to avoid the risksof profi t uncertainties.


Information Disparity Risks Information is limited in the direct equity investment market. Typically, the direct investment business seldom involves public market operations and is not required to disclose transaction details. The target enterprise being invested may exploit the disparity of informa-tion to prevent the securities trader from making decisions in an effi cient and correct way.

The Spread of Risks While engaging in direct investment, the role of asecurities company changes from a fi nancial intermediary to an equity inves-tor and manager. The securities intermediary services of the securities trader cover the primary and secondary market, investment and fi nancing, andfi nancial strategy consultation. The securities trader is thus able to provide its clients with all‐around one‐stop integrated intermediary services. Theseadvantages meet the needs of clients of the securities direct investment busi-ness. The securities trader is willing to accept synergic development between various business lines, thus playing the dual role of both service provider and service recipient. In this way, different business risks interact, take cover,mutate, and amplify. The whole operation process of the direct investment business—from fi nancing, project decision making, management, to the fi nal exit—is closely connected to other business divisions of the securities company. The fi nancing process is not viable without the customer base of the company. Assistance from the sales division and retail division is needed. Sometimes even the product innovation division needs to transform equity capital from a certain concept to an innovative product for sale. The originalretail business then becomes a type of capital market business participatingin high‐risk activities. Support from various divisions of the company isindispensable in the project decision making and management processes. Multidivisional cooperation increases compound risks, causing originallyconcentrated risks to spread from one division to another. The interconnec-tion of different business lines will fi nally amplify the risk impact of a singlebusiness line, magnifying the overall risk for the company.

Risk Management for the Direct Investment Business Risk Management in Financing For directed investment in securities, the work to reduce project investment failures and control risks starts even before the company takes on the project. Not all risks facing innovative business can be predicted, and not all diffi culties and emergencies can beanalyzed and assessed ahead of time. As a result, it is unnecessary to go after a scale of fund‐raising. In contrast, it is necessary to appropriately control the amount of funds to be raised. In practice, investment amounts beyond the investor’s own investing capability are actually detrimental tothe investor. Considering that raising funds from the outside will lead to the


spread of risks—in particular, the leveraging effect of hedge funds—thereshould be certain control on the sources of capital for the direct investmentbusiness. In the early phase of the direct investment business, capital owned by the securities company itself can be used to make direct investment. This will avoid risks that might come with the use of funds raised from the out-side. The capital used to set up a direct investment company must be con-trolled at a certain percentage of the total capital owned by the securities company. This prevents the proportion of capital in the direct investment company from getting so high that it has an overall impact on the securitiestrader once it suffers a major loss. The key factors to be controlled are the securities trader’s own capital and the proportion of the capital injected inthe direct investment business.

Risk Management and Control for Investment Decision Making and Exit The fi rst question to answer when making a project investment is how to use the investment capital. Distributed investment and a percentage investmentlimit for individual projects should be considered. For an individual directinvestment project, it is also essential to decide what kind of team should beemployed, when to get into the project, and at what price. Generally speaking, both the investors and the corporate side are currently not mature enough. Thus, it is even more important to have specifi c investment and management strategies for each individual project, such as determining the industrial dis-tribution, market development trend, project price fl uctuation or fund cycle, as well as exit considerations. Factors such as the fl uidity and risks of the capital market will increase the uncertainty of equity trading prices. Experts’ views are needed to make investment decisions such as how to evaluate the price, what approaches should be adopted, and what the right timing may be. If the decision‐making process is done with the participation of mul-tiple experts in the form of a decision‐making committee, misjudgment canbe reduced.

Exit plans are usually made during the project’s decision‐making process. The company should be able to exit whether the project is making profi t or suffering losses. Besides the primary means of IPO exit, an appropriate exit channel should be considered, such as the introduction of strategic partners or entrepreneur buy‐backs, to lower the exit risks of the project.

Control of the Spread of Risks In its operation process, the securities directinvestment business is interconnected with such business lines as invest-ment banking, fi nancial counseling, and asset management. With its own advantages, it coordinates the buyer business of direct investment and theseller business of investment banking and fi nancial counseling. They thenenhance each other and lead to common growth. To engage in the securities


direct investment business, a fi rewall must be set up between the parentcompany and its subsidiaries to monitor the interaction between the direct investment business and the investment banking and other business (issu-ance, underwriting, sponsoring, and tutoring) of the securities trader. This also strengthens supervision on joint investment with companies directly invested by other securities traders in the underwriting team, as well as the disclosure of relevant information.

Prevention of Moral Risks Private funds in China currently adopt the“2‐20” model. This means that the income of private fund managers con-sists of a 2 percent management fee, plus 20 percent of the profi t. In the event of losses, the manager will bear unlimited joint and individual liability. Although securities companies currently have some performance‐based reward, they still largely stick to a post‐salary system or a post‐rank sal-ary system. These are weak in terms of both incentives and constraints inthe direct investment business. Therefore, effective inventive and constraint mechanisms should be adopted to explicitly tie the interests of the invest-ment management team to their performance.

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Yuming , Fu. 2003 . “Examining Real Estate Risk and Return in an Equilibrium APT Model.” Paper presented at AREUEA annual conference in Washington, DC.

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CHAPTER 6 6 Analysis on Structure and

Competitiveness of Talent inChinese Securities Companies

The securities industry is knowledge and intelligence intensive, and it is also one of the most competitive industries. Talent is the key strength and

competitive weapon of a securities company, and it has a unique, specifi c nature. The most signifi cant task for the human resources department of a securities company is how to recruit top talent and how to then train, appraise, and motivate the individuals to realize their full potential. With the impressive strides in capital markets, the securities sector has cultivated animpressive array of talented individuals. In recent years, the topic of human resources for securities fi rms has been a major concern in capital markets.The issues include how to effectively cooperate with brokers in their devel-opment and transformation processes, how to rationally allocate humanresources, and how to cultivate and develop talented individuals. These same challenges are bound to dominate development strategy of brokers as the capital market continues to expand and as foreign investment banks compete together with the expectation of fi nancially mixed operations.

DEVELOPMENT TREND AND CORE COMPETITIVE STRENGTH IN THE SECURITIES INDUSTRY

With the rapid development of the Chinese capital market, the securities industry has entered into a new developmental stage. Continuous opti-mization of policies and improvement of the market system have greatly expanded the room for development of the securities market. The constantexpansion of the market and fast growth of resident wealth have given rise to a huge demand for wealth management. Therefore, the securities industry is facing unprecedented development opportunities. At the same time, the


Chinese securities industry is also facing severe challenges because it is con-stantly penetrated by other fi nancial industries such as the banking indus-try. Threatened by an all‐out invasion of foreign‐invested institutions with advantages in mixed operation, capital, and talents, it is further compoundedby homogenous competition and a price war on commission rates. Faced with such situations, Chinese securities companies must make innovative development the fi rst priority on their agendas. They must follow a path of structural transformation. The industry needs to promote intensive develop-ment, large‐scale operation, conglomeration, comprehensiveness, and inter-nationalization. This must be done while making great efforts to build upcompetitive strength in terms of expertise, management, innovation, andrisk control. Securities companies need to become modern fi nancial enter-prises with core competitive strength.

Development Trends of Securities Companies

Business transformation and innovation‐driven development will be the major topic for securities companies for years to come. This period will see major changes in the securities industry in terms of the profi tability model, competition model, and competition pattern. These three areas are detailed below:

1. The profi tability models of securities companies will undergo funda-mental changes. Although there is still room for profi t with the traditional conduit‐based profi tability mode, a revolution toward a market‐based system will make competition in traditional business increasingly intense, driving down the profi t rate. In contrast, nonconduit businesssuch as M&A, collective entrusted wealth management, and direct investment will grow rapidly. These are likely to become fast growingand stable sources of revenue. The change will be driven by the adjust-ment of the national economy strategic layout, the deepening of thereform on the state‐owned asset management system, and the release of residents’ potential investment demand.

2. Comprehensive innovation, large business scale, mixed operation, and conglomeration will be key factors to competition among securities companies. In the face of external changes in the market, securities com-panies must promote comprehensive innovation in services, products,and management based on knowledge and information technologies. They must also promote intensive operation by implementing client relation management, business process restructuring, and corporateresource planning. They have to raise their capital scale by issuing addi-tional shares and issuing bonds. They must also realize mixed operation

Analysis on Structure and Competitiveness of Talent in Chinese Securities Companies 319

and conglomeration through M&A, cooperation, and joint ventures. Establishing fi nancial holding groups will also raise their core competi-tive strength.

3. With intensifi ed polarization, strong securities companies will get stronger. Fierce competition pressure will come with mixed operation,market based systems, and internationalization. Due to this, polariza-tion in the securities industry will be increasingly prominent. A num-ber of large securities companies with great comprehensive competitivestrength and standardized management will win the support of policies and the favor of the market. They will become bigger and stronger bymeans of bond issuance, private placement, listing in a stock exchange,and M&A. Securities companies with weak capital strength and insuffi -cient core competitive strength, however, will exit the market after being acquired by bigger companies or going bankrupt. The securities indus-try will become a place where the strong get stronger.

Core Competitive Strength of Securities Companies

The history of the international and domestic fi nancial industry shows that, in the long run, sustainable fi nancial enterprises are those that pay greatattention to risks, stick to a professional and pragmatic approach, and pri-oritize services and innovation.

For a rather long period in the future, the trends of information glo-balization and global economic integration will remain unchanged. The fi nancial innovation development based on technology and knowledge will change the global fi nancial pattern. The strategic restructuring of the Chinese economy is gaining momentum as the economic development and reform of China enters a new stage. The domestic capital market has also entered intoa new developmental period. Competition in the securities industry is now in an era dominated by services.

In front of rare historic opportunities and unavoidable challenges, domestic securities companies must strengthen their sense of mission, responsibility, and urgency. They must seize the opportunity, take to explo-ration and innovation, improve corporate governance, standardize their operation according to law, strengthen coherence, and focus their efforts to rebuild the glory of the securities industry.

Securities companies should meet requirements in the following fi ve aspects:

1. Capital suffi ciency: They should improve their net capital strength to enhance their resistance to risks, while ensuring there is enough capitalfor business exploration and innovation.


2. Step up business collaboration and enhance service quality: They should build up the overall service brand of the company, improve collabora-tion among various business lines, and raise their integrated customer service level.

3. Scientifi c management and high‐effi ciency operation: The transforma-tion should be realized from extensive operation to intensive operation. The internal governance structure, organizational architecture, opera-tion process, and bylaws of the company should be further improved to raise management effi ciency and business implementation effectiveness, translating the ambitious strategic planning of the company into real productivity. A corporate operation and management culture should becultivated, characterized by complete organiza tional architecture, well‐designed management systems, and effective implementation.

4. Stringent internal control and safe operation: Robustness of opera-tion should be ensured. Various management mechanisms and processes should be able to function smoothly. Operation and management risks should be predictable, controllable, and avertable to counter the negative impact from changes in the external environment.

5. Great ability to make profi t: The ability to profi t from business shouldbe gradually built, commensurate with the net capital strength of the company to ensure constant profi tability and continuous growth.

To build a modern fi nancial enterprise, core competitive strength is indispensable in the aspects of expertise, management, innovation, and risk prevention, as detailed below:

■ Expertise: Expertise is the direct manifestation of a securities company’s competitiveness and service capability, epitomizing the core competitivestrength of the company. Starting from the needs in market competition,in comparison with other multiservice securities traders, the expertise of a company should include:

■ Marketing ability ■ Wealth management ability ■ Market trend analyzing ability ■ Ability to determine the value of products and services ■ Ability to develop and design products and services ■ Ability to evaluate the value of a client ■ Ability to provide the client with comprehensive fi nancial solutions ■ Ability to conduct and increase the value of investment transactions, investment counseling ability, haggling, and pricing abilities

■ Ability to securitize assets ■ Ability to develop, implement, and integrate information technologies


■ Management: This mainly refers to the ability to make plans, orga-nize, and coordinate in the context of the operation and management of a company. It epitomizes a company’s organizational architecture, rules and bylaws, processes, and mechanisms. The cornerstone of management strength is the building of a managerial talent pool. Senior managers should have industrial foresight. Medium man-agers should have solid industrial experience and implementation effectiveness.

■ Innovation: Innovation can be found in every link and aspect of the operation and management of a company. It is the fundamental force driving the development of the company. It mainly consists of innova-tion in products and services, organizational innovation, and managerialinnovation. Innovation of products and services is the core component, organizational innovation is the safeguard, and managerial innovationis the basis.

■ Risk Prevention: Risk prevention is the ability to strike a balancebetween profi ts and risks, and to control and stay on top of risks. It includes identifying, measuring, controlling, and resolving risks.

DEMAND FOR TALENTS IN THE DEVELOPMENTOF THE SECURITIES INDUSTRY

In this new developmental stage of the Chinese securities market, the right way forward for securities companies is through large‐scale and intensive operation. Characterized by high talent and capital intensity, the securities industry can take full take advantage of the intermediating and resource allo-cating functions of the market only when talent and capital have reached a certain scale and amount. Cultivating a high‐quality talent pool has becomean urgent task for the operation and development of a securities company.With the development of the securities market, competition between securi-ties traders will further intensify. Talents will therefore become an increas-ingly determinative factor.

Modern fi nancial enterprises belong to a knowledge intensive industry. With the progress of time and development of science and technology, fi nancial enterprises constantly develop new business types, services, andfunctions to meet people’s increasing demand for fi nancial services. New technologies are quickly implemented and spread in the securities busi-ness, which will keep raising the bar for the knowledge structure and ser-vice skills of securities practitioners. On the other hand, the market‐based economy is an open economy. The internationalization of the Chinese economy and the integration of the global economy both call for talents


who understand not only economic theories and specifi c business, but also international practices and communication skills. As a result, the demand for talents in the Chinese securities market currently focuses on the follow-ing two types of talent:

1. High‐caliber professional talent 2. Interdisciplinary talent for both operation management and securities

business

Professional Talent

Talented, high‐caliber professionals engage in fi nancial theoretical research and practice, R&D of innovative fi nancial products, and R&D and manage-ment of fi nancial derivatives. Through the development of advanced theo-ries, they manage a great amount of products and services catering to the needs of various demographic groups. Unlike interdisciplinary manage-rial talents, professional talent includes line experts who create value with advanced, highly accurate, and specialized expertise. For securities com-panies, professional talent can be arranged by foreground, middle ground, and background categories, or by the nature of specifi c business lines, such as retail, and innovation. The capital market is currently marked by fi erce business competition. Competition for talent is particularly strong. The specifi c areas of professional talent discussed next are the focus of major competition.

Investment Research Talent These are professionals who can come up withdiversifi ed investment portfolios and who work hard to ensure the robust-ness and long‐term value increase in capital. As high‐level talent in the fi nancial industry, investment managers are responsible for the construc-tion, operation, and management of funds. In the fi nancial industry, invest-ment managers and researchers have always been the most important posts. In the fund market, there is already an abundance of funds of various types, such as closed‐end funds, principal guaranteed funds, hybrid funds, securities‐based funds, bond‐based funds, and Qualifi ed Domestic Institu-tional Investor (QDII) funds. However, there is a severe shortage of invest-ment managers with advantageous knowledge structure and rich investmentexperience. Domestic asset management businesses are fi ercely competing with each other for excellent investment managers and research analysts. In fact, a researcher is a very valuable talent resource for both a securities company and the client—fund companies. With years of research, investi-gation, and analysis, a researcher has a unique and accurate conviction of an industry and tends to play a determining role when the manager of the


fund company chooses which stocks to invest in. On the other hand, the most top‐notch and quintessential talent of a securities company tends to be concentrated in the industrial research team. Recent years have seen the majority of researchers in famous domestic research institutes with master’s degrees or even PhDs. They have educational backgrounds from famous Chinese and international universities covering such fi elds as securities andfutures, fi nance and banking, real estate, corporate management, laws, com-puters, electronics, auto, pharmaceuticals, and chemistry. This provides out-standing ability to conduct effective industrial analysis.

In overseas markets, the salary of a manager in a fund company falls below that of researchers. An insider recently told journalists that a fund company belongs to a stable growth industry and lives on fi xed commissionsprovided by investors. On the other hand, a securities company has morecyclic characteristics due to different sources of revenues. The more bullish the market is, the more revenues a securities company can reap. When the market is in favorable condition, overseas securities companies may offerwhopping bonuses that are virtually irresistible. In contrast, most overseasfund companies have an annual salary system for their staff.

Recent years of competition for investment talents in the domestic market has shown various major trends. The securities trader cultivatesresearch analysts who compete amongst themselves for such awards as the New Fortune Award and the Crystal Ball Award. The winners get to secure their industrial status and may expect bountiful and stable compensation. More established research analysts tend to pivot toward the position of an investment manager. Frequent job‐hopping from the position of a researcherto that of a fund manager has led to persistent vacancies on the research staff of many securities traders. It is not uncommon for one person in a securities company to keep track of multiple industries simultaneously. In fact, there is a shortage of researchers across the board in the securities and fund industries. In Shanghai, there is a static shortfall of at least 3,000researchers. Taking into account the possibility of profession‐hopping and business needs, it’s not an exaggeration to put the fi gure at over 10,000. In recent years, people have been paying increasing attention to researchers. Some fund investment staffers have resumed their old jobs as researchers in securities companies, largely because some securities companies are raising bonuses for researchers, having realized their value. The career development trend of investment managers is one‐sided: Investment managers move from securities companies to public offering funds, and then from public offer-ing funds to private placement funds. Behind the scenes, it is the invisiblehand of the market—the incentive mechanism—that is controlling the fl ow of resources. However, as domestic investors become more mature, theystart to notice that a substantial number of investment managers lack solid


investment experience. Some frequent concerns among investors include a short investment career, a marketing person turned investment manager, andincomplete absolute return records. The capital market investment manager team still needs to be built up step‐by‐step in parallel to the development of the Chinese capital market.

Sponsor Representative As competition intensifi es in the investment banking business, sponsor representatives have become hotly contended resources. Fueled by generous job‐hopping rewards, higher ranking positions, or a bet-ter platform, the mobility of sponsor representatives regularly picks up atthe turn of the year. An insider from a Shanghai‐based headhunting fi rm reveals that in his scouting career, few people resort to job‐hopping just forsalary. This is because there is no substantial difference in salaries offered to sponsor representatives by different securities traders. Even with somedifference, in this relatively closed talent market, the securities trader will be forced to raise the pay to keep up with other traders. Major reasons for job‐hopping decisions include better platforms and job promotions.

Investment banking staffers of several securities traders have identifi ed the following two trends in the fl ow of sponsor representatives:

1. Moving from large securities traders to small and medium securitiestraders

2. Flowing from foreign invested securities traders to Chinese invested securities traders

Securities companies with newly received licenses for the securities underwriting business and sponsoring business are also among the major recruiting forces. Some sponsor representatives have been preoccupied by hopping from one job to another for a long period of time without working on any project. A small number of newly appointed sponsor representatives are not very competent and have failed to fulfi ll their due diligence. In someisolated cases, some sponsor representatives were even reduced to contract signing duty while not actually involved in the project. How to enhance the management of sponsor representatives and fully utilize this resource is a question that urgently needs to be addressed.

Chartered Financial Analysts (CFA) Chartered fi nancial analysts mostly work for large investment banks. They are the top talents in the fi nancial industry. In the highly competitive and fast‐changing investment management sector, chartered fi nancial analysts represent the best work ethic and professionalism. Since 1963, chartered fi nancial analysts have been considered the standard of professionalism in the global investment fi eld. The gradual opening of mixed


operation in the domestic fi nancial market has created a shortage of elite talent in the domestic fi nancial industry. Some experts conservatively estimate that in the next seven years, about 10,000 chartered fi nancial analysts are going to be needed nationwide. However, according to statistics from the CFA Asia Pacifi c Association, only 1,800 chartered analysts were available in the country as of the end of 2010. CFA is an international calling card for fi nancial professionals. However, in order to put the expertise into application and create value, the calling card should be complemented with fi nancial practice.

Wealth Manager Wealth managers formulate sound wealth management plans based on the characteristics of various learned fi nancial wealth management products and wealth management methods. They do so in consideration of multiple factors such as asset scale, risk resistance, and profi t expectation of different demographics. As of the end of 2010, China’s balance of saving deposits of urban and rural residents exceeded CNY 30 trillion. Over the last fi ve years, CNY 2.84 trillion has been raised from the domestic stock market, which is 3.1 times the total amount raised in the fi rst 15 years after the opening of the market. China’s securitization ratio jumped from 17.5 per-cent in 2005 to 70.8 percent in 2010. By the end of 2010, the proportion of circulated stock value in the A‐share market had risen to 71.9 percent from 32.8 percent in 2005. The Chinese stock market has transformed from a partial circulation market into a unifi ed full circulation market. There is huge market development potential in the domestic personal wealth management business. Wealth managers will become a handy tool for the exploration of the personal investment and wealth management business for the securities industry.

Securities traders are now making great efforts to develop the invest-ment counseling business, in keeping with the major trend of wealth man-agement transition in the Chinese capital market. To a great extent, the success of the transition hinges on the securities traders building up their counseling teams and successfully establishing a profi tability model for investment counseling services. Unlike regular marketing, in investment counseling, a series of services are needed to improve “customer sticki-ness,” and revenues have to be generated from services. Investment coun-seling services differ from regular conduit business. In the overseas market, only a small conduit fee is collected for regular conduit services, whilethe value added by wealth management counseling services is the major source of revenue. The investment counseling business has at the same time raised the bar for marketing service talents, and increased market demand for such talents. The Chinese wealth management business cannot copy the overseas model. Instead, it has to experiment with its solutionsand keep exploring, through practice, for a wealth management model that best fi ts Chinese securities traders.


Risk Management Risk management talent is responsible for managing risks and safeguarding assets in a fi nancial enterprise. The ongoing fi nancial glo-balization has accentuated the great importance of risk management to the modern securities industry. Major functions of risk management includeassessing and monitoring risks in a securities company, keeping track of the market and conducting comprehensive risk monitoring, and managementin such aspects as fi nancial accounting, staffi ng, and discipline and cyber securities.

The risk manager controls and manages potential risks in day‐to‐day business operation activities of the company based on assigned duties and relevant authorization. The individual ensures the healthy development of daily business operation. A risk manager not only needs to have relevant qualifi cations, but also has to be familiar with banking, economics, law, andfi nance, as well as relevant risk‐management theories and techniques. Risk managers have to possess leadership, competence, and coordination skillsin operation management of the company. The duty of a risk manager alsoincludes identifying, assessing, monitoring, and controlling various risks the enterprise is faced with in its operation and management. The risk manager has an important role to play in the daily operation of fi nancial enterprises. Profi ciency directly bears on the risk prevention and control ability of the enterprise and may directly infl uence the realization of organizational value.

Information Management Information management talent is specialized in the collection, synthesis, feedback, and research of dynamic information in the fi nancial industry. The information battle among different regions and fi elds is getting fi ercer by the day. Economic intelligence collection helps dif-ferent types of enterprises identify new opportunities. Undoubtedly, excel-lent information‐management talent gives an edge in competition. The U.S. government started using the title of “chief information offi cer” (CIO) inthe 1980s. This designation was later adopted by commercial banks after its success in government. The CIO is responsible for the planning, design, improvement, operation, and maintenance of the information system. The CIO also provides the decision makers of the enterprise with information they need from different perspectives and at different levels. The CIO leadsthe information team in its efforts to tap into information resources rel-evant to the company, formulate the IT strategy of the enterprise, follow through with the IT layout of the company, and assess the value of informa-tion technologies to the enterprise. At the execution level, by collecting and analyzing information from within and outside the enterprise, the CIO pro-vides decision makers with a basis for decision making. By integrating the information fl ow, the logistic fl ow, and the cash fl ow, the CIO takes on the work of e‐commerce management and information engineering supervision.


The CIO constructs an information support system for decision making and execution of the enterprise with information technologies and managementtechniques.

Interdisciplinary Talent

Interdisciplinary talent includes extensive expertise, broad culture knowl-edge, versatility in skills with great potential for development, as well as a personality characterized by harmonious development and creativity. It embodies integrated knowledge, integrated capability, and integrated think-ing. Interdisciplinary talent professionals in securities companies under-stand both operation management and the securities business. Comparedwith specialized talent, interdisciplinary talent professionals create value for the client and the enterprise through integrated use of their expertiseand their managerial, marketing, and service abilities. For securities trad-ers, the essence of interdisciplinary talents lies in their entrepreneurship and capability.

Senior Managers Senior executives at headquarters, managers at specialized functional divisions, and operation management talent at various branches are the mainstay of a securities company. Only with their business planningand management support can a company properly implement its strategy in the real world and conduct its daily production and operation. Their majorresponsibilities include implementing the development goals set up by the decision makers, as well as taking charge of daily operation and manage-ment in various branches at various levels in the aspects of HR, technology, information, fi nance, and marketing.

Marketing Service Management Talent These are operation professionals directly facing clients of various demographics. They are responsible for wealth man-agement marketing services and the sale of innovative fi nancial products, as well as organizing and managing the implementation of the securitiestrader’s marketing strategies. They are responsible for marketing planning based on market rules and for overseeing the workfl ow of the staff. General managers of the operation divisions of securities companies have becomethe apple of the capital market’s eye. Numerous securities traders have come up with operation division general manager succession plans basedon the characteristics of their business. However, the market competition for excellent general managers is very intense. It is often the case that an enterprise takes pains to train talented individuals only to see them lured to work for a rival. It takes more than eight years to cultivate an operation division general manager to maturity. An important practical topic facing


many securities traders is how to attract and retain these marketing servicemanagement professionals through integrated managerial measures such as corporate culture, career development platform, and incentives.

COMPARATIVE ADVANTAGES AND DISADVANTAGES OF WEALTH MANAGEMENT TALENT IN THE SECURITIES INDUSTRY

In recent years, international fi nancial institutions have been struggling to develop the emerging wealth management business that will be a major pil-lar for the profi t of fi nancial institutions in the future. Wealth management originated in Europe and grew in the United States. For fi nancial institu-tions, wealth management is a new type of business operation model. For clients, wealth management is a type of integrated fi nancial service. Wealth management has become an emerging fi nancial fi eld perpetuated by securi-ties companies, commercial banks, and insurance companies. A large num-ber of commercial banks have started transitioning from capital providers to national wealth managers. Many securities traders have also jumped on the wealth management bandwagon.

Wealth management covers such aspects as investment counseling, life-long wealth management planning, and capital value retention and increase.It has become one of the three major business sectors of the global fi nan-cial industry, alongside credit/lending and investment banking. It is likelyto become the most important growth area. Sizable middle and wealthyclasses have emerged in China. Wealth management will therefore become a major contender among domestic fi nancial institutions. Specifi cally, wealth management involves providing clients with pragmatic plans, suggestions concerning relevant tactics, and action plans to help clients meet their wealth management goals in a comprehensive way.

In the fi eld of wealth management, securities traders have to face com-petition from banks and third‐party wealth management providers, as wellas other enterprises. At the core of the competition not only is there exper-tise, products, and brands, but also a profi tability model, which is even more important. Banks have obvious conduit and customer base advantages, but fall short in terms of the ability to provide professional services. Third‐partywealth management provides opportunities for matchmaking betweenupstream and downstream clients. Their core competitive strength lies in product development participation and selection. Securities traders do notcompare favorably with banks in terms of conduit networks, but they havean edge in their ability to provide professional services. In comparison with banks and mature third‐party wealth management, securities traders have


another weakness in the wealth management competition—a limited selec-tion of products to offer.

As far as professional service goes, securities traders can provide inte-grated fi nancing and investment business services. However, in their wealth management practice, most Chinese securities traders are still unable toeffectively integrate internal resources in a way that enables them to providetheir own characteristic, client‐centric, integrated institutional/retail/investment and fi nancing services. Often they simply confront banks and third‐party wealth management organizations on the product battleground. This is equivalent to fi ghting with a handicap, and the result is obvious. Accord-ingly, due to a lack of clearly defi ned wealth management profi tability mod-els, the team‐building effort for wealth management is a bit muddled. In investment counseling, oriented team building is hugely favored by securi-ties traders. In operation practice, however, securities traders still count on a team development model with marketing at the core. The dream of creating value through investment counseling services in reality suffers from a lackof profi tability model guidance, product support, and the ability to providehigh quality professional investment counseling services. Most securitiestraders are still taking baby steps on the path of wealth management transi-tioning and teambuilding, experimenting their way forward. Based on previ-ous discussions about the core competitive strength of securities traders and key talents, in order to develop wealth management, securities traders need to address the three core issues discussed next.

Profi tability Model Needs to Be Clearly Defi ned

Securities traders need to make it clear that it is their principle to center their services on the needs of the client and allocate the assets of the client professionally to ensure value retention and to increase the client’s assets. Wealth management needs of the client tend to arise from investment and fi nancing. Securities traders have multiple functions such as research, asset management, investment banking, outlet conduit, and product development. However, there is serious bureaucracy and departmentalism between most functional divisions. Even if a wealth management division is set up to leadthe effort, it can be diffi cult for it to coordinate things based on the needs of the client, becoming a target of departmentalism. In contrast, most of the outstanding investment banks or banks overseas have established a dedi-cated division to provide services for wealth management clients. Relevantdepartments and divisions, however, still have such common characteristics as a deep understanding of the needs of the clients and the ability to inde-pendently coordinate various resources in the company, to provide services for the clients based on their fi nancial condition and risk preferences.


Team Building Should Be Conducted in a Coordinated Way

For domestic securities traders, the success of the wealth management busi-ness relies on a couple of key talented professionals as follows:

■ Competent wealth managers should possess integrated marketing and service capabilities. Unlike middle ground service staffers (commonlyknown as “tutors”) in the operation division of many securities traders, a wealth manager cannot talk theoretically and provide stock recom-mendation services based on technical analysis. It has been shown in practice that it is extremely risky to manage wealth simply through stock recommendation. Wealth managers need to provide wealth individual-ized management services with privacy elements. Therefore, a wealthmanager needs to have rich social exposure, wealth management expe-rience, excellent marketing ability, and personality. A wealth manager has to win the trust of the client through a long period of interaction; it will not come with just a few successful stock or product recommenda-tions. The investment counseling qualifi cations granted by the industry are just the threshold for entrance. A competent wealth manager growsto maturity in marketing service practice. It will take some time beforethe effort to build such a team comes to fruition.

■ The operation division general manager should have marketing service competence, and more importantly, entrepreneurship. These general managers are the fi rst‐line commanders who lead the marketing service personnel of the branches in providing wealth management services for clients. They also have to be responsible for the revenue generation andfi nancial performance of the operation divisions. A competent opera-tion division general manager has to build the team, understand the clients and provide good services to them, and enable the operationdivision to make profi t or offset losses while providing added value to the clients. Generally, besides expertise, a successful operation division general manager should have the following abilities:

■ Entrepreneurial traits such as ambition and sense of responsibility for the profi t of the enterprise

■ Intelligence, logical thinking, creativity, and judgment ■ Control over interpersonal relations, including strong confi dence, ability to bring the best out of others and lead by example, beinggood at encouraging others and communicating with others, abilityto maintain close relationship with superiors and subordinates, opti-mism, and connection to the grassroots

■ Mature character and self‐discipline ■ Initiative and resolution


■ The ability to treat different opinions objectively and realize one’s own shortcomings

■ Flexibility ■ Frugality ■ Hardworking spirit

Solid Evaluation and Incentive Mechanisms Are Needed

The evaluation and incentive mechanisms support the profi tability model and the team‐building effort. They are also the institutional guarantee forthe implementation of the wealth management transition strategy. The eval-uation and inventive mechanisms should follow the principles of being fair,open, and just. Contributions should be accurately measured. Outstanding performers should be rewarded and the underperformers sanctioned.

Contents of the Wealth Management Business

Generally, the wealth management business can be divided into the following seven categories:

1. Asset management services: Based on the extent of client participation, asset management services can be further divided into entrusted asset portfolio management and proprietary asset portfolio management. In addition to traditional bonds and stocks, asset portfolio investment tar-gets also include new fi nancial products such as mutual funds, managed funds, unit trust, asset restricted funds, index funds, return guaranteed funds, umbrella funds, and value guaranteed funds. Specifi c target invest-ment includes fi nancing lease, affi liated companies, private equity invest-ment, venture investment, and leveraged M&A. Luxury investment may instead target paintings, porcelain items, sculptures, rare portraits, musi-cal instruments, jewelry, antique cars, and horse‐drawn carts.

2. Insurance services: These include life insurance, personal accident insur-ance, general insurance, and medical insurance.

3. Fiduciary services: The client entrusts the bank with operating and man-aging the assets according to the requirement of the trustor.

4. Taxation counseling and planning: Taxation planning may includedrawing up a preimmigration tax plan for immigrants; taxation coun-seling and planning unrelated to investment; quasi‐fi duciary services, including fi lling out the tax return; tax law and procedure assistance; and taxation counseling and planning in relation to investment man-agement, such as the impact of income tax, company dividends, stamp tax, capital gains, and taxation laws on asset portfolio management.


5. Estate counseling and planning: Estate planning is necessary to drawup a will and inheritance contract, implement the will, and liquidate the assets of the deceased.

6. Real estate counseling: This includes real estate research, real estatepurchase, real estate fi nancing, contract review, and real estate liquida-tion.

7. Other services: Other services include concierge services, such as ticketpurchases, and pet services.

Functional Requirements for Wealth ManagementService Personnel

Wealth management is not simply the job of a single individual. To a greater extent, it is the job of a wealth management team. The wealth managementteam includes the following professionals:

■ Investment managers ■ Insurance experts ■ Tax advisors ■ Lawyers ■ Profi t counselors ■ Commerce experts ■ Lifestyle experts ■ Accountants

Wealth management goes far beyond the traditional concept of manag-ing the assets and wealth of the client. It involves planning for the entire life of the client and is inclusive of everything from wealth and legal disputes to estate planning.

Excellent wealth management personnel give full consideration to the overall fi nancial state of the client. They are able to make effective plans based not only on the current condition, but also the future fi nancial situations of the client, as well as possible capital demands and fi nancial crises.

Evaluating the Overall Financial Condition of the Individual at Present This is the bedrock of wealth management. For this task, suffi cient client information should be gathered to enable the wealth manager to achieve the follow-ing goals:

■ Evaluate the current fi nancial condition of the client. ■ Understand the character of the client (risk tolerance).


■ Understand the short‐term and long‐term goals of the client. ■ Formulate a series of strategies to achieve these goals.

Identifying Their Purposes and Goals Wealth managers demand that clientsclearly express their goals. They have to determine if these are individual goals or family goals. They also need to know the quantities of the goals, whether these goals are practical, and whether they are attainable and quan-tifi able. While setting up goals for clients, a wealth manager may design different investment plans based on different time cycles. Short‐term clientsmay need to fi nalize home mortgages and car loans, for example. There-fore, the wealth manager may arrange for assets with low risks and good liquidity. On the other hand, for long‐term investment goals of the client,the wealth manager may focus the investment more on products with less liquidity but higher returns.

Identifying Potential Problems After setting up goals for the client, the wealthmanager needs to compare the gap between the current fi nancial condition of the client and the target, and then evaluate the feasibility of attaining the client’s goals. Wealth management should pay attention to the client’s goals and needs in terms of insurance, investment, retirement, estate planning, and special needs.

Recommending Possible Solutions Upon completion of the information gather-ing and goal identifi cation tasks, the wealth manager starts designing the investment plan. In a well‐established capital market, the design tends to be done using professional software. Based on the input of the client’s capitalfl ow, current fi nancial condition, and various goals, the software automati-cally calculates the investment portfolio for the client and provides sensible suggestions.

Providing and Implementing Suggestions The client and the wealth manager implement the plan. The key to this part is to coordinate with and seekassistance from other external advisors, including accountants and lawyers.As noted earlier, wealth management is not the job of an individual, but the efforts of a whole team. As a coordinator, the wealth manager needs coop-eration from various external professionals. The accountant may providetax suggestions, while the lawyer may provide professional services in rela-tion to estate matters of the client.

Supervising the Wealth Management Plan The wealth manager needs to super-vise the implementation of the wealth investment plan. The investment plan is not unchangeable. In fact, the investment portfolio is usually


subject to an annual review. If major changes occur in the fi nancial con-dition of the client, the wealth manager has to reorganize the investment tactics.

Generally, the following competences are required in order to engage in wealth management:

■ Expertise in the fi elds of fi nance, securities, investment, and insurance ■ Strong communication capability and skills ■ More importantly, the ability to gain the trust of the client

Wealth management in a real sense has a high degree of privacy. The basis of privacy is interpersonal trust. From this point of view, wealth man-agement is an integrated manifestation of one’s skills concerning han-dling people, professional service, marketing, and psychological analysis. Individualized high‐end wealth management services need privacy. In fact, the main difference between wealth management and common personal fi nance is that wealth management targets high‐end clients, and greater emphasis is put on security and privacy. In terms of hardware, the wealth management center has to provide clients with private meeting spaces.

In terms of software, the wealth management center has to be equipped with a complete and integrated data management system for regular tracking. The account manager should create a personal fi le for each client to record personal information such as life cycle, risk pref-erence, characters, wealth management products previously bought, and expectations for return from future investment. The data has to be supplemented and improved constantly to provide clients with accurate wealth management and investment suggestions on a regular basis and to deliver individualized services. Thoughtful services are very important for the wealth management business to be conducted effectively and for the client to accept suggestions provided by the account manager. In order to broaden and widen the services, the bank has to prioritize the client’s needs and provide a series of services throughout the cycle such as education, tax avoidance, insurance, retirement, wealth transfer, and estate planning.

A “humane” approach is key to thoughtful services. Importance should be given not only to the client’s wealth management demands, but also to their psychological needs. Account managers should be allocated based on the characteristics of each client to promote effi cient communication and improve acceptance and responsiveness. For the client, a wealth manager should provide individualized value‐added services. For the securities com-pany, a wealth manager should be able to increase the enterprise’s assets and revenues.


Wealth Management Talent Environment Analysis

Quantitative Analysis of Talent Demand With the development of the Chinese capital market, the demand for wealth management talent will signifi cantly increase in the market. Data shows that the value of the domestic wealth management market in China has far exceeded CNY 100 billion. In the wealth management market of a city, there should be at least one profes-sional wealth manager for every three families. Currently, there is a wide gapin the wealth management profession in China. In Shanghai alone, 50,000 more professionals are needed. In China, less than 10 percent of consum-ers have received professional management for their wealth, compared to50 percent in the United States. Both securities companies and banks alike are in dire need for wealth management professionals. Wealth management services are targeted to high‐end clients. The content of services covers such a variety of areas including stocks, funds, insurance, foreign currencies, gold, futures, tax avoidance, and asset planning. This dictates that these professionals need a high caliber of comprehensive talents. They have tobe well‐trained, perspicacious about international fi nancial market move-ments, and possess extraordinary interpersonal communication skills and organization/coordination capabilities. However, as a result of the separatedoperation of different business units in Chinese banks, the availability of such a comprehensive set of talents is diffi cult to fi nd.

The wealth management business for both securities companies and banks is still rising, constrained by separated operation in the fi nancial industry, overrestriction on products offered by fi nancial institutions for their clients, and a lack of choice. The wealth management business is less than successful in the domestic market, thanks to the lack of products. Most services offered to the clients are product driven. They consist of market-ing for the purpose of product promotion. Wealth managers of banks andinvestment advisors in securities companies act more like senior fi nancial salespeople.

Client Group Analysis As relatively well‐established fi nancial bodies in theChinese fi nancial industry, banks are in a favorable monopolistic position due to their outlet resources and credit. Wealth is increasingly concentrated in Chinese society. According to indexes released by the National StatisticsBureau, the standard annual income of a middle class family is between CNY 60,000 and 500,000. Based on this standard, Merrill Lynch predicts that in the next 10 years, the middle class population in China will reach 350 million. Ernst & Young estimates that there are currently 150 millionmiddle-class people living in China. BCG estimates that by 2013, the numberof Chinese millionaires had reached 2.4 million, and that China, behind the


United States, has the second largest number of families with total assets of more than USD 1 million.

The income of domestic residents is increasing rapidly. China’s socialwealth and individual wealth have shown a conspicuous upward trend.As of September 2011, the GDP of China (absolute value) reached CNY 32.0692 trillion. In terms of domestic resident wealth accumulation, theaverage disposable income of urban residents increased from CNY 343 in 1978 to CNY 19,109 in 2010. The balance of savings deposits for urban and rural residents at 2010 year end broke through the CNY 30 trillion mark, to reach CNY 30.7166 trillion. The balance of resident savings deposits has been growing rapidly, with the annual growth rate averaging 16.5 percent from 2000 to 2008. The fast growth of resident disposable income and savings deposit balance has laid a solid foundation for com-mercial banks to engage in the wealth management business. A large num-ber of depositors have become potential clients of the wealth management business of banks.

In terms of the accession threshold for client groups, the threshold for wealth management is higher in a bank than in a securities company. Cur-rently, the threshold for VIP wealth management in Chinese capital banks is about CNY 300,000. In comparison, the threshold in securities companiesis typically around CNY 200,000.

Product Line Analysis The vigorous development of the wealth manage-ment market has attracted the participation of institutions in various sectors of the fi nancial industry. The banking industry has been making great efforts to develop its wealth management business, drawing on its advantages in outlets and size of client base. According to incomplete statistics, in 2009, banks launched more than 7,000 wealth manage-ment products, 15 percent more than in 2008. China Merchants Bank alone launched over 700 wealth management products, raising as much as CNY 1 trillion. In comparison, products launched by securities com-panies fall short in terms of both variety and quantity. In response to the conditions of the capital market over recent years, a majority of excellent wealth management products launched by securities traders are fi xed‐return products with low risks and fi xed profi ts. Most of them use the bank deposit interest rate over the same period as the performance benchmark. For clients with a high‐risk preference, securities companies may draw on their professional think‐tanks to come up with more inno-vative fi nancial derivatives, most of which are leveraged and belong to the high‐risk, high‐return category.

The lack of variety has become a bottleneck for securities trad-ers in their effort to develop the wealth management business, as the


development of salable products based on market conditions crystallizes the service capability of a securities trader. In the context of the cur-rent bear market, securities traders would be well‐advised to provide clients with fi xed‐return products, as well as currency products such as the repurchase of treasury bonds, monetary funds, and short‐term bond funds. With good liquidity, stable return, and slightly higher yield than the demand deposit rate, such products help the client retain value in a bear market. For securities traders, they are also helpful to the retention of client assets in a bear market.

Resource Input Analysis Good wealth management requires the support of an excellent information system. Effective segmentation of high‐quality clients may help examine client contributions, assess the service quality and costs of an account manager, understand the demand for a certain product and its return on investment, and formulate better client man-agement plans. Securities traders need to devote certain fi nancial and material resources to upgrading and improving databases and informa-tion resources. This will help set up an automated wealth management system in support of the fi rst‐line service staff. In addition, the inexpensive electronic and cyber conduits will provide handy services for clients on a real‐time basis. When changes take place in client assets, such as when there is wide fl uctuation in the exchange rate, interest rate, share prices, or the net values of funds, the wealth management system should be able to provide real‐time notifi cation to the client, along with personal wealth management recommendations. Although securities companies have been committed to improving and upgrading their information system in recent years, there is still a substantial gap in terms of meeting the requirements for wealth management.

Service Capability Analysis The goal of traditional product‐centric wealth management is to sell more products. However, fi nancial products cannot be patented. Therefore, a product is not likely to stay in a leading positionfor very long. The only means to retain clients and win the favor of the mar-ket is good services. Therefore, in recent years wealth management has beenpivoting toward a client‐centric approach, as emphasis is increasingly puton excellent services. After years of reform, a service philosophy that puts client needs as the central focus has been basically established in Chinesecommercial banks. However, the services offered by Chinese commercial banks can be characterized as being hardware‐based, rather than software‐based. The hardware is not combined with commensurate service levels and professional advisory skills. The wealth management center is not able to provide customized client service models to meet the different needs of


various wealth groups. Unfortunately, this is indispensable to wealth man-agement. Securities companies, in comparison, are slightly more advanced than banks in terms of research and service capabilities, especially for ser-vices related to the secondary market.

Third-Party Wealth Management Companies Currently, separate operation andseparate regulation are practiced in the Chinese fi nancial industry. Third‐party fi rms such as Noah Wealth Management, Hang Tang Wealth, Rhine Wealth, and Haobuy Fund belong to the “shadow banking” system. They engage in mixed operation in a separate‐regulation environment. These com-panies do not have a particular license for the fi nancial industry, but they sell products and gain profi ts with a product sales permission in the insurance,limited partnership, and fi duciary sectors. They also do this through regula-tion avoidance. For example, Noah Wealth’s argument is that they have nowealth management products and no handling of client funds—they only provide suggestions and counseling services. In practice, however, it is very diffi cult to draw a line between advising and selling. So far, this market is less than CNY 100 billion in value. And yet, Noah Wealth alone has a mar-ket share of CNY 30 billion.

By targeting high‐end clients, independent third‐party wealth management fi rms provide wealth management services and product packages by integrating upstream and downstream resources. They do so with diversifi ed product lines as their central theme and with the investment counseling staff as their main-stay. Their main profi tability model does not charge the end client, but earns sales commissions from product suppliers. For Noah Wealth Management and Hong Kong Convoy Wealth Management, profi ts in the wealth management business are mainly a result from recommending products of fi nancial institu-tions to their clients, and then sharing the profi ts with the product distributor. A commission between 1 percent and 4 percent of product sales is collected from the product supplier. They also gain profi ts by establishing a membership system (Gaofu Investment Advisory with Australian background, Beijing MyFP Advisory Wealth Advisory) or a counseling fee system (Haobuy Fund, TX Investment Consulting), or by extending into product design and management (Noah Wealth Management). Noah also offers such services as family fi nancial balance allocation planning, as well as family fi nancial investment, tax, and real estate investment counseling. The third‐party wealth management models of Zhongrong Trust and Jiashi Fund are still in the process of taking shape.

The profi tability models of third‐party wealth management fi rms as represented by Noah are becoming increasingly sophisticated. However,the fundamentals remain the same. They claim to provide clients with onlywealth management suggestions. However, these companies look for proj-ects, on the one hand, and capital and clients on the other. When a matching


pair is identifi ed, they use the shell of a trust company to make a trust prod-uct, or use the currently popular limited partnership to make a PE product. They actually play the role of a fi nancing intermediary, or a shadow bank.In its early stage, Noah used to invest in some public offering funds and cooperate with securities traders. But it is very risky to offer client assetvalue retention and increase services relying on only the secondary market. Starting in 2007, the company has been gradually diversifying client asset allocation and extending its business to trust products and PE investments.

Currently, Noah’s products fall into the following four categories:

1. Public offering funds 2. Investment-related insurance products 3. Fixed-return products (including mortgage‐backed fi xed-return prod-

ucts issued by trust companies) 4. Private equity fund products (including private equity fund products

issued by domestic and foreign fund management institutions)

Judging by data from the fi rst three quarters of 2010, the percentage of securities fund and investment‐related insurance products declined sig-nifi cantly, while the percentage of private equity fund products rose to 68.7 percent. Noah is optimistic about the development of private equityfunds. Third‐party wealth management companies have been rising quickly in terms of fi nancial product sales based on a large amount of high‐end clients and conduit resources, in combination with participation and place-ment in product development. Their fast growth has provided a very helpfulmodel for wealth management transformation.

There is a question about risk management at this point. In case matur-ing trust plans or wealth management products suffer a defi cit due to major changes in the securities market, what kind of risks and responsibilities should a third-party wealth management company bear for the wealth man-agement products sold through its own conduits? Regulatory provisions on this matter are rather ambiguous at the moment.

EFFECTIVE TALENT MANAGEMENT IN SECURITIES COMPANIES

The development of the securities industry, changes in the operation environ-ment, and increasingly fi erce competition are raising and changing the criteria for securities professionals. The high criteria for talents and the complexity of the mechanism have set higher standards for talent management processes including recruitment, training, and incentives in securities companies.


Human resource management refers to the effective allocation of human resources according to a plan based on the requirements of an enterprise’sdevelopment strategy. It uses a series of processes such as recruitment, train-ing, deployment, assessment, incentives, and readjustment. Human resources management motivates the staff, taps into their potential, creates value for the enterprise, and ensures the realization of the enterprise’s strategic goals.It includes a series of human resources policies and the corresponding man-agement activities of an enterprise.

Characteristics of Securities Company HR ManagementDetermined by the Industry

Compared with other types of enterprises, securities companies tend to have an enriched pool of high‐caliber talent. Human resources play a far greater role in a securities company than in a common enterprise. This gives rise to some special characteristics of human resources management in a securitiescompany, as compared to other industries.

High-Caliber Personnel The securities industry is one of the most talent‐intensive industries. A behavior‐oriented human‐based management model with corporate culture at its core should be the best approach to human resource management in this type of securities company. Human‐based management, however, does not preclude competition. On the contrary, the competition mechanism should be the key note of the corporate culture of a securities company. The construction of a favorable working environ-ment sets the stage for all employees to give full play to their talent and display their skills. On the other hand, the introduction of the competi-tion mechanism strengthens the internal motivation and self‐discipline of employees. There are many ways to apply human‐based management at the workplace. Examples include career planning based on the characteristics of an employee’s capabilities, replacing lecturing‐based employee training with research‐based employee training, providing more opportunities for communication and cooperation between different divisions and between different employees, self‐assessment, and project teams voluntarily formed by employees.

Modern organizational behavior studies have started paying attention to motivations of work‐related behaviors. Motivation is defi ned as a pro-cess that refl ects the magnitude, direction, and persistence of an employee’seffort to reach a goal. Magnitude refers to how much effort a person is will-ing to make. However, high magnitude does not necessarily lead to satisfac-tory performance at work, unless the effort is in line with the development direction of the company. Therefore, managers should guide the behaviors


of employees so that they are aligned with the strategic development direc-tion and business planning of the company. The persistence factor refers tothe period of time over which an individual is willing to keep working for the goal. For example, is the individual willing to work on a task for a long time until the target is met?

According to Thomas’s (2000) internal motivation theory, the most effective way to inspire the internal motivation of an employee is to let the employee have a sense of choice, a sense of competence, a sense of signifi -cance, and a sense of progress. To gain a sense of choice, employees need to be able to choose the work content and approach that makes sense to them, which is also an important factor in human‐based management. To gain asense of competence, an employee has to feel fulfi lled at the completion of the work. To gain a sense of signifi cance, the employee has to be able to feel the intrinsic value and long‐term signifi cance of the work. The sense of prog-ress comes from the growth and development experienced by the employeeat work, which is also the bedrock of the modern human‐based manage-ment theory. Human‐based management allows the employee to engage in meaningful work content that is appealing and inspires his or her internal motivation to accomplish the work.

Diversifi ed Business Categorization Requires the Leadership of the Company to Play a Leading Role in a Series of Human Resources Decisions The internal labor divi-sion of a well‐fl edged, multiservice securities company is no less complex than that in a large enterprise group. Based on their nature, different posts need different personnel competence, knowledge structures, and work approaches. This calls for higher responsiveness and specifi city in corporatehuman resources management. As a result, human resource management insecurities companies is trending toward greater power for division managers who are in direct contact with grassroots employees. The division managerwill have a greater role to play in such aspects as recruitment, assessment, incentive policies, and training.

High Personnel Mobility Becomes a Double-Edge Sword in Human Resource Management Frequent job hopping among employees is a nuisance for any securities com-panies. The loss of quality talent acts as a double whammy for a securities company because with the lost talent goes a part of the company’s develop-ment process. On the other hand, in order to optimize the personal structureand create a virtuous competition environment, securities companies doneed to maintain a suitable level of personnel mobility, which is conduciveto the vitality of the enterprise and the health of its business operation. It is currently believed that 10 percent is an appropriate personnel mobility rate. However, that fi gure is useful as a reference only. Different companies may


have different standards. Something that needs to be foreseen and protectedagainst is personnel mobility leading to excellent employees frequently leaving. Less‐than‐competent employees then become diffi cult to remove. Therefore, to address this confl ict in personnel mobility, managers of a secu-rities company should step up their effort in such aspects as incentive level, retention of outstanding talent, performance‐based promotion and relega-tion, and the establishment of a personnel exit mechanism. The issue should be vigorously addressed from both sides.

The Prevailing “Buyer’s Market” of Talent Is Forcing Securities Companies to Make Breakthroughs in Their Talent Recruitment Techniques The securities industryis one of the most promising sunrise industries. It is extremely appealing to high‐quality talent. The human resource management divisions of securities companies don’t have to worry about understaffi ng. However, how to iden-tify the best among the candidates while avoiding incompetence remains a pressing question. So far, some leading enterprises in the industry have started introducing quantitative intelligence and psychological evaluation techniques in their recruitment processes. They have done this to reduce subjective fac-tors and lower the probability of error. This has opened a new front for the improvement of human resource management in securities companies.

Information Plays an Essential Role in Business Competition Securities companies must establish a resource gathering and sharing incentive mechanism open to the entire staff. Human capital is at the core of competitive strength in thesecurities industry. An individual’s resources, such as information and rela-tions, are important ingredients for one’s personal human capital. However, a securities company with foresight should establish a set of resource gather-ing and sharing incentive mechanisms open to the entire staff, so that everyemployee will voluntarily and willingly collect information for the company.All available resources can be tapped in to their full extent, helping improve the performance of the company.

Development Trend of Human Resource Management in Securities Companies in the Future

Industrial competition continues to intensify and information technology spreads at an accelerated pace. The status and functions of human resourcemanagement in securities companies will experience profound changes over the next few years. In the future, human resource management in securities companies will display the following three trends:

1. Human resource management is evolving into an HR information cen-ter, research center, organization center, and coordination center of the


company. In order to fi t into the development trend toward decentral-ized management, the human resource management division needs to put in place a complete HR information database with extensive coverage, including such contents as HR information (employee and job appli-cants), HR policies, advanced management methods and approaches, and management experience contributed by other people. Line managers can then handily consult relevant materials while making HR decisions. How-ever, the information center also functions to coordinate communication between the management and the employees concerning the goals of the company, the operation condition, and reasonable suggestions from the employees. Ceding part of its line management authority does not reduce the importance of the human resource management department. Its sta-tus and functions in the company will instead become more essential. The human resource management department will become the engine of corporate optimization and reform. One of its new tasks involves design-ing advanced and practical assessment and incentive policies and training methods to better tap into the potential of the employees, based on the specifi c situations of the company. In order to draw on the cumulative advantages of various divisions of the company and accentuate the inte-gration effect, the human resource management department also has to assume the role of the organization center and coordination center. In operation projects that can be completed only through interdepartmen-tal collaboration, the human resource management department plays the role of organizer in the early stages of the project. It plays the role of coordinator when problems or confl icts need to be addressed, during the middle stages of the project.

2. Information and cybertechnologies are the brightest features of the twenty‐fi rst century. They have brought refreshing changes to the secu-rities industry, but the focus of competition between securities compa-nies has gradually shifted from low‐level hardware competition over the environment and equipment improvement to high‐level competitionover service quality. The account manager system has become an inevi-table trend for future development. As a result, the trickiest problemfacing securities companies in this century will probably be a situationwith a large number of employees made redundant by technological progress on one hand and a major shortage of professional talent on the other. Therefore, human resources management departments shouldtake precautions by stepping up training efforts to redevelop redundant staff by making great efforts to address the personnel exit issue, while protecting the development of the company and the stability of society.

3. Cybertechnology will greatly improve the methods and means of human resource management and signifi cantly raise human resource management


effi ciency and results. External recruitment is a top priority in human resources related work. Recruitment is convenient and easy to do in cyberspace, where the quality of recruitment is also signifi cantly higher. Applicants can take cybertests remotely, which enables the enterprise to choose from a bigger pool of talent and screen more candidates at the same time. In terms of recruitment quality control, information provided by the applicant can be verifi ed directly in a website, which helps the enterprise avoid unqualifi ed candidates. With all branches of the company connected through remote satellite transmission and intranet, the human resource management department can easily organize training and rel-evant assessment online. The human resource management department can also arrange that all employee performance be evaluated across divi-sions or individually in cyberspace. Thus, the evaluation results become more fair and objective, and evaluation data can be processed directly with computer software. The human resource management department can also take advantage of the information dissemination function via the Internet to honor employees, making it known that certain employ-ees have been rewarded, or to run reports on outstanding employees. This is not only a high distinction for the employee, but also an effective behavior guidance education for the entire workforce. Cybertechnologies streamline the internal information exchange and communication of a company. It is even possible to gradually establish and cultivate a sound and positive corporate culture in the company through persistent ideo-logical instillation and public opinion guidance.

Theoretical Frameworks for Human ResourceManagement in Securities Companies

A fi rst‐class workforce must be matched with fi rst‐class human resource management. The improvement of human resource management depends not only on innovation in approaches and techniques, but also, more impor-tantly, on a fundamental change of management concepts. Based on the industrial characteristics of securities companies, their human resource management work needs to build a management system characterized by “one system, two strategies, three levels, four bodies, and fi ve mechanisms,”as detailed below:

■ One system: This refers to the information communication system. It isthe artery of an organizational body and a potential business expansion cradle in a securities company. Effective information communication is an important block for the building of team spirit and corporateculture. The information communication system can build horizontal


and vertical connection channels that are orderly and interactive. Based on these channels, the company may, in a timely manner, inform theemployees about the company’s goals for future development, current operational situation, and existing weak links. Lower‐ranking depart-ments and employees can give their feedback to the decision makers of the company or relevant departments, including their suggestions anddiffi culties facing them. Information is no longer proprietary. Given cer-tain channels, even a layman is able to obtain certain information ahead of others. This is particularly true in securities companies. Therefore,through the establishment of sound and institutionalized information communication channels and information gathering and sharing incen-tive mechanisms, it is possible to take full advantage of each employee’sinformation gathering channels for the purpose of improving the com-pany’s profi ts.

■ Two strategies: The term two strategies refers to the development strategy and human resource strategy of the company. Actually, there is an affi liation relationship between the two strategies. The latter is an important part of the former, while the former provides the basis and specifi es the fi nal goals for the latter. In the next few years, the Chinese securities industry will enter a critical stage in its evolution. Every secu-rities company will have to formulate its own development strategy for the future based on its own conditions and position itself properly in the future market. Accordingly, human resource management departmentsshould also formulate human resource strategies that are foresightedand practical, so that they can adjust ahead of time the knowledge struc-ture of employees, optimize the set‐up in various departments, forecasthuman resource demand, reserve professional talents, and build up the company’s core competitive strength with a head start.

■ Three levels: A sound and effective human resources management sys-tem should center on the human resources strategic planning. Work should be carried out on three levels: fundamental work, institutionalconstruction, and culture management. Of them, work at the funda-mental level is the basis of human resources management. It includesadministrative routines such as work analysis and management of labor insurance, social insurance, and various provident funds. Institu-tional construction mainly includes external recruitment mechanisms, performance assessment mechanisms, employee training mechanisms, incentive mechanisms, and competition mechanisms. Work in these fi elds is the most important component of the human resource manage-ment system, and also the indicator of the management quality of an enterprise. Culture management refl ects the highest level management art of an enterprise. Corporate culture is the sum of a series of codes


of conduct that embodies a value system formed in the internal andexternal environments of an enterprise. By building a vigorous, positive,and enterprising corporate culture, efforts by different employees and departments can be integrated to form a set of evaluation and judgmentstandards that is conducive to the development of the company and that cause the employees to work hard and be willing to thrive and fail together with the company.

■ Four bodies: In securities companies, human resources management iscarried out by four different groups: the leadership of the company,heads of departments, human resource management personnel, andindividual employees. The leaders of the company are the commanders-in-chief in human resource management. They lead the securities com-pany into human resource management reforms, advocate the creation and evolution of corporate culture, and get personally involved in theprocess. In practice, human resource management affects the interestsof every employee. Without strong support and oversight from the topleaders, positive changes in human resources management can hardlycome to fruition. Department heads and the human resources manage-ment department form the main body that conducts human resourcemanagement. Of these two groups, department heads should gradually assume the leading role, as the function of the human resource depart-ment becomes a supportive role. Employees are at the center of human resource management. They are active participants of human resourcemanagement work. Because employees of securities companies are high‐caliber talents working highly decentralized and individualized jobs, human resource management in securities companies should make a greater effort to guide the employees to engage in self‐training, self‐development, self‐encouragement, and self‐management.

■ Five mechanisms: These are the fi ve most important mechanisms amongvarious aspects of human resource management: the external recruitment mechanism, the performance assessment mechanism, the development and training mechanism, the incentive mechanism, and the competition mechanism. Talent is the core competitive strength of a securities company. But how to identify the best among a large number of high‐quality applicants is an important topic for human resource management departments. Development training is an important means to improve the human resource content and realized sustainable development of the company in keeping with the regenerative and proliferating properties of talents. A high‐caliber staff is usually characterized by self‐awareness and spontaneity. The contents and approaches of training should be adjusted accordingly. For example, the training approach may shift from spoon‐feeding‐style lecture sessions to explorative research sessions.


Performance assessment is the foundation for the manifestation, retention, and improvement of talent value, and the basis for the compensation system, employee promotion, and training. Performance assessment in securities companies should be managed at a series of separate levels and carried out on a regular basis. The items assessed should be specifi c. The inventive mechanism is an important means to improve employee engagement. In principle, incentive measures in securities companies should be implemented on the corporate and department levels. At the corporate level, the human resource management department should head the formulation of inventive mechanisms, and heads of departments should provide incentives for employees in their respective departments in a timely and moderate manner. Competition is the key note of the corporate culture of a securities company. The competition mechanism is the fundamental guarantee for the optimization of personnel structure, the improvement of employee quality, and the activation of human resource deposit. In practice, the human resource management department may adopt various measures such as competition for positions, unconventional promotions, job rotation, and appropriate dismissal in order to boost employee morale and promote the fast development of the company.

REFERENCES

Cascio , Wayne F. 2006 . Managing Human Resources. Translated by Wang Chongming. Beijing : China Machine Press .

China Statistical Yearbook and data disclosed by the website of the National Bureau of Statistics. Retrieved from www.stats.gov.cn/english/. Last accessed August 1,2014.

Pose , P. S. 1999 . Bank Management and Financial Services. Translated by Tang Xuand Wang Danyi. Beijing : Economic Science Press .

Robbins , S. P. , and T. A. Judge . 2008 . Organizational Behavior. Translated by LiYuan and Sun Jianmin. Beijing : China Renmin University Press .

Thomas , K. ( 2000 ). Intrinsic Motivation at Work: Building Energy and Commitment. San Francisco, CA : Berrett‐Koehler Publications Inc.

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http://www.stats.gov.cn/english/

349

CHAPTER 7 7 Analysis of Sponsor Regime for

Chinese Securities Companies

The sponsor regime is an institutional innovation intended to improve the securities issuing system. It was initiated by China’s securities market

and is based on its success in overseas markets. From the perspective of its operation, however, there is an asymmetry between risk and return forsponsors. This has been cause for concern and criticism of the sponsor regime. This chapter reviews a number of enforcement sanctions that the ChinaSecurities Regulatory Commission (CSRC) has taken against sponsors since 2004. The chapter also makes policy recommendations to help improve the sponsor regime for the future.

ORIGIN AND DEVELOPMENT OF THE SPONSOR REGIMEIN CHINA

The sponsor regime of the Chinese securities market was gradually estab-lished as the stock issuing system was continuously improved. This wasdone in consideration of the development history of the overseas securitiesmarket.

Sponsor Regimes in Overseas Securities Market

The sponsor regimes of overseas securities markets, such as the United Kingdom, the United States, Malaysia, and Hong Kong, each have their own characteristics.

The U.K. Alternative Investment Market (AIM): Lifelong Sponsor System The Alter-native Investment Market (AIM) was launched in 1995 by the London Stock Exchange. The sponsor regime is a requirement for the orderly andsteady development of the AIM. It is also a means to prevent and dissolve


risks in market operation. The fi nancial market regulation in the UnitedKingdom has long been known for its strictness. The primary objective of institutional regulators is to maintain market confi dence and safeguard the interests of investors. In light of the omnipresent coexistence of high return and high risk, regulators require that enterprises listed on the AIM comply with the lifelong sponsor system. Lifelong sponsor means that an enterprise must, from the day it goes public, have a sponsor to ensure its operation activities comply with market rules. A sponsor should be in place for every single day the enterprise remains public. If the sponsor position becomesvacant, the sponsored enterprise has to suspend its stock transactions until a new sponsor takes over.

The sponsor has different roles to play before and after the enterprise goes public. Before public listing, the sponsor is mainly responsible for reviewing the quality and condition of the enterprise, ensuring that it meetsthe standards and requirements for public listing and providing advice for the enterprise to be listed. At this point, the sponsor essentially plays theroles of tutor and independent auditor. After public listing, the focus of the sponsor’s work shifts to urging the enterprise to continuously abide by mar-ket rules and perform its information disclosure duties. The sponsor mayalso communicate with exchanges and investors on behalf of the enterprise. At this stage, the sponsor plays the roles of board of directors’ secretary andpublic relations expert.

The U.S. NASDAQ Market: Assorted Sponsor System The NASDAQ market doesnot have special regulations regarding sponsors. However, the role of a spon-sor is implicitly manifested in the responsibilities of securities underwriters, market makers, peer review committees, professional council members, and securities regulators. In other words, the NASDAQ market has developed a comprehensive assorted sponsor system. This system includes mandatory legal person governance structures, peer review plans, voluntary professional council guidance plans, and professional services provided by underwriters, market makers, and analysts. It also includes a system of material regulatory examinations. These systems perform their own functions in coordination to successfully spread out risks and protect investors, as detailed next:

■ The two most critical elements of the “assorted” sponsor system are the mandatory legal person governance structure and the professional council guidance plan. Both these elements work perfectly in place of the core functions of a sponsor system. Requiring small‐scale capital markets to meet the high standards of national markets can effectivelyprevent risks in the growth enterprise market. The establishment of inde-pendent audit committees, whose members are exclusively independent

Analysis of Sponsor Regime for Chinese Securities Companies 351

directors, motivates the company to exercise self‐discipline, which ensures a standardized and law‐abiding operation.

■ Exchanges offer professional council guidance plans for all listed com-panies. Council members usually have rich experience and professionalknowledge in the industry in which the issuer operates. They therefore can answer stock‐related questions and provide comprehensive guid-ance for the company. The council members also remain in contact with investors, essentially playing the role of a market advisor for companiesabout to go public.

■ In the NASDAQ market, it is the market regulators who conduct material examinations on the public listing conditions of the issuing company. In particular, IPOs are regulated by both federal laws andstate laws, in addition to rules of self‐discipline organizations such asexchanges. The Securities and Exchange Commission (SEC) is mainlyresponsible for reviewing the operation and fi nancial performance of the issuer, whereas NASDAQ examines the charging standards, issuing terms, and arrangements to determine if they are reasonable.

■ In NASDAQ, the underwriter provides various listing services, including counseling on strategic decisions affecting the development of the com-pany, various forms of support for the trading of the enterprise’s shares, and continuous research services. The market makers provide compre-hensive services, including publishing research reports on the under-written shares, facilitating transactions of shares through retail channelsand institutional dealers, and providing fi nancial advice in relation toIPOs and follow‐up fi nancing activities. Among those services provided by intermediary institutions, the exact duties and functions of a sponsorare the analysis, counseling, research, and trading support.

The Malaysia MESDAQ Market: Relay Sponsor System The MESDAQ Market of Malaysia was opened in 1997. It was geared toward high‐tech companieswith great growth potential and operated independently from the Kuala Lumpur Stock Exchange. Its “relay” sponsor system subjects a company todifferent rules before and after its public listing. All companies applying for public listing must hire their main underwriter as the advisor for the period that includes the application stage plus one year after the listing. Upon expi-ration of the one year after public listing, the company has to hire anothercompetent intermediary institution as its sponsor with a minimum term of fi ve years. The relay between the advisor and the sponsor is thus completed. Regulators encourage advisors to take on the role of sponsor. Generally,however, selecting different intermediary institutions based on different demands of the issuer before and after listing results in more specifi c and professional counseling and guidance.


The primary sponsor and advisor, usually served by an investment bank, is mainly responsible for preparing and submitting all listing application documents, confi rming to the exchange in a written form as required that theissuer meets listing rules and standards, communicating with the exchangeon behalf of the issuer, conducting due diligence investigation, and serving as the advisor of the company for one year from the listing. After one yearfrom the listing, the sponsor is served by a formal member of the exchange or an authorized investment bank with a minimum term of fi ve years. The responsibilities of the sponsor include studying the shares of the company and publishing research reports to improve the investor’s understanding of the company. Responsibilities also include providing tutoring for the direc-tors of the company to ensure the company complies with market rules on a constant basis, and serving in the role of the contact person between the company, regulators, and investors. Again, the sponsor position should not be vacant at any time in the period.

The Hong Kong Growth Enterprise Market: A System of Decomposed Sponsor Roles The Growth Enterprise Market (GEM) of the Hong Kong Stock Exchange was offi cially launched in 1999. Sticking to British traditions, it put in place a fairly complete sponsor system that mirrors that of the London SecuritiesExchange, requiring listed enterprises to hire at least one sponsor. In 2003, the Hong Kong Stock Exchange established a simple sponsor system for the main board. It requires applicants for the listing of equity securities,redeemable shares of unit trust funds, and mutual funds to hire sponsorswho cease to be responsible upon listing. However, in terms of sponsor inde-pendence, the provisions are far less clear than those of the London Securi-ties Exchange. Therefore, a series of fi nancial scandals and closures involvedmultiple listed companies in the second half of 2002.

In order to change the situation, the Hong Kong Securities Regulatory Commission and the Hong Kong Stock Exchange jointly amended the Main Board Listing Rules and the GEM Listing Rules in 2003. They created new rules regarding sponsors and compliance advisors, new rules regarding inde-pendent fi nancial advisors, and implementation guidance in relation to due diligence investigation by sponsors. At the core of the changes is the division of the role of sponsor into the following three parts:

1. Sponsor: The sponsor takes on the responsibility of sponsoring andtutoring before the applicant gets listed.

2. Compliance advisor: The compliance advisor is responsible for assisting and supervising the issuer after the listing.

3. Independent fi nancial advisor: The independent fi nancial advisor is responsible for reviewing major transactions or arrangements.


Another essential part of the amendment of the sponsor system in Hong Kong is the emphasis on the independence of sponsors. Investors rely onthe disclosures in the prospectus to make investment decisions. The stockexchange also relies on the due diligence work performed by the sponsor.Any substantial acquisition of shares or important relations may affect the independence of the sponsor and bring down sponsoring quality. Therefore,it is vital to emphasize independence.

The Chinese Mainland Stock Markets: From Quota Management to Sponsor System

The Chinese stock markets have a short history. Accordingly, the stock issu-ance regulatory system was established on a late date, mostly in light of the experience of overseas securities market. The stock issuance system of China has gone through the following stages:

■ Quota management stage (1993–1995): The securities management authorities of the State Council, based on the demands of national eco-nomic development and the condition of the capital market, determinedthe total quota. This was then divided and allocated to each provinciallevel administrative area and each industry. The quota was then again divided at the local level by local authorities on their own prerogative.

■ Index management stage (1996–2000): The securities management authorities of the State Council determines the total number of enter-prises allowed to go public in a certain period of time. The indexes are passed down to the government of each provincial area and the watch-dog of each industry. The local authorities then recommend enterpriseswithin the above indexes and submit the candidate lists to the securitiesregulatory authorities.

■ Channel system stage (2001–2004): This is an approval system. The number of enterprises that can be recommended for listing is assigned to each securities company. A securities trader with main sponsor quali-fi cation has two to nine channels, which means that they can recom-mend two to nine enterprises for listing. The main sponsor bears therisks associated with stock issuance and obtains the power to recom-mend stocks for listing.

■ Sponsor system (2004–present): According to the provision laid out bythe Chinese securities authorities, the major players of the sponsor sys-tem include the sponsor and the sponsoring institution. The system was designed for sponsors to improve the quality of listed companies and maintain order in the securities market throughout the listing process. However, it has yet to fulfi ll its expectations as it continues to mature.


Comparison of the Sponsor Systems of Various Countries

The following is a comparison of the sponsor systems of various countries from several different perspectives.

Sponsor Structure Sponsor structure refers to whether the sponsor posi-tion is served by one or more institutions or individuals. Some countries have strict restrictions on the number of institutions. Others countries may directly assign professionals to serve as sponsors for companies going pub-lic. Different countries have different provisions based on their respective history, tradition, and the development level of their capital markets, as well as policy considerations in the design of the sponsor system.

The United Kingdom and Canada allow the position of sponsor to be served by one sponsoring institution, as did Hong Kong before it amendedits system. That is because these countries and regions emphasize effi ciency more than anything else. The appointment of one institution alone canavoid the familiarization and coordination processes between multiple insti-tutions, thus saving a great amount of communication costs. However, it follows that confl icts of roles tend to arise from the fact that one institu-tion is at the same time responsible for tutoring, review, and supervision. In order to address this problem, the United Kingdom emphasizes the indepen-dence of sponsors, requiring them to go through very strict independencetests. This has worked out very well. However, in Canada and Hong Kong, some problems have occurred due to insuffi cient regulations on sponsor independence.

On the other hand, the NASDAQ in the United States, the MESDAQ in Malaysia, and the Hong Kong Market after the amendment focus onthe division and balance of role responsibilities, emphasizing transactionsecurity more than anything else. Although the NASDAQ market doesn’t have special regulations on sponsors, the role of a sponsor is hidden in the responsibilities of securities underwriters, market makers, peer review com-mittees, professional council members, and securities regulatory institutions. The MESDAQ market in Malaysia divides the responsibility of a sponsorinto two parts, which correspond to the periods before and after listing. TheHong Kong market divides the responsibility of a sponsor into three parts:the sponsor, the compliance advisor, and the independent fi nancial advisor.

According to the current Chinese sponsor system, securities operation institutions, as well as individuals registered with the China Securities Reg-ulatory Commission and included in the sponsor institution list or spon-sor representative list, may engage in sponsoring. The sponsor institution assigns two sponsor representatives to supervise a company that is going public. However, there is no regulation as to whether the representative may


sponsor more than one project at the same time. This refl ects the character-istic of the Chinese sponsor system, which is basically a securities operation institution dominated by regulations for companies going public. The Chi-nese system is more similar to the British approach. However, it is less strict than the British system in terms of independence regulations.

Sponsor Qualifi cations Sponsor qualifi cations are the criteria for an interme-diary institution to be able to play the role of a sponsor in the securities market. Those qualifi cations include the aspects discussed next.

Rich Experience in the Industry and Complete Business Record A sponsormust take on the responsibilities of sponsoring, supervision, and approval,which might involve civil liabilities, administrative liabilities, and criminal liabilities. Higher criteria are conducive to the effective performance of sponsor responsibilities. Canada requires that the sponsor must be a mem-ber of the exchange and with a good record. The United Kingdom requires that the sponsor must be either a member of the exchange or a registeredsecurities trader. The amended regulations in Hong Kong require that the sponsor must be on the list made by the exchange and published by the exchange from time to time. The CSRC also requires that only securitiesinstitutions included in the sponsor institution and sponsor representativelists engage in sponsoring.

Requirements in Terms of Investment Bank Business Experience The sponsor must have years of investment experience in investment banking and share listing, which provides the knowledge and experience necessary for tutoring companies that want to go public. The mandated experienceranges from two to seven years in different countries. In China, there has been no business experience requirement in this fi rst time of the sponsor system being introduced. The only regulations in this respect are that an institution should not be registered as a sponsor if it has fewer than twosponsor representatives, major fl aws in corporate governance structure, or a risk control system that is incomplete or not effectively implemented. The institution should also not be registered if it has been removed from the list by the CSRC for a breach of law or regulation in the last 24 months.

Complete Internal Control Mechanisms Only strict internal controlmechanisms can subject the staff to suffi cient supervision and managementand ensure they do not overstep their authority while performing specifi c duties. Both Hong Kong and the United Kingdom require that each spon-sor institution specify the authority of their staff members. Hong Kong alsorequires the establishment of a staff supervision and management system.


The United Kingdom simply requires that staff members without profes-sional qualifi cation should work under the guidance of a business director who is in possession of such qualifi cations. China has not yet laid out direct requirements regarding internal control, but internal control is mentioned inthe requirements that an integrated securities company has to meet in order to serve as a sponsor. This is a form of internal control requirement.

Absolute Independence The relationship between the sponsor and thesponsored company is comparable to an athlete and a referee. Contactshould be at an appropriate distance with limited common interests betweenthe two. Otherwise, the equity and order of the securities market will suffer. The UK London Securities Exchange has the strictest requirements on spon-sor independence among many countries. There are considerations such as associated interests between the sponsor and the issuer through bonds and shares. Other considerations include whether one is controlled by the other, whether both are controlled by the same institution, or whether the business cooperation of the two parties may actually benefi t the sponsor if the issuance is successful. The exchange will not accept accountant reports conducted bythe sponsor in the capacity of the accountant. All securities margin trad-ing transactions of the sponsor and its associates must be disclosed to the public. In Hong Kong, a series of fi nancial scandals in 2002, caused by lack of independence, served as a lesson for the formulation of the new system. The CSRC has also set forth regulations on the proportions of shares held by associated parties, shares held by senior executives and employees of the company, and securities margin trading.

Criteria for Accession Are Basically the Same for Sponsors and Sponsor Institutions In addition to requirements regarding professional experienceand credibility, there are requirements on professional competence andskills. Sponsors must have a specifi c educational background. They must have passed relevant accreditation tests and must hold relevant certifi cates. Canada requires that there is one director and one deputy director, bothwith accreditation certifi cates as registered fi nancial analysts or registeredbusiness valuators, or with a specifi c number of years of experience in rel-evant industries. The United Kingdom and Hong Kong require at least two to four business executives with at least three years of hands‐on experi-ence in corporate fi nancing. China has a dual sponsor system based on both sponsor institutions and sponsors. The only provisions on the qualifi cationof sponsor representatives are that the sponsor representative must pass a sponsor representative competence test and must have not been subjectedto any administrative punishment by the CSRC in the last 36 months. Thesponsor institution must also have at least two sponsor representatives.


The Term of Sponsors The term of a sponsor refers to the length of time that a sponsor remains in the sponsor position, as required by the securities laws of various countries. Most companies listed in the secondary market are marked by small scale, weak resistance to market risks, and great moral and operational risks. Therefore, the continuity of the sponsor position is essential for these companies to overcome such weaknesses and operate in a sustainable way. For that reason, most countries in the world provide long terms for sponsors to ensure the continuity of post‐listing work. The United Kingdom requires that the sponsor have a lifelong term, and that companies listed in the AIM market must have a sponsor throughout their existence. Otherwise, their stock trade will be suspended. The assorted sponsor system of the NASDAQ market has similar characteristics. The relay sponsor system of the MESDAQ market of Malaysia also stipulates that the terms of the advisor and the sponsor together should cover the period from the listing stage, fi rst year after listing, and at least fi ve years after that. This also provides for long‐term supervision and guidance by the sponsor. The sponsor term provision of Hong Kong has been amended. It was once the period from before the listing to two years post listing, but has now become a lifelong term. The independent fi nancial advisor always exists in the company, once it is listed. These refl ect the trends toward extended sponsor terms.

The sponsor system of mainland China defi nes the term of the sponsor based on IPO and refi nancing: For IPOs, the continuous supervision period includes the remaining days in the year that the IPO is listed plus two full fi scal years after that. In the case of public companies issuing new shares or convertible corporate bonds, the continuous supervision period includes theremaining days in the year of issuance plus a full fi scal year after that. Thecontinuous supervision period is calculated from the date of the listing of securities. Obviously, the supervision period in China is still far below the average international level and needs to be extended in the future.

Sponsor Duty System The duty of sponsors forms the core content of thesponsor system, refl ecting the intrinsic demands and ultimate goals of asponsor system. It usually consists of the following two parts:

1. Duty at the due diligence sponsoring stage: This is mainly the responsi-bilities of the sponsor during the listing process.

2. Duty at the continuous supervision stage: This consists of the responsi-bilities of the sponsor after listing.

Currently, sponsor duty provisions are largely the same across different counties. All emphasize the importance of a systemic and integrated regime


and strictly distinguish the responsibilities of the sponsor, the issuer, andother intermediary institutions, so that they can check each other. But at the same time, the responsibilities of the sponsor are enhanced. Sponsorsbreaching laws and regulations may be subject to severe punishment, includ-ing lifelong disqualifi cation from the profession and criminal liabilities.

The difference is that the listing rules of the London Stock Exchange have no specifi c requirements concerning the authenticity, accuracy, andcompleteness of the listing materials provided by the sponsor for the issuer.This is probably due to the well‐established fi nancial law and regulationsystem of the United Kingdom. The liability for providing false materialsis provided for in other laws and regulations. In terms of the continuoussupervision stage after listing, both London and Hong Kong have set forth principles that require the sponsor to continuously guide and supervisethe issuer. This ensures that the issuer always abides by market rules and performs all information disclosure duties as required. However, these pro-visions are not very specifi c. This might be due to the solid fi nancial and business foundations of the two cities.

The Chinese securities market has a short history. There are many breaches of rules by listed companies, and intermediaries lack integrity andcredibility awareness. In this respect, China has adopted more rigorous pro-visions for the sponsor system to obtain the desired effect. The provisionsrequire sponsor institutions to determine the contents and key areas of con-tinuous supervision based on the specifi c situations of the issuer. Sponsorinstitutions must take on the following tasks:

■ Supervise and guide the effective implementation and improvement by the issuer of systems to prevent big shareholders and other related par-ties from illegally using the resources of the issuer.

■ Supervise and guide the effective implementation and improvement by the issuer of systems to prevent senior executives from harming the interests of the issuer by taking advantage of their positions.

■ Supervise and guide the effective implementation and improvement of systems regarding the fairness and compliance of connected transac-tions, and provide opinions on related transactions.

■ Supervise and guide the performance of the issuer’s information dis-closure duties, and review information disclosure documents and otherdocuments submitted to the CSRC and the exchange.

■ Track the issuer’s use of funds raised, implementation of investment projects, and other commitments.

■ Track the provision of guarantees by the issuer for others, and provide opinions accordingly.

■ Perform other tasks specifi ed by the CSRC and the sponsorship agreement.


ANALYSIS OF PUNISHMENTS IMPOSED BY THE CSRC ON RULE-BREACHING SPONSORS

In recent years, the sponsor system has been the subject of a lot of criticism. An analysis of the types of punishment imposed by the CSRC on rule‐breaching sponsors may help determine the problems in the sponsor system. Interestingly, not all sponsors who have breached rules have been punished by the CSRC, as they clearly should have been.

The Interim Measures for Securities Issuance and Listing Sponsor Sys-tem was published on December 28, 2003, and took effect on February 1, 2004. It marks the actual arrival of the sponsor system for share issuance. Compared with the approval system and the ratifi cation system, the enforce-ment of the sponsor system is undoubtedly a sign of progress in terms of improving the quality of listed companies and the professional competence of securities companies. It has also helped protect the lawful interests and rights of investors, while promoting the sound development of the securities market. The sponsor system requires the sponsor institution and sponsor representatives to maintain honesty, keep promises, and perform duties con-scientiously in sponsoring the listing of the issuer’s shares. In a case in which false information is disclosed during the issuance process due to the failure of other intermediary institutions, the “fallback provisions” of the sponsor system stipulate that the sponsor institution and the sponsor representative shall be held responsible. As a result, the sponsor institution and sponsor representative are, in reality, undertaking much greater responsibilities and risks.

Punishment for Rule-Breaching Sponsors

Since the implementation of the sponsor system, 56 punishments were imposed from October 25, 2004, when the fi rst credit regulatory fi ne wasdealt out by the CSRC, to November 28, 2011. Table 7.1 lists all relevantdetails for each of the 56 cases.

Looking at the information in Table 7.1 , it is clear that major breaches tend include the following activities:

■ The registration application documents include false records, and thus fail to meet registration requirements. This is in violation of article 69 of the Administrative License Law and articles 12 and 59 of the Interim Measures for the Stock Issuance and Listing Sponsor-ship System.

■ While working for the sponsor institution, the sponsor representative works for another company under a formal employment contract and

360

TABL

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na

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ory

Com

mis

sion

).

2011

‐6‐1

3

Wen

Fus

heng

A w

arni

ng le

tter

.W

hile

spo

nsor

ing

for

the

IPO

and

list

ing

of J

ium

uwan

g C

o.

Lt d

., vi

olat

ed t

he p

rovi

sion

of

arti

cle

24 o

f th

e A

dmin

istr

ativ

eM

easu

res

for

the

Spon

sors

hip

Bus

ines

s of

the

Iss

uanc

e an

d L

isti

ng o

f Se

curi

ties

(In

junc

tion

No.

58

of C

hina

Sec

urit

ies

Reg

u lat

ory

Com

mis

sion

).

2011

‐6‐1

3

Niu

Zhe

nson

gA

war

ning

lett

er.

Whi

le s

pons

orin

g fo

r th

e IP

O a

nd li

stin

g of

Jiu

muw

ang

Co.

L

td.,

viol

ated

the

pro

visi

on o

f ar

ticl

e 24

of

the

Adm

inis

trat

ive

Mea

sure

s fo

r th

e Sp

onso

rshi

p B

usin

ess

of t

he I

ssua

nce

and

Lis

ting

of

Secu

riti

es (

Inju

ncti

on N

o. 5

8 of

Chi

na S

ecur

itie

s R

egul

ator

y C

omm

issi

on).

2011

‐6‐1

3

(con

tinu

ed)

362

Su H

aiya

nA

war

ning

lett

er.

Whi

le s

pons

orin

g fo

r th

e se

cond

ary

equi

ty o

ffer

ing

of S

hang

hai

Xia

ndai

Pha

rmac

eutic

al C

o. L

td.,

viol

ated

the

prov

isio

n of

art

icle

s4

and

29 o

f the

Adm

inis

trat

ive

Mea

sure

s fo

r th

e Sp

onso

rshi

pB

usin

ess

o f th

e Is

suan

ce a

nd L

istin

g of

Sec

uriti

es (I

njun

ctio

n N

o.58

of C

hina

Sec

uriti

es R

egul

ator

y C

omm

issi

on).

2011

‐6‐1

3

Du

Wei

min

A t

alk

wit

h th

e re

gula

tor.

Whi

le s

pons

orin

g fo

r th

e IP

O a

nd li

stin

g of

Fuj

ian

Teng

xin

Food

Co.

Ltd

., vi

olat

ed t

he p

rovi

sion

of

arti

cle

24 o

f th

e A

dmin

istr

ativ

e M

easu

res

for

the

S pon

sors

hip

Bus

ines

s of

the

Is

suan

ce a

nd L

isti

ng o

f Se

curi

ties

.

2011

‐4‐8

Gu

Jian

hua

A t

alk

wit

h th

e re

gula

tor.

Whi

le s

pons

orin

g fo

r th

e IP

O a

nd li

stin

g of

Fuj

ian

Teng

xin

Food

Co.

Ltd

., vi

olat

ed t

he p

rovi

sion

of

arti

cle

24 o

f th

e A

dmin

istr

ativ

e M

easu

res

for

the

Spon

sors

hip

Bus

ines

s of

the

Is

suan

ce a

nd L

isti

ng o

f Se

curi

ties

.

2011

‐4‐8

Zho

u K

aiPr

ojec

ts in

the

cha

rge

of t

he s

pons

orw

ill n

ot b

e ac

cept

ed f

or 1

2 m

onth

s.W

hile

spo

nsor

ing

for

the

IPO

and

list

ing

of G

uilin

San

jin,

faile

d to

con

duct

due

dili

genc

e on

‐sit

e in

vest

igat

ion

and

cons

cien

tiou

sly

perf

orm

rel

evan

t du

ties

.

2010

‐8‐2

3

Zha

ng M

iao

A w

arni

ng le

tter

.W

hile

spo

nsor

ing

for

the

IPO

of W

uhan

Gao

de I

nfra

red

Co.

Ltd

., fa

iled

to r

epor

t to

the

Chi

na S

ecur

itie

s R

egul

ator

y C

omm

issi

on, a

nd r

evis

ed t

he p

rosp

ectu

s w

itho

ut p

erm

issi

on.

2010

‐8‐9

Lei

Wen

long

A w

arni

ng le

tter

.W

hile

spo

nsor

ing

for

the

IPO

of W

uhan

Gao

de I

nfra

red

Co.

Ltd

., fa

iled

to r

epor

t to

the

Chi

na S

ecur

itie

s R

egul

ator

y C

omm

issi

on, a

nd r

evis

ed t

he p

rosp

ectu

s w

itho

ut p

erm

issi

on.

2010

‐8‐9

Fu Z

huA

tal

k w

ith

the

regu

lato

r.W

hile

spo

nsor

ing

for

the

IPO

of X

ingw

angr

uijie

, fai

led

to c

ondu

ct

due

dilig

ence

inve

stig

atio

ns o

n pa

tent

issu

es r

elat

ed to

the

issu

er,

whi

ch le

d to

a th

e pu

blic

ann

ounc

emen

t on

Apr

il 9,

201

0

2010

‐6‐9

TABL

E 7.

1 (C

onti

nued

)

Reg

ula

tion S

ubje

ctR

egula

tion M

easu

reB

reach

Eff

ecti

veD

ate

363

Yan

g G

uang

A t

alk

wit

h th

e re

gula

tor.

Whi

le s

pons

orin

g fo

r th

e IP

O o

f Fu

jian

Xin

gwan

grui

jie, f

aile

d to

con

duct

due

dili

genc

e in

vest

igat

ions

on

pate

nt is

sues

rel

ated

to

the

issu

er.

2010

‐6‐9

Liu

Xuy

ang

Proj

ects

in t

he c

harg

e of

the

spo

nsor

will

not

be

acce

pted

for

12

mon

ths.

Dur

ing

the

IPO

and

GE

M li

stin

g pr

oces

s of

Suz

hou

Hen

gjiu

Phot

o el

ectr

onic

Tec

hnol

ogy

Co.

Ltd

., w

hile

con

duct

ing

due

dilig

ence

, vio

late

d th

e pr

ovis

ions

of

arti

cle

11 o

f th

e Se

curi

ties

L

aw o

f th

e Pe

ople

’s R

epub

lic o

f C

hina

and

art

icle

4 o

f th

eA

dmin

istr

ativ

e M

easu

res

for

the

Spon

sors

hip

Bus

ines

s of

the

Is

suan

ce a

nd L

isti

ng o

f Se

curi

ties

.

2010

‐6‐4

Lia

n Y

anA

tal

k w

ith

the

regu

lato

r.D

urin

g th

e IP

O a

nd G

EM

list

ing

proc

ess

of S

uzho

u H

engj

iuPh

oto

elec

tron

ic T

echn

olog

y C

o. L

td.,

whi

le c

ondu

ctin

g du

edi

li gen

ce, v

iola

ted

the

prov

isio

ns o

f ar

ticl

e 11

of

the

Secu

riti

es

Law

of

the

Peo p

le’s

Rep

ublic

of

Chi

na a

nd a

rtic

le 4

of

the

Adm

inis

trat

ive

Mea

sure

s fo

r th

e S p

onso

rshi

p B

usin

ess

of t

he

Issu

ance

and

Lis

ting

of

Secu

riti

es.

2010

‐6‐4

Liu

Xuy

ang

A t

alk

wit

h th

e re

gula

tor.

Dur

ing

the

IPO

and

GE

M li

stin

g pr

oces

s of

Suz

hou

Hen

gjiu

Phot

o el

ectr

onic

Tec

hnol

ogy

Co.

Ltd

., w

hile

con

duct

ing

due

dilig

ence

, vio

late

d th

e pr

ovis

ions

of

arti

cle

11 o

f th

e Se

curi

ties

L

aw o

f th

e Pe

ople

’s R

epub

lic o

f C

hina

and

art

icle

4 o

f th

eA

dmin

istr

ativ

e M

easu

res

for

the

S pon

sors

hip

Bus

ines

s of

the

Is

suan

ce a

nd L

isti

ng o

f Se

curi

ties

.

2010

‐6‐4

Liu

Xuy

ang

A w

arni

ng le

tter

.D

urin

g th

e IP

O a

nd G

EM

list

ing

proc

ess

of S

uzho

u H

engj

iuPh

oto

elec

tron

ic T

echn

olog

y C

o. L

td.,

whi

le c

ondu

ctin

g du

edi

ligen

ce, v

iola

ted

the

prov

isio

ns o

f ar

ticl

e 11

of

the

Secu

riti

es

Law

of

the

Peop

le’s

Rep

ublic

of

Chi

na a

nd a

rtic

le 4

of

the

Adm

inis

trat

ive

Mea

sure

s fo

r th

e Sp

onso

rshi

p B

usin

ess

of t

he

Issu

ance

and

Lis

ting

of

Secu

riti

es.

2010

‐6‐4

(con

tinu

ed)

364

Lia

n Y

anPr

ojec

ts in

the

cha

rge

of t

he s

pons

orw

ill n

ot b

e ac

cept

ed f

or 1

2 m

onth

s.D

urin

g th

e IP

O a

nd G

EM

list

ing

proc

ess

of S

uzho

u H

engj

iuPh

oto

elec

tron

ic T

echn

olog

y C

o. L

td.,

whi

le c

ondu

ctin

g du

edi

ligen

ce, v

iola

ted

the

prov

isio

ns o

f ar

ticl

e 11

of

the

Secu

riti

es

Law

of

the

Peop

le’s

Rep

ublic

of

Chi

na a

nd a

rtic

le 4

of

the

Adm

inis

trat

ive

Mea

sure

s fo

r th

e Sp

onso

rshi

p B

usin

ess

of t

he

Issu

ance

and

Lis

ting

of

Secu

riti

es.

2010

‐6‐4

GF

Secu

riti

es C

o.L

td.

A w

arni

ng le

tter

.D

urin

g th

e IP

O a

nd G

EM

list

ing

proc

ess

of S

uzho

u H

engj

iuPh

oto

elec

tron

ic T

echn

olog

y C

o. L

td.,

whi

le c

ondu

ctin

g du

edi

li gen

ce, v

iola

ted

the

prov

isio

ns o

f ar

ticl

e 11

of

the

Secu

riti

es

Law

of

the

Peo p

le’s

Rep

ublic

of

Chi

na a

nd a

rtic

le 4

of

the

Adm

inis

trat

ive

Mea

sure

s fo

r th

e S p

onso

rshi

p B

usin

ess

of t

he

Issu

ance

and

Lis

ting

of

Secu

riti

es.

2010

‐6‐4

Lia

n Y

anA

war

ning

lett

er.

Dur

ing

the

IPO

and

GE

M li

stin

g pr

oces

s of

Suz

hou

Hen

gjiu

Phot

o el

ectr

onic

Tec

hnol

ogy

Co.

Ltd

., w

hile

con

duct

ing

due

dilig

ence

, vio

late

d th

e pr

ovis

ions

of

arti

cle

11 o

f th

e Se

curi

ties

L

aw o

f th

e Pe

ople

’s R

epub

lic o

f C

hina

and

art

icle

4 o

f th

eA

dmin

istr

ativ

e M

easu

res

for

the

S pon

sors

hip

Bus

ines

s of

the

Is

suan

ce a

nd L

isti

ng o

f Se

curi

ties

.

2010

‐6‐4

Zha

ng Q

ings

heng

Proj

ects

in t

he c

harg

e of

the

spo

nsor

will

not

be

acce

pted

for

12

mon

ths.

Wor

ked

conc

urre

ntly

at

a sp

onso

ring

inst

itut

ion

and

at C

MB

Inte

rnat

iona

l, an

d si

gned

em

ploy

men

t co

ntra

cts.

Con

ceal

ed t

he

a bov

e fa

cts

whi

le a

pply

ing

for

regi

stra

tion

cha

nges

.

2009

‐9‐2

9

Lin

Lin

Dis

qual

ifi ed

as

a sp

onso

r.T

he s

pons

or r

epre

sent

ativ

e re

gist

rati

on a

pplic

atio

n fi l

ed b

y L

in L

in c

onta

ined

fal

se in

form

atio

n an

d fa

iled

to m

eet

the

regi

stra

tion

req

uire

men

ts.

2009

‐9‐2

9

TABL

E 7.

1 (C

onti

nued

)

Reg

ula

tion S

ubje

ctR

egula

tion M

easu

reB

reach

Eff

ecti

veD

ate

365

Wan

g Z

hini

Dis

qual

ifi ed

as

a sp

onso

r.T

he s

pons

or r

epre

sent

ativ

e re

gist

rati

on a

pplic

atio

n fi l

ed b

y W

ang

Zhi

ni c

onta

ined

fal

se in

form

atio

n an

d fa

iled

to m

eet

the

regi

stra

tion

req

uire

men

ts.

2009

‐9‐2

9

Yu

Yin

hua

A w

arni

ng t

alk.

Whi

le H

uata

i Sec

urit

ies

was

spo

nsor

ing

for

the

IPO

and

list

ing

of J

ian g

su S

hent

ong

Val

ve C

o. L

td.,

the

spon

sor

repr

esen

tati

ves

of t

he p

roje

ct f

aile

d to

con

duct

due

dili

genc

e by

not

pru

dent

ly

veri

fyin

g th

e op

inio

ns p

rovi

ded

by t

hird

‐par

ty in

term

edia

ryin

stit

utio

ns, i

nclu

ding

the

acc

ount

ant

and

the

asse

t va

luat

or.

The

ir s

pons

orin

g w

ork

faile

d to

com

ply

wit

h th

e pr

ovis

ions

of

arti

cle

24 o

f M

easu

res

for

S pon

sors

hip.

2008

‐8‐2

7

Du

Che

nhui

A w

arni

ng t

alk.

Whi

le H

uata

i Sec

urit

ies

was

spo

nsor

ing

for

the

IPO

and

list

ing

of J

iang

su S

hent

ong

Val

ve C

o. L

td.,

the

spon

sor

repr

esen

tati

ves

o f t

he p

roje

ct f

aile

d to

con

duct

due

dili

genc

e by

not

pru

dent

ly

veri

fyin

g th

e op

inio

ns p

rovi

ded

by t

hird

‐par

ty in

term

edia

ryin

stit

utio

ns, i

nclu

ding

the

acc

ount

ant

and

the

asse

t va

luat

or.

The

ir s

pons

orin

g w

ork

faile

d to

com

ply

wit

h th

e pr

ovis

ions

of

arti

cle

24 o

f th

e M

easu

res

for

S pon

sors

hip.

2008

‐8‐2

7

Guo

Xia

ogua

ngA

war

ning

tal

k.Fa

iled

to d

o th

e sp

onso

ring

wor

k co

nsci

enti

ousl

y an

d co

nduc

tsu

ffi c

ient

due

dili

genc

e in

vest

igat

ion.

The

app

licat

ion

docu

men

ts

wer

e no

t ca

refu

lly p

repa

red

and

faile

d to

mee

t th

e re

quir

emen

ts

set

fort

h b y

Art

icle

Fiv

e of

the

Mea

sure

s fo

r Sp

onso

rshi

p.

2008

‐8‐2

7

Xu

Gan

gA

war

ning

tal

k.Fa

iled

to d

o th

e sp

onso

ring

wor

k co

nsci

enti

ousl

y an

d co

nduc

t su

ffi c

ient

due

dili

genc

e in

vest

igat

ion.

The

app

licat

ion

docu

men

ts w

ere

not

care

fully

pre

pare

d an

d fa

iled

to m

eet

the

requ

irem

ents

set

for

th b

y ar

ticl

e 5

of t

he M

easu

res

for

S pon

sors

hip.

2008

‐8‐2

7

(con

tinu

ed)

366

Liu

Xia

osha

nPr

ojec

ts in

the

cha

rge

of t

he s

pons

orw

ill n

ot b

e ac

cept

ed f

or t

hree

m

onth

s.

The

spo

nsor

rep

rese

ntat

ive

spon

sore

d th

e lis

ting

of

Xia

ngta

n E

lect

ro‐C

hem

ical

Co.

Ltd

. in

Apr

il 20

07. T

he c

ompa

ny’s

sal

espe

rfor

man

ce h

as s

ince

dro

pped

sig

nifi c

antl

y.

2008

‐6‐2

7

Lei

Mao

Proj

ects

in t

he c

harg

e of

the

spo

nsor

will

not

be

acce

pted

for

thr

ee

mon

ths.

The

spo

nsor

rep

rese

ntat

ive

spon

sore

d th

e lis

ting

of

Xia

ngta

n E

lect

ro‐C

hem

ical

Co.

Ltd

. in

Apr

il 20

07. T

he c

ompa

ny’s

sal

espe

rfor

man

ce h

as s

ince

dro

pped

sig

nifi c

antl

y.

2008

‐6‐2

7

Hua

ngC

hong

chun

Proj

ects

in t

he c

harg

e of

the

spo

nsor

will

not

be

acce

pted

for

six

mon

ths.

Fort

une

Secu

riti

es C

o. L

td. m

ade

som

e m

ista

kes

whi

le

subm

itti

n g t

he “

Bas

ic I

nfor

mat

ion

abou

t th

e St

ock

Issu

ance

by

Hun

an N

anlin

g C

ivil

Exp

losi

ve M

ater

ial C

o. L

td.”

spr

eads

heet

to

the

She

nzhe

n Se

curi

ties

Exc

hang

e, c

ausi

ng t

he is

suan

ce t

o be

sus p

ende

d, t

hus

nega

tive

ly a

ffec

ting

the

mar

ket.

2006

‐12‐

9

Tang

Jin

song

Proj

ects

in t

he c

harg

e of

the

spo

nsor

will

not

be

acce

pted

for

six

mon

ths.

Fort

une

Secu

riti

es C

o. L

td. m

ade

som

e m

ista

kes

whi

le

subm

itti

ng t

he “

Bas

ic I

nfor

mat

ion

abou

t th

e St

ock

Issu

ance

by

Hun

an N

anlin

g C

ivil

Exp

losi

ve M

ater

ial C

o. L

td.”

spr

eads

heet

to

the

She

nzhe

n Se

curi

ties

Exc

hang

e, c

ausi

ng t

he is

suan

ce t

o be

susp

ende

d, t

hus

nega

tive

ly a

ffec

ting

the

mar

ket.

2006

‐12‐

9

Fort

une

Secu

riti

es

Co.

Ltd

.Pr

ojec

ts in

the

cha

rge

of t

he s

pons

orw

ill n

ot b

e ac

cept

ed f

or t

hree

m

onth

s.

The

sus

pens

ion

of th

e is

suan

ce b

y N

anlin

g C

ivil

Exp

losi

veM

ater

ial C

o. L

td. w

as c

ause

d by

the

laps

e of

the

spon

sor

Fort

une

Secu

ritie

s C

o. L

td.,

whi

ch le

d to

neg

ativ

e im

pact

on

the

mar

ket.

2006

‐12‐

9

Liu

Hao

A w

arni

ng t

alk.

Hai

bo C

o. L

td.’s

app

licat

ion

was

coa

rsel

y m

ade.

The

spo

nsor

fa

iled

to c

ondu

ct s

tric

t qu

alit

y co

ntro

l and

the

spo

nsor

repr

esen

tati

ve f

aile

d to

per

form

its

due

dilig

ence

.

2006

‐11‐

27

Eve

rbri

ght

Secu

riti

es C

o. L

tdA

war

ning

tal

k.H

aibo

Co.

Ltd

.’s a

pplic

atio

n w

as c

oars

ely

mad

e. T

he s

pons

or

faile

d to

con

duct

str

ict

qual

ity

cont

rol a

nd t

he s

pons

orre

pres

enta

tive

fai

led

to p

erfo

rm it

s du

e di

ligen

ce.

2006

‐11‐

27

TABL

E 7.

1 (C

onti

nued

)

Reg

ula

tion S

ubje

ctR

egula

tion M

easu

reB

reach

Eff

ecti

veD

ate

367

Qiu

Xia

obin

gA

war

ning

tal

k.H

aibo

Co.

Ltd

.’s a

pplic

atio

n w

as c

oars

ely

mad

e. T

he s

pons

or

faile

d to

con

duct

str

ict

qual

ity

cont

rol a

nd t

he s

pons

orre

pres

enta

tive

fai

led

to p

erfo

rm it

s du

e di

ligen

ce.

2006

‐11‐

27

Wan

g Ji

anhu

iA

war

ning

tal

k.N

ingb

o M

oshi

’s a

pplic

atio

n w

as c

oars

ely

mad

e. T

he s

pons

or

faile

d to

con

duct

str

ict

qual

ity

cont

rol a

nd t

he s

pons

orre

pres

enta

tive

fai

led

to p

erfo

rm it

s du

e di

ligen

ce.

2006

‐11‐

10

Che

ng J

ianx

inA

war

ning

tal

k.N

ingb

o M

oshi

’s a

pplic

atio

n w

as c

oars

ely

mad

e. T

he s

pons

or

faile

d to

con

duct

str

ict

qual

ity

cont

rol a

nd t

he s

pons

orre

pres

enta

tive

fai

led

to p

erfo

rm it

s du

e di

ligen

ce.

2006

‐11‐

10

Zhe

ng H

uafe

ngA

war

ning

tal

k.G

uang

dong

LE

IYI

(Gro

up)

Co.

Ltd

.’s a

pplic

atio

n fo

r pr

ivat

e pl

acem

ent

in t

he B

‐sha

re m

arke

t w

as c

oars

ely

mad

e. T

hes p

onso

r re

pres

enta

tive

fai

led

to p

erfo

rm it

s du

e di

ligen

ce.

2005

‐1‐2

4

Xie

Jiju

nA

war

ning

tal

k.G

uang

dong

LE

IYI

(Gro

up)

Co.

Ltd

.’s a

pplic

atio

n fo

r pr

ivat

e pl

acem

ent

in t

he B

‐sha

re m

arke

t w

as c

oars

ely

mad

e. T

hesp

onso

r re

pres

enta

tive

fai

led

to p

erfo

rm it

s du

e di

ligen

ce.

2005

‐1‐2

4

Jian

g L

anA

war

ning

tal

k.In

rel

atio

n to

the

case

in w

hich

Gua

ngdo

ng W

EIE

R M

edic

alSc

ienc

e an

d Te

chno

logy

Co.

Ltd

. vio

late

d th

e ru

les,

the

s pon

sor

repr

esen

tativ

e fa

iled

to p

ay a

tten

tion

to th

e co

mpa

ny’s

mis

appr

opri

atio

n of

fund

s an

d br

each

es o

f inf

orm

atio

n di

sclo

sure

ru

les,

and

was

foun

d la

ckin

g in

sup

ervi

sion

per

sist

ency

.

2004

‐12‐

30

Yu

Hao

A w

arni

ng t

alk.

In r

elat

ion

to th

e ca

se in

whi

ch G

uang

dong

WE

IER

Med

ical

Scie

nce

and

Tech

nolo

gy C

o. L

td. v

iola

ted

the

rule

s, th

esp

onso

r re

pres

enta

tive

faile

d to

pay

att

entio

n to

the

com

pany

’s m

isap

prop

riat

ion

of fu

nds

and

brea

ches

of i

nfor

mat

ion

disc

losu

re

rule

s, a

nd w

as fo

und

lack

ing

in s

uper

visi

on p

ersi

sten

cy.

2004

‐12‐

30

(con

tinu

ed)

368

Shui

Hao

feng

A t

alk

wit

h th

e re

gula

tor

Whi

le k

now

ing

that

Fuj

ian

Coa

l Pow

er C

o. L

td d

idn’

t m

eet

the

basi

c cr

iter

ia f

or li

stin

g, in

sist

ed o

n su

bmit

ting

app

licat

ion

docu

men

ts.

2004

‐11‐

8

Ren

Jun

jieA

war

ning

tal

k.W

hile

kno

win

g th

at F

ujia

n C

oal P

ower

Co.

Ltd

did

n’t

mee

t th

e ba

sic

crit

eria

for

list

ing,

insi

sted

on

subm

itti

ng a

pplic

atio

n do

cum

ents

.

2004

‐11‐

8

Zha

ng J

unjie

A w

arni

ng t

alk.

Zha

ng J

unjie

vio

late

d th

e pr

ovis

ions

of a

rtic

le 2

2 of

the

Inte

rim

M

easu

res

for

the

Stoc

k Is

suan

ce a

nd L

istin

g Sp

onso

rshi

p Sy

stem

by

sig

ning

the

spon

sor

lett

er fo

r th

e IP

O o

f Zhe

jiang

HO

NG

DA

W

arp

Kni

ttin

g C

o. L

td. i

n th

e ca

paci

ty o

f a s

pons

or r

epre

sent

ativ

e w

ithou

t con

duct

ing

suffi

cien

t due

dili

genc

e in

vest

igat

ion.

2004

‐11‐

2

BO

C I

nter

nati

onal

(Chi

na)

Lim

ited

A w

arni

ng t

alk.

Ass

igne

d a

spon

sor

repr

esen

tativ

e w

ho h

ad n

ot y

et r

egis

tere

d as

one

of i

ts m

embe

rs to

re p

lace

a s

pons

or r

epre

sent

ativ

e w

hoha

d re

sign

ed, t

hus

brea

chin

g re

leva

nt p

rovi

sion

s of

the

Inte

rim

M

easu

res

for

the

Stoc

k Is

suan

ce a

nd L

istin

g Sp

onso

rshi

p Sy

stem

, an

d le

adin

g to

inac

cura

te in

form

atio

n di

sclo

sure

by

the

issu

er.

2004

‐10‐

2 5

Shen

Jia

nA

war

ning

tal

k.W

itho

ut t

he p

erm

issi

on o

f th

e is

suan

ce s

uper

visi

ng d

epar

tmen

t, ch

ange

d th

e sp

ecia

l ale

rt in

the

LO

I, de

leti

ng im

port

ant

cont

ents

.20

04‐1

0‐21

Wan

g Y

ang

A w

arni

ng t

alk.

Wit

hout

the

per

mis

sion

of

the

issu

ance

sup

ervi

sing

dep

artm

ent,

chan

ged

the

spec

ial a

lert

in t

he L

OI,

dele

ting

impo

rtan

t co

nten

ts.

2004

‐10‐

21

Yan

g H

ujin

A w

arni

ng t

alk.

The

app

licat

ion

was

coa

rsel

y m

ade.

The

spo

nsor

rep

rese

ntat

ive

faile

d to

per

form

due

dili

genc

e.20

04‐6

‐25

Che

n Y

ongy

ang

A w

arni

ng t

alk.

The

app

licat

ion

was

coa

rsel

y m

ade.

The

spo

nsor

rep

rese

ntat

ive

faile

d to

per

form

due

dili

genc

e.20

04‐6

‐25

Sour

ce: O

ffi c

ial w

ebsi

te o

f C

hina

Sec

urit

ies

Reg

ulat

ory

Com

mis

sion

, ww

w.c

src.

gov.

cn/p

ub/c

src_

en.

TABL

E7.

1 (C

onti

nued

)

Reg

ula

tion S

ubje

ctR

egula

tion M

easu

reB

reach

Eff

ecti

ve

Date

http://www.csrc.gov.cn/pub/csrc_en


does not disclose this when applying for change registration. The spon-sor institution appoints a sponsor representative not yet registered as one of its members to replace a sponsor representative who has left. Thesponsor representative submits application documents despite knowing that the company doesn’t meet the basic requirement for listing. These behaviors violate relevant provisions of the Interim Measures for the Stock Issuance and Listing Sponsorship System.

■ The sponsor institution fails to work in good faith, to conscientiously sponsor the listing of the issuer’s stock, and to persistently supervise the issuer in performing its duties regarding standardized operation, delivery of promises, and information disclosure. The project sponsor representative fails to work diligently enough to carefully verify opin-ions provided by intermediary institutions such as accountants and asset valuators. The sponsor representative fails to take part in on‐sitedue diligence investigations, or prepares the application documents in a mindless and irresponsible way. The sponsor representative (or spouse)holds shares of the issuer. The sponsor representative alters the pro-spectus without reporting to the CSRC and obtaining permission from the commission. The sponsor institution or its sponsor representatives acquire illegitimate benefi ts from sponsorship. These behaviors violate the following articles: article 67 of the Measures for the Administration of Initial Public Offering and Listing of Stocks; article 6 of the Content and Format of Information Disclosure by Companies Issuing Securi-ties to the Public No. 10—Application for Issuance of New Shares byListed Companies Prospectus; articles 5, 24, and 29 of the Administra-tive Measures for the Sponsorship Business of the Issuance and Listing of Securities (Injunction No. 63 of China Securities Regulatory Com-mission); article 11 of the Securities Law of the People’s Republic of China; and article 22 of the Interim Measures for the Stock Issuanceand Listing Sponsorship System.

■ The information disclosed by the issuer is untrue, inaccurate, or incom-plete, or the information contains false records, misleading statements, or substantial omissions. This violates the provisions of article 4 of the Admin-istrative Measures for the Sponsorship Business of the Issuance and Listing of Securities (Injunction No. 32 of China Securities Regulatory Commis-sion) and article 118 of the Content and Format of Information Disclosure by Companies Issuing Securities to the Public No. 1—Prospectus (ZJFXZ [2006] No. 5).

■ The sales performance of the company sponsored by the sponsor rep-resentative drops signifi cantly, which violates the provision of article72 of the Administrative Measures for the Sponsorship Business of the Issuance and Listing of Securities.


Analysis of Punishments against Sponsors byRegulatory Measures

From the perspective of regulatory measures, these 56 penalty notices can be divided into eight categories, which are listed below in order of severity:

1. Disqualifi cation of the sponsor representative 2. Rejecting the sponsor representative’s projects for 12 months 3. Rejecting the sponsor representative’s projects for six months 4. Rejecting the sponsor institution’s projects for three months 5. Rejecting the sponsor representative’s projects for three months 6. Warning letters 7. Talks with regulators 8. Warning talks

Table 7.2 lists the above eight categories with information about issuer’s regulation targets and dates for each of these measures.

Analysis of Sponsor Institution and Representative CreditRegulation by Regulatory Measures

Regulation targets may include the sponsor institution or the sponsor rep-resentative. Table 7.3 lists the fi ve sponsor institutions that were regulated. Of these institutions, four of them (80 percent) received a warning letterand one received a warning talk. Table 7.4 lists the 51 sponsor representa-tives that were regulated. Of these representatives, 41 of them (58.8 percent) received either a warning letter or warning talk.

Analysis of the Market Boards of Breaching Sponsors

Looking at whether the issuers subjected to regulatory investigations were publicly listed, we fi nd that 19 were listed companies and 6 were not listed companies. Of the listed companies, nine belong to the SME board, onebelongs to the GEM board, and nine others belong to the main board. Table 7.5 lists specifi c regulation items for all 25 issuers subjected to regula-tory investigation.

Analysis of the Annual Frequency of Punishments against Sponsors

Judging by the implementation frequency (Table 7.6 ), the regulators’ approach to the regulation of the primary market is becoming increasingly more strict and more mature.

371

TABL

E 7.

2 A

Lis

t of

Spo

nsor

Cre

dit

Reg

ulat

ions

by

Reg

ulat

ion

Mea

sure

s

Reg

ula

tion M

easu

res

Issu

erR

egula

tion T

arg

etE

ffec

tive

Date

Dis

qual

ifca

tion

of

spon

sor

repr

esen

tati

veH

unan

SH

EN

GJI

NG

SH

AN

HE

Bio

logi

cal

Scie

nce

and

Tech

nolo

gy C

o. L

td.

Lin

Hui

, Zho

u L

ingy

un20

11‐1

1‐24

—W

ang

Zhi

ni20

09‐9

‐29

—L

in L

in20

09‐9

‐29

Rej

ecti

ng t

he s

pons

or r

epre

sent

ativ

e’s

proj

ects

for

12

mon

ths

Gui

lin S

AN

JIN

Zho

u K

ai20

10‐8

‐23

Suz h

ou H

engj

iu P

hoto

‐Ele

ctro

nic

Scie

nce

and

Tech

nolo

gy C

O. L

td.

Liu

Xuy

ang,

Lia

n Y

an20

10‐6

‐4

—Z

hang

Qin

gshe

ng20

09‐9

‐29

Rej

ecti

ng t

he s

pons

or r

epre

sent

ativ

e’s

proj

ects

for

six

mon

ths

Hun

an N

anlin

g C

ivil

Exp

losi

ve M

ater

ial C

o. L

td.

Tang

Jin

gson

g, H

uang

C

hong

chun

2006

‐12‐

9

Rej

ecti

ng t

he s

pons

or in

stit

utio

n’s

proj

ects

for

thr

ee m

onth

sH

unan

SH

EN

GJI

NG

SH

AN

HE

Bio

logi

cal

Scie

nce

and

Tech

nolo

gy C

o., L

td.

Ping

An

Secu

riti

es C

o., L

td.

2011

‐11‐

24

Hun

an N

anlin

g C

ivil

Exp

losi

ve M

ater

ial C

o. L

td.

Fort

une

Secu

riti

es C

o., L

td.

2006

‐12‐

9

Rej

ecti

ng t

he s

pons

or r

epre

sent

ativ

e’s

proj

ects

for

thr

ee m

onth

sD

alia

n K

EM

IAN

Woo

d C

o. L

td.

Ma

Chu

jin, Z

hang

Xin

gyan

2011

‐11‐

28

Xia

ngta

n E

lect

ro‐C

hem

ical

Sci

ence

and

Tech

nolo

gy C

o. L

td.

Liu

Xia

osha

n, L

ei M

ao20

08‐6

‐27

A w

arni

ng le

tter

Shen

zhen

Hep

alin

k Ph

arm

aceu

tica

l Co.

Ltd

.M

ao H

uayo

u, W

ang

Tao

2011

‐6‐1

4

Wuh

an G

AO

DE

Inf

ra‐r

ed C

o., L

td.

Lei

Wen

long

, Zha

ng M

iao

2010

‐8‐9

Nin

gbo

Con

stru

ctio

n E

ngin

eeri

ng C

o. L

td.

Li G

uang

zeng

, Zha

oyua

n20

11‐6

‐27

JIU

MU

WA

NG

Co.

Ltd

.W

en F

ushe

ng, N

iu Z

hens

ong

2011

‐6‐1

3

Shan

ghai

XIA

ND

AI

Phar

mac

euti

cal C

o. L

td.

Xia

ng W

enya

n, S

u H

aiya

n20

11‐6

‐13

Jian

gsu

Hen

gjiu

Pho

to‐E

lect

roni

c Sc

ienc

e an

dTe

chno

logy

Co.

Ltd

.L

iu X

uyan

g, L

ian

Yan

, GF

Secu

riti

es C

o., L

td.

2010

‐6‐4

(con

tinu

ed)

372

TABL

E7.

2 (C

onti

nued

)

Reg

ula

tion M

easu

res

Issu

erR

egula

tion T

arg

etE

ffec

tive

Date

A t

alk

wit

h th

e re

gula

tor

Fujia

n T

EN

GX

IN F

ood

Co.

Ltd

.G

u Ji

anhu

a, D

u W

eim

ing

2011

‐4‐8

Xin

gwan

grui

jieY

ang

Gua

ng, F

u Z

hu20

10‐6

‐9

Suzh

ou H

engj

iu P

hoto

‐Ele

ctro

nic

Scie

nce

and

Tech

nolo

gy C

o. L

td.

Liu

Xuy

ang,

Lia

n Y

an20

10‐6

‐4

Fujia

n C

oal P

ower

Co.

Ltd

.Sh

ui H

aofe

ng20

04‐1

1‐8

A w

arni

n g t

alk

Jian

gsu

Shen

tong

Val

ve C

o. L

td.

Du

Che

nhui

, Yu

Yin

hua

2008

‐8‐2

7

Shan

ghai

Hai

bo C

o. L

td.

Qiu

Xia

obin

g, L

iu H

ao,

Eve

rbri

ght

Secu

riti

es C

o.,

Ltd

.

2006

‐11‐

27

Nin

gbo

Mos

hi G

roup

Co.

Ltd

.C

heng

Jia

nxin

, Wan

g Ji

anhu

i20

06‐1

1‐10

Gua

ngdo

ng L

EIY

I (G

roup

) C

o., L

td.

Xie

Jiju

n, Z

heng

Hua

feng

2005

‐1‐2

4

Gua

ngdo

ng W

EIE

R M

edic

al S

cien

ce a

nd

Tech

nolo

gy C

o. L

td.

Yu

Hao

, Jia

ng L

an20

04‐1

2‐30

Fujia

n C

oal P

ower

Co.

Ltd

.R

en J

unjie

2004

‐11‐

8

Bei

jing

Aer

oSpa

ce C

hang

feng

Co.

Ltd

.W

ang

Yan

g, S

hen

Jian

2004

‐10‐

21

Shan

dong

Jiu

fa E

dibl

e M

ushr

oom

Co.

Ltd

.C

hen

Yon

gyan

g, Y

ang

Huj

in20

04‐6

‐25

Kun

shan

JIN

LI T

rade

mar

k C

o. L

td.

Xu

Gan

g, G

uo X

iaog

uang

2008

‐8‐2

7

Zhe

jiang

HO

NG

DA

War

p K

nitt

ing

Co.

Ltd

.Z

hang

Jun

jie20

04‐1

1‐2

SDIC

ZH

ON

GL

U F

ruit

Jui

ce C

o. L

td.

BO

C I

nter

nati

onal

Lim

ited

2004

‐10‐

25

LIU

GO

NG

Mac

hine

ry C

o. L

td.

BO

C I

nter

nati

onal

Lim

ited

2004

‐10‐

25

Sour

ce: O

ffi c

ial w

ebsi

te o

f th

e C

hina

Sec

urit

ies

Reg

ulat

ory

Com

mis

sion

, ww

w.c

src.

gov.

cn/p

ub/c

src_

en.

http://www.csrc.gov.cn/pub/csrc_en


TABLE 7.3 Sponsor Institution Credit Regulation List by Regulation Measures

Regulation MeasuresRegulation Targets (SponsorInstitution)

Rejecting the sponsor institution’s projectsfor three months

Fortune Securities Co. Ltd.

A warning letter GF Securities Co. Ltd.

Ping An Securities Co. Ltd.

A warning talk BOC International Limited

Everbright Securities Co. Ltd.

Source: The offi cial website of the China Securities Regulatory Commission.

TABLE 7.4 Sponsor Representative Credit Regulation List by Regulation Measures

Regulation MeasureNumber of Tegulation

Targets (time)Percentage Regulated

Disqualifi cation of the sponsor representative 4 7.8

Rejecting the sponsor representative’s projects for 12 months

4 7.8

Rejecting the sponsor representative’s projects for six months

2 3.9

Rejecting the sponsor representative’s projects for three months

4 7.8

A warning letter 12 23.5

A talk with the regulator 7 13.7

A warning talk 18 35.3

Total 51 100


Ten punishments were dealt out in 2004 and two in 2005. Of these, all but one were warning talks, and the other was a talk with the regula-tors. Since 2006, regulatory measures have been increasingly stringent. The CSRC has dealt out eight punishments against six sponsor representatives and two sponsor institutions. The rejection of their projects for three to sixmonths has become a regulatory measure. In 2007, no punishments weredealt out. Six punishments were given in 2008 and three in 2009. Of the punishments given in 2008, two were rejection of projects for three monthsand 4 were warning talks. Since the IPO process was re‐launched in the second half of 2009, few punishments were dealt out in that year. However,

374

TABL

E 7.

5 Sp

onso

r C

redi

t R

egul

atio

n L

ist

by M

arke

t B

oard

s

Mark

et

Board

Issu

erR

egula

tion T

arg

etR

egu

lati

on M

easu

reE

ffec

tive

D

ate

SME

boa

rdD

alia

n K

EM

IAN

Woo

d C

o. L

td.

Ma

Chu

jin, Z

hang

Xin

gyan

Rej

ecti

ng t

he s

pons

or r

epre

sent

ativ

e’s

proj

ects

for

thr

ee m

onth

s20

11‐1

1‐28

Shen

zhen

Hep

alin

k Ph

arm

aceu

tica

l C

o. L

td.

Mao

You

hua,

Wan

g Ta

oA

war

ning

lett

er20

11‐6

‐14

Gui

lin S

AN

JIN

Zho

u K

aiR

ejec

ting

the

spo

nsor

rep

rese

ntat

ive’

spr

ojec

ts f

or 1

2 m

onth

s20

10‐8

‐23

Wuh

an G

AO

DE

Inf

ra‐r

ed C

o. L

td.

Lei

Wen

long

, Zha

ng M

iao

A w

arni

ng le

tter

2010

‐8‐9

Xin

gwan

grui

jieY

ang

Gua

ng, F

u Z

huA

tal

k w

ith

regu

lato

rs20

10‐6

‐9

Jian

gsu

Shen

tong

Val

ve C

o. L

td.

Du

Che

nhui

, Yu

Yin

hua

A w

arni

ng t

alk

2008

‐8‐2

7

Xia

ngta

n E

lect

ro‐c

hem

ical

Sci

ence

and

Tech

nolo

gy C

o. L

td.

Liu

Xia

osha

n, L

ei M

aoR

ejec

ting

the

spo

nsor

rep

rese

ntat

ive’

spr

ojec

ts f

or t

hree

mon

ths

2008

‐6‐2

7

Hun

an N

anlin

g C

ivil

Exp

losi

ve

Mat

eria

l Co.

Ltd

.Ta

ng J

inso

ng, H

uang

C

hong

chun

Rej

ecti

ng t

he s

pons

or r

epre

sent

ativ

e’s

proj

ects

for

six

mon

ths

2006

‐12‐

9

Fort

une

Secu

riti

es C

o. L

td.

Rej

ecti

ng t

he s

pons

or in

stit

utio

n’s

proj

ects

for

thr

ee m

onth

s20

06‐1

2‐9

Gua

ngdo

ng W

eier

Med

ical

Sci

ence

an

d Te

chno

logy

Co.

Ltd

.Y

u H

ao, J

iang

Lan

A w

arni

ng t

alk

2004

‐12‐

30

GE

M b

oard

Suzh

ou H

engj

iu P

hoto

‐Ele

ctro

nic

Scie

nce

and

Tech

nolo

gy C

o. L

td.

Liu

Xuy

ang,

Lia

n Y

anA

tal

k w

ith

regu

lato

rs20

10‐6

‐4

Liu

Xuy

ang,

Lia

n Y

anR

ejec

ting

the

spo

nsor

rep

rese

ntat

ive’

spr

ojec

ts f

or 1

2 m

onth

s20

10‐6

‐4

Liu

Xuy

ang,

Lia

n Y

an, G

FSe

curi

ties

Co.

Ltd

.A

war

ning

lett

er20

10‐6

‐4

375

Mai

n bo

ard

Nin

gbo

Con

stru

ctio

n E

ngin

eeri

ng

Co.

Ltd

.L

i Gua

ngze

ng, Z

hao

Yua

nA

war

ning

lett

er20

11‐6

‐27

JIU

MU

WA

NG

Co.

Ltd

.W

en F

ushe

ng, N

iu

Zhe

nson

gA

war

ning

lett

er20

11‐6

‐13

Shan

ghai

XIA

ND

AI

Phar

mac

euti

cal

Co.

Ltd

.X

iang

Wen

yan,

Su

Hai

yan

A w

arni

ng le

tter

2011

‐6‐1

3

Shan

ghai

Hai

bo C

o. L

td.

Qiu

Xia

obin

g, L

iu H

ao,

Eve

r bri

ght

Secu

riti

es C

o.

Ltd

.

A w

arni

ng t

alk

2006

‐11‐

27

Gua

ngdo

ng L

EIY

I (G

roup

) C

o. L

td.

Xie

Jiju

n, Z

heng

Hua

feng

A w

arni

ng t

alk

2005

‐1‐2

4

SDIC

ZH

ON

GL

U F

ruit

Juic

e C

o.

Ltd

.B

OC

Int

erna

tion

al L

imit

edA

war

ning

tal

k20

04‐1

0‐25

Gua

ngxi

LIU

GO

NG

Mac

hine

ry C

o.L

td.

BO

C I

nter

nati

onal

Lim

ited

A w

arni

ng t

alk

2004

‐10‐

25

Bei

jing

Aer

ospa

ce C

hang

feng

Co.

L

td.

Wan

g Y

ang,

She

n Ji

anA

war

ning

tal

k20

04‐1

0‐21

Shan

dong

Jiu

fa E

dibl

e M

ushr

oom

Co.

Ltd

.C

hen

Yon

gyan

g, Y

ang

Huj

inA

war

ning

tal

k20

04‐6

‐25

(con

tinu

ed)

376

Mark

et

Board

Issu

erR

egula

tion T

arg

etR

egula

tion M

easu

reE

ffec

tive

Date

Not

list

edH

unan

SH

EN

GJI

NG

SH

AN

HE

Bio

logi

cal S

cien

ce a

nd T

echn

olog

y C

o. L

td. (

IPO

not

app

rove

d)

Lin

Hui

, Zho

u L

ingy

unD

isqu

alifi

cati

on o

f th

e sp

onso

rre

pres

enta

tive

2011

‐11‐

24

Ping

An

Secu

riti

es C

o. L

td.

A w

arni

ng le

tter

2011

‐11‐

24

Fujia

n T

EN

GX

IN F

ood

Co.

Ltd

.(I

PO n

ot a

ppro

ved)

Gu

Jian

hua,

Du

Wei

min

A t

alk

wit

h th

e re

gula

tor

2011

‐4‐8

Kun

shan

JIN

LI T

rade

mar

k C

o. L

td.

(IPO

not

app

rove

d)X

u G

ang,

Guo

Xia

ogua

ngA

war

ning

tal

k20

08‐8

‐27

Nin

gbo

Mos

hi G

roup

Co.

Ltd

(IP

Ono

t ap

prov

ed)

Che

ng J

ianx

in, W

ang

Jian

hui

A w

arni

ng t

alk

2006

‐11‐

10

Fujia

n C

oal P

ower

Co.

Ltd

. (IP

Ono

t a p

prov

ed)

Shui

Hao

feng

A t

alk

wit

h th

e re

gula

tor

2004

‐11‐

8

Ren

Jun

jieA

war

ning

tal

k20

04‐1

1‐8

Zhe

jiang

HO

NG

DA

War

p K

nitt

ing

Co.

Ltd

. (IP

O w

ithd

raw

n)Z

hang

Jun

jieA

war

ning

tal

k20

04‐1

1‐2

Sour

ce: T

he o

ffi c

ial w

ebsi

te o

f th

e C

hina

Sec

urit

ies

Reg

ulat

ory

Com

mis

sion

.

TABL

E 7.

5 (C

onti

nued

)


TABLE 7.6 Sponsor Credit Regulation List by Years

YearNumber of

Regulatory Measures Specifi c Regulatory Measure

2004 10 One talk with regulators

Nine warning talks

2005 2 Two warning talks

2006 8 Two cases of rejecting projectssponsored by the sponsorrepresentatives for six months

One case of rejecting projects sponsoredby the sponsor institution for threemonths

Five warning talks

2007 0 —

2008 6 Two cases of rejecting projectssponsored by the sponsor representativefor three months

Four warning talks

2009 3 Two cases of disqualifi cation of sponsor representatives

One case of rejecting projects sponsoredby the sponsor representative for 12months

2010 12 Three cases of rejecting projectssponsored by the sponsor representativefor 12 months

Five warning letters

Four talks with regulators

2011 (Jan–Nov) 15 Two cases of rejecting projectssponsored by the sponsor representativefor three months

Two cases of disqualifi cation of sponsor representatives

Nine warning letters

Two talks with regulators

Total 56 —



those few punishments were more rigorous than any in the past. One of them involved rejection of projects for 12 months and the other two were disqualifi cations of the sponsor representative.

In 2010, the trend toward tougher and more stringent regulatory mea-sures became more prominent. The CSRC dealt out 12 punishments against seven individuals and one institution. On June 4, 2010, alone, the CSRC gave seven punishments against GF Securities and its sponsor representa-tives, Liu Xuyang and Lian Yan. The reason given was that GF Securities Co. Ltd. and its sponsor representative failed to work conscientiously while conducting due diligence investigation in relation to the IPO of Suzhou Hengjiu Photo‐Electronic Science and Technology Co. Ltd. and its listing in the GEM market. They did not check and verify the truthfulness and accu-racy of the documents before using them to support the application, leadingto serious misstatements in the prospectus as to the patent status disclosed. Their behaviors violated the provisions of article 11 of the Securities Laws of the People’s Republic of China (the Securities Law) and article 4 of the Administrative Measures for the Sponsorship Business of the Issuance and Listing of Securities. According to the provisions of the Securities Law andthe Administrative Measures for the Sponsorship Business of the Issuanceand Listing of Securities, warnings were given to GF Securities Co. Ltd. andits sponsor representatives, Liu Xuyang and Lian Yan. They were also sub-jected to regulatory measures such as talks with regulators, warning letters,and rejection of projects for 12 months.

For the year 2011 (by November 28), the CSRC had given 15 punish-ments. Of those regulatory measures, there were no warning talks and only two talks with regulators. There were nine warning letters, two cases of sponsor representative disqualifi cation, and two cases of rejection of proj-ects for three months.

It seems obvious that sponsor regulation is becoming more and more rigorous. Table 7.6 lists for comparison the number of regulatory measures given each year from 2004 to 2011 (by the end of November).

RULE BREAKING SPONSOR—CASE STUDIES

The Case of Suzhou Hengjiu Photo-Electronic

At the thirty‐fi fth work meeting of the GEB Issuance Approval Committee on June 11, 2010, the IPO application of Suzhou Hengjiu Photo‐Electronic Science and Technology Co. Ltd. was rejected, again. In early 2010, SuzhouHengjiu’s new shares became popular with a price/earnings ratio of 77.04 at CNY 20.80 per share, and 158 times online overfi nancing. Related sponsor


institutions and law fi rms were also punished accordingly. Because of the untruthful information disclosure and its impact, the issuance approvalcommittee believed Suzhou Hengjiu failed to comply with the Interim Mea-sures on Administration of Initial Public Offering and Listing on Growth Enterprise Board and other relevant provisions. Therefore, the decision wasmade not to approve the application. Based on the review opinions of the issuance approval committee, the CSRC withdrew its previous approval in accordance with law. After the CSRC made the decision to withdraw its approval, the issuer was also asked to refund shareholders the issue price and the interest calculated on the price using the bank deposit interest rate for the corresponding period. All of this was in accordance with the provi-sions of article 26 of the Securities Law.

The Issuance Approval Committee believed that the legal status of the fi ve patents and two pending patents disclosed in the prospectus and the documents submitted didn’t comport with the facts. All products of SuzhouHengjiu were currently using four lapsed design patents. Half of the prod-ucts were using one lapsed utility patent. From an overall perspective, thelapse of the fi ve patents had a negative effect on the applicant. During theissuance approval process, the CSRC paid close attention to the core tech-nologies of the company and its patent and proprietary technology docu-ments, urging the issuer to make suffi cient disclosure regarding possible right infringement and legal issues and urging agencies concerned to verify the information prudently. However, the response from the issuer and agen-cies concerned still failed to disclose the fact that all of the fi ve patents had lapsed and the two pending patents had been considered as withdrawn. Obviously, the issuer and the agencies concerned were responsible for the misstatement in the information disclosure.

This shows that as far as the verifi cation of these patents was concerned, the sponsor institution and the lawyer of the applicant provided profes-sional opinions that were factually wrong, simply based on the patent cer-tifi cates, patent application acceptance notifi cations, and other documents provided by the applicant. They failed to perform due diligence.

The prospectus of Suzhou Hengjiu disclosed that the company held four organic photo conductive drum design patents (ZL200430054254.9, ZL200430054255.3, ZL200430054256.8, and ZL200430054257.2), as wellas one organic photo conductive drum utility patent (ZL200420058463.5). The applications for the fi ve patents were all fi led in December 2004 with the State Intellectual Property Offi ce.

There were four patents pending, including three invention patents for a photoconductor using a new barrier layer containing macromolecular material, a method to improve the fatigue property of photoconductors, and a multilayered organic photoconductor respectively (patent application


numbers 200410041098.1, 200410066179.7, and 200910032466.9). Therewas also an additional utility patent for a multilayered organic photocon-ductor (patent application number 200920047194.5).

Suzhou Hengjiu also claimed to have the following three internationally advanced and domestically pioneering unpatented technologies:

1. Laser photoconductor drum production equipment development, design, and integration technology

2. Integration and gradient distribution technology for the function sepa-ration interfaces of OPC products

3. Removable wheel technologies for color laser photoconductor drums

In addition, it claimed to have the following seven internationally advanced and domestically leading technologies:

1. Coating material series formulation and preparation technology 2. High precision aluminum pipe processing and cutting technology 3. OPC series products of various types and lasers 4. Improved self‐lubricating material and abrasion‐resistant dopant material 5. New anode‐free oxide coating 6. Color laser photoconductor design and development 7. Production processes and techniques

However, a patent legal status search showed that the patents of the fi ve technologies owned by Suzhou Hengjiu had been terminated by the State Intellectual Property Offi ce as a result of the company’s failure to payrelevant annual fees. The two patent applications for a new type of barrier membrane using macromolecules and a technique to improve the fatigue property of organic photoconductors, after entering the substantial review process, were proclaimed withdrawn from consideration in April 2008, post‐invention patent application publication.

Despite the fact that the granted patents of their technologies had been terminated by the State Intellectual Property Offi ce for not paying the annual fee, and their two invention patent applications were deemed withdrawn automatically by the applicant, Suzhou Hengjiu claimed in its prospectus the ownership of the fi ve patented technologies. It also insisted that the two invention patents were still pending, while they had already been declaredwithdrawn from consideration, saying nothing about the actual legal status of the corresponding patent applications.

Based on the provisions of the Administrative Measures for the Spon-sorship Business of the Issuance and Listing of Securities, the CSRC issueda warning letter to GF Securities Co. Ltd., the sponsor institution of the


issuer. Two signed sponsor representatives—Liu Xuyang and Lian Yan—were subject to talks with regulators, received warning letters, and had to face the rejection of any documents signed by them in relation to securitiesissuance for 12 months. According to relevant provisions, Beijing TIANYINLaw Firm, which was the lawyer of the issuer, also received a warning letter from the CSRC. Three assigned lawyers were also subjected to talks with the regulators, warning letters, and rejection of any documents signed by them in relation to securities issuance for 12 months.

The case showed that the sponsor either failed to perform due dili-gence investigations or intentionally condoned the misstatement by Suzhou Hengjiu. Public opinions in the market generally hold that the sponsor deserves tougher punishment.

The Case of Hepalink

On June 14, 2011, after a waiting period of over one year, the CSRC fi nally reached an explicit conclusion regarding the claim by Hepalink that it was the “only FDA‐certifi ed company.” Based on its investigation, the CSRC found that while sponsoring the IPO and listing of Shenzhen Hepalink Pharmaceuti-cal Co. Ltd., sponsor representatives Mao Youhua and Wang Tao of China JIANYIN Investment Securities Company Ltd. failed to perform due diligence regarding the issuer’s alleged certifi cation by the U.S. Food and Drug Admin-istration. Their behaviors violated the provision of article 4 of the Adminis-trative Measures for the Sponsorship Business of the Issuance and Listing of Securities (Injunction No. 32 of China Securities Regulatory Commission). According to the provision of article 66 of the Administrative Measures for the Sponsorship Business of the Issuance and Listing of Securities, the CSRC decided to warn Mao Youhua and Wang Tao. The punishment was considered very light in comparison to the loss suffered by a large number of investors.

On May 6, 2010, Hepalink was offi cially listed on the Shenzhen Exchange. The issuance by Hepalink seemed to perfectly epitomize three highs: high price/earnings ratio, high issue price, and high overfi nancing. The issue price at CNY 148 per share was dubbed the highest IPO share price. The price/earnings ratio at 73.27 was far greater than the average price/earnings ratio of the pharmaceutical industry, both domestic and international, ranking near the top among stocks on the SME board. The initially planned fi nancing amount was no more than CNY 900 million. But in fact, CNY 5 billion was raised, making it the largest overfi nancing on the SME and GEM boards.

Hepalink was offi cially listed on May 6. The opening price on the same day was CNY 166. But the price soon broke through CNY 188, making it the king of stocks in China. The price slid back slightly in the afternoon, but still closed at CNY 175.17. The next day, the price of Hepalink’s shares


reached a high of CNY 188.88. Later, however, the shares of Hepalink fell below its issue price without warning. On May 10, the shares fell by theirdaily limit. On May 11, the shares closed at CNY 144.25, after falling bythe daily limit. By the fourth day after the listing of Hepalink, its shares fell below the opening price of CNY 148 per share. By the end of 2011, the price was hovering around one‐third of the highest price recorded soon after its listing (complex), as shown in Figure 7.1 .

What caused the absurdly high price of Hepalink’s new shares and the dif-fi culty that followed? The imbalance between supply and demand that exists in the new share issuing mechanism in the Chinese market is partly to blame. Investors scramble to buy new shares, sending the prices rocketing. Another reason has to do with the great appeal of the prospectus of Hepalink. Accord-ing to the prospectus, Hepalink’s strength lies in the following three aspects:

1. Hepalink was the heparin sodium producer and seller with the largest global sales. All of its products were intended for export. As the main anticoagulant for seniors, the market of heparin sodium continues to

FIGURE 7.1 Hepalink Share Prices on the Shenzhen Exchange, 2010 to 2011 Source: Sina Finance, http://fi nance.sina.com.cn/realstock/company/sz002399/nc.shtml.

200

170

140

110

80

50

20

27

20

14

7

x7524 10

0.00

−24,16

2010/05/06

MACD KDJ BOLL PSY OBV RSI WVAD CCI

2010/08/29

DF: −0.63

MA5: 9375 MA10: 14936 MA30: 27143

DEA: −0.32 MACO: −0.62

2011/02/26 2011/07/20 2011/12/09

2010/07

MA5: 28.15

Opening: 28.30, High: 28.68, Low: 27.09, Closing: 28.56, Volume: 9866, Change: 0.92%

MA10: 28.76 MA30: 30.33

2011/01 2011/07

http://finance.sina.com.cn/realstock/company/sz002399/nc.shtml


grow with each passing year in our aging societies. Data showed that the compound annual growth rate of sales in the global anticoagulant market was 10.40 percent. Heparin sodium was also proven to lowercholesterol, making the clinical application scope and market of heparin sodium continue to expand.

2. Hepalink claimed in its prospectus that the company was “certifi ed by the FDA (US) and CEP (EU), as the only Chinese heparin API producer to be certifi ed by the FDA.” FDA certifi cation is considered a barrier toentry into the U.S. market set up by the U.S. Food and Drug Adminis-tration. The company’s claim as the “only FDA certifi ed Chinese enter-prise” made it a company from China without rivals in the U.S. market (Zhang 2012 ).

3. Hepalink recorded CNY 2.24 billion of sales in 2009, with net profi ts reaching CNY 809 million. In the next two years, the compound annualgrowth rate reached 172.56 percent and 244.53 percent respectively.The profi tability of Hepalink was far above any comparable listed phar-maceutical company by the end of 2011.

Of the three preceding aspects, Hepalink’s major selling point was its claim as the only FDA certifi ed Chinese Heparin Sodium API producer. As a result, the shares of the company became highly favored by investors, especially institutional investors. In offl ine inquiry, some institutions offeredprices as high as CNY 200.

However, before the work to get Hepalink was complete, some doubt was heard in the market regarding the uniqueness of Hepalink’s FDA certi-fi cation. This directly led to an embarrassing situation in which Hepalink, after breaking the record for the highest issue price in the A‐share market, saw its price fall below the issue price in just three days after listing.

There was also doubt in the market regarding whether the sales of Hep-alink could grow fast enough. Three reasons for this doubt were as follows:

1. Hepalink suffered a lack of variety. According to the company’s annual report for 2010, Hepalink had two product grades: FDA‐grade hepa-rin sodium API and general‐grade heparin sodium API. The FDA gradeaccounted for 12.44 percent of sales and general grade for 87.55 per-cent, which accounted for 96.49 percent of exported products. Heparin‐derived anticoagulant drugs downstream were facing challenges from alternative drugs.

2. The supply of raw material seemed unable to keep up with the expan-sion of its production capacity in the face of rising prices.

3. The threat posed by other Chinese enterprises once they acquired FDA certifi cation was also an issue.


Although Hepalink was the largest supplier of heparin sodium in the world, three companies alone (Sanofi ‐Aventis, APP, and Chemi) were responsible for nearly 90 percent of its sales. This was a clear indication of high risks associated with the sales of Hepalink. If the three buyers were to abruptly reduce their orders, or turn to other suppliers, the sales of Hepalink would drop dramatically, leading to huge losses.

Hepalink therefore decided to hold a press conference in Shenzhen on May 24, 2010, to respond to questions regarding its status as the only Chi-nese heparin sodium producer approved and certifi ed by the FDA. Hepalinkalso addressed other issues including the impact of upstream ingredients on the enterprise, the use of the overfi nanced amount, the condition of com-petitors, shares held by Goldman Sachs, and others. Hepalink insisted that it was the only Chinese heparin sodium API producer certifi ed by the FDA. Sponsor representatives from Drug Source Company and China InvestmentSecurities were present at the press conference at the invitation of Hepalink.

But the market still had doubt about Hepalink. Xu Kangsheng, secre-tary general of the China Biochemical Pharmaceutical Industry Association, stated that a number of heparin sodium API producers in addition to Hep-alink had also been certifi ed by the FDA. The other companies included DONGCHENG in Yantai, QIANHONG in Changzhou, and CHANGSHANin Hebei.

On May 12, 2011, FDA spokesperson Karen Riley pointed out that “what Shenzhen Hepalink has obtained is a second class permit, which is for API products. That doesn’t constitute a certifi cation in any form, letalone making the enterprise FDA certifi ed. The FDA never certifi es enter-prises” (Global Times 2010).

All of these matters indicated serious factual issues in several parts of the description regarding FDA endorsement in Hepalink’s prospectus.

Discrepancies were also found between the actual performance of Hep-alink and the corresponding statement in the prospectus.

Since the fi rst quarter of 2011, the net profi t of Hepalink had been declining. The company reported a net profi t growth of −39.11 percent year upon year for the fi rst quarter. And the half‐year net profi t plunged −39.5 percent year upon year. The report for the third quarter released in late 2011showed that the net profi t was CNY 510 million, down 46.29 percent yearupon year. The company then forecasted a 30 percent to 50 percent decrease in profi t for the complete year.

As to the cause of the declining performance, the company stated in its quarterly report for the third quarter that “the selling price in 2011 is expected to be lower than the same period last year. In addition, as producers of Enoxaparin Sodium derived generic drugs and new heparin preparations gain approval from the FDA, competition in the downstream


market is expected to intensify. Sales for the whole year are expected to be lower than last year, which will lead to a lower performance of the company.”

Based on the above circumstances, there was false information in Hep-alink’s prospectus. It showed dereliction on the part of the sponsor. It might even have been done on purpose. The uniqueness of FDA certifi cation bearson the bargaining power, heparin sodium production capacity, and indus-trial status of Hepalink. By releasing false information, the underwriter and sponsor institution may infl ate the issue price and lure investors into buying overpriced shares, thus taking more procedure fees.

Insiders from the sponsor institution, China Investment Securities, revealed that “China Investment Securities was under great pressure because it had not made a dime from the fi rst 108 projects in the GEM board. At one point, it planned to introduce Hepalink to the GEM board. However, senior executives at Hepalink believed the company had already gone through the unstable start‐up period, and now had a mature market. They, therefore, voluntarily chose to have it listed in the SME board.”

In fact, the main business of Hepalink had a compound growth rate of 173.78 percent and a net profi t growth rate of 244.53 percent, which were enough to qualify the company for listing on the GEM board. Ma Qiang also made this analysis as he stated: “The market value of Hepalink reachedCNY 59.2 billion, which was greater than Yunnan BAIYAO (CNY 36.312 billion). Hepalink should have been listed on the main board.”

In this case, the CSRC was also responsible for not issuing punishment commensurate to the offence.

The CSRC warned the two sponsor representatives on June 14, 2011. But the target of the warning was the two sponsor representatives of China Investment Securities based on their failure to perform due diligence inves-tigation conscientiously. There was no mention of further action. Accordingto the provisions of the Administrative Measures for the Sponsorship Busi-ness of the Issuance and Listing of Securities, sponsor representatives who have failed to perform relevant duties conscientiously and in good faith may be subject to a probe by the Securities Regulatory Commission and may be handed over to the judicial authorities. With regard to the Hepalink sponsor project, the CSRC did not start a probe, it just gave a less severe warning instead.

A Shenzhen‐based lawyer stated: “The fact that the Securities Regulatory commission dared to send a warning letter showed it had partial evidence in hand. The warning letter, however, has two problems. First, the Securities Regulatory Commission didn’t start a probe and its response stopped at the regulatory level. Second, the Securities Regulatory Commission didn’t give a detailed description of the negligence on the part of China Investment Securities and the false statement made by Hepalink. The measures were so


limited that it’s very diffi cult for investors to seek legal redress.” The lawyeralso said that it basically can be established that Hepalink and China Invest-ment Securities violated regulations and deserved appropriate repercussions.

INTRINSIC FLAW OF THE SPONSOR SYSTEM: IMBALANCEBETWEEN PROFIT AND RISK

An analysis of the 56 punishments issued by the CSRC and typical cases shows that China’s fundamental fl aw of the sponsor system is an imbalancebetween the benefi t and risk of sponsors. Specifi cally, the system has a num-ber of problems, as detailed in the following section.

Incompetence of Sponsors

A sponsor should have a good credit record; deep understanding of the backgrounds and aims of various laws, regulations, and rules; good connec-tions in the industry; as well as project coordination capability and manage-ment experience. However, with the current system, a sponsor’s ability can be assessed only through exams, which has given rise to a large number of sponsors who are only good at taking exams, not practice. Therefore, many professional sponsor duties such as tutoring, sponsoring, review and verifi -cation, communication, continuous supervision, and reviewing and report-ing on information disclosure are not actually performed.

Unreasonable Sources of Income for Sponsors

With the current system, the economic interest of the sponsor relies on the successful listing of the issuing company. After successfully sponsoring the listing of the company and extracting sponsor fees and underwriting fees from the funds raised, the right to collect issuing fees comes to an end. Theobligation between the sponsor and the issuing company to pay such fees also comes to an end. However, the sponsor’s duty does not stop there. The sponsor is still responsible for continuous supervision for the remain-ing time in the year the company is listed, plus two full fi scal years. Such arrangements have some drawbacks, as follows:

■ Sponsor overlooking listing verifi cation and continuous supervision:It is the sponsor’s duty to conduct prudent verifi cation and continu-ous supervision. A shortage of sponsor representatives, large businessdemand, and bountiful benefi ts have led some sponsors to focus onthe development and listing of new issuing companies. They have been


overly obsessed with the number of companies getting listed while con-ducting the listing verifi cation in a perfunctory way. As a result, manyenterprises were found to lack core competitive strength after being listed. The absence of material incentives for the sponsor representative and the sponsor institution to conduct continuous supervision in the continuous supervision period has allowed the sponsor to profi t as long as the listing was successful. As a result, the sponsor would spend littletime and energy on continuous supervision. Relevant laws also indicatethat the term of a sponsor is relatively short. From the point of view of the third person in securities investment, this is not a favorable situation for the settlement of civil disputes. A responsible party is diffi cult toidentify in the end, leaving the third person in securities investment uncompensated.

■ Fraudulent listing: The realization of the sponsor’s economic benefi t mainly depends on the successful listing of the issuing company. Thismakes an interest group of the sponsor representative, the sponsor insti-tution, and the issuer. Such an interest group could easily collude in a listing fraud. A prevalent covert practice for the issuer and the sponsoris to exchange favors in an arrangement in which the sponsor holds shares in the sponsored company or engages in “direct investment plus sponsoring.” This practice has been driven by interests, giving rise to thethree highs phenomenon and PE corruption problems.

Ambiguous Rights and Responsibilities among the Sponsor,the Issuer, the Regulator, and Other Intermediary Institutions

Ambiguous Rights and Responsibilities for the Sponsor Representative and the Sponsor Institution It is very diffi cult to set the criteria to determine whether the sponsor has conducted due diligence investigation. The sponsor and the sponsor representative should conduct due diligence investigation on the issuer and its substantial shareholders and actual controllers. However,an objective standard with which to determine whether the sponsor and sponsor representative have conducted due diligence investigations does not exist. Subjective judgments by various parties alone are not convincing.

It is a dual sponsor system that China is implementing. Both the sponsor representative and the sponsor organization have sponsor duties. The cur-rent system doesn’t specify the respective rights and obligations of the spon-sor institution and the sponsor representative, which has led to the reality that the sponsor representative actually bears greater duties and risks than the sponsor institution. Because of the employment relationship between the two, the sponsor representative is not able to provide securities sponsoring services independently, and the sponsor institution has the fi nal say about


the sponsor’s work. Sponsor representatives have to be responsible for theinterests and goals of the company and department that hire them, therebylosing their independence.

The sponsor is not able to take on responsibilities regarding the quality of the company, the reliability of the information disclosure, and the contin-uous supervision on the issuer’s proper operation, integrity, and information disclosure. Sponsor institutions are also in a very disadvantageous position. They have to compete with each other in the sponsor market, or even collude with the issuer. Therefore, some “congenitally fl awed” companieshave been listed with a “makeover.” However, when it comes to account-ability, the sponsor representative tends to be held accountable to a greater extent than the sponsor institution. Once a problem is found with the issuer,the Securities Regulatory Commission punishes the sponsor representative, while the sponsor institution can often escape punishment. The quality of the listed company therefore depends completely on the overall capability and competence of the sponsor representative, which effectively makes thedual sponsor system a singular system.

Ambiguous Rights and Responsibilities between the Sponsor and the Issuer The major responsibility of the sponsor is to urge the issuer to perform its infor-mation disclosure duty and to be legally responsible for the truthfulness, timeliness, and completeness of the information disclosed. However, there are few provisions about the sponsoring rights of the sponsor. For example, to investigate whether the issuer has a connected transaction problem, a review of the shareholder accounts and the capital account is necessary. According to the current legal framework, the CSRC may review the bank account of a legal person if authorized by the state council. But current laws don’t authorize the CSRC to review individual deposit accounts. Regarding connected transactions, even the legally authorized body, the Securities Regulatory Commission, hasn’t had much success. If the issuer and its initiator and senior executives intentionally cover up some facts or refuse to cooperate, it is diffi cult for the sponsor representative to inquire about and verify connected transactions because they are internal affairs of the company. As a result, the sponsor is rarely able to carry out investiga-tions inside the enterprise. The sponsor then has to rely on the information provided by the issuer, leading to an obvious asymmetry of information. If the original materials provided by the issuer to the sponsor were incom-plete or inaccurate, or if the sponsor is not informed about a decision, the sponsor representative will be held accountable for false information, even with no means to have known about it. The responsibilities of the two par-ties must be clearly defi ned to prevent the issuer from transferring liability to the sponsor.


Ambiguous Rights and Responsibilities between the Sponsor and the Regulator According to the current Chinese system, the sponsor is required to review various application materials submitted by the issuing company. Securities regula-tory authorities are also responsible for conducting material reviews on these documents. Once a problem arises in association with the application materi-als, however, the sponsor alone will bear the responsibility. This makes the quality of the listed company solely dependent on the overall capability and competence of the sponsor.

Ambiguous Rights and Responsibilities between the Sponsor Institution and Other Intermediary Institutions. According to the current Chinese system, duringthe listing process, the sponsor organization should prudently verify professional opinions in the prospectus provided by intermediary agenciesand their signatories. The sponsor organization also judges the materialsand information disclosed by the issuer. However, accounting, auditing, and legal affairs are highly professional fi elds. And the audit report and legalopinions themselves have legal effects. Therefore, relevant agencies shouldtake the corresponding legal responsibility by right. To require the sponsorto conduct material verifi cation on professional opinions provided by inter-mediary agencies is to make the rights and responsibilities between the sponsor and such intermediary agencies ambiguous.

More Severe Punishment Needed for Breaching Sponsors

The punishment mechanism for breaching sponsors should be improved. They currently have the following two major issues to be resolved:

1. The regulator’s regulatory measures on sponsor institutions are weak, which has something to do with the fact that the fi nancial reform in China has not been completed. Most securities companies in the Chinese market were originally state‐owned fi nancial institutions. Althoughthey came from different backgrounds, they all were affi liated with the government at different levels. And although they have adopted corporation style operation models, they still have very distinctive bureaucratic characteristics. This is why the regulators and the sponsororganizations share some common interests.

2. It is true that there are specifi c punishment measures against breaches committed by sponsors. Specifi cally, there are restrictions for the spon-sor institution, its sponsor representatives, the person in charge of thesponsor business, or the person in charge of the internal check. If any of these parties fail to perform their relevant obligations faithfully and diligently in accordance with these measures, the CSRC may order them


to make a correction. The CSRC may also take regulatory measures including talking with them, paying special attention, ordering them tostudy business, issuing warning letters, ordering them to issue a publicstatement, or identifying them as inappropriate candidates. If it is nec-essary to impose an administrative penalty, such a penalty is imposedin accordance with relevant provisions. If the circumstance is seriousand certain individuals are suspected of committing crimes, then they are handed over to the judicial authorities and criminal liabilities are imposed in accordance with the law.

However, the restraint on sponsors and sponsor representatives is essen-tially limited to regulatory levels. It is an embarrassment that we still lack defi nite provisions on civil and criminal liability. This makes the cost of crime for sponsors ignorable compared to the benefi t. As a result, collusion between the issuer and the sponsor in fraudulent listing seems to be running wild.

DIRECTION FOR SPONSOR SYSTEM REFORM

Improving Stock Issuance Pricing System and SecuritiesMarket Litigation System

The most criticized part of the sponsor system is the asymmetry of the profi t and risk of sponsors. This asymmetry is, to a great extent, caused not bythe sponsor system itself, but by the insuffi cient stock issuance pricing sys-tem and securities market litigation system. In a mature securities market,various systems tend to have deep‐rooted connections, which is a frequently overlooked point. It is the existence of a market‐based stock issuance pric-ing system and a market‐based securities market litigation system (e.g., classaction) that makes sponsors in a mature securities market fearful that theymay go broke and be sentenced to jail. In a sense, the judicial system may be considered a key factor for the development of the fi nancial system. An inde-pendent and sound litigation system in the securities market is conducive to the improvement of a series of systems in the securities market, includingthe sponsor system.

Sponsor Competence Standardization

In order to standardize the professional capability of sponsors, the spon-sor exam system must be reformed. It must establish a multilayer sponsor selection system based not only on knowledge exams, but also on work experience, managerial capability, and other abilities that can be obtained


only through practice. Then, people with different levels of skill are given different professional qualifi cations. By doing this, talented individuals withrich experience but lacking exams skills can be attracted to join the sponsor profession. A larger population of sponsors may also help build a sponsormarket with suffi cient competition, promote competition between sponsors,make them more vigilant, and improve their competence and service quality.This then improves the overall quality of listed companies.

On the other hand, the professional practice of sponsors must be sub-ject to greater oversight. That is, it must establish a professional archive of sponsors that combines the professional experience and breach records of sponsors in a credit archive. The professional track record of a sponsor can then be rated regularly and the result released to the public. The market thus plays a supervisor role, forcing sponsors to work diligently and ensuring the transparency and order of the sponsor market.

Tying Profi t to Duties Performed by a Sponsor

In order to tie the profi t to duties performed by a sponsor, we must fi rst ensure that the duties of the sponsor can basically be performed. According to the provision of article 29 of the Interim Measures for the Stock Issuanceand Listing Sponsorship System, the period of continuous supervision andguidance for an issuer of initial public offer of stocks is the remaining time of the current year of the listing of the securities plus the following two com-plete fi scal years. For a listed company who issues new stocks or convertible corporate bonds, the period of continuous supervision and guidance is theremaining time of the current year of the listing of the securities plus the following one complete fi scal year. The period of continuous supervisionand guidance begins the day of the listing of the securities. This provisionshows that the term for sponsors is currently too short for them to performtheir sponsor duties. The term of sponsors should be extended to a lifetime position. Implementing a lifelong sponsor term can subject a listed company to continuous supervision, examination, and guidance from the sponsor as long as it remains listed. This is of great importance to preventing breaches of laws and regulations by listed companies, thus improving the quality of listed companies and protecting the interests of investors.

The performance of a sponsor’s duties should also be provided with the following incentives:

■ Underwriting expenses should be determined by the market and a pay -ment system should be established for the costs of continuous super-vision. Sponsor institutions should be encouraged to establish and maintain a good market reputation and improve the quality of their


sponsoring business. Relevant regulators should loosen their control on underwriting fees and establish a market‐based underwriting servicepricing mechanism. Underwriting services can then be priced to suffi -ciently refl ect the quality of the sponsor business and the value of reputa-tion capital. Sponsor institutions can get return and compensation from their investment in reputation and efforts to improve the quality of the sponsoring business. This in turn creates the conditions for streamliningthe relationship between the reputation of sponsor institutions and the quality of continuous information disclosure supervision. A continuous supervision fee payment system should also be established with the cri-teria based on the quality of the continuous supervision business. Thiswould encourage sponsor institutions to improve the quality of the con-tinuous supervision business.

■ A long‐term incentive mechanism should be applied to the salary of sponsors to encourage and guide them into long‐term behaviors. Forexample, if the sponsor exaggerates the investment value of the issuer inorder to drive up the issue price and the share price ends up lower than the valuation, it might help to require the sponsor to buy a certain pro-portion of the shares from the secondary market and not cash out until the price approaches the upper limit of the valuation. This can preventthe sponsor from arbitrarily valuating and thus affecting institutional bidders.

■ Within its organization, the sponsor institution should transform its incentive mechanism for sponsor representatives. It is worth considering the idea of strengthening the independence of sponsor representatives, changing the operation mode of sponsor institutions, and providingincentives for the work of sponsor representatives through limited part-nership or the business director system. This would tie their incomes to the proper operation and long‐term prospects of the sponsor institution. The sponsor representatives would thus consciously follow standard sponsoring practices.

Specifying the Rights and Responsibilities of the Sponsor, the Issuer, and the Regulator

Specifying the Rights and Responsibilities between the Sponsor Representative and the Sponsor Institution A set of highly operable standards of minimum sponsordue diligence investigations should fi rst be put in place to determine whether the sponsor has conducted due diligence investigation. In this respect, prac-tices in the mature market can be duplicated. For example, in their legal precedents for relevant cases, U.S. courts have specifi ed the minimum requirements for sponsor due diligence investigation. Those requirements


play an important role in accurately measuring the behaviors of the sponsor and accurately determining the appropriate extent of penalty. At the sametime, a practical set of minimum sponsor due diligence investigation stan-dards should be established in view of the specifi c conditions of the Chinesesecurities market.

The responsibilities of the sponsor should then be further specifi ed. Rights and responsibilities should be clearly divided between the sponsor representative and the sponsor institution. Restraints imposed by the spon-sor institution on the sponsor representative should be rolled back, and theindependence of the sponsor representative should be strengthened. A spon-sor representative talent pool, as well as a sponsor talent pool, could be set up. In practice, the CSRC may collect fees and the sponsor and the sponsor representative would receive their compensations from the CSRC separately. The CSRC randomly would select the sponsor and the sponsor representa-tive from the sponsor talent pool and the sponsor representative talent pool. The two parties together could be responsible for sponsoring the listing of a company. This could ensure the independent legal status of the sponsor representative.

Specifying the Rights and Responsibilities between the Sponsor and the Issuer In order to ensure that the sponsor can obtain information necessary for the suffi cient performance of duties in a timely manner, the authority of the sponsor should be expanded appropriately. Relevant legislation could give the sponsor certain rights. For example, they could have the right to be present at the shareholders meeting or the board of directors meetingof the issuer, or the right to express opinions on major decisions made by the issuer. They could also make it mandatory that the company cooperate with the sponsor’s efforts to examine its bank accounts, important fi nancial materials, important contracts and agreements, texts, and other important documents. A balance would thus be reached between the sponsor’s respon-sibilities to the issuer and the sponsor’s rights.

Specifying the Rights and Responsibilities between the Sponsor and the Regulator The sponsor alone should be put in charge of reviewing the listing application materials and should be held accountable for any problem associated with the process. This could clearly defi ne the responsibilities of the sponsor, mak-ing the sponsor more aware of such responsibilities and more motivated.

Specifying the Rights and Responsibilities between the Sponsor Institution and Other Intermediary Agencies The sponsor should only bear supplementary guaran-tee liability for professional opinions or technical documents provided by accountant fi rms, law fi rms, and other intermediary agencies. In a case in


which these professional opinions or documents contain false information, mistakes, or omission, the sponsor would be spared of legal liability as long as it could prove that it has performed necessary examination duties. Thiscould ensure that the sponsor and these intermediary agencies take care of their own business.

Tougher Penalties for Law-Breaching Sponsors

Market‐oriented reform should be accelerated. The introduction of a diver-sifi ed investment body may help decentralize the equity structure of Chinesesponsor institutions. In turn, this is conducive to eliminating the interest tiesbetween the sponsor institution and government agencies. It would enablethe regulator to play its role fairly and justly. It would also strengthen penal-ties against sponsor institutions and improve the overall capability of spon-sor institutions.

The sponsor punishment system and relevant systems must also be improved. The legislation process in relation to criminal liability of a spon-sor must be sped up. The sponsor civil compensation system and compul-sory liability insurance system should be built up. The sponsor’s sense of responsibility should be raised. Their failure to actively perform their spon-soring, tutoring, and supervision duties should be appropriately sanctioned. Only through tougher punishment, greater risks, and higher costs of breach-ing will sponsors realize that they will bear economic losses if investors suf-fer losses from misleading, incomplete, inaccurate, and overdue disclosures by the issuing company.

REFERENCES

Cao , Zhongming . 2010 . “ The Sponsoring System Needs Further Improvement .” Western Forum 10 .

Chen , Xiangyou . 2010 . “ The Reasons for the Non‐Signifi cant Correlation between Sponsor Institution Reputation and the Quality of Information Disclosure by IPO Companies during the Continuous Supervision Period and Counter Measures .” Accountant Monthly 2 .

Chen , Zhengrong . 2003 . “ Comparative Analysis of the Sponsor Systems in Some Countries and Regions .” Securities Daily , August 4.

Chen , Zhengrong . 2004 . “ A Study on Sponsor Systems in Overseas Markets .” Capital Market 6 . t

Gao , Qingfu . 2004 . “ Research on the Development of the Sponsor System of the Chinese Securities Market .” Economic System Reform 2 .

Global Times . 2010 . “FDA Confi rmed Hepalink’s False Report in IPO Prospectus,” GlobalTimes.cn, May 14. www.globaltimes.cn/content/531993.shtml.

http://www.globaltimes.cn/content/531993.shtml


Guo , Shuhui . 2011 . “ Analysis of the Status of China’s Sponsor System and Sugges-tions for Improvement .” Legal System and Society 6 .

He , Jin . 2005 . “ Perfecting the Sponsor System of China’s Securities Market .” East China Economic Management 10 .t

Hou , Ruifeng . 2010 . “ Status Quo of the Sponsor Liability System and the Improve-ment Thereof .” Industrial and Science Tribune 3 .

Huang , Xiangyuan . 2010 . “ Sponsor or Conman .” Finance & Economy 17 . Li , Youxing , and Xiao Qiong Xu . 2008 . “ On Perfecting Sponsor’s Responsibility in

Securities Issuing and Listing .” Journal of Business Economics 1 . Liang , Wanquan . 2011 . “ Issue and Reform Solution of Sponsor System about Secu-

rity Market in China .” Reformation & Strategy 8 . Liu , Jianghui , and Ruibo Song . 2003 . “ Analysis of the Phenomenon Breaches of

Rules and Trust by Sponsors in China and the Causes Thereof .” Management World 12 .d

Wu , Fei . 2003 . “ Analysis of the Effi cacy of the Sponsor System—Centering on the Interim Measures for Securities Issuance and Listing Sponsor System .” Financial Law Forum 7 .

Xu , Liu and Taotao Zhang . 2010 . “ A Simple Analysis of the Stock Issuance and Listing Sponsor System .” Fazhi Yu Jingji (Legal System and Economy) 9 .

Yin , Heng . 2010 . “ Empirical Research on the Relationship between Underwriters’ Reputation and IPO Firms’ Quality in Sponsor System .” Humanities & Social Sciences Journal of Hainan University 4 .

Zhang , Junmian . 2012 . “Top 10 Biggest Losers of Wealth in China 2011.” China.org.cn, February 16. www.china.org.cn/top10/2012‐02/16/content_24642026_6.htm.

http://www.china.org.cn/top10/2012-02/16/content_24642026_6.htm

397

CHAPTER 8 8 Experience and Lessons from

International Investment Banks(Securities Companies)

in Mature Markets

China’s securities industry has been facing fresh opportunities and chal-lenges as profound changes have shaped the international economic and

fi nancial environment in recent years. During this development trend, it hastransformed from a separate operation to mixed operation. A major issuenow is how to achieve a healthy and stable development under this newbusiness environment. One opportunity for Chinese securities companies isto step into the “bright future” paved by business development models andexperiences from foreign investment banks (securities companies).

This chapter examines the general laws of development for investmentbanks in the new differentiated environment by looking at the externalregulation mode, organizational structure, business structure, and internalcontrol of international investment banks in mature markets. It then putsforward a range of proposals, combined with China’s specifi c circumstances,for Chinese securities to develop and prosper.

OVERVIEW OF THE DEVELOPMENT HISTORY OF INVESTMENTBANKS IN THE MATURE OVERSEAS MARKET

Internationally, there is a plurality of designations for investing banks withvarying connotations and denotations. Before getting into the specifi cs of the development experience of overseas investing banks, let us fi rst defi neinvestment banks themselves. There are narrow and broad concepts of investment banks. Based on the coverage of business lines, the four levelsshown in Table 8.1 can be defi ned.


As shown in Table 8.1 , investment banks on the fi rst level simply engage in the most traditional investment banking business, which includes only stock and bond underwriting and some fi nancial counseling services in the primary market. Investment banks on the second level have common invest-ment bank business lines and relatively complete coverage of primary and secondary market services. Investment banks on the third level have a rather comprehensive business scope. They engage in such types of knowledge‐intensive business as asset management and research, which are usually con-sidered to be the basic features of large investment banks. Investment banks on the fourth level are actually beyond the traditional defi nition of invest-ment banks. They fi t the concept of a holding company with investment banking at the core of its business, similar to Goldman Sachs and MorganStanley.

In addition to differences in connotation and denotation, investment banks under the same level tend to have different designations from country to country. For example, investment banks on the third level are called invest-ment banks in the United States, merchant banks in the United Kingdom,and securities companies in Japan and China. In this chapter, depending on the context, the terms investment bank and securities company are usedinterchangeably to refer to investment banks on the third level, unless speci-fi ed otherwise.

Evolutionary History and Structural Patterns of InvestmentBanks in the United States

From the perspective of the relationship between investment banks and commercial banks, the development history of investment banks in the

TABLE 8.1 Defi nition of Investment Bank

HierarchicalStructure of Investment

Banks

PrimaryMarket

Business: Stockand Bond

Underwritingand Counseling

SecondaryMarket

Business:Stock and

Bond Trade, Brokerage

AssetManagement

Business, Research Business

OtherBusiness

Related tothe Capital

Market

First Level

Second Level

Third Level

Fourth Level

Experience and Lessons from International Investment Banks 399

United States was punctuated by the separation, integration, reseparation and reintegration of investment banks and commercial banks, which is the American way of investment bank development. These four phases aredetailed here:

1. The fi rst phase: Natural separation phase. Investment banks fi rst appeared in the United States in the beginning of the nineteeth century.The investment bank and the commercial bank were independent of one another, each with its own well‐defi ned business scope. Investmentbanks mainly engaged in securities underwriting. Commercial banks mostly engaged in deposits, loans, and other types of credit business. Inthis phase, the separation of investment banks and commercial bankswas a natural result of historical and economic development, rather than something created by law or statute.

2. The second phase: “Early mixed operation” phase. With the develop-ment of the domestic economy in the United States, the capital market also grew bigger. In the late nineteeth century and early twentieth cen-tury, direct fi nancing gradually took center stage in the development of the fi nancial industry, which had been previously occupied by indirect fi nancing. The shift was manifested in unprecedented active investment, speculation, underwriting, and brokering activities in the securitiesmarket. The development of the securities market expanded fi nancingchannels for enterprises and brought in a large amount of direct fi nanc-ing. Favorable returns from the securities market also caused enterprises and investors to transfer their capital from banks to the securities mar-ket. In the face of a capital drain that severely challenged their traditional business, commercial banks started making great effort to get into theinvestment banking business, drawing on their great capital strength.This transformation was convenient partly due to the fact that fewer legal barriers existed at that time. The competition for turf between investment banks and commercial banks during that time essentially led to the fi nal integration of the “two industries.”

3. The third phase: Post‐depression “modern separation” phase. After over a decade of prosperity, the U.S. stock market plummeted in 1929to trigger the Great Depression. The “mixing” of securities and bank-ing was considered by many to be the root cause of the crisis. As the result of “mixed” operation, money could easily fl ow into the stock market and create bubbles. When the bubbles burst, the stock market collapsed and fi nally led to the complete collapse of the economy. In order to protect the safe development of commercial banks and avoid similar crises from happening again, the United States passed the famous Glass‐Steagall Act in 1933, which clearly defi ned the business


scope of commercial banks and investment banks for the fi rst time. This brought to an end to the era of mixed operation of investment banks and commercial banks in the United States, and established theseparate operation model. After the Second World War, many countries including the United Kingdom and Japan followed in the footsteps of the United States and enforced separate operation for investment banks and commercial banks.

4. The fourth phase: “Modern mixing” phase. In the 1980s, mixed opera-tion once again became the development trend of investment banks, fueled by a new round of technological revolution, fi nancial innovationand liberalization, and fi nancial globalization. In dealing with internal and external competition, investment banks and commercial banks made attempts to dodge the Glass‐Steagall Act in order to expand their business share. From the perspective of the regulators, in order to secure the status of the United States as the center of the global fi nancial market and maintain the global competitiveness of U.S. fi nancial insti-tutions, a series of liberalization measures needed to be taken to pro-mote the development of the fi nancial industry. During the period fromthe late 1970s to the late 1990s, relevant laws and regulations were made or revised to relax restrictions on mixed operation. For example,the interpretation of the Securities Law was loosened in 1977. Restric-tions on the underwriting of commercial papers and corporate bonds by commercial banks were loosened in 1978. The Deregulation Act waspassed in 1980. In 1987, some commercial bank holding companies were allowed to engage in securities business through their subsidiaries. In 1989, commercial banks were allowed to underwrite corporatebonds. In 1991, the U.S. Department of Treasury promulgated the Fed-eral Deposit Insurance Corporation Improvement Act of 1991, whichallowed some banks to acquire and hold common shares or preferredshares to an amount equal to 100 percent of their capital. In 1999, theU.S. Congress passed the Financial Service Modernization Act, which offi cially abolished the symbol of the separate operation system, the Glass‐Steagall Act, putting the fi nishing touch on the shift from “sepa-rate” operation to “mixed” operation. In 2008, marked by the bank-ruptcy or merger of the fi ve biggest U.S. investment banks in the face of the international fi nancial crisis, major investment banks in the United States transformed into bank holding companies, ushering in an era of full‐on mixed operation.

The following two major development models are identifi able in the development history of investment banks in the United States: The Merrill Lynch model and the Citigroup model.


The Merrill Lynch Model The Merrill Lynch model, also known as the inde-pendent investing bank model, is exemplifi ed by Merrill Lynch and adoptedby Merrill Lynch, Morgan Stanley, and Goldman Sachs.

Under this model, investment banks are independent market entities. Most cases are specialized in, or at least mainly focused on, the invest-ment banking business. They are characterized by a high level of intrain-dustry specialization, outstanding credit and reputation, and relatively less involvement in commercial banking. Institutions following the independentinvestment bank model mainly engage in securities issuance and underwrit-ing, securities brokerage and proprietary business, M&A counseling, fund management, venture capital investment, and credit and debt securitization. They are the major market makers in the U.S. securities market and serve the institutional investors in the U.S. fi nancial market, together with mutual funds and insurance companies. Because they are not commercial banks intheir own right, most of these companies chip away at the territory of com-mercial banks through “fi nancial innovation.”

In the early twenty‐fi rst century, the capital market departments of investment banks such as Merrill Lynch Securities started making a signifi -cantly bigger contribution to the total revenue, as the percentage of the pro-prietary business rose remarkably. It was the derivative trading that would, in the future, lead investment banks to dire straits, and even closure. Beforethe outbreak of the subprime mortgage crisis in 2007, mergers and acquisi-tions among investment banks were mainly used for the purpose of business expansion. Such types of M&As included the acquisition of First Boston byCredit Suisse, the merger of Salomon Smith Barney and Travelers Groupinto Citigroup, the acquisition of Bankers Trust by Deutsche Bank, and the merger of Warburg into Union Bank of Switzerland.

In 2008, the fi ve largest investment banks in the United States found themselves at the center of the fi nancial crisis. They were forced to go bank-rupt or restructure under the pressure of a large amount of debt and a high leverage rate. In March 2008, the fi fth‐largest investment bank in the United States, Bear Stearns, was on the brink of bankruptcy and was acquired by J.P. Morgan. In September 2008, the fourth‐largest investment bank in the United States, Lehman Brothers, announced its bankruptcy, which launched the subprime mortgage situation into a complete international crisis. MerrillLynch was then acquired by Bank of America. Goldman Sachs and Morgan Stanley ended up as the only two survivors of the fi ve giant investment banks.

The Citigroup Model The Citigroup model, also known as the fi nancial hold-ing company model, is exemplifi ed by Citigroup and adopted by Citigroup, J.P. Morgan, Bank of America, and HBC.


Under this model, the parent company engages in both investment banking and commercial banking at the same time. The investment banking department is relatively independent, and there is a rather apparent fi rewall between the investment banking and other types of business. The parentcompany’s control over the investment bank is relaxed. This is often referred to as the fi nancial holding company model.

In developing its investment banking business, Citigroup pulled off a great strategic shift through its merger with the Travelers Group, and laterthe acquisition of Schroders. Its investment bank has the following threecomparative advantages:

1. Conspicuous measures insulating investment banking from other types of businesses make it diffi cult for fi nancial risks to spread within the entity.

2. The investment bank is relatively independent and has clearly defi ned responsibilities, rights, and interests, as well as well‐balanced constraints and incentives.

3. The operation network of the commercial bank can be utilized to mar-ket investment bank products in a comprehensive way, realizing econo-mies of scale and economies of scope, and bringing the synergistic effectinto full play.

The international fi nancial crisis of 2008 led to an across‐the‐board shift from the independent investment bank model to the fi nancial holding com-pany model in the United States. In September 2008, Goldman Sachs and Morgan Stanley, the only survivors of the fi ve major investment banks in the United States, quickly became bank holding companies. They are regulated by the Federal Reserve and treated similar to Citigroup and J.P. Morgan. In fact, before this even happened, Goldman Sachs and Morgan Stanley had already engaged in some commercial bank business. The transformation into bank holding companies enabled Goldman Sachs and Morgan Stanley to apply for various loans and fi nancial support from the Federal Reserve. This gave them legitimacy in engaging in various types of commercial banking business. Through the transformation, they increased the number of avail-able fi nancing channels from three (commercial papers, long‐term debts, and secured fi nancing) to nine (including deposit taking, Federal Reserve loan tools, and the Federal Reserve discount window). This greatly enhanced their ability to acquire emergency funds in the event of a risk.

Presumably, the expansion of fi nancing channels and the strengthening of the commercial banking business will give new competitive advantages to Goldman Sachs and Morgan Stanley. In their future development, they will continue to draw on their core competitive strength in investment


banking, sticking to a development model in which investment bankingis primary and commercial banking is secondary. The transformation of Goldman Sachs and Morgan Stanley, the acquisition of Merrill Lynch, andthe examples of Citigroup, HSBC, and J.P. Morgan all showed that fi nan-cial institutions with both commercial banking and investment bankingunits are more resistant to risks in a fi nancial tempest. This is thanks to their stable fund sources and wide fi nancing channels. Integrated fi nancial groups with fully interactive commercial banking and investment banking units will be in a more advantageous position in future investment bank-ing competition.

Evolutionary History and Structural Patterns of InvestmentBanks in the United Kingdom

In the United Kingdom, investment banks are also known as merchant banks. They were created in response to the increasing demand for fi nanc-ing and services in overseas trade.

After the eighteeth century, London gradually replaced Amsterdam as the international fi nancial center. It played that role until the period leading up to the First World War. In that period, increasingly intense internationaltrade competition led to a decline in revenues from overseas trade. At the same time, the trend toward specialization became increasingly prominent in the manufacturing industry, which made businessmen in the manufac-turing industry unable to afford the fi nancial risks associated with market exploration. In order to distribute risks and meet the demand for fi nanc-ing, the United Kingdom established a large number of accepting houses in London. In their early stage, these accepting houses specialized in takingfi nancial risks associated with export. Later, they expanded their business to cover fund‐raising for large companies with international operations or even foreign government, in addition to the traditional acceptance and trade loan business. These fi nancial institutions had distinctive family business characteristics. The larger ones among them included the Rothschild fam-ily and the Barings Bank. However, they were considered typical merchantbanks. Besides engaging in conventional deposit/loan business and earning income from the difference of interest rates, they also helped their clientsraise funds, provided fi nancing for public projects launched by the govern-ment, and made investments with the bank’s own capital.

After World War I, the United Kingdom’s status as the international fi nancial center declined. Although it still had the most developed merchant bank business in Europe, the banks entered a period of slow development.

During the Great Depression of the 1930s, international trade was dras-tically reduced. Business focus shifted to corporate fi nances as the banks


arranged fund sources for companies, helped with corporate fi nancingefforts through the issuance of bonds and shares, and provided counselingservices for acquisitions, mergers, and restructuring. The role of merchant banks became provider of relevant fi nancial services for companies. This included making arrangements for the sale or issuance of the shares of a company to the public, fi nding ways to get the shares of a company listed in a securities exchange, and providing acquisition and merger counseling. Other activities included managing investment funds for charities, insurancecompanies, pension funds, investment trusts, and unit trusts. The banks alsoprovided general bank services, such as accepting demand deposits and timedeposits, but mainly for corporate clients.

After the 1970s, the privatization of state‐owned enterprises in the United Kingdom provided merchant banks with a broad base for their business. OnOctober 27, 1986, the London Securities Exchange adopted the FinancialService Act, which broke the previous rigorous business barriers betweenmerchant banks and commercial banks. The act allowed strong domestic and foreign commercial banks, insurance companies, and securities com-panies to apply for membership with the London Securities Exchange, orto directly take part in the securities business with a 100 percent stake in a member organization. Entering the twentieth century, some merchant banks in the United Kingdom kept the traditional bill acceptance as their main business, as typifi ed by the 17 members of the Accepting House Committee (AHC). Other merchant banks, however, entered the capital market, engaged in the securities underwriting business, and played the role of intermediariesand managers.

When the subprime mortgage crisis broke in 2008, Barclays Banks rushed to acquire the investment banking and capital market units of Lehman Brothers. This secured its status in the U.S. fi nancial market anda top 10 ranking among investment banks around the world. Today’s well‐known investment banks in the United Kingdom include Barclays, HSBC Holdings, and the Royal Bank of Scotland.

The most fundamental characteristic of the European model, as rep-resented by investment banks in the United Kingdom, is a high degree of integration and interpenetration between the investment bank business and the commercial bank business. This is important because British merchant banks take a foothold in the domestic market or in continental Europe, focus on a certain business fi eld, and secure a leading position in that fi eld. For example, Warburg (mostly acquired by USB) has long been the leader inthe fi eld of M&A fi nance counseling for European enterprises and has been actively exploring the Pound‐denominated bond underwriting business and the fund management business. Schroder has been aggressively exploringinternational business, especially arrangements for the overseas issuance of


British securities, while establishing a sound fund management system. Itstentacles have reached the United States and eastern Asian countries. Thecurrent situation in the United Kingdom is a domestic market dominated by about a dozen fi rst‐class merchant banks together with a multitude of small‐sized family businesses.

Evolutionary History and Structural Patterns of InvestmentBanks in Germany

The most salient characteristics of the development of investment banks in Germany is that investment banks have always been integrated with com-mercial banks and are engaged in mixed operation. This model was formed under some special conditions. American investment banks infl uenced the development of the fi nancial industry, but only to a certain point. American banks started as independent entities and then developed into a hybrid of investment banks and commercial banks. German investment banks, on the other hand, have been integrated with commercial banks since the very begin-ning and are marked by an unmistakable tint of government architecture.

The three major reasons behind the creation and development of the mixed operation investment bank model in Germany are as follows:

1. High dependence of German enterprises on banks provided the basis for the development of multiservice banks.

2. The special interest relationship between major German banks and political parties and the special political system of Germany also played a role in the consolidation and development of multiservice banks. In an election in Germany, it is the political party, rather than the candidatewho plays the major role. Therefore, despite some politicians’ opposi-tion to multiservice banks, the special interests between major banksand political parties tend to reduce any dissidence.

3. The rigorous regulatory measures adopted by the government are the fundamental guarantee for the survival of multiservice banks.

Multiservice banks in Germany experienced many crises during their formation and development processes. In particular, during the global eco-nomic depression of the 1930s, some multiservice banks were closed down after the bankruptcy of industrial enterprises. Other multiservice banks hadto shift their business focus from start‐up of new enterprises and securi-ties‐related business to the deposit business. After the Second World War, Germany was stranded in a very diffi cult economic situation. Compoundedwith pressures from the allied forces for economic democratization, it greatlyconstrained the development of multiservice banks in Germany. It was then


that the German government rose to the occasion, making a great effort to improve the multiservice banking system and strengthen regulation. Thosemeasures enabled multiservice banks to survive, grow stronger, and fi nally serve as the most powerful engine for the rise of the German economy.

Banks under the multiservice model are also called universal banks.Mixed banking/securities operation and mixed management are their quint-essential characteristics. Powerful universal banks do not only dominate thecommercial banking business, but also hold a leading position in investment banking business such as securities underwriting and securities brokerage. Deutsche Bank leads all other German banks in terms of the total deposit and loan amounts, liquidation services, and other commercial bankingfi elds. It also controls the issuance and transaction volumes of most securi-ties in the country. As a combination of an investment bank and a commer-cial bank, it enjoys convenient access to various fi nancial markets.

Compared with the separated service model, the biggest advantage of the multiservice model is that it does not constrain the development of banks in terms of their business scope. Specifi cally, the multiservice model has the following advantages:

■ The multiservice model helps banks scale up their operations. As a com-bination of an investment bank and a commercial bank, a universal bank can take full advantage of limited fi nancial resources to realizeeconomies of scale, reduce costs, and improve profi tability.

■ The multiservice model can help reduce risks for the bank itself. This is manifested in two aspects: 1. Diversifi ed business ensures stable profi ts for the bank. If the bank’s

income from the deposit business drops, the securities investmentbusiness can make up the difference, maintaining profi t at a stable level.

2. Compared with a pure commercial or pure investment bank, a uni-versal bank has a better and more complete grasp on the operational condition of an enterprise. It is therefore able to reduce the ratio of bad debt and risks associated with the underwriting business.

■ The multiservice model strengthens competition between banks, which helps select the superior and eliminate the inferior. On one hand, this improved the strength and competitiveness of operational entities at the microscopic level in the fi nancial industry. On the other, it improved the profi tability of the whole society. The disadvantage of the multiservice model is that it may bring great risks to the entire fi nancial system. Theclosure of a single bank may trigger a chain of reactions in many banks, which can lead to a credit crunch. A serious credit crunch may give rise to a crisis. It is just because of this fl aw of the multiservice model that


after the Great Depression in 1929–1933, most countries in the worldadopted the separated service model for their banking system.

The Deutsche Bank model is exemplifi ed by Deutsche Bank and adopted by Dresdner Bank, Credit Suisse First Boston, USB Warburg, Barclays, BNP Paribas Euronext, and the Royal Bank of Scotland. This is the major devel-opment model of local investment banks in Europe. The investment banking division is affi liated to a universal bank instead of existing independently. The investment banking business is not clearly separated from, but ratheris closely connected to, the commercial banking business. It is most often referred to as the universal bank model.

In fact, the Deutsche Bank model had been the dominant model for investment banks until 1930. The universal bank model disappeared in suchcountries as the United States and Japan only because the U.S. governmentforced the separation of investment banks and commercial banks through legislation after the Great Depression in 1930 and other countries followed suit. However, European countries, especially Germany and Switzerland, are still holding on to the universal banking system. That explains why the two biggest German banks, Deutsche Bank and Dresdner Bank, as well as the two biggest Swiss banks, Union Bank of Switzerland and Swiss Bank, have always been among the most well‐known banks in Europe, playingan important role in the global investment banking industry. In mid‐ and late 1980s, other big banks in Europe such as BNP Paribas Euronext, ABN AMRO, and the Royal Bank of Scotland also chose to pursue the path of universal banks. Looking at Europe alone, the universal bank model is thedominant model for investment banks.

Most investment banks of the Deutsche Bank model are in an absolutely dominant position in their domestic capital markets. For example, the threebiggest German banks, Deutsche Bank, Dresdner Bank, and Commerzbank, have monopolized the German capital market and penetrated deeply into the industrial capital market. In Switzerland, the powerful Credit Suisse First Boston and USB Warburg leave other institutions in the capital market far behind. In the Netherlands, ING is the dominating leader of the capital market.

Evolutionary History and Structural Patterns of InvestmentBanks in Japan

Unlike those of the United Kingdom and the United States, investment banks in Japan came into being in their own way. Investment banks arecalled securities companies in Japan because their creation and developmentdirectly depends on the creation and development of the Japanese securities


market. After the Meiji Reform, Japan started establishing its securities mar-ket, whereupon securities companies appeared. However, capital was largely concentrated in the hands of fi nancial oligarchs, and the securities mar-ket suffered a severe shortage of capital. As a result, securities companieswere not well‐developed. At that time, shares issued by large enterprisestended to be absorbed internally by the same fi nancial group. The enterprisebond underwriting business was almost completely monopolized by banks. The business scope of securities companies was limited to stock trading brokerage. After the Second World War, the oligarchs disintegrated, freeing up a large number of shares and corporate bonds. Securities trading expe-rienced some substantial changes and securities companies took on a brandnew look. They started engaging in the marketing and selling business.

Yet another event that greatly promoted the development of Japanese securities companies involved the promulgation of the Securities Trading Law in 1948 and the establishment of the mixed operation model in the banking industry. Banks are not allowed to engage in intermediation for secu-rities other than government bonds, local treasury bonds, and government‐guaranteed bonds. It is stipulated that the majority of securities businessshould be undertaken by securities companies, which play a leading role inthe securities market. This greatly boosted the securities market and pro-moted the development of securities companies.

Development Paths of Overseas Investment Banks as Inspirations for China

In their development process, Chinese investment banks share more charac-teristics with their U.S. counterparts. Therefore, the model and developmentpath of U.S. investment banks should serve as the main reference point.However, benefi cial practices of investment banks in other countries should also be considered. This approach is of great signifi cance to the development of the Chinese investment banking industry.

Investment banks are the product of a mature and developed market economy, exemplifying economic innovation. As the epitome of fi nancial innovation, investment banks have accentuated the knowledge economy and information economy elements of the market economy. Investment banks in economically developed countries have the following major characteristics:

■ A high level of industrial concentration and signs of monopolistic competition.

■ Implementation of a global operation strategy. ■ Trends toward diversifi cation and specialization in business:


Specifi cally, the business of investment banks has expanded from traditional underwriting and brokerage to such fi elds as M&A of enter-prises, asset management, risk investment, risk avoidance, and invest-ment counseling.

■ Mixed operation adopted by most investment banks. Complex and diversifi ed competition: This includes domestic and

international competition between the investment banks of various countries and the constant selection of the fi ttest by the market as aresult. It also includes the challenge to investment banks from modern “universal banks” in various countries.

■ Great importance attached to the cultivation of professional talents.

Amidst the trend of transition from separated operation to mixed oper-ation, Chinese investment banks should take full advantage of the develop-ment patterns and experience of overseas investment bank business models in the following ways:

■ Great efforts should be made to expand the fi nancing channels for investment banks. One of the reasons that Chinese investment bankshave been suffering from weak capital strength and a small asset scale is that the fi nancing channels for Chinese investment banks, securitiescompanies in particular, are somewhat obstructed. The shortage of funds has greatly constrained the development of securities companies. A series of policies and regulations introduced in China in recent years have improved the fi nancial situations of securities companies to someextent. For example, securities companies are now allowed to raisetheir capital scale through share expansion and public offering. In addi-tion, 72 Chinese securities companies have gained permission to enter the interbank borrowing market for fund position adjustment, whichrelieved the capital pressure on securities companies. Securities compa-nies are also allowed to mortgage their proprietary shares and invest-ment funding bonds for loans from commercial banks or other fi nancial institutions, which helps them get fl exible term funds and optimize theirasset structure.

■ They should attach great importance to fi nancial innovation, expand their business scope and realize diversifi cation. Unlike overseas investment banks with excessive innovation and well‐developed derivative prod-ucts, Chinese investment banks are apparently lacking in innovation. For that reason, domestic investment banks should strengthen the devel-opment of new products, break through the bottleneck of traditional services, and promote a transition of their main business from tradi-tional types (securities underwriting and brokerage and proprietary


business) to innovative types (strategic services such as M&As and restructuring of enterprise) and derivative types (asset management and fi nancial derivative instrument trades). By doing that, investment banks can diversify and stabilize their income and improve their resistance to risks.

■ The capital scale of Chinese investment banks should be raised through M&As and asset restructuring. The overall industrial concentration of Chinese investment banks should be raised. Specialized and profes-sional services should also be offered, based on the conditions of the Chinese capital market.

■ Internationalization strategies should be implemented at the right time.Chinese investment banks mostly focus on the domestic market. This ismainly because Chinese investment banks are still not strong enough. Domestic investment banks should run their investment banking busi-ness from a global perspective like domestic commercial banks do. They can fi rst improve their expertise through cooperation with international investment banks and then get into the overseas market and take part in international competition at the right time. In this respect, the success of China International Capital Corporation and BOC International have already set good examples for domestic investment banks.

ANALYSIS OF INVESTMENT BANK REGULATION IN MATUREOVERSEAS MARKETS

Categorization of International Investment Bank Regulation Systems

The government and self‐regulatory organizations in various countries play different roles and functions in the regulation of investment banks. Investment bank regulation systems can be divided into the following three categories:

1. Government regulation type: Under a government regulation system, the government effects oversight and administration on investment banks by formulating special laws and by setting up national regulatory and administrative organizations. In essence, the government is in a dominant position and plays a leading role in regulation. This type of regulation sys-tem is exemplifi ed by the United States and has been adopted by Canada, Japan, Brazil, the Republic of Korea, the Philippines, and China.

2. Self‐regulation type: The self‐regulation system is the opposite of thegovernment regulation system. Under a self‐regulation system, except for some necessary national legislation, the government seldom interferes


with the investment banking business. Regulation of investment banks is mainly carried out by industrial self‐regulatory organizations such as securities exchanges and investment bank associations. In essence, it attaches importance to and emphasizes the role of self‐discipline and self‐regulation by investment banks themselves. This type of regulation system is exemplifi ed by the United Kingdom and adopted by most countries and regions in the Commonwealth.

3. Intermediate type: Regulation systems that fall between the governmentregulation type and the self‐regulation type are referred to as the inter-mediate regulation type. In essence, this type emphasizes both adminis-tration through national legislation and self‐regulation by the industry itself. This type of regulation system is adopted by German and Italy.

The Investment Bank Regulation System in the United States

The characteristics of the investment bank regulation system in the United States can be viewed from the perspective of legislation or from the perspec-tive of regulatory bodies.

From the perspective of legislation, the United States has a set of coor-dinated and constantly improving federal level laws and regulations that set standards for investment banks. They include the Securities Act, the Securi-ties Exchange Act, the Investment Company Act, the Investment AdvisorAct, and the Securities Investor Protection Act. These acts form the basis for government regulation of investment banks and the code of conduct by which investment banks must abide.

From the perspective of regulatory bodies, the United States has set up a specialized federal regulatory organization: the Securities Exchange Commission (SEC). The commission includes fi ve members appointed by the president and approved by the Senate. All fi ve are full‐time members.They are not allowed to hold other public offi ces concurrently nor engage in securities trading directly or indirectly. The SEC is directly responsibleto Congress. It is an independent organ with complete quasi‐legislative andquasi‐judicial functions. It regulates investment banks and their behaviors according to law, without inference from the president or other government agencies. In order to ensure the fulfi llment of its duties and functions, the SEC has a large and close‐knit organizational system that consists of four departments, 18 divisions including 14 offi ces, as well as several regional branches (agencies). In addition, exchanges and securities traders associa-tions nationwide are under the leadership of the SEC. Obviously, the SECis the most important regulatory body in the investment bank regulation system of the United States. Full authorization from the government ensures that it has enough authority to safeguard the enforcement of laws in the


operation of investment banks. Therefore, the SEC is the symbol of the gov-ernment regulation system of the United States.

The government regulation system as represented by the United States has the following advantages:

■ Emphasis is put on legislative regulation. The activities of the regulator and the regulated are both put on a track of legalization, giving solem-nity, fairness, and authority to regulative activities.

■ As the all‐important leading regulatory body in regulatory activities, the regulatory agencies of the government are above the fray of the partici-pants of the capital market. This enables them to better represent and stand for the fairness, justice, and transparency principles in the market and pay greater attention to the protection of investor interests. This isconducive to orderly competition and coordinated development in the investment banking industry.

However, the government regulation system falls short in the following aspects:

■ Legislative regulation tends to be too rigid and infl exible. As a result, investment banks often fall victim to overregulation and excessive inter-ference from the government, which runs counter to virtuous competi-tion and innovation among investment banks.

■ The distance between the regulators and the market means they are often not able to respond appropriately and timely to changes in the market. The regulators tend to be either absent or overstepping, thusaffecting regulation effi ciency to some extent.

Investment Bank Regulation System in the United Kingdom

The investment bank regulation system in the United Kingdom can also be viewed from the perspective of legislation or from the perspective of regula-tory bodies.

From the perspective of legislation, the United Kingdom’s government has only passed a few laws for necessary adjustment of investment banks, includ-ing the Statute of Fraud, the Fair Trade Statute, the Company Law, and the Financial Service Law. The government almost never legislatively interferes with investment banking. Instead, self‐regulation rules formulated by industrial self‐regulation organizations are the main code of conduct for investment banks.

From the perspective of regulatory agencies, the United Kingdom has never had a centralized government regulatory agency for the whole country. Instead, the country relies on self‐regulation exercised by industrial


self‐regulation organizations that are independent from the government. Before 1986, the self‐regulation system of the United Kingdom consisted of the following three nongovernmental organizations:

1. The Securities Industry Council 2. The Securities Exchange Association 3. The Enterprise M&A Expert Panel

The Securities Exchange Association was established in 1890 and con-sisted of brokers and traders from various securities exchanges. The M&AExpert Panel was established in 1978, based on a proposal by the Royal Bank of Scotland, and consisted of 10 or more industrial association experts.Obviously, investment banks in the United Kingdom are not directly regu-lated by government offi cials, but by professionals who understand the rulesof the market. Although there have been major changes in the U.K. invest-ment bank regulation system, the traditional self‐regulation‐based model has not been fundamentally altered since 1986.

The self‐regulation based system in the United Kingdom excels where the government‐based regulation system falls short in the following ways:

■ It minimizes unnecessary interference in investment banks by the gov-ernment and causes investment banks to operate according to market rules, which is conducive to competition and innovation among invest-ment banks.

■ Members of the self‐regulation organizations are mainly from invest-ment banks. They have the most thorough understanding and fi rm grasp of the market. They know the effect of a certain regulation on the market. Therefore, in the face of market changes, they tend to be ableto resolve targeted solutions for problems in the market, thus makingregulation more fl exible and effi cient.

However, the self‐regulation‐based system has the following two major dis-advantages:

1. Self‐regulation organizations tend to attach greater importance to the smooth running of the market and the interests of their members than to the interests of society and investors, which makes it diffi cult to embody the fairness, justice, and transparency principles. If unchecked,this phenomenon will impede market competition.

2. Without the backing of legislation, regulation tends to lack uniformity and authority. Apparently, where the self‐regulation‐based system fallsshort is also where the government‐based regulation system excels.


What Can China Learn from Overseas Investment BankRegulation Systems

A comparison of investment bank regulation systems of such countries as the United States and the United Kingdom reveals important areas in which China can fi nd improvement. For a better investment bank regulation sys-tem in China, and to ensure a stable and healthy development of the securi-ties market, the following areas should be emphasized:

■ The principles of legality, coordination, effi ciency, and transparencyshould be respected without compromising fairness. The primary goal of investment banking regulation in China should be to protect the interests of investors, ensure fair competition, and reduce systematic risks in the banking sector. Investment banking regulation in China should also stick to the principles of legality, coordination, effi ciency, and transparency. The legality principle in the regulation of the invest-ment banking industry means that any regulation in breach of law car-ries no legal effect. The coordination principle in the regulation of theinvestment banking industry emphasizes that different departments of the same regulatory body and different levels of the institutional hierar-chy should have their respective, but coordinated, responsibilities. Thejurisdictions of different regulatory bodies should be clearly defi ned, and coordination should be strengthened in enforcing the laws. The effi ciency principle in the regulation of the investment banking indus-try requires the establishment of an effective regulatory mechanismthat can minimize the cost and maximize the benefi t of regulation. At the same time, the overall effi ciency of the investment banking systemshould be improved through regulation, standardized competition, and monopoly prevention. The transparency principle in the regulation of the investment banking industry means that as the regulatory body, theregulatory departments of the government should solicit the opinions of investment banks and other market participants before promulgat-ing or changing major regulatory policies or rules. This will overcome the information asymmetry between the regulator and the regulated, increase their willingness to cooperate with the regulator, and improve regulation effi ciency.

■ Centralized legislation based regulation should be primary and self‐regulation supplementary. Internationally, there is not an absolutely fi xed and immutable model for the regulation of the investment banking industry. Recent years have seen international securities integration and increased communication and exchange between the securities regulatory agencies, investment bank (or securities trader)


associations, and securities exchanges of different countries. This has drawn the centralized regulation model and the self‐regulation model toward merging with each other. Therefore, in the regulation of the investment banking industry in China, centralized legislation‐based regulation should play the leading role, supplemented by self‐regulation. The contents of regulation should be comprehensive and multidimensional.

■ Risk supervision should be strengthened. Every business line of aninvestment bank, whether traditional business or innovative business, develops with risks. With the fast development of the global economyand fi nancial market, investment banks keep creating fi nancial instru-ments with greater risks. Uncertainties in macroeconomy, political policies, and micro‐operation environments are also increasing. As a result, investment banks are facing unprecedented risks. Therefore, risk supervision has taken center stage in the regulation of investment banks. Chinese investment banks should draw on the experience of advanced markets in consideration of their own development char-acteristics and constantly improve their ability to detect and control risks through new technologies and methods. At the same time, an investment bank insurance system needs to be established as soon as possible to better prevent risks in the regulation of the Chinese invest-ment banking industry.

■ Information disclosure should be strengthened. Complete informa-tion disclosure and substantial examination are also known as the report system and the approval system, respectively. Each of these two systems has its own advantages and disadvantages. The invest-ment bank regulation system of China should raise the requirements regarding mandatory disclosure of information. In particular, when an investment bank is preparing for equity fi nancing, public offer-ing, or other activities of innovation and development, strengthening information disclosure of the investment should be the top priority. This is conducive to the healthy development of the Chinese invest-ment banking industry, the formation of its competitive strength, and the improvement of the information disclosure system in the Chinese capital market, leading to the healthy development of the Chinese capital market.

■ Importance should be attached to being prospective. The regulation of Chinese investment banks should be prospective to some degree, giv-ing full consideration to the impact of new technologies and fi nancial globalization on securities regulation. It should also take into accountthe trend toward mixed operation to lay a foundation for the Chinesefi nancial industry and transition into a mixed operation system.


ANALYSIS OF THE ORGANIZATIONAL STRUCTURES OFINVESTMENT BANKS IN MATURE INTERNATIONAL MARKETS

In order to analyze the organizational structures of investment banks in mature international markets, we fi rst need to review two aspects of their organizational forms and governance structures, in an analysis process that eventually leads to determining what Chinese securities companies can learn from the organizational structures of investment banks in mature interna-tional markets.

Organizational Forms of Investment Banks in Mature International Markets

Generally, the organizational structure adopted by an investment bank is closely connected to its internal architecture and operational philosophy.The following are the four major types of organizational systems adopted by modern investment banks:

1. Family business and partnership 2. Mixed companies 3. Publicly held companies 4. Modern fi nancial holding companies

Family Business and Partnership From a historical perspective, and accord-ing to the latest defi nition, independent investment banks started appearingwhen J.P. Morgan separated its business and Morgan Stanley was established after the Great Depression of the late 1920s and early 1930s. Most of theearly investment banks were family businesses thanks to their simple busi-ness structure and limited membership. In a family business, the majority of the capital or shares are controlled by a family, whose members occupyimportant posts in the leadership. The core characteristic of a family busi-ness is that both the ownership and operation right belong to a family. Once its ownership and operation right are directly or indirectly controlled by a family or several closely linked families, the enterprise becomes a family business. For example, Goldman Sachs, which has withstood every fi nan-cial crisis so far, was a very conservative family business in 1929. It was owned and operated by its founder, German immigrant Marcus Goldman, his son‐in‐law Samuel Sachs, and his son Ludwig Dreyfuss.

However, the size of the enterprise can grow. In its inception, a family business has a simple business structure and a small size. Its core mem-bers are related by blood or marriage. The founder has natural patriarchicauthority. Based on this, the enterprise can be well managed by the family.


In its early stages, the amounts of residual claim and residual rights of control are relatively small. Under such circumstances, confl icts between parties inside the family over the sharing of benefi ts and interests are not too intense. Family ethics that emphasize patriarchic authority and fam-ily affection can effectively keep the confl icts of interests under control. At this stage, what the enterprise needs is monetary capital, rather than human capital. The requirements of management are also not too high. As the enterprise develops, however, the fast growth of the enterprise size leads to a signifi cantly higher demand for human resources. Constrained by the rate of natural increase in population, however, the family is far from able to keep up with the increase of the demand for human resources. On the other hand, due to the growth in size, management becomes more complex, which leads to a greater demand for high‐caliber human capital. Constrained by such factors as the talent growth probability, however, the chance for high‐caliber talent appearing from the small demographicgroup of the family is extremely low. Therefore, in essence, the family members are not able to ensure the supply of human capital. Based on this analysis, it is inevitable that a family business will face talent bottlenecks in its development.

It was under such circumstances that investment banks started to shift toward the partnership type. In this organizational form, two or more part-ners collectively operate and own a company and share the profi t of thecompany. The partners are the owners or the shareholders of the company. A partnership has the following three distinctive features:

1. Two or more partners share the revenues from the operation of the enterprise.

2. The partners can be general partners or limited partners depending on the liability they bear. General partners bear unlimited joint and several liability for the debts of the partnership, whereas limited partners are liable for the debt of the partnership only to the extent of their capital contributions. They bear fi nancial responsibility without participatingin the daily operation and management of the organization.

3. In all partnership companies, at least one major partner takes charge of the daily business operation of the enterprise.

With the constant increase of their business size and demand for capi-tal, a growing number of investment banks have adopted the partnership model. It was not until May 1999 that Goldman Sachs gave up its 130‐year‐old partnership model by making public offerings in the New York Stock Exchange. Goldman Sachs was the last investment bank to opt outthe partnership model.


Mixed Companies Mixed companies are usually formed through the merger of capital funds or companies that are not closely related in their functions in a bid to create bigger capital funds or companies. After the 1960s, dur-ing the diversifi cation of the production and operation of large companies, investment banks became important targets to mergers and acquisitions for the formation of mixed companies. In periods of economic growth, due to the pro‐cyclical nature of investment banks, the increase of market demanddrives their fast development. In periods of economic recession, the drop of market demand causes them to shrink and consolidate. After the economic backslide of the United States in 1987, the market saw a fl urry of consoli-dation among investment banks. After the economic recovery in the early 1990s, investment banks were caught by another wave of consolidation, as shown in Table 8.2 .

All of these mergers and acquisitions were aimed at raising the busi-ness scale of the parent company. It was during this process that investmentbanks gradually began transitioning from the partnership system to the modern company system, resulting in further concentration and specializa-tion of investment banks, among other things.

Publicly Held Companies Looking at the entire development history of the investment banking business, it becomes apparent that the transformationinto publicly held companies is the most signifi cant breakthrough. The mod-ern company system endows a company with an independent personality.The establishment of the system was concentrated around and marketedby the corporate legal person’s property rights. The legal person’s property right is the corporate legal person’s entitlement to all the assets of the com-pany, including the investment and income from investment. The existence

TABLE 8.2 Big Events Involving M&As of U.S. Investment Banks in the 1980sand 1990s

Year M&A Event

1981 Sears acquired Reynolds

1986 GE acquired RCA

1987 Primerica acquired Smith Barney and Harris Upham

1993 Primerica acquired Shearson, formerly owned by AmericanExpress, and formed Smith Barney Shearson

1995 ING Group acquired Barings Bank

1997 Morgan Stanley merged with Dean White

Source: Zhenming and Wei (2001).


of the legal person’s property rights shows that the rights of a legal entityare no longer manifested in personal rights. The form of publicly held com-panies, in which the public holds the shares of the company, gives invest-ment banks advantages over traditional family businesses, partnerships, andmixed companies in terms of fund‐raising, fi nancial risk control, and mod-ernization of operation and management. These advantages are refl ected in the following four aspects:

1. Distributed ownership: Ownership is divided into smaller units (shares) for sale and transfer.

2. Easy transfer of ownership: Ownership is easily transferred through stock trading.

3. Limited fi nancial risks: Shareholder loss of assets extends only to theirinvestment in the company, and their personal assets will not be used topay off debts owed by the company.

4. Greater fund‐raising capability: Publicly held companies can effectively raise large amounts of funds through the capital market.

For that reason, when the New York Stock Exchange loosened its restric-tions of trading seat memberships and allowed for the formation of limited liability companies by shares, investment banks all made the transition andsought to go public, as shown in Table 8.3 .

Table 8.3 also shows that in this stage, most investment banks went public through buying a shell. For example, Lehman Brothers went public

TABLE 8.3 Big Events Involving United States Investment Banks Going Public from the 1970s to the 1990s

Year Investment Bank Going Public Approach

1970 Merrill Lynch, Bache IPO

1972 Dean Witter, Eastman Dillion, Paine Webber

The fi rst one through IPO, the latter two through buying a shell

1981 Salomon Brothers Buying a shell

1984 Lehman Brothers Buying a shell

1985 Bear Stearns IPO

1986 Morgan Stanley, Kidder Peabody

The former through IPO, the latter through buying a shell

1987 Smith Barney Buying a shell

1999 Goldman Sachs IPO

Source: www.nyse.com.

http://www.nyse.com


after being acquired by the public company Sheaxson. Kidder Peabody alsowent public after being acquired by GE Financial. This goes along withthe features noted previously, where a large number of mixed companiesformed amidst a tidal wave of mergers and acquisitions among investmentcompanies. By the early twenty‐fi rst century, overseas investment banks hadgone through the extensive M&A phase and completed the transition into publicly held companies. Publically held companies are still one of the major organizational forms of overseas investment banks.

Modern Financial Holding Companies In the fi rst 11 years of the twenty‐fi rstcentury, with fast economic development and intense competition inside the industry, overseas investment banks went through paradigm shift-ing changes. The organization forms of overseas investment banks can now be essentially divided into the publicly held company category and the fi nancial holding company category. The fi nancial holding company form has become the major trend among overseas investment banks. The Principles on Supervision of Financial Holding Companies was released in February 1992 by three major international fi nancial supervisors: the Basel Committee on Banking Supervision, the International Organization of Securities Commissions, and the International Association of Insurance Supervisors. The document stated that a fi nancial holding company refers to “a supervised entity that under the same right of control engages in at least two types of business in banking, securities, and insurance, with dif-ferent levels required for each type of business.” Specifi cally, a fi nancial holding company is an organizational form for the fi nancial industry to realize multiservice operation. It is also a form of capital operation aimed at capital investment optimization and capital profi t maximization. In a fi nancial holding group, the holding company may be considered the groupcompany, and the other fi nancial enterprises can be considered member enterprises. The group company and the member enterprises are connected with each other through property ownership or management relations. Each member enterprise is controlled and infl uenced by the group com-pany but bears civil liability independently.

The replacement of separated operation by mixed operation in the fi nancial industry is the theoretical basis for the development of fi nancial holding companies. Whether a country adopts mixed operation or separateoperation is infl uenced by the following four factors:

1. Stability, security, competition, and effi ciency of the fi nancial system 2. Specifi c historical and economic conditions 3. Credit culture and regulation 4. Financial competition between different countries


Progress made in the fi nancial industry since the 1990s is the direct reason behind mixed fi nancial operation, as shown by deregulation, scientifi c and technological advancement, industrial integration, securitization, global-ization, and product innovation. This has created the opportunity for the appearance of the fi nancial holding companies. The fi nancial holding com-pany model has become the major path for investment banks in developed Western countries such as the United States, Japan, and the United Kingdom to engage in cross‐sector operation.

Relevant legislation passed overseas has also promoted the development of fi nancial holding companies. For example, the U.S. Congress passed the Financial Services Modernization Act on November 12, 1999. The act provided that fi nancial holding companies could engage in a series of business sectors, including underwriting and brokerage of insurance and marketable securities, commercial bank business, and insurance company investment portfolio busi-ness. In addition, fi nance‐related subsidiary business was also within the ratifi ed scope of business. This act enabled every American to get one‐stop fi nancial services. Enterprises and consumers could go through all fi nancial transactions within the same fi nancial company. It was at that time that fi nancial holding companies secured their legitimate status in the United States. After that, the U.S. Congress amended the Bank Holding Company Act and other laws in early 2000, which facilitated the transition from bank holding companies to fi nancial holding companies. As long as a nonbank company had 85 percent or more of its total revenue from fi nancial services and promised to strip away its nonfi nance assets within 10 years, it could apply for a transformation into a fi nancial holding company. Driven by these laws and regulations, fi nancial holding companies developed very quickly in the United States. Some gigantic fi nancial holding companies were incorporated, including Citigroup, Goldman Sachs Group, Bank of America, and J.P. Morgan Chase. In the United Kingdom, the fi nancial “explosion” changed the separated operation system in the fi nan-cial industry. It promoted the integration of commercial banking and stock bro-kerage and the combination of commercial banks and investment banks. This gave rise to well‐rounded fi nancial groups not restricted by business boundar-ies. They include HSBC, Lloyds TSB, Barclays, and NatWest Group.

Japan is no exception. In June 1997, Japan promulgated the Financial Reform Planning, which paved the way for the establishment of the fi nancial holding company system. Later, in December 1997, the Banking Law was amended, and the Financial Holding Company Deregulation and Reorga-nization Law and the Bank Holding Company Incorporation Special Case Law were ratifi ed. These changes allowed mixed operation and set forth regulations for internal governance of fi nancial holding companies. Against this backdrop, a whole group of fi nancial holding companies represented by Mizuho group appeared in Japan.


Figure 8.1 shows the evolution of the organizational forms of invest-ment banks in mature overseas markets, based on this analysis. It also shows the overall development of investment banks in mature overseas markets, with specifi c reference to the four trends of concentration, public sharehold-ing, formation of groups, and internationalization.

Governance Structures of Investment Banks in Mature International Markets

The governance structure of a company is an institutional framework that coordinates and standardizes the distribution of rights and obligations among shareholders (asset owners), the board of directors, the board of supervisors, and senior executives. It also dictates relevant issues such aselections and supervision. Simply put, it determines how to divide powerinside the company. Sound corporate governance structures can address issues related to profi t distribution among various parties and constitute a deciding factor for the operation effi ciency and competitive strength of the company. As previously discussed, almost all investment banks in mature international markets have adopted the joint‐stock limited liability company

FIGURE 8.1 Evolution of Investment Bank Organizational Forms in Mature International Markets

FamilyBusiness

Partnership

MixedCompany

PubliclyHeld

Company

FinancialHoldingsCompany


system. Therefore, excellent corporate governance structure is also an indis-pensable factor in overseas investment banks.

Equity Structure In order to analyze the governance structure of an invest-ment bank, the fi rst step must be to analyze its equity structure. By studyingdata from fi nancial reports of top investment banks in mature international market, we fi nd the following features common to their equity structures.

Institutional Investors Make Up a Large Percentage, but the Equity Is Widely Distributed In the equity structures of investment banks listed in the U.S. market, institutional shareholders make up a large proportion of the bank’s equity. However, the equity is widely distributed, thanks to the large number of investors. We will review this feature in two steps.

The fi rst step is to look at the shareholding of institutional investors. Table 8.4 shows the holdings of institutional investors in the top fi ve invest-ment banks in terms of market value as of December 1, 2011.

Table 8.4 shows that institutional shareholders account for an aver-age of 55.90 percent, more than half of all shares in the fi ve investmentbanks. Morgan Stanley has the largest proportion of institutional investors at 75.88 percent, or more than three quarters. The average number of insti-tutional investors is just under 1,000 (991.2). J.P. Morgan has the most institutional investors at 1,583. Despite the large percentage of shares held by these investors, the percentage of shares held by an average institutionalinvestor in the fi ve investment banks is merely 0.0555 percent, due to thelarge number of investors. The percentage of each investor is less than 1 out of 1,000. Even in Morgan Stanley, the highest among them, the percentage is just over one‐thousandth.

The next step is to focus on the equity concentration of investment banks. The indexes used for equity concentration are the percentage of shares held by the largest shareholder and the percentages of shares held by the top fi ve shareholders in the top fi ve investment banks in terms of market value as of December 1, 2011. The percentages are shown in Table 8.5 .

As shown in Table 8.5 , only one of the fi ve major investment banks has more than 10 percent of its shares held by its largest shareholders. HSBC has only 0.36 percent of its shares held by its largest shareholder. Only one bank has over 20 percent of its shares held by its fi ve largest shareholders. HBC has only 1.08 percent of its shares held by its fi ve larg-est shareholders. Of the top fi ve investment banks, Morgan Stanley has the largest percentage of its shares (22.4 percent) held by its largest share-holder. Similarly, Morgan Stanley has the highest percentage of its shares(40.30 percent) held by its fi ve largest shareholders. If the percentage of shares held by the fi ve largest shareholders is used as the measuring index,

424

TABL

E 8.

4 Sh

ares

Hel

d by

Ins

titu

tion

al I

nves

tors

in T

op F

ive

Inve

stm

ent

Ban

ks in

Ter

ms

of T

otal

Mar

ket V

alue

Sto

ck S

ym

bol

Nam

e of

Sto

ckM

ark

et V

alu

e(U

SD

)

Inst

ituti

onal In

vest

ors

Am

ount

Per

centa

ge

of

Share

s in

Cir

cula

tion

Ave

rage

Ho

ldin

gPer

cen

tage

JPM

J.P.

Mor

gan

117.

650

billi

on15

8373

.93%

0.04

67%

HB

CH

BC

139.

900

billi

on37

72.

70%

0.00

72%

BA

CB

ank

of A

mer

ica

55.1

40 b

illio

n13

0056

.71%

0.04

36%

GS

Gol

dman

Sac

hs49

.368

bill

ion

1006

70.2

6%0.

0698

%

MS

Mor

gan

Stan

ley

28.5

10 b

illio

n69

075

.88%

0.11

00%

Ave

rage

991.2

55.9

0%

0.0

55

5%

Sour

ce: B

ased

on

data

fro

m w

ww

.nas

daq.

com

/sym

bol/j

pm/o

wne

rshi

p‐su

mm

ary.

http://www.nasdaq.com/symbol/jpm/ownership%E2%80%90summary

425

TABL

E 8.

5 E

quit

y C

once

ntra

tion

Ove

rvie

w o

f Top

Fiv

e In

vest

men

t B

anks

in T

erm

s of

Tot

al M

arke

t Val

ue

Sto

ck S

ym

bol

Nam

e of

Sto

ck

Sh

are

s H

eld b

y

Inst

ituti

ons

Share

s H

eld b

y

the

Big

ges

t Share

hold

er

Sh

are

s h

eld

by t

he

To

p F

ive

Sh

are

ho

lder

s

JPM

J.P.

Mor

gan

73.9

3%4.

08%

15.5

0%

HB

CH

BC

2.70

%0.

36%

1.08

%

BA

CB

ank

of A

mer

ica

56.7

1%4.

50%

14.6

3%

GS

Gol

dman

Sac

hs70

.26%

5.70

%18

.91%

MS

Mor

gan

Stan

ley

75.8

8%22

.42%

40.3

0%

Ave

rage

55.9

0%

7.4

1%

18

.09

%

Sour

ce: B

ased

on

data

fro

m w

ww

.nas

daq.

com

/sym

bol/j

pm/o

wne

rshi

p‐su

mm

ary.



the average equity concentration ratio of the top fi ve investment banks in the United States is merely 18.09 percent.

There are mainly two reasons behind the decentralized equity of investment banks in mature international markets:

1. In mature international markets, there tend to be legal restrictions on institutional investors holding a large percentage of shares in a certain company (including investment banks). In the United States, for example, extremely unfavorable tax treatment will be imposed on any insurance company holding more than 5 percent of all shares of a specifi c com-pany, or any mutual fund or pension fund holding more than 10 percent of all the shares in a company. In addition, once the percentage of shares held by any institution in a specifi c company reaches 10 percent, the institu-tion will be barred from trading the company’s shares without permission.

2. Institutional investors in mature international markets are very familiar with risks in the fi nancial market. In order to distribute risks and lower nonsystematic risks as much as possible, they tend to choose the mostdiversifi ed investment portfolio.

Low Percentage of Internally Held Shares and High Equity Liquidity Most shares issued by U.S. investment banks are active shares, which can be traded freely and publicly. Active shares refers to the shares issued by aninvestment bank apart from those held by senior executives and employeesinternally, those held by shareholders holding over 5 percent of the shares each, and those subject to other types of trade restrictions. Trading of such shares is relatively active.

As shown in Table 8.6 , internally held shares averaged only 2.41 percent in the top fi ve investment banks, whereas active shares averaged 97.59 percent. The percentage of active shares is about 100 percent in HSBC. Even on the low end, active shares accounted for 92.47 percent in Goldman Sachs.

Obviously, the high liquidity of equity in mature international markets is based on the highly decentralized distribution pattern of equity. Under a widely distributed equity structure, institutional investor shareholders areusually not willing to actively and directly involve themselves in the cor-porate governance of investment banks. This may be due to their short-sightedness, constraints in information and expertise, costs of participationin governance, or the public nature of the products. They instead tend toexpress their judgment on the operation effi ciency of an investment bank by buying in or selling out shares, which gives high liquidity to the equity of investment banks.


The Structure of the Board of Directors As a standing body of the share-holders assembly, the board of directors in an investment bank in mature international markets is responsible for routine decision making, just like the board of directors of a company in other industries. Without a board of supervisors in investment banks of some major mature international mar-kets, such as the United States, the functions of the board of directors also include auditing and oversight. The board of directors in investment banks in mature international markets generally sets up various committees to help it make operational decisions and fulfi ll its oversight duties. There can be a wide variety of committees. However, the basic ones are the audit commit-tee, the remuneration committee, and the nomination committee. The audit committee is responsible for overseeing the internal audit process of the company, fi nancial control, and relevant problems that may exist. In com-bination with supervision and auditing conducted by external audit institu-tions, the audit committee ensures that the operation and fi nancial reports of the company comply with relevant legal requirements. The remuneration committee is responsible for deciding the salary levels of senior executivesof the company and making distribution plans. The nomination committeeis responsible for conducting systematic assessment on inside directorsand senior executives of the company. The risk‐management committee is responsible for overseeing risks facing the company and ensuring that various business units strictly identify, measure, and monitor risks associ-ated with their respective business according to requirements. The top‐leveldecision implementation committee of the company sets the risk‐tolerancethresholds for various business lines and approves major risk‐management decisions of the company, including changes to important risk policies

TABLE 8.6 Overview of Internally Held Shares in Top Five Investment Banks inTerms of Total Market Value

Stock Symbol Name of StockInternally

Held SharesExternally

Held Shares

JPM J.P. Morgan 1.88% 98.12%

HBC HBC 0.00% 100.00%

BAC Bank of America 0.63% 99.37%

GS Goldman Sachs 7.53% 92.47%

MS Morgan Stanley 2.03% 97.97%

Average 2.41% 97.59%

Source: Based on data from www.nasdaq.com/symbol/jpm/ownership‐summary.



proposed by the risk‐management committee. In addition to assisting the board of directors to exercise its decision‐making and overseeing powers, these committees also play an important role in improving the internal man-agement of the company.

Boards of directors of investment banks in mature international mar-kets also have the important role of outside directors, in addition to setting up various committees to help with the board’s work. Table 8.7 shows thecomposition of the boards of directors of the top fi ve investment banks in terms of market value.

Table 8.7 shows that the top fi ve U.S. investment banks have an average of 13.60 members in their board of directors. Of all members, 85.05 percent are outside directors. This is fi ve times more than inside directors. J.P. Morgan has the highest outside director proportion at 91.67 percent. The lowest percentage of outside directors at Goldman Sachs still reaches 75 percent. The outside directors of an investment bank are usually senior experts or scholars in a certain fi eld from outside the company. They have unique expertise or extensive connections in their fi elds. They are objective and attach great importance to their own credibility and market value. They can actively take part in the discus-sion and supervision of important operational decision making in the company, playing an important role in supervising and checking the power of the management of the company.

Although inside directors make up only a small portion of the board of directors in mature international markets, most are senior execu-tives in the investment bank. The inside directors of the top fi ve invest-ment banks are all key members of the management of their respective

TABLE 8.7 Board of Directors Makeup of Top Five Investment Banks in Terms of Total Market Value

Name of Investment Bank

TotalNumber of Directors

Numberof OutsideDirectors

Percentage of OutsideDirectors

J.P. Morgan 12 11 91.67%

HBC 17 15 88.24%

Bank of America 13 11 84.62%

Goldman Sachs 12 9 75.00%

Morgan Stanley 14 12 85.71%

Average 13.60 11.60 85.05%

Source: Compiled with data from the offi cial websites of the banks listed.


companies. The CEO is always one of the inside directors. Having inside directors take on management positions concurrently helps follow‐through on major operational decision‐making activities of the company. This also refl ects the blurring boundaries between the board of directors and management in U.S. investment banks. It reduces friction between the board of directors and management. However, it also tends to com-promise the ability of the board of directors to effectively supervise and constrain management.

Board of Supervisors and the Management The operation of the company mustbe conducted in a proper and orderly way according to relevant rules. The company must make correct decisions and the leadership must fulfi ll its duty correctly. Abuse of power must be prevented to avoid harm to the interests of the company, its shareholders, or a third party. In order to ensure allof the above, various countries provide for the establishment of supervisor positions or a board of supervisors in a company. The board of supervisors is a standing supervisory body under the shareholders’ assembly that fulfi lls the function of supervision. The board of supervisors exists in parallel with the board of directors. It independently exercises its power in supervising theboard of directors, the general manager, senior staff, and the managementof the entire company. In order to ensure the independence of the board of supervisors from the board of directors, a supervisor shall not serve con-currently as a director or manager. The board of supervisors is responsible to the shareholders assembly and comprehensively supervises the operation and management of the company. This includes investigating and review-ing the condition of the company’s business, examining various fi nancialissues, reporting to the shareholders assembly or the board of directors, overseeing the behaviors of company offi cials at all levels, providing sugges-tions regarding the engagement and dismissal of leaders and offi cials of the company, and overseeing the plans and decisions of the company and their implementation.

The United States does not mandate the establishment of a board of supervisors in public companies, including investment banks. In place of aboard of supervisors, the functions of auditing and supervision are usuallypartly fulfi lled by independent directors or an audit committee or an inves-tigation and inspection committee under the board of directors.

For the managers of an investment bank in mature international mar-kets, their management tactics, operational activities, and the fi nal opera-tional performance are subject to the judgment of the market. Investors eventually vote based on their judgment, albeit in a different way of voting. Bad performance of the company and declining share prices might lead to career risks for the managers that could get them replaced. This constitutes


very good external market restraints on abuse of power and insider control by managers.

Functional Divisions The organizational structures of functional divisions ininvestment banks in mature international markets are somewhat complex, with various methods of labor division. However, three basic divisions are identifi able: the capital market division, the consumer market division, and the research division. Of these, the capital market division covers all tradi-tional investment banking business and corporate fi nancial business. It isthe organizational form that is largely consistent across investment banks in mature international markets. The consumer market division has to do with the distribution and sale of various securities, covering the whole process from the creation of new fi nancial products to the operation and manage-ment of the branching system. It is closely related to mainstream invest-ment banking in terms of securities provision and distribution methods. Theresearch division is a high‐caliber research body set up by an international investment bank above and independent of the capital market division and the consumer market division. A direct responsibility system is adopted inthe research division. Its most important task is to study and develop globalfunds and fi xed revenues.

What China Can Learn from the Organizational Structures of Investment Banks in Mature International Markets

As previously discussed, the organizational forms of investment banks in mature international markets have gradually evolved from family businessesto today’s large international fi nancial holding companies, which is an inevi-table result of economic development and business expansion. Based on thecurrent development status, we can now draw a framework chart to repre-sent the governance structures of investment banks in mature international markets, which would look as shown in Figure 8.2 .

The empirical analysis on the governance structures of investment banks in mature international markets, as previously discussed, found that most successful investment banks in mature international markets have the fol-lowing six characteristics:

1. Widely distributed equity or low equity concentration 2. High equity liquidity and low percentage of internally held shares 3. A relatively independent board of directors, with the majority of direc-

tors coming from outside the company 4. Blurred boundaries between directors and managers, with most senior

executives concurrently serving as directors


5. Diminished functions and power of the board of supervisors, with audi-tors in the board of directors working in the place of the board of super-visors in most cases

6. A large number of functional divisions and well‐defi ned division of responsibilities

These conclusions lead us to a number of discussion points on the topic of helping develop Chinese securities companies.

Focusing on the Cultivation of Financial Holding Companies in Keeping with the Trend of the Time Our earlier discussion on the evolution of the organizational

FIGURE 8.2 General Framework Diagram of Governance Structures of Investment Banks in Mature International Markets

ShareholdersAssembly

Board ofDirectors

AuditCommittee

RemunerationCommittee

General Managers and Senior Executives

Cor

pora

te F

inan

cing

Div

isio

n

Sec

uriti

es U

nder

writ

ing

Div

isio

n

Acq

uisi

tion

Div

isio

n

Mer

chan

t Ban

k D

ivis

ion

Cur

renc

y M

arke

t Ins

trum

ent D

ivis

ion

Hig

h P

rofit

Bon

d D

ivis

ion

Ris

k M

anag

emen

t Div

isio

n

Inno

vativ

e S

ecur

ities

Div

isio

n

Ass

et B

acke

d F

inan

cing

Div

isio

n

Pro

ject

Fin

anci

ng D

ivis

ion

Priv

atiz

atio

n D

ivis

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Cor

pora

te R

estr

uctu

re D

ivis

ion

Sec

uriti

es T

radi

ng D

ivis

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Rea

l Est

ate

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isio

n

Ris

k C

apita

l Div

isio

n

Inte

rnat

iona

l Bus

ines

s D

ivis

ion

Dev

elop

men

t Res

earc

h D

ivis

ion

Pla

nnin

g an

d F

inan

ce D

ivis

ion

NominationCommittee

Risk-ManagementCommittee

DecisionImplementation

Committee

Board ofSupervisors


forms of investment banks in the mature international market determinedthat with constant business expansion and intensifying competition in the industry, Chinese securities companies will inevitably go through the type of large‐scale mergers and acquisitions experienced by mature international markets late last century. It is certain that the winners will be securities companies with suffi cient funds, high operation effi ciency, and great com-petitive strength. According to the Securities Law of China, securities com-panies can be incorporated as either a company with limited liability or a company limited by shares. However, a list of Chinese securities companies as of August 2010 released by the CSRC shows that of the 106 securities companies registered in China, only 41 are companies limited by shares, which is less than half. This shows that Chinese securities companies are still fundamentally constrained in terms of capital sources and operation and management levels. Therefore, as a fi rst step, more securities companies in the future should adopt the form of companies limited by shares. This will gradually raise the percentage of companies limited by shares among securities companies.

We have also seen in the Chinese market the bud of fi nancial holding companies, the prevailing form for investment banks in mature internationalmarkets. China made it clear as early as 1993 that separate administration policies will be implemented for the banking industry and the securitiesindustry. The separate regulation system that remains will consist of the Peo-ple’s Bank of China, the China Banking Regulatory Commission, the China Securities Regulatory Commission, and the China Insurance Regulatory Commission. With recent fast economic development and the deepening of fi nancial reform and innovation, however, the Chinese securities industry is now facing unprecedented broad space for development, which is giving rise to integrated operation. This will undoubtedly become the cradle forChinese fi nancial holding companies. Driven by such factors as synergistic effects, economies of scale, diversifi cation of revenues, dispersion of risks, and integration of customer needs, a number of fl edgling fi nancial holding companies have already appeared in China, as shown in Table 8.8 .

In addition to the banking‐centric fi nancial holdings companies shown in Table 8.8 , Ping An Group is an insurance‐centric group also involved in commercial banking and investment banking. China will likely see suchphenomena in the future as fi nancial institutions expand their business into a diversifi ed set of sectors and large enterprises enter into the fi nancial industry. In particular, as the deadline draws near for China to deliver on its promise to the WTO of fully opening its fi nancial sectors, the competition in the securities industry will be increasingly internationalized. Building upa number of domestic fi nancial holding companies will help the Chinese securities industry win fi erce competition in the future.

433

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Expediting Financial Legislation and Improving the Legal Environment for Securities Companies Development of investment banks in the mature international market has been predicated upon the development and expansion of their business. Every cycle of separated operation, or mixed operation, and every reform in the organizational structure of investment banks would not have been possible without relevant legislation and regulatory systems. Inthe transition period after China’s accession into the WTO, it is of great signifi cance for China to expedite fi nancial legislation, improve the legal environment for securities companies, safeguard its fi nancial sovereignty, and strengthen the competitiveness of its fi nancial industry.

In view of the development history of the organizational structures in the mature international market, from a legislative perspective, emphasis should be placed on the improvement of the regulatory system and corpo-rate governance requirements based on the current Company Law and Secu-rities Laws. Statutory provisions in mature international markets such as the United States, Japan, and the United Kingdom can be consulted duringlegislative processes. And based on the actual development needs of Chinese domestic securities companies, a sound legal environment can be created for the development of securities companies.

Optimizing Governance Structures and Improving Operation Effi ciency of Securities Companies Financial holding companies emerged on the back of a corpo-rate governance structure with the modern property right system at its core. As previously discussed, a company limited by shares should be the pre-vailing organizational form for Chinese securities companies in the future. Therefore, it’s all the more important to have the right person to implement a proper governance structure. In order for Chinese securities companies to optimize their governance structures and improve their operation effi ciency,they should take efforts toward the following goals:

■ Reduce equity concentration level and increase equity liquidity. This can reduce insider trade and connected trade to a greater extent, and alsoimprove the capital strength of securities companies and reduce their operational risks.

■ Raise the proportion of outside directors in the board of directors and strengthen the construction of the director system. The ability of the board of directors to make operational decisions should be improved to ensure the decisions are sensible and scientifi c.

■ Enhance the communication mechanism between the board of directors and management.

■ Establish a necessary “Chinese wall” system between various functional divisions.


ANALYSIS OF BUSINESS STRUCTURES OF INVESTMENTBANKS IN MATURE INTERNATIONAL MARKETS

General Analysis of Business Structures of Investment Banks in the United States

Investment banks in the United States are mainly engaged in the brokerage business, investment banking business, proprietary business, and asset man-agement business. The brokerage business reaps commission income fromtransactions of shares, commodities, futures, or over‐the‐counter (OTC)instruments. The investment banking business includes two business lines: (1) securities issuance, and (2) underwriting and counseling, which consistsof underwriting of bonds, shares and share‐related securities, and counseling services in relation to M&A and equity incentives. The proprietary business includes market maker transactions and investments. The asset management business includes investment account management and investment portfolio counseling for individual investors or institutional clients.

From the perspective of business revenues in this industry, the total revenue of the U.S. securities industry in 2003, for example, was USD 144.5 billion. Of that amount, 25.6 billion (17.5 percent) came from commission fees, 15.1 billion (10.3 percent) came from securities underwriting, 2.1 billion (1.4 percent) came from securities investment, 23.1 billion (15.8 percent) came from market maker transactions, 4.8 billion (3.3 percent) came from interest incomes in credit transactions, 11.8 billion (8 percent) came from asset management, 6.1 billion (4.1 percent) came from mutual fund sales, and 47.9 billion (32.8 percent) came from other securities related incomes (see Figure 8.3 ).

FIGURE 8.3 Revenues of Various Business Lines of the U.S. Securities Industry in 2003 Source: Bloomberg.

Commission17.5%

Market Maker15.8%

Investment1.4%

Underwriting10.3%

CreditInterest3.3%

Fund Sales4.1%

Asset Management8.0%

Other SecuritiesRelated32.8%

Other Revenues6.7%

Commission Market Maker InvestmentUnderwriting Credit Interest Fund SalesAsset Management Other Securities Related Other Revenues


Of the commission revenue, 14.4 billion (56 percent) came from com-missions for transactions of shares at stock exchanges. The remaining 44 percent came from commissions for OTC transactions of securities, futures, and other items (see Figure 8.4 ). Of the underwriting revenue, 24.5 percent came from stock underwriting income. Of the market maker transaction revenue, 75.8 percent came from bond transactions (see Figure 8.5 ).

In terms of the development trends of the various business lines, the proportion of commissions decreased from 35 percent in 1980 to 14 percent in 2003. The proportion of asset management income rose from 1 percent in 1980 to 8 percent in 2003. The proportions of underwriting

FIGURE 8.4 Trend of Percentages of Commission and Asset Management Revenues in the Total in the U.S. Securities Industry (1980–2003) Source: Bloomberg.

Commissions

0%5%

10%15%20%25%30%35%40%

0%

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

1%2%3%4%5%6%7%8%9%

Fees, Asset Management

FIGURE 8.5 Trend of Percentages of Underwriting and Market Maker Revenues in Total in the U.S. Securities Industry (1980–2003) Source: Bloomberg.

Underwriting Market Maker

0%5%

10%15%20%25%30%

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003


and market maker incomes were relatively stable, showing insignifi cant signs of change.

The next section will examine the case studies of four representative American investment banks: Goldman Sachs, Morgan Stanley, Merrill Lynch, and Lehman Brothers. Dissecting the business structures of investment banks in the United States will help shed some light on the path for future develop-ment of Chinese securities companies.

U.S. Investment Bank Business Structure Case Study:Goldman Sachs

In 2010, Goldman Sachs divided its business into the following three units:

1. Investment banking 2. Asset management and securities services 3. Trading and principal investment

The investment banking unit provides a series of investment banking services for companies, fi nancial institutions, governments, and individu-als. The asset management and securities services unit focuses on helping institutions, governments, and government agencies across the world meettheir investment needs. The trading and principal investment unit engages in investment, trading, liquidation, and market maker business. This unit has the following three divisions:

1. The fi xed income, currency, and commodities division (FICC) 2. The equities division 3. The principal investment division

Of these divisions, the FICC engages in trading and market making in relation to interest rates, credit products, loans, currency, derivatives, andcommodities. It enjoys a great reputation among investors around the world. The equities division mainly engages in trading of stocks and stock‐relatedderivatives, as well as proprietary business. The principal investments divi-sion mainly invests in real estate and company equities.

In terms of the absolute amounts of revenues, the income of Goldman Sachs skyrocketed from USD 12.8 billion in 2001 to 46 billion in 2007. Although its revenue plummeted in 2008 due to the subprime mortgage crisis, it bounced back to USD 45.2 billion in 2009. The nine‐year track record shows a stable net interest income, investment banking income, asset management income, and securities service income. The net interest income came mainly from fair value‐based asset transactions and


securities reverse repurchases, which signifi cantly increased during the crisis. The incomes for 2006, 2007, 2008, and 2009, respectively, were USD 3.5 billion, USD 4.0 billion, USD 4.3 billion, and USD 7.4 billion. Incomes from transactions and proprietary business were volatile in com-parison, plummeting from USD 29.7 billion in 2007 to USD 8.1 billion in 2008, which was due to the market environment during the crisis, as well as Goldman Sachs’s own risk position (see Figure 8.6 for a graphic representation).

In terms of the relative amounts of revenues throughout the period from 2001 to 2007, revenues from transactions, proprietary business, and invest-ment banking were the major income contributors for Goldman Sachs, accounting for approximately 70 percent consistently, including 78 percent in 2001 and 81 percent in 2007. In 2008, the percentages of transaction reve-nues and proprietary business revenues dropped, but the percentage of invest-ment banking revenues rose, so the combination of the two still accounted for 60 percent of total income. Even in the worst market environment, the twobusiness lines were still the core business of Goldman Sachs. Their stability as income sources is beyond doubt. Goldman Sachs has traditional advantages in investment banking. However, in recent years, the most profi table business has been transactions and proprietary business, with revenues mainly from FICC, which engages in transactions with mainly proprietary funds. In com-parison, the asset management business and brokerage business of Goldman Sachs are not as signifi cant (see Figure 8.7 for a graphic representation).

FIGURE 8.6 Comparison of Various Revenues of Goldman Sachs (2001–2009) Source: Goldman Sachs Annual Report 2001–2009.

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

2001 2002 2003 2004 2005 2006 2007 2008 2009

Million USD

Asset Managementand SecuritiesServices RevenueInvestment BankingRevenueTrade and ProprietaryBusiness RevenueNet Interest Revenue


After 2010, Goldman Sachs restructured its business into the following four blocks:

1. Investment banking 2. Institutional client services 3. Investment and lending/borrowing 4. Investment management

The investment banking business provides a series of investment banking services to companies, fi nancial institutions, governments, and individuals. The institutional client service business provides transaction services to cli-ents in the fi xed income market, stock market, futures market, and com-modities market. The investment and lending/borrowing business mainly involves long‐term investment, lending, and borrowing, investing mostly in funds, bonds, loans, stocks, real estate, and industrial assets managed by the company. The investment management business provides wealth manage-ment products to discrete individual and institutional clients through asset portfolios. Adjustments were also made to the revenue statistics structure accordingly. The original four‐part structure was changed into a six‐partstructure. Although the investment banking income and the net interest income remained unchanged, the transaction and proprietary businessrevenue and the securities service income were further divided into asset management income, commission income, market maker income, and other proprietary business income. Incomes from investment banking and pro-prietary business still account for 65 percent of the total revenue, rather consistently. See Figure 8.8 for a graphic representation of this information.

FIGURE 8.7 Goldman Sachs Revenue Structure (2001–2009) Source: Goldman Sachs Annual Report 2001–2009.

0%10%20%30%40%50%60%70%80%90%

100%

2001 2002 2003 2004 2005 2006 2007 2008 2009

Asset Management andSecurities ServicesRevenueInvestment BankingRevenueTrade and ProprietaryBusiness RevenueNet Interest Revenue


U.S. Investment Bank Business Structure Case Study:Morgan Stanley

Morgan Stanley has adopted a structure consisting of several business units under a holding company. Each business unit specializes in a certain fi eld of business as an independent profi t center. Its organizational structure consistsof the following four parts:

1. Institutional securities division 2. Individual investor division 3. Investment management division 4. Credit service division

In terms of revenue structure, its revenue consists of seven parts: (1) net inter-est and dividend income, (2) transaction income, (3) investment income, (4) asset management income, (5) investment banking income, (6) commission income, and (7) other incomes. (Figures 8.9 and 8.10 illustrate the revenue sources and revenue structure of Morgan Stanley.)

In terms of absolute amounts of revenues, from 2001 to 2007 revenues grew steadily, although the growth rates were not particularly high. Thetotal revenue was USD 19.6 billion in 2001 and USD 26.9 billion in 2007. Revenue then dropped to USD 22.1 in 2008 due to the fi nancial crisis. How-ever, considering that the drop was mostly due to the loss from a USD 3.9 billion investment, the revenues from other sources didn’t drop in 2008. The total revenue bounced back to USD 23.4 billion in 2009. Based on the track record of the company’s income over the nine years, we can see that thecommission revenue, investment banking revenue, and asset management

FIGURE 8.8 Revenue Structure of Goldman Sachs in 2010 Source: Goldman Sachs Annual Report 2010.

InvestmentBankingRevenue12%

AssetManagementRevenue12%

CommissionRevenue9%

Market MakerRevenue35%

OtherProprietaryBusinessRevenues18%

Net InterestRevenue14%


revenue were pretty stable without much fl uctuation. The combined rev-enue from these three business lines grew from USD 10.8 billion in 2001 to USD 16.5 billion in 2007 and was not signifi cantly affected by the subprime mortgage crisis. The combined revenue remained high in 2008 and 2009,reaching USD 13.4 billion and USD 15.1 billion, respectively. In contrast, theinvestment revenue, transaction revenue, net interest, and dividend revenue

FIGURE 8.9 Comparison of Various Revenues of Morgan Stanley (2001–2009) Source: Morgan Stanley Annual Report 2001–2009.

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

2001 2002 2003 2004 2005 2006 2007 2008 2009

Million USDOther Revenues

CommissionRevenue

InvestmentBankingRevenue

AssetManagementRevenue

InvestmentRevenue

TradingRevenue

Net Interestand DividendRevenue

FIGURE 8.10 Morgan Stanley Revenue Structure (2001–2009) Source: Morgan Stanley Annual Report 2001–2009.

–20%

0%

20%

40%

60%

80%

100%

2001 2002 2003 2004 2005 2006 2007 2008 2009

Other Revenues

CommissionRevenue

InvestmentBanking Revenue


InvestmentRevenue

TradingRevenue

Net Interest andDividendRevenue


were fl uctuating. The investment income, swinging back and forth between positive and negative territory, registered a defi cit of USD 400 billion in 2001, a defi cit of USD 3.9 billion in 2008, and a defi cit of USD 1.1 billion in 2009. The transaction revenue was also unsteady, reaching a small peak of USD 11.8 billion in 2006 before plummeting to a nine‐year low of USD 3.2 billion. The net interest and dividend revenue stood at USD 1 billion in2009, the lowest point of that phase. In most years, however, the revenue was near USD 3 billion.

In terms of relative amount of revenues, from 2001 to 2007 commis-sions, investment banking income, and asset management income were the three stable and important sources of revenues for Morgan Stanley, jointly accounting for approximately 55 percent of the total revenue consistently. Of these, investment banking accounted for an average of 17 percent, commissions accounted for an average of 16 percent, and asset manage-ment accounted for an average of 21 percent. Transactions were also an important source of revenue. However, due to the great uncertainties asso-ciated with transactions, the percentage of income from transactions fl uc-tuated wildly. For example, the percentage was 34 percent in 2003 but only 12 percent in 2007. Therefore, transactions are not a stable source of income, but one with great potential. If transactions are combined with the three business lines mentioned earlier, the four together accounted for 83 percent of Morgan Stanley’s total revenue. The percentage even hit as high as 97 percent in 2009. The income from investment generally hada small percentage in total revenue, which was usually below 6 percent, except in 2007.

Proprietary business, asset management business, and investment bank-ing business are the income generators for Morgan Stanley. Considering thatinterest income also comes from proprietary and asset management busi-ness, the three business sectors are the dominant income contributors. The investment banking business with securities issuance and underwriting at the core is the leading business in Morgan Stanley. In 2004, Morgan Stanleyovertook its rival Goldman Sachs as the top player in the IPO business, with a 10 percent share of the global IPO market.

U.S. Investment Bank Business Structure Case Study:Merrill Lynch

Merrill Lynch has adopted a structure consisting of several business units under a holding company, like the internal organization structures of many large international investment banks. Each of these business units is an inde-pendent profi t center specialized in certain business lines. The business of Merrill Lynch consists of the following three parts:


1. Global market and investment banking group (GMI) 2. Global private client group (GPC) 3. Merrill Lynch investment manager group (MLIM)

GMI provides fi nancial services for large corporate clients and institutional clients across the world. GPC provides fi nancial services for small andmedium corporate clients and private clients. MLIM is responsible for man-aging assets from various types of clients. (Figures 8.11 and 8.12 illustratethe revenue sources and revenue structure of Merrill Lynch.)

In terms of absolute amounts of revenues, from 2003 to 2006 the total business revenues of Merrill Lynch were in a phase of stable growth. The growth of revenue from the proprietary business was particularly signifi cant, amounting to an increase from USD 2.6 billion in 2003 to USD 7 billion in 2006, which made it the most profi table business. Invest-ment income was only a small portion of the total income and never went beyond USD 600 million. Investment banking, commissions, asset man-agement, net interest, and dividend incomes were stable sources of rev-enues. Of these, revenues from asset management and commissions both reached USD 6 billion in 2006. The revenue from investment banking andthe revenue from net interest and dividend both reached USD 4.6 billion in 2006.

FIGURE 8.11 Comparison of Various Revenues of Merrill Lynch (2003–2006) Source: Merrill Lynch Annual Report 2003–2006.

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

2003 2004 2005 2006

Million USDOther Revenues

InvestmentRevenue

ProprietaryBusinessRevenue


CommissionRevenue




In terms of relative amounts of revenues, the revenues from commission and asset management were most stable, constantly accounting for about 21 percent and 23 percent of total revenue, respectively. Revenue from invest-ment banking was a low 10 percent in 2004, but accounted for approximately 15 percent in the three other years. The revenue from proprietary business reached a high of 22 percent in 2006, but remained around 14 percent in the three other years. The revenue from net interest and dividend hit a low of 14 percent in 2006, but remained near 19 percent in the three other years. In comparison, the revenue from investment was a small percentage in the total revenue, below 2 percent in all four years. With the exception of investment income, revenues of Merrill Lynch were well‐balanced, which is testament to the diversifi ed operation strategy of Merrill Lynch.

U.S. Investment Bank Business Structure Case Study:Lehman Brothers

Lehman Brothers used to be the fourth‐largest investment bank on Wall Street. Despite its bankruptcy in 2008, the profi tability model of this cente-narian operation is still worth studying. The business of Lehman Brothers can be divided into the following three categories:

FIGURE 8.12 Merrill Lynch Revenue Structure (2003–2006) Source: Merrill Lynch Annual Report 2003–2006.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2003 2004 2005 2006

OtherRevenues

InvestmentRevenue



CommissionRevenue


Net Interestand DividendRevenue


1. Capital market division 2. Investment banking division 3. Investment management division

The capital market business division further included the fi xed income sub-division and the stock subdivision. The business covered institutional clientbrokerage, research, mortgage backed securities, secondary transactions, and fund‐raising activities related to equity and fi xed income products. The investment banking division engaged in counseling services, global debts and fi nances services, and global equity and fi nances activities. The invest-ment management division engaged in asset management and private invest-ment management. (Figures 8.13 and 8.14 illustrate the revenue sources and revenue structure of Lehman Brothers.)

In terms of absolute amounts of revenues, the total revenue of Lehman Brothers experienced rapid growth from 2001 to 2007, increasing from USD 6.7 billion in 2001 to USD 19.3 billion in 2007. The revenue from pro-prietary business was the biggest driver behind growth, surging from USD2.8 billion in 2001 to USD 9.2 billion in 2007. Revenues from asset man-agement, commission, investment banking, net interest, and dividend also grew to varying degrees, but not as fast as proprietary business. Revenues

FIGURE 8.13 Comparison of Various Revenues of Lehman Brothers (2001–2007) Source: Lehman Brothers Annual Report 2001–2007.

0

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10,000

15,000

20,000

25,000

2001 2002 2003 2004 2005 2006 2007

Million USD

AssetManagement andOther Revenues

CommissionRevenue





from commissions and investment banking were relatively more stable, withcommission income rising from USD 1.1 billion in 2001 to USD 2.5 billion in 2007, and investment banking income rising from USD 2 billion in 2001 to USD 3.9 billion in 2007. Revenues from proprietary business, investment banking, and commissions constituted the majority of Lehman Brothers’ total revenue.

In terms of relative amounts of revenues, the revenue from proprie-tary business was always in a prevailing position, growing an average of 50 percent every year from 2003 to 2007. Revenues from investment bank-ing and commissions both showed a downward trend, with the revenue from investment banking dropping from 30 percent in 2001 to 20 percentin 2007, and the revenue from commissions dropping from 16 percent in 2001 to 13 percent in 2007. The percentage of the revenue from asset man-agement grew signifi cantly from 1 percent in 2001 to 9 percent in 2007. The revenue from net interest and dividend fl uctuated widely, but generally showed a downward trend, declining from about 15 percent to 10 percent.

During 2003 through 2006, when mortgage‐backed business grew rapidly, the capital market business division accounted for an average of 68 percent of total revenue and the fi xed income subdivision accounted forabout 74 percent of the revenue of the capital market division. As a result,the fi xed income subdivision made up about half of the total revenue for Lehman Brothers. However, after the outbreak of the subprime mortgage

FIGURE 8.14 Lehman Brothers Revenue StructureSource: Lehman Brothers Annual Report 2001–2007.

0%

10%

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30%

40%

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60%

70%

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2001 2002 2003 2004 2005 2006 2007

AssetManagement andOther Revenues

CommissionRevenue


ProprietaryBusiness Revenue

Net Interest andDividend Revenue


crisis in 2007, the performance of the fi xed income division that had oncebeen the pride of Lehman Brothers plummeted a whopping 29 percent,which led to a mere 2 percent growth for the capital market division. Theinvestment banking division and the investment management division grew by 24 percent and 28 percent, respectively.

What China Can Learn from the Business Structures ofAmerican Investment Banks

Having done a general analysis of the securities industry overseas and case studies on four representative international investment banks, we arrive at the conclusion that the profi tability models of foreign securities companieshave the following fi ve characteristics:

1. Diversifi ed operation model: The four investment banks studied previ-ously developed their business in a well‐balanced way. The brokeragebusiness, investment banking business, proprietary business, and assetmanagement business all made up a considerable percentage. AlthoughGoldman Sachs and Lehman Brothers relied more on their proprietary business, Morgan Stanley and Merrill Lynch adopted a more balancedapproach.

2. The steadily decreasing proportion of commissions to total revenue:Since 1980, commissions have been making an increasingly smaller per-centage of total income in the U.S. securities industry, declining from the original 35 percent to the current 18 percent, which is far below the per-centage contributed by commissions in the Chinese securities industry. Of the fi ve largest international investment banks, commissions account for only 9 percent of the total income in Goldman Sachs, 16 percent in Morgan Stanley, 19 percent in Merrill Lynch, and 14 percent in Lehman Brothers, far below what Chinese securities traders’ earn from commissions. In addition, of the commission income in the U.S. securities industry, commissions from stock trading in exchanges account for only about 56 percent. Commissions from OTC securities trading, futures, and other items account for 44 percent. In contrast, Chinese commis-sions from stock trading in exchanges account for 87 percent of total commission income.

3. The importance of market maker transactions to the income of a secu-rities trader: Market maker transactions account for about 20 percentof the income of U.S. securities trades. For example, the percentage of total income from market maker transactions is 35 percent in Goldman Sachs, 17 percent in Merrill Lynch, and 29 percent in Morgan Stanley.


4. A larger portion of securities traders’ income from asset management than in China: About 8 percent of the income of U.S. securities traders currently comes from asset management. The percentage of total income attributable to asset management is 13 percent in Goldman Sachs, 21 percent in Morgan Stanley, 23 percent in Merrill Lynch, and 5 percent in Lehman Brothers. In China, asset management accounts for only 1 percent of total income. There is plenty of room for securities traders to improve their asset management business.

5. Bond and enterprise counseling services represent a signifi cantly larger percentage in international investment banking business than in Chineseinvestment banking business: The percentage of total income attribut-able to investment banking is largely consistent among international and Chinese securities traders. Of the four major international invest-ment banks, the percentage of total income attributable to investmentbanking is 12 percent in Goldman Sachs, 16 percent in Morgan Stanley,19 percent in Merrill Lynch, and 22 percent in Lehman Brothers. These are comparable to 14 percent in China. However, 75 percent of income from investment banking business in China comes from underwriting and sponsoring. Less than 10 percent comes from corporate bonds and enterprise counseling. In contrast, stock underwriting, bond underwrit-ing, and enterprise counseling each account for one‐third of the invest-ment banking business of overseas securities traders.

ANALYSIS OF THE INTERNAL CONTROL OF INVESTMENT BANKS IN MATURE INTERNATIONAL MARKETS

The Five Factors of Internal Control

Internal control refers to an organizational form of a business and respon-lsibility division system established by an economic unit and various orga-nizations in economic activities. The objective of internal control is toimprove operation and management, as well as economic profi tability. The internal control of an investment bank refers to a series of methods,procedures, and measures for self‐adjustment, constraint, planning, assess-ment, and control. The measures are designed by an investment bank to achieve operational goals. The goals include protecting capital securityand integrity and ensuring the accuracy and reliability of accounting infor-mation. The investment bank also aims for the effective implementation of operation strategies, as well as the economy, effi ciency, and effectiveness of its operational activities. According to the Internal Control Framework compiled by the Committee of Sponsoring Organizations of the Treadway


Commission, the internal control system of a company can be analyzed from the perspective of the following fi ve factors: (1) internal environ-ment, (2) risk assessment, (3) control activities, (4) information and com-munication, and (5) supervision. This section analyzes the internal control of investment banks in a mature international market based on these fi ve factors.

Internal Environment Corporate culture plays a fundamental internal control role in investment banks in mature international markets. This is best dem-onstrated by Goldman Sachs, a time‐honored American investment bank. At the core of the corporate culture of Goldman Sachs is team spirit, greatvalue, and reputation. Regarding team spirit, most divisions of Goldman Sachs are headed by two persons. This arrangement sets Goldman Sachs apart from other investment banks, such as Lehman Brothers, which tendsto give free reign to one individual. Goldman Sachs never gives anyone a promise regarding a certain level of salary, nor does it reward a dealer with a certain percentage of the profi t. That constitutes the foundation for the environment of internal control.

A cautionary tale in this respect comes to us from Lehman Brothers, which went bankrupt during the last round of the fi nancial crisis. FormerLehman Brothers CEO Dick Fuld became a hero of the company after lead-ing the company out of dire situations on many different occasions and overseeing years of outstanding performance. As a result, his power in the company’s board of directors was dramatically magnifi ed. However, he ended up failing to help Lehman Brothers avoid the loss caused by the real estate business. Even amidst the economic downturn in 2007, Fuld’s salary was still as high as USD 34 million, which speaks to a very unreasonable salary system. Regarding corporate reputation, article 2 of the GoldmanSachs Operation Principles says: “Our assets lie in our employees, our capi-tal and our reputation.” Of these three assets, damage to reputation is themost irredeemable. Companies must be committed to abiding by the laws, regulations, and moral codes that are applicable to them, in both letter andspirit. Goldman Sachs has been free of fatal scandals. However, Salomon Smith Barney, once the archrival of Goldman Sachs, went almost bankruptfor illegal behaviors. At the time, Salomon Smith Barney was fi ned USD 290 million by the SEC for fraudulent operation. It is evident that a soundcorporate culture and internal environment are the secret ingredients for the lasting prosperity of successful investment banks in mature international markets.

Risk Assessment In an investment bank, risk assessment refers to the worktconducted to quantitatively evaluate a risk event’s effects on the assets and


operation of the bank and the possibility of losses before or after its occur-rence (but before it ends). Risk assessment has the following fi ve tasks:

1. Identify the risks facing the subject of the assessment. 2. Evaluate risk probability and possible negative impact. 3. Determine the risk resistance of an organization. 4. Determine the priority levels of risk mitigation and control. 5. Recommend risk mitigation measures.

After years of crisis and multiple waves of mergers and acquisitions, investment banks in mature international markets have established rather scientifi c and sensible risk assessment systems (see the next section, “RiskManagement of Investment Banks”). Despite that, real‐life operation andmanagement of investment banks may still make mistakes by failing to suf-fi ciently identify a risk or by overestimating risk resistance.

Again, using Lehman Brothers as an example, in the fi ve years from 2003 to 2007 Lehman Brothers’ profi t averaged USD 1.6 billion. Its share price rose by 29 percent every year. But an overly optimistic view on the prospects of the company directly led the board of directors and the management of the company to overlook the importance of internal risk assessment. Of the USD 800 billion shown on its balance sheet, net assets only accounted for USD 25 billion. Securitized products, which were diffi cult to evaluate,accounted for 2.5 times the amount of its net assets. The leverage ratio more than doubled the maximum number allowed by U.S. regulators.

Even investment banks in mature international markets have to consider the internal risk‐assessment system as the lynchpin of the internal control of the company as a whole. In practice, management and operation shouldbe conducted with a cool head and suffi cient objectivity. In addition, due to its special nature, an investment bank usually faces much greater risks thana regular enterprise. To some extent, investment banks are institutions that operate risks. Therefore, provided that sound risk‐assessment techniques are adopted, the decision makers are well‐advised to be relatively pessimistic. A risk should be considered as real until proven otherwise. The risk resistanceof the bank itself is better to be underestimated than overestimated. Those are the lessons from the large number of investment banks that went bank-rupt during the fi nancial crisis.

Control Activities Control activities refer to policies and procedures thatensure the implementation of the instructions of the management. Control activities take place at all levels and in all functional units of an enterprise. In investment banks in mature international markets, control activities include authorization, performance evaluation, information processing, physical


object control, and segregation of duties. Table 8.9 shows the contents of the work on each of these fronts.

Due to the large number of business units and complex relations within an investment bank, segregation of duties is especially important. It is the fi rst line of defense against insider trade. Without exception, investment banks in mature international markets require strict segregation to avoid confl icts of interest and insider trade. The segregation affects the investment banking business, proprietary business, entrusted investment management business, securities research, and securities investment counseling business in terms of staffi ng, information, accounts, and offi ce sites.

Information Communication Information processed in an investment bank includes internal information and external information. Internal information includes external regulation information and industrial information. Infor-mation communication in an investment bank includes lateral communica-tion between employees in the same division, vertical communication between employees at different levels of the hierarchy, and cross‐communication between different divisions. Thanks to the rapid progress of computers and relevant information technologies, investment banks in mature international markets currently conduct their information communication through excel-lent computer, cell phone, or other multimedia platforms effi ciently and without obstruction. Therefore, information communication does not con-stitute an internal control issue requiring much attention from investment banks. All employees of an investment bank should understand their respec-tive positions in the corporate structure and their relations with each other. They must also conduct effective communication with people from outside groups such as clients, regulators, and shareholders.

Supervision The previous discussion about the governance structures of investment banks in mature international markets mentioned that effectivesupervision is an indispensable safeguard for the sound development of the company. In U.S. markets, the role of the board of supervisors has been increasingly diminished. Most investment banks in the United States don’thave a board of supervisors, and the duty of supervision is left to the audit committee or the risk‐management committee under the board of directors. However, because the number of board of directors meetings is limited, and most of the directors are outside directors, it has become impractical to timely and effectively track the operation of the company. To a great extent, this has magnifi ed the decision‐making power of the management of the company. Lehman Brothers amassed a defi cit of USD 2.8 billion in the fi rst two quarters of 2008, but it wasn’t until then that the discontent of the inves-tors over the defi cit forced the company to reshuffl e its management and

452

TABL

E 8.

9 O

verv

iew

of

Con

trol

Act

ivit

ies

of I

nves

tmen

t B

anks

in M

atur

e In

tern

atio

nal M

arke

ts

Auth

ori

zati

on

Per

form

ance

Ass

essm

ent

Info

rmati

on P

roce

ssin

gPhysi

cal O

bje

ct C

on

trol

Sep

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tio

n o

f D

uti

es

■

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pur

pose

of

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to

ensu

re t

hat

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esc

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auth

oriz

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yth

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anag

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dismiss several international business executives. Therefore, how to enhance internal supervision is a question that needs to be addressed urgently, even by investment banks in mature international markets. Under current super-vision systems, it is worth considering to raise the frequency of audit com-mittee or risk‐management committee meetings or to strengthen the duties of outside members of the board of directors, among other measures.

Risk Management of Investment Banks

Risk management is at the center of the internal control of investment banks in mature international markets. Therefore, it is necessary to analyze it separately. This section discusses the topic from three perspectives: (1) major categories of risks facing investment banks in mature international markets, (2) internal risk‐management structures of investment banks, and (3) risk‐management methods commonly used in the industry.

Major Categories of Risks Investment banks in mature international markets engage in various types of business, each associated with a special set of risks. Based on the sources of the risks, as well as the coverage of their impact, risks facing investment banks in mature international markets can be divided into the six categories shown in Figure 8.15 .

Market Risks Market risks are among the most important risks in thefi nancial system. They are unavoidable for all participants in the fi nancial

FIGURE 8.15 Types of Risks Facing Investment Banks

Macro Level

Market Risks

System Risks

Credit Risks

Operation RisksLiquidity RisksOperation Risks

Industrial Level

Exterior Level

Corporate Level

Type

s of

Ris

ks F

acin

gIn

vest

men

t Ban

ks


industry. Investment banks are no exception. Market risks are often defi ned as the risks of losses to on‐balance‐sheet or off‐balance‐sheet positions due to changes in market prices or changes in market variables, depending on the sensitivity of fi nancial instruments and portfolios.

Based on the market variables involved, market risks can be further divided into interest rate risks, exchange rate risks, infl ation risks, and vari-able fl uctuation risks. Market risks have an across‐the‐board impact on the loss and profi t of all business lines of an investment bank. Changesof macroeconomic parameters such as market interest rate, exchange rate, and infl ation rate can also trigger changes in securities prices. This in turn affects the uncertainty of securities profi tability, putting business innovationof an investment under risks associated with pricing, marketing, or profi t.In order to reduce market risks, investment banks often take such measuresas setting risk‐assessment standards, putting together a special market risk‐management team, and setting risk limits.

System Risk System risks are specifi c to mixed‐operation banks and fi nan-cial holding companies created against the backdrop of mixed fi nancial operation in the fi nancial industry. They include the risks of the collapseof a whole investment bank triggered by the collapse of a single subsidiary or business unit of the bank, as well as the risk of the collapse of the entireindustry triggered by the collapse of a single investment bank. They are the result of the spread of risks and the chain reaction that follows within an investment bank or within the industry. When the amount of system risks reaches a tipping point, they will lead to the bankruptcy of investment banks in quick succession. They can also bring about circulation diffi culty in theentire market and trigger a crisis of confi dence among investors. Examples of the malignant result of system risks, to some extent, include the failure of a large number of mature investment banks since 2007, the bankruptcy of Lehman Brothers and Salomon Smith Barney, and the acquisition of MerrillLynch, as well as the European bank crisis as represented by French banks. For the regulators, fi nancial markets, and fi nancial institutions (includinginvestment banks) of various countries, system risks might be the singlegreatest threat. Therefore, it is necessary and urgent to build a set of uniform and fl exible risk‐management and control frameworks that are suffi ciently combined with capital fund standards.

Credit Risks Credit risks are most commonly seen in OTC transactions inwhich an investment bank acts as the intermediary. They are default riskscaused by the counterparty’s failure to fulfi ll its obligations to the invest-ment bank. Credit risks occur when the operation of an investment bank involves overdraft or securities borrowing, or the investment bank allows


its client to do overdraft trading in order to go short or long, while the client refuses to repay the overdrafted amount. The client’s refusal to pay the principal and interest after being fi nanced by the bank can also lead to credit risks. For an investment bank, the loss from the counterparty’s failure to fulfi ll its contractual obligations is closely related to the nature of the transaction as well as the credit system.

Generally, derivative products are much riskier than nonderivative products, thanks to their credit nature and lack of a sound margin system and daily market‐to‐market system. As investment banks in mature interna-tional markets deepen their fi nancial business innovation and raise the scaleof their derivative products, credit risks occur more frequently in investment banks. To control credit risks, investment banks make efforts in the follow-ing three major aspects: (1) Always choose standardized exchange trading when possible, (2) strengthen the counterparty screening process, and (3)spread out counterparties.

Operation Risks These include losses due to erroneous strategic position-ing, business structures, or decisions of an investment bank. They may also be due to changes of external factors that are too sudden for the investmentbank to make adjustments in its operational strategies. Risks associatedwith operation beyond the scope allowed by laws and regulations are also operation risks. Usually, operation risks can be lowered by improving thegovernance structure of the company and raising the operational caliber of the management.

Liquidity Risks Liquidity risks are caused by an investment bank’s failureto sell or assign fi nancial instruments at a reasonable price due to a low liquidity ratio, a lack of liquidity in its fi nancial structure, or imbalance inits asset debt structure. When interest rates surge, transactions of fi nancialinstruments with high credit and interest risks will be suspended. In theabsence of any counterparty, the person holding these fi nancial instruments will not be able to sell them at a price close to the original purchase price. Therefore, the investment bank suffers losses. When the accumulated risks reach a certain amount, a securities company may owe more than the value of all of its assets, which eventually leads to bankruptcy. Usually, investment banks lower liquidity risks through hedging.

Operational Risks Internal operational risks are caused by human error, system breakdown, operation program malfunction, or failure of control. Operational risks are to a great extent the result of management lapseand overreach. Human error that can lead to operational risks includeslaw‐ or regulation‐breaching behaviors by investment bank workers while


conducting investment banking business. This includes illegitimate solici-tation and underwriting of stocks, document forgery, making up false information, and intentionally cheating regulators in order to avoid issu-ance regulation. Operational risks caused by system breakdown or control failure in an investment bank may also happen during account opening, deposit/withdrawal, agency transactions, delegation, clearing and delivery,or computer entry. Without prevention and timely detection, such incidents might bring damage to the reputation and fi nances of the company, andcan even lead to compensation claims, litigation, or regulatory punishmentagainst the company. In order to mitigate operational risks, an investmentbank may set out clear and detailed employee responsibilities, issue more severe punishment for operational errors, and establish and enhance warn-ing and insurance systems.

Risk-Management Architecture Risk‐management architectures of investment banks in mature international markets are constantly enriched and improved in line with their constant economic and fi nancial development and constant business expansion, making the organizational structures of these banks increasingly complex. The development history in risk management archi-tectures is summed up in Table 8.10 .

The development of investment banks in mature international markets has led their risk management to adopt comprehensive management models. The Committee of Sponsoring Organizations of the Treadway Commission (COSO) defi nes comprehensive risk management as the process of identify-ting events that may potentially affect the enterprise and managing risks, based on the enterprise’s preference scope of risks, so that the company canreasonably expect to meet its goals. The process is affected by the board of directors, the management, and other persons. It runs from strategy formu-lation to every activity of the enterprise.

As a process that runs through every activity of an enterprise, comprehen-sive risk management needs the support of an effective architecture. A com-plete risk‐management architecture includes the following six ingredients:

1. Complete modern enterprise risk‐management organizational structures 2. Standardized risk‐management processes 3. Complete risk‐management handbooks 4. Effective risk warning system 5. Effective prevention system 6. Highly effi cient risk‐management information system

Figures 8.16 and 8.17 depict two examples of risk‐management organiza-tional architectures of investment banks in mature international markets.

457

TABL

E 8.

10 E

volu

tion

of

Inve

stm

ent

Ban

ks in

Mat

ure

Inte

rnat

iona

l Mar

kets

Model

Evo

luti

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ent

Model

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trib

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ent

Model

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isk‐

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and

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The two examples in Figures 8.16 and 8.17 show that investment banks in mature international markets have already established sound comprehen-sive risk‐management architectures based on constant practice. Risk man-agement is a process. Therefore, the various aspects of the risk‐management architecture are not discrete units; rather, they are complementary.

Risk-Management Methods Risk‐Management Processes To discuss risk‐management methods of invest-ment banks, their risk‐management processes must fi rst be understood.Figure 8.18 is a graphical representation of the risk‐management process. The application of risk‐management methods is mainly focused on the two areas of risk identifi cation and risk assessment. The next step is to reviewmajor risk‐management methods adopted by investment banks in mature international markets.

Major Risk‐Management Techniques and Methods Theoretically, the proposal of the asset management theory, the arbitrage pricing theory,

FIGURE 8.16 Goldman Sachs Group Risk‐Management Organizational Architecture Diagram

Shareholder’sAssembly

Board ofDirectors

ManagementCommittee

Corporate RiskCommittee

CapitalCommittee

VariousDivisional Risk

Committee

FinanceCommittee

Operation RiskCommittee

InnovativeProduct

AssessmentCommittee


and the option pricing model together laid the foundation for invest-ment bank risk‐management methods in their modern sense. In practice, several world‐shocking fi nancial crises in the 1990s (such as the Barings Bank incident and the Daiwa Bank incident) caused some large interna-tional banks to study and establish their own internal risk‐management measurement and capital allocation models. As the worldwide demand by fi nancial institutions for fi nancial risk management and relevant tech-niques and software increases, a large number of counseling companies and software companies specializing in risk‐management services have surfaced. Their presence drives the continuous update and development of risk‐management techniques, methods, and software. Following are today’s major risk‐management methods, techniques, and software, cat-egorized by type of risk:

■ Market risks: The change of interest rate directly affects the value of fi xed income securities and loan portfolios. Therefore, interest rate risks are the most important market risk facing investment banks.

FIGURE 8.17 Morgan Stanley Group Risk‐Management Organizational Architecture Diagram

Shareholder’sAssembly

Board ofDirectors

Risk Control Teams, Market Risk Experts, CreditRisk Experts, Finance Experts, Legal Experts

Securities RiskCommittee and Its

AffiliatedImplementation

Committee

Various BusinessRisk Committees

and Their AffiliatedImplementation

Committee

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460

FIGUR

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As a result, the development of interest rate risk‐management meth-ods is most notable. The major methods include gap analysis, dura-tion analysis, and convexity analysis. The key behind gap analysis is the measurement of sensitivity to the asset/debt ratio. The duration and convexity analyses evaluate interest rate risks of bond securities.Duration analysis refl ects bonds’ sensitivity to interest rate changes.Convexity analysis refl ects the sensitivity of the duration of a bond to changes in interest rates. The best‐known specifi c measurement model is the risk metrics developed by J.P. Morgan to measure the value at risk (VaR) or market risk of its assets. Other methods developed to allocate capital according to risks include the risk adjust return oncapital (RAROC).

■ Credit risks: The prevailing risk‐management methods are those that make decisions based on a comprehensive analysis of the client or coun-terparty’s ability to perform its contractual duty and the probabilityof default. They mainly include the expert method, the credit rating method, and the credit scoring method. Major measuring models includethe risk metrics developed by J.P. Morgan, the credit risk method devel-oped by CSFB, the KTV model developed by the KTV company, and the McKinley model developed by the McKinley company.

■ Comprehensive risk management: At the methodology level, this mainly includes statistical analyses and scenario analyses. Statistical analysisexamines factors affecting the income of portfolios and evaluates the cor-relation coeffi cients between them through a series of metric techniques.These parameters refl ect the extents to which the asset income reactsto different risk factors. This also provides technical specifi cations thatmay hedge against certain types of risks. Scenario analyses require risk managers to envision possible states of an investment portfolio and examine potential losses in extreme situations. These steps are repeated for all relevant variables to reach a fi nal conclusion. The following three models are well recognized in the industry: 1. The risk monitor model developed by AXIOM Software Company

integrates variance and covariance analyses. This Monte‐Carlo simu-lation, historical simulation, and multiple factor analysis provide a sustainable and consistent measuring method for all markets, busi-ness lines, and fi nancial instruments.

2. The risk watch model developed by Algorithmics Company is based on market pricing. It further gave rise to the mark to future mode forthe pricing of asset portfolios. As a spin‐off from scenario analyses,this model puts the asset portfolio in a scenario at one or more pointsin time in the future and determines the price of the asset portfolio based on the impact of risk factors on the portfolio.


3. The risk book model developed by Askari Company integrates vari-ous risk analyses into a consistent analysis structure, providing mul-tiple risk perspectives through a consistent analysis system.

■ Financial engineering methods: In addition to the risk‐management methods mentioned previously, modern fi nancial engineering methodsare also worth noting. This generation of methods was facilitated by thetransformation to the market‐based interest rate system in the 1970s and the subsequent rapid development of derivative fi nancial instruments. Financial engineering methods involve the design, development, andimplementation of novel fi nancial instruments and fi nancial means,as well as innovative solutions to fi nancial problems. Typical methodsinclude the VaR Delta model developed by Financial Engineering Asso-ciates, Inc. The model is able to determine how a new transaction will affect the VaR of the entire asset portfolio without recalculating the VaR of the investment bank. The model also provides VaR composition analyses, as well as client data not included in risk metrics. Anothertypical model is the risk IQ model developed by IQ Financial Systems. This is an integrated analysis model for market risks, credit risks, and liquidity risks. In particular, the model can be used to measure the over-all risks of investment banks.

Intrinsic Flaws of Risk‐Management Models Our previous discussions andanalyses have shown that risk management in investment banks in mature international markets has entered a stage of comprehensive management. Accordingly, risk‐management techniques have also evolved from qualitative analysis into current quantitative analysis, based on a large number of data models. Quantitative techniques and mathematical statistics models were once considered a major breakthrough in risk management. They improved the precision of risk measurement in investment banks to the extent that measurement is no longer a general interval or ambiguous subjective judg-ments. However, every model is based on certain hypotheses. Any discrepancy between the hypothesis and reality will compromise the effectiveness of con-clusions from the model. Simulation techniques for future securities prices also need further improvement. Currently, neither historical data nor data based on certain hypothetic models can be relied on and expected to stand theoretical and factual tests, which gives rise to the so‐called model risks. Therefore, if an investment bank relies too heavily on quantitative models for risk management while ignoring relevant qualitative research, accumulated hidden model risks may, over time, bring on a fatal blow to the bank. Risk‐management models have intrinsic fl aws. Their calculated results are effective as a reference for investment decision making only within certain bounds, and they should not be used as the fi nal basis for any investment decision.


What China Can Learn From Internal Control of InvestmentBanks in Mature International Markets

The internal control of investment banks in mature international markets consists of the fi ve major ingredients shown in Figure 8.19 .

The development history of a large number of international investment banks shows that the internal environment underpins the keynote of inter-nal control for the entire investment bank and dictates internal control deci-sion making and policies inside the investment bank.

Risk management is the lynchpin of the internal control of the whole investment bank. Risk assessment is the key and main content of risk man-agement in investment banks. It is the most technology‐intensive part of thewhole process, and takes advantage of the largest set of techniques. Currentrisk management in investment banks in mature international markets has already entered into the comprehensive management stage, which is char-acterized by constant innovation in statistical measurement and one break-through after another in computer software technology. A large number of mathematic models and algorithms have been developed for risk assessment

FIGURE 8.19 Five Major Ingredients of Investment Bank Internal Control

InternalEnvironment

Supervision

InvestmentBank Internal

Control

InformationCommunication

ControlActivities

RiskEvaluation


and measurement. The more common ones include the value at risk (VAR)method, the risk metrics method, the risk monitor method, the risk watch method, the mark to future method, the Var Delta method, and the risk IQ method. Although these models and methods allow for more accurateassessment of risks associated with investment banks, they are fl awed in that the model hypothesis and simulation data may bring about model risks. Therefore, the calculated results based on these models should only be used moderately as a reference, rather than something to be blindly relied upon.

Excellent implementation of control activities is impossible without sen-sible risk‐management architecture. Nearly complete top‐down management architecture has been established with branches in all divisions of an invest-ment bank, consisting of the shareholders assembly, the board of directors, the risk‐management committee, and the risk‐management division of vari-ous business lines, as well as various risk management teams and experts.

As the lifeblood for the survival and development of investment banks, information can now be effectively disseminated and operated upon in the management architecture based on advanced computer and communication technologies in the mature international market.

In addition, supervision of internal control in investment banks is affected by the high percentage of outside directors. In the future, supervi-sion of internal control can be improved through such methods as increas-ing the frequency of board of directors meetings and strengthening the responsibility of outside directors.

As latecomers, however, Chinese securities companies have yet to enrich research on internal control, fl esh out their management structures, and explore relevant risk‐management techniques. Studying internal control ininvestment banks in mature international markets may provide very good references for the development of Chinese securities companies. The key points that follow are drawn from experience.

Emphasize Corporate Culture, Avoid “Lone Wolf” Approaches Case studies relatedto the internal environment of investment banks have shown that effectiveinternal control not only entails “hard” control tools such as budgeting andinternal audits, but also relies on “soft” control tools such as corporate cul-ture, management philosophy, and operation principle. Through effective corporate culture, the operation ideals and core values, as well as profes-sional principles of the company, can take root in the hearts of the employees.“Lone wolf” approaches should be avoided. Otherwise, the internal controlof the company might be gutted. While making various decisions in a securi-ties company, taking advice in a one‐sided manner from certain individualswithout suffi ciently listening to voices on the opposite side will directly lead to the failure of internal control.


Therefore, a top priority for the future development of Chinese securi-ties companies should be to give in to the construction of corporate culture. Specifi c ideals may differ, but generally, honesty and integrity should beindispensable corporate culture ingredients for any securities company. Asecond priority is to avoid lone wolf approaches as much as possible. Taking advice in a one‐sided manner will, without a doubt, signifi cantly increase operational risks to a company. In modern corporate systems, checks and balances are the cornerstone for effective internal supervision and optimizedoperational management. Therefore, for the purpose of internal control, Chinese securities companies should emphasize the construction and com-munication of corporate culture and avoid lone wolf approaches. In terms of operation, the principles of honesty and integrity should be followed. Interms of power layout, power separation and checks and balances shouldbe maintained.

Comprehensive Risk Management, Systematic Decision Making Currently, riskmanagement in investment banks in mature international markets has entered an era of comprehensive management models. The models arebased on valuable experience that these international investment banks have obtained from many years of mixed operation and many waves of merg-ers and acquisitions. Mainstream international fi nancial holding companies,while enhancing their core competitiveness and resistance to risks through mixed operation, have also amplifi ed, by several fold, their system risks and the impact of a single risk. In making risk‐management decisions, paying attention only to localized benefi ts while ignoring overall risks should be absolutely avoided.

Therefore, it is an inevitable trend for securities companies to adopt comprehensive risk management models in their future development. Com-prehensive management should be applied to the management of risks between various business lines of an investment and the managementof risks between the parent company and its subsidiaries, as well as the management of risks between the headquarters and various domestic and overseas branches. While taking measures to lower overall risk inside the company or group, a fi rewall system should be established between various business lines, branches, and subsidiaries to effectively prevent the spread and expansion of risks. Accordingly, relevant risk management decisions should be made in a systematic manner. Common goals and systematic deci-sion making should be realized across the board, from the headquarters to the branches, from the parent company to subsidiaries, and from the risk‐management division to various business divisions. Risk‐managementdivisions should also be adjusted in a dynamic manner, based on changes in the operation environment and internal control objectives of the company.


Improving Risk-Management Architecture, Making It Compatible with the Operation Management Model Basically, the function of risk management is to ensure that the company attains its goals while maintaining risks at a preferred level. Risk management runs through the daily operation and management activities of a company. Therefore, the risk‐management architecture should match the operation and management model of the company. First of all,the risk‐management architecture should be compatible with the develop-ment stage of the company itself, such as the governance structure, businessscope, and business lines of the company. The risk‐management architecture should also be compatible with the organizational architecture of the com-pany. Based on its own characteristics, a company may choose the client‐driven model, the business‐driven model, or the client‐and‐business‐driven model, among other models. Risk‐management architecture must also be compatible with external regulatory requirements. A securities companyshould carefully review policy changes introduced by the regulators to establish a risk‐management architecture that is compatible with external regulatory requirements.

Taking Full Advantage of Advanced Risk-Management Techniques without Relying Too Much on Them The advancement of modern information technologies isan important driving force for the development of investment banks in mature international markets, as well as for their fi nancial innovation. As the business of investment banks becomes bigger and more sophisti-cated, effective integration of resources is possible only through modern information technologies. With the constant development of information technologies, it is indispensable to adopt a set of highly effi cient risk‐management technologies. Based on the experience of investment banks in mature international markets, securities companies should possess technologies and techniques for the management of risks associated with various business lines and products, as well as with overall risk. The specifi c methods adopted by each securities company to implement risk monitoring depend on the nature, scale, and complexity of the company’s business. There are many well‐established technologies and techniques in international markets. Taking full advantage of these advanced risk‐management techniques greatly improves risk measurement accuracy and risk‐management effi ciency of Chinese securities companies. It is also important to be aware that these quantitative methods and techniques have some fl aws stemming from model hypotheses and simulation techniques. Therefore, they by no means replace the entire risk‐management decision‐making process. Securities companies should never rely heavily on these advanced risk‐management techniques. Rather, risks should be managed based on the integrated use of various methods.


WHAT CHINA CAN LEARN FROM THE DEVELOPMENT OFINVESTMENT BANKS IN MATURE INTERNATIONAL MARKETS

Previous sections analyzed what China can learn from various aspects of investment banks in mature international markets. This section is an overall analysis of how the evolution of international investment banks (especiallyafter the outbreak of the subprime mortgage crisis) may inform the future development of Chinese securities companies.

Messages in Terms of Regulation

The subprime mortgage crisis exposed the fl aws of the U.S. securities market in terms of regulation. For example, the overreliance on self‐regulation of the market and the deregulation effort weakened the strength of regulators. The net capital and leverage rate requirements were not strictly followed. Information disclosure in the OTC market was extremely opaque, andsupervision of credit rating agencies was weak. These regulatory shortcom-ings, exposed in the U.S. subprime mortgage crisis, are very helpful refer-ences for regulation in the Chinese securities market.

Strengthening Regulation on Derivatives There are many types of credit deriva-tive products traded by a variety of market players. They are indispens-able fi nancial tools for investors to manage credit crises. They have such important functions as spreading out credit risks, raising return on capital,and improving basic asset liquidity and fi nancial market effi ciency. Credit derivative products represent a new round of consolidation in the fi nancial market that has brought fi nancial institutions to more market areas. By con-necting all markets, they have improved the liquidity of the markets and improved their effi ciency.

The fi nancial vulnerability exposed by the subprime mortgage crisis didn’t come from fi nancial innovation itself, but from the insuffi ciency of regulation. Regulatory policies in the past gave free reign to fi nancial institu-tions, which led to the failure of the regulatory system. Lacking regulation on fi nancial innovation was the fundamental reason behind the fi nancial crisis and economic recession. Of course, regulation should not stand in theway of fi nancial innovation. Giving more choices to fi nancial consumers and extending the availability of credit makes fi nancial innovation indis-pensable. Financial innovation is also essential for the realization of fl ex-ibility in the fi nancial system without hindering the attainment of the goals of the market process. Regulators should focus on the overall interests of society, rather than the interests of individuals. Regulation should be con-ducted with greater foresight, focusing on the prevention of systematic risks.


The subprime mortgage crisis showed that it is extremely important to strengthen comprehensive and prudent regulation and risk control on fi nancial derivatives. For that purpose, regulators should specify the upper limit for leverage applicable to product and business innovation in securitiescompanies and enhance sensitivity analysis regarding the effect of market changes to innovative business. This helps nip potential crises in the budand make risk regulation systems and mechanisms keep pace with fi nancial innovation.

Securities companies should strengthen risk management and control over product and business innovation, using fi nancial leverage prudently to maintain the leverage rate at a proper level, thus lowering control and oper-ation risks. Securities companies should also include product and businessinnovation risks into the overall comprehensive risk‐management system of the company, clearly defi ning the specifi c responsibilities of various business lines and relevant divisions. The internal control system and mechanismsshould be improved so that the nature, variety, and scope of fi nancial inno-vation (especially off‐balance‐sheet business positions) are commensuratewith the net capital scale and the risk management and control system, aswell as the risk management and internal control capability of the company.Irregular inspections on off‐balance‐sheet business should be strengthenedfor early detection of potential risks in off‐balance‐sheet business operation. Securities companies should provide a greater amount of useful informationconcerning the structures and subject matters of complex fi nancial deriva-tives to improve the transparency and effectiveness of fi nancial regulation.

Strengthening Regulation on the Securities Market, Especially the OTC Market The organizational architecture for investment bank risk management in the United States consists of the audit committee, the implementation and man-agement committee, the risk‐monitoring committee, the risk policy team,the business units, the risk‐management committee, and various manage-ment committees of the company. During the international fi nancial crisis, however, these investment bank risk‐management organizations failed to play a suffi cient role in managing and controlling risks, showing signs of weakness. Therefore, regulation should be strengthened on the securities market, and in OTC transactions in particular. Off‐balance‐sheet business should be subjected to the same regulation that is applied to on‐balance‐sheet business to reduce regulatory arbitrage and to better motivate risk management. With constant development of integrated operation in the Chinese securities industry, banking industry, and insurance industry, cross‐institution and cross‐market hybrid fi nancial products are being developed. They are accompanied by increasingly interwoven, interpenetrated, and integrated business, which calls for better fi nancial regulation.


For that reason, the reform of the fi nancial regulatory system should be strengthened. Financial regulatory coordination mechanisms should be enhanced. Information exchange and sharing between different regulatory bodies should be improved with enhanced regulatory cooperation andcoordination for collaborative regulation. The regulatory hierarchy should be adjusted and the regulatory jurisdiction of each regulatory body should be clearly defi ned to avoid repeated regulation. Universal regulatory stan-dards should be set to minimize regulatory confl icts and fi ll up regulatory vacuums or blind areas. A transition should be made from the originalinstitutional regulation to function‐based and objective‐based regulation. An umbrella‐shaped regulatory system should be put in place. Favorable conditions should be created to reform the “big ministry” fi nancial regula-tory system and implement integrated fi nancial regulation. Measures to consider include: improving the fi nancial regulatory joint meeting mecha-nism, setting up a multilateral emergency negotiation system, setting up a fi nancial holding group regulatory coordination system with central-ized and decentralized components, and building a statistics information‐monitoring system compatible with the fi nancial regulatory coordination mechanism.

Messages in Terms of Organizational Structure

Even before the outbreak of the international fi nancial crisis, universal banks had already been challenging independent investment banks. The outbreakof the international fi nancial crisis provided a rare historic opportunity for the development of universal banks. The fi nancial crisis exposed the fl aws of investment banks, such as a lack of liquidity in times of fi nancial crises and simplistic business and profi tability models, which brought them existentialthreats. On the other hand, supported by bank deposits, commercial banks mostly lived through the diffi cult situations of the crisis, especially universal banks with integrated operation. It is foreseeable that with large indepen-dent investment banks becoming the subject of acquisition, bankruptcy and closure, capital injection, or conversion into bank holding companies, large deposit banks will again play the leading role in the development of the international fi nancial industry and the trend toward mixed operation will be strengthened.

Before the deterioration of the subprime mortgage crisis, the opera-tion model of universal banks was still widely doubted, but that has now changed. Although Citibank, UBS, HSBC, and other large universal banks with mixed operation suffered huge losses in the subprime mortgage cri-sis, they survived thanks to their ability to cope with crises, as will other universal banks. The international fi nancial crisis indicated that the mixed


operation and integrated operation model of universal banks was robust, and it dominated the development of the international fi nancial industryafter the crisis. This will inevitably have a profound impact on the futurepath of the international fi nancial industry. From a global perspective, inde-pendent investment banks may disappear in the future. Most pure invest-ment banks will likely be acquired by commercial banks and the operation model of universal banks will be more popular. Mixed operation led bycommercial banks will probably be the mainstream model for the future development of the fi nancial industry.

Compared with independent investment banks in the United States, traditional European banks, especially German banks, were less affected by the international fi nancial crisis. Major German banks, including Deutsche Bank and Commerzbank, were not severely impacted. This may not prove that the universal bank model of Germany is necessarily better than the U.S. independent investment bank model. However, universal banks undoubtedly have lower risks and more stable operation. Therefore, the universal bank model of Germany may attract more attention in the future.

Compared with investment banks, commercial banks have more abun-dant sources of capital, more transparent operation, and more rigorous risk‐management and control systems. In addition, they are subject to strict regulation and are protected by deposit insurance mechanisms. Inte-grated operation is conducive to the mitigation of revenue fl uctuations. Of course, without effi cient fi nancial regulation, mixed operation might make it easier for risks to spread in fi nancial institutions. That is why some see mixed operation as the reason for the persistency of the subprime mortgage crisis. Regardless, the trend toward mixed operation in fi nancial institu-tions around the world is irreversible and has obtained a dominant position. Undoubtedly, the separated operation model will not return. Mergers and acquisitions are used in the deleveraging process of some fi nancial insti-tutions with high leverage operation. Therefore, the deleveraging process is also raising the requirement for mixed operation, especially in terms of the reaffi liation of investment banks to commercial banks. In fact, high‐ranking international investment banks such as Goldman Sachs and Merrill Lynch started the transition before the outbreak of the subprime mortgage crisis. The crisis actually provided a good opportunity for them and forced them to speed up the process. In view of the important global role of the U.S. banking industry and fi nancial market, once a mixed‐operation model dominated by large American deposit banks is established it may further integrate with the current mixed operation model in Europe before becom-ing the mainstream model that drives the development of the international fi nancial industry.


Messages in Terms of Business Structure

In recent years, the Chinese securities industry has been moving closer to international standards in terms of market structure, trading tools, and inves-tor makeup. With the launch of new boards and an international board in the future, the Chinese capital market is developing a multilayer structure. It consists of the main boards, Shanghai and Shenzhen Stock Exchanges, the Small-Medium Enterprise (SME) Board, the growth enterprise board, ChiNext, and a national over-the-counter (OTC) equities market, the National Equities Exchange and Quotations (NEEQ). In terms of trading instruments, a diver-sifi ed fi nancial product structure has taken form consisting of stocks, bonds, futures, stock index futures, and securities margin trading. In terms of investors, an investor structure with multidimensional demand has taken shape, consist-ing of public offering funds, privately offered funds, social security funds, QFII, QDII, overseas investors (targeting those investing in Chinese shares listed in overseas markets), high‐end individual investors, and retail investors. In terms of securities intermediaries, an environment has been created in which Chi-nese securities traders and large international investment banks coexist. Favor-able conditions are in place for Chinese securities companies to grow. Learning from the experience and lessons of large international investment banks helps to carve a special path for Chinese securities companies to grow bigger and stronger. Specifi c areas for improvement are examined next.

Raise the Capital Scale of Securities Companies Although the number of securi-ties companies is large, most have a small capital scale and lack competitive strength. Therefore, we should raise the capital scale of securities companies based on overseas development experience. The capital scale of securitiescompanies can be raised in the following three ways:

1. Going public after restructuring: Going public allows securities companies to get the funds they need for development, on the one hand, and carrying out restructuring through acquisitions with the help of the capital market, on the other. Therefore, in the restructuring stage, new equity funds should be introduced. The company can go public for fi nancing when a proper corporate legal person governance structure has been established.

2. Mergers: Cross‐regional cooperation may be carried out to form alli-ances in capital and technology markets. This will realize resources and business consolidation and give rise to large regional securities companies.

3. Developing fi nancial groups: A fi nancial group is a union of enter-prises engaged mainly in the fi nancial sector. It has a complete inter-nal organization and management framework, implementing a group


operation model consisting of separate operation and mixed manage-ment. It is usually controlled by a holding company. The business of the group is allocated among various subsidiaries. Currently, internationalfi nancial holding companies are normally integrated fi nancial groups such as CITIC and Everbright.

Active Innovation in Business Varieties A new securities service means a newgrowth point and a means to take the high ground in future competition. Faced with strong foreign competitors that will enter China after the coun-try fully opens its fi nancial market, Chinese securities companies should actively engage in the search for innovative services and conduct diversifi ed operation. Specifi cally, business innovation can be made in the following fi ve aspects:

1. Focusing on the development of OTC business: Securities companiesshould seize the opportunity that comes with the approval of the estab-lishment of the OTC market. They should strive to become underwriters of the OTC market who can reap some of the earliest profi ts in the market. Securities companies can make efforts in the following directions:

■ OTC trading tutors responsible for tutoring in relation to company underwriting and issues before and after OTC listing, ensuring that the issuing company becomes familiar with the standard operation of stock issuance and OTC listing

■ OTC trading underwriters responsible for the sale of shares (or other assets) of the issuing company in the OTC market, as well as relevantissues

■ OTC sponsors responsible for helping the company deal with OTC related issues and grasp OTC‐related knowledge

■ Playing the role of an investing entity in the OTC market in the capac-ity of an institutional investor

■ Taking part in OTC market transactions as a market maker 2. Developing asset management business: Business development prac-

tices of international investment banks have shown that as the capital market becomes increasingly mature, the proportion of asset manage-ment in their business rises. Financial assets in China have recentlymade strides in terms of both scale and variety. There is already a huge demand for asset management. As a result, asset management business will have broad prospects in China and should become an important benefi t growth point for investment banks in the future.

3. Engaging in venture capital investment: The venture capital business has been growing at a fast pace in China. There is still plenty of room in the market. Securities companies should take advantage of their strong


research capability and capital strength by actively taking part in ven-ture capital investment in the market to reap abundant return.

4. Taking part in fi nancial derivatives innovation and trading and explor-ing business fi elds such as asset securitization: The evolution of the busi-ness of foreign investment banks has shown that fi nancial derivativesare the inevitable fruit of the development of the securities market at a certain stage. By establishing and trading innovative fi nancial instru-ments, the business space and return on capital of investment banks can be further expanded. In the wake of the subprime mortgage crisis, we should not refuse to eat for fear of choking. Instead, Chinese securi-ties companies should accumulate knowledge and actively pursue and explore fi nancial derivative innovation and trading, asset securitization, and other business fi elds.

5. Developing international and domestic business in parallel: While build-ing up the foundational domestic business, efforts should be made to open outlets overseas. This will expand the scope of business into inter-national markets, realize cross‐border business operation, and take part in international market competition on all fronts.

Cultivating Core Business, Launching Differentiated Services and Specialty Services From a global viewpoint, well‐known large securities companies around the world all have their own special operational characteristics in business development. In a way, this crystallizes the core competitive strength of these securities companies. Chinese securities companies should cultivate their core business based on their own characteristics such as capital strength, specialty services, research capability, and geographical advantages, as well as the current com-petition pattern in the market. They should also deliver differentiated services and specialty services. Securities companies should make efforts to develop innovative business and clearly defi ne their business features and positioning through market segmentation. They should transform their business models while adapting to new mechanisms for standardized industrial development to realize development through innovation. With special operation approaches, securities companies can enhance their core competitiveness, provide indi-vidualized services in their respective business fi elds, and build up their brands through differentiated strategies.

Messages in Terms of Corporate Governance andInternal Control

The subprime mortgage crisis that swept the whole world tells us it is essen-tial to have both rigorous internal risk management and rigorous external regulation. In view of fi nancial innovation and the opening of the fi nancial


industry, it is impractical to subject the trading of every fi nancial product to comprehensive and real‐time external regulation. Therefore, the ultimate measure should be to guide market players to build and improve an internal risk‐control system.

Improving Understanding of Internal Control Systems The concept of scientifi cmanagement of risks in the securities industry should be established, andrisk‐control systems should be built and improved in securities companies. As the Chinese securities market grows in size, accumulated risks will becomeirreversible if high‐risk securities companies fail to release risks in a timely manner. Therefore, establishing scientifi c concepts of risk management in this industry is essential. A complete set of management systems should be gradually built that covers the whole process from detection, measurement, and assessment to control. Securities companies should be urged to con-duct risk control over their brokerage business, underwriting business, and proprietary business through qualitative and quantitative risk‐management techniques. They should also put in place a close‐knit control frameworkthat is able to identify and assess risks on a real‐time basis.

Setting Internal Control Objectives in a Dynamic Way for Different Periods of Time An enterprise should use internal control to ensure its survival, development,profi tability, and fi nally, the maximization of shareholders’ wealth. In differ-ent developmental stages, the company needs to eliminate different threats that may potentially affect the attainment of its goals through internal control. For example, the environment around Lehman Brothers changed when Fuld acquired absolute power. The original internal control could nolonger keep Fuld in check. The failure of Lehman Brothers to change in a timely manner rendered the company’s internal control system unable to respond to the changes in its control environment.

Attaching Importance to Risk Identifi cation and Response While Setting Strategic Goals for Internal Control The failure of some American investment banks engag-ing in high‐risk business during the crisis was caused by their obsession with high profi t combined with reluctance to conduct risk assessment and to identify and analyze risks associated with the goals, which would havecreated a foundation for risk control. Therefore, as a valuable driving fac-tor, risk should be included in the internal control goal selection framework. While constructing the “risk and response” control factor, risks should bematched with the goals of the enterprise and divided into the following three tiers: (1) strategic risks, (2) operation and fi nance and relevant risks, and (3) specifi c business risks. Risk identifi cation at every tier should bepredicated upon event identifi cation, or the identifi cation of events that may


potentially affect the goals. On that basis, risk analysis and assessment can be conducted, and the acceptable risk level can be determined. Risk response should avoid and reduce risks based on a reasonable risk level.

Attaching Importance to the Effect of Culture on Internal Control Effective internalcontrol entails not only hard control tools such as budgeting and inter-nal audits, but also soft control tools such as corporate culture, manage-ment philosophy, and operation styles. With effective corporate culture, theemployees take the ideals, objectives, and code of conduct of the companyto heart. The corporate culture of many international investment banks favors lone wolf approaches. That, however, may cause a lack of opposi-tion, which may severely compromise the effectiveness of information com-munication, leading to the failure of internal control. In their developmentprocess, Chinese securities companies should avoid lone wolf approaches as much as possible and establish an authority system with proper checks and balances. The checks and balances principle was set forth in the Securities Company Internal Control Guide released by the CSRC. A hasty opera-tional style affects the employees deeply in a way that signifi cantly amplifi es the operation risks of the whole company, making it vulnerable in the faceof price fl uctuation. In their development process, Chinese securities compa-nies should always remember that high profi t always comes with high risks. They should follow the robustness principle as much as possible to improve the company’s ability to deal with risks.

Appropriately Spreading Out Equity and Enhancing the Foundation of Internal Control The internal control structure of a company is closely related to its equity structure. Therefore, the optimization of the equity structure is the foundation for the improvement of internal control. Such phenomena as insider control can be greatly curbed by improving the internal control mechanisms of thecompany. By taking full advantage of the internal mechanisms, the operation performance of the company can be promoted, which further enhances the prosperity of the entire securities market, giving rise to a virtuous cycle.

The Chinese securities industry should promote the diversifi cation of property right entities, carefully select and introduce strategic investors fromChina and abroad, and adjust the equity structure to form a property right pattern in which the parties check and balance each other. In recent years, some Chinese securities companies started introducing foreign capital and absorbing private capital by means of equity participation. These practiceshave greatly promoted the improvement of the internal control structures of these companies. Securities companies should seize this opportunity, engagein constant innovation, and strive to broaden the channels for internal con-trol reform to fundamentally improve their internal control quality.


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479

The eighteenth and nineteenth centuries belonged to the United Kingdom. It changed the map of the world with development of its industry, politics,

and the British Empire. The twentieth century was the century of the United States. It was the country to gain most from World War I and World War II, completely changing lifestyle by developing a range of new technologies. The twenty-fi rst century, however, will be the century of China. Global mar-kets have been looking forward to China to drive global growth. But how can China maintain the leading economic position for the long term? Its strong military power is guaranteed, and its robust fi nancial strength pro-vides capital control. Both of these are necessary for the establishment of an international fi nancial center to become a reality.

As the most signifi cant participants in fi nancial markets in China’s future, Chinese securities companies face numerous opportunities and challenges. Collectively, there will be more opportunities than challenges. Chinese securities companies need to continuously improve their integrated strengths by carrying out a series of reforms in order to conform to a much more marketized and internationalized competition in the future to provide new vitality and momentum for China’s economic development. Chinese securities companies will become the dominant power of international fi nancial centers in the future. They will prove to be the reform’s driving force, product innovators, risk allocators, and wealth managers in China’s fi nancial system.

To realize these objectives, securities companies must have an international outlook. They will need to become bigger and stronger with a concentration of capital. They will also need to operate and compete in differentiation, while transforming their business models to create a fi nancial culture that promotes harmony and mutual benefi ts.

CHAPTER 9 9 Future Development and Reform

Focuses of Chinese SecuritiesCompanies—General Principle


SOME DIRECTIONS FOR THE FUTURE DEVELOPMENTOF CHINESE SECURITIES FIRMS

The Main Driving Force of an Emerging International Financial Center in China

Functionally, an international fi nancial center is supposed to at least allow for and facilitate international fi nance, global investment, international pay-ment, settlement, and fi nancial transactions. It should also have the capital asset pricing power in the global market. To enable these essential functions, such a center needs the capital market as a platform at its core. The history of global capital markets shows that securities fi rms that came into existence along with the development of capital markets are the best medium for capital markets to function. China will be the new location of international fi nancial centers, and Chinese securities fi rms will become the main driving force of an emerging international fi nancial center in China. This will pro-vide public companies and investors with a full range of fi nancial services and direct participation in various market activities.

International Finance-Related Services Due to their asymmetric format, com-mercial banks are the main players in indirect fi nancing activities, whereas securities fi rms are the most important intermediaries to promote direct fi nancing. The reality in China is that commercial banks still dominate the market. This goes against the market forces and the emergence of an interna-tional fi nancial center. To help such a center emerge, China should cause con-siderable quality assets to be tradable in the Chinese capital market, including allowing a number of foreign companies to be listed on the international board of the Chinese stock market. This requires that Chinese securities fi rms go for every opportunity of strategic development in the next decade. They need to continue to help the capital market increase the means of fi nance, and also offer China-based fi nance-related services to foreign companies, enabling global fi nance and faster internationalization in the Chinese capital market. Chinese securities fi rms have the advantages of strong marketing and fi nancial support, as well as a better understanding of related Chinese laws and regu-lations and IPO processes. By making the best of these advantages, Chinese securities fi rms can help companies design standardized fi nancial products and raise funds directly in the capital market for further business growth.

Global Investors’ Services Securities fi rms play an important role in the capi-tal market where investors invest in and trade fi nancial assets. Investors have different risk appetites and consequently have the demand for fi nancial products of different risk structures. Securities fi rms are expected to design

Future Development and Reform Focuses of Chinese Securities Companies 481

a range of fi nancial products to cater to investors of different needs. Ordi-nary investors with limited knowledge may also lack rational judgment of complex fi nancial products relating to portfolio and timing. These inves-tors will need investment advisory services and asset management servicesfrom professionals such as investment advisers, researchers, and managers.Along with China’s increasing social wealth, Chinese residents are asking for more options with higher requirements for asset allocation. However, current asset classes cannot meet such demands and requirements. This huge market potential can provide a fertile ground for the business growth of Chinese securities fi rms. They are expected to make an effort in constantproduct and business innovation to meet the diversifi ed needs of investors in China and in the rest of the world. Along with an expanding Chinese capital market and the diversifi cation of fi nancial products, Chinese securities fi rmswill also have great business opportunities in investment advisory servicesand wealth management.

Guaranteed Market Liquidity Any market that lacks liquidity will probably not be of great infl uence, let alone support an international fi nancial center. As “facilitators,” securities fi rms guarantee suffi cient liquidity in capital markets. In today’s fi nancial world, the American capital market is the largest in terms of asset size. It is also one of the marketplaces with the highest liquidity. Such a position builds upon the efforts of a large numberof American securities fi rms. As the Chinese capital market expands, marketliquidity will be particularly important for an emerging international fi nancial center in China, as well as for the Chinese fi nancial market. High-performance Chinese securities fi rms will help guarantee market liquidity.They can provide investors with channels of effi cient fl oor and onlinetrading, and continue to reduce the cost. As fi nancial intermediaries linking public companies with investors, they can help reduce asymmetric infor-mation and create a rational pricing mechanism by disseminating informa-tion about the true value of securities. They can also directly participate inmarket transactions, exploring the intrinsic value of securities products andimproving market liquidity.

Product Pricing Pricing power is one of the most important functions for an international fi nancial center to have over global assets, or at least over the assets denominated in the currency of the host country. Undoubtedly,pricing power resides in the American capital market with respect to most assets (stock, bond, and futures markets). Any price fl uctuation in oil, gold, stocks, treasury bonds, and others in the American market will affect the prices of the same assets in other markets (Huang 2005 ). Basic factors such as demand and supply affect price fl uctuation. However, securities fi rms with


an international infl uence can have some effect on money fl ows, thereby causing an effect on the prices of assets.

Before the 2008 global fi nancial crisis, the forecasts of the global economy and opinions on commodities given by leading American investment banks,such as Goldman Sachs, J.P. Morgan, and Merrill Lynch, affected the money fl ows of institutional investors around the world. Global investment activitiesof American mutual funds also had a direct infl uence on the global price fl uctuations of commodities and securities. Such infl uence still exists, althoughit has faded somewhat. With the American investment banks having lost some vitality after the fi nancial crisis, Chinese securities fi rms are given a great develop-ment opportunity. As core players in product pricing in the international fi nan-cial market, they are expected to attract the best employees, improve researchskills, build a global vision, and participate in international competition.

The Promoters of Change in the Chinese Financial System

Globally, there are two mainstream fi nancial systems in major economies as follows:

1. Bank-based (e.g., the German system) 2. Market-oriented (e.g., the American system)

The existing Chinese fi nancial system is bank-based. Banks have absolute dominance regardless of fi nancing sources and aggregate fi nancial assets to GDP ratio. History suggests that the bank-based fi nancial system may not be best to support the greatest countries and help build the most powerful national competitiveness. It was left far behind by the market-oriented system in terms of effi ciency and capital control. Therefore, China should choose a market-oriented fi nancial system. Chinese securities fi rms will be the main promoters of the change from a bank-based fi nancial system to a market-oriented one. Figure 9.1 underscores the role of the bank-based fi nancial system in China.

Since 2000, the Chinese stock market has experienced fast growth. Particularly after the split-share structure reform, the aggregate amountfi nanced in equity fi nancing activities was more than CNY 100 billion each year (340.6 billion in 2008 and a record high of 985.5 billion in 2010). In2010, the Chinese stock market had a total market capitalization of CNY 23.16 trillion, making it the world’s second-largest stock market in terms of market cap. But this market cap is still low in consideration of China’s hugeGDP. As of December 31, 2010, the stock market cap to GDP ratio was only 66.2 percent in China, compared to 118 percent in the United States, despite the impact of the global fi nancial crisis. (See Figure 9.2 for the GDP comparison between the two countries.)


FIGURE 9.1 Amount Financed in Bank Loans and via the Issuance of Stocks, Bonds, and Debentures in China (1997–2011) (CNY in 100 million) Source: The People’s Bank of China website and the Statistical Yearbook of China (Securities).

120,000

100,000

80,000

60,000

40,000

20,000

1997

1998

1999

2000

2001

2002

2003

2004

2006

2005

2007

2008

2009

2010

Oct

−11

0

New loans

Government bonds

Equity financing

Corporate debenture funding

A Comparison between China and the United States in Terms of Stock Market Capitalization to GDP Ratio Source: The World Bank website.

160

140

120

100

80

60

40

20

0

China: the Stock Market Cap to GDP ratioThe United States: the Stock Market Cap to GDP ratio

2002 2003 2004 2005 2006 2007 2008 2009 2010


The Chinese stock market has created its own growth enterprise market and over-the-counter bulletin board, and will be creating an international board. By then, the Chinese capital market will have a multilevel structure to meet the fi nancing needs of all kinds of companies, as well as the investment demand of investors of different risk appetites. As of November 2011, the number of listed companies was 1,436 on the Main Board, 631 on the SME board, and 276 in the GEM, taking the shape of an inverted pyramid. Such a market structure will be gradually reversed into a regular pyramid structure. During the transition, securities fi rms will play an important part. With fewer large Chinese companies queuing for IPOs, Chinese securities fi rms will turn to business opportunities in the growth enterprise market and on the international board. If the Main Board market was a wealth management center, the GEM will be a wealth incubator. China is still in an economic take-off stage, and it will continue to enjoy a rapid economic growth in the next two decades. A large number of small- and medium-sized companies with innovation skills and growth potential will emerge and a growing number of companies will go public on the SME board and in the GEM. With the potential to be another NASDAQ, the Chinese GEM will bring a change to the existing structure of the Chinese stock market. The international board will also attract high-performance foreign companies to the Chinese capital market, thereby pushing forward its internationalization. After the launch of the international board, Chinese securities fi rms will start looking for high-performance international companies and bring them to the Chinese stock market, helping further the structural optimization.

Due to a late start, the Chinese bond market is relatively small in terms of total number and issue size of government bonds and corporate deben-tures. In particular, the corporate bond market is the weakest link in the Chinese capital market. Corporate debentures issued in the fi rst 10 monthsof 2011 were worth CNY 209.6 billion, only 3.76 percent of new bank loans in the same period. In the United States where the bond market ismature and active, the government debt alone is 93.4 percent, as much as the GDP. By contrast, the aggregate size of the Chinese bond market (includ-ing outstanding treasury bonds and corporate debentures) to GDP ratio is only 50.6 percent (see Figure 9.3 ). These statistics imply that there is a longroad ahead for the Chinese bond market. In every market-oriented country, the size of the corporate bond market is greater than the total market cap of the stock market, and companies raise more money from debentures issuedthan bank credit obtained. Therefore, the corporate bond market, as a pri-ority in the future development plan, will profoundly change the existingfi nancial structure where companies mainly rely on indirect fi nance.

Under the current legal framework on the principle of “separation of activities,” it is securities fi rms that underwrite most corporate debentures.


We know from the history of mature markets that securities fi rms have some inherent advantages in underwriting. Building on the strong marketing strength and innovation skills that conventional commercial banks cannot match, securities fi rms can offer and sell tailor-made securities products for and on behalf of different companies. When conventional brokerageactivities are affected due to deregulation, investment banking activitiesthat have low risk but generate high returns are attractive enough to turn securities fi rms to selling debt fi nancing plans to companies. Companies are also willing to consider such plans because of better economical benefi ts in cost and time (compared to bank credit). Since 2008, the fi nancing costs of corporate debentures have been generally 1 percent lower than thoseof bank loans (see Figure 9.4 ). On the other hand, when bank credit is not easily available, junk bonds become a good choice for companies with risky fi nancing plans or for small companies in a risky, fast-growing business to raise money. In the 1980s, U.S. junk bonds poured into the market in a total amount more than USD 170 billion. Drexel and other investment banks made that happen.

The Chinese government bond market seems to be even more prom-ising than the corporate bond market. When Renminbi (RMB) becomes an international currency, Chinese government bonds will be among theinvestment products with the best liquidity, provided that there are a range

FIGURE 9.3 A Comparison between China and the United States in terms of the Size of the Bond Market/Aggregate Amount of Government Debt to GDP Ratio Source: The World Bank website.

100

90

80

70

60

50

40

30

20

10

02002

China: the Size of the Bond Market to GDP ratio

The United States: the Aggregate Amount of Outstanding Government Debt to GDP ratio

2003 2004 2005 2006 2007 2008 2009 2010


of products in a suffi cient amount and with different interest earning periods. As of November 2011, the outstanding Chinese treasury bonds were CNY 6.37 trillion and the outstanding local government bonds were 0.59 trillion. Together with the local government fi nancing platform (about CNY 10 trillion), the Chinese government was in debt by about CNY17 trillion and could further incur about CNY 23 trillion, as calculated by the 100 percent debt-to-GDP ratio (Li 2011 ). Although Chinese banks arethe mainstream underwriters of the Chinese government bonds, Chinesesecurities fi rms with an international vision will benefi t from their global marketing skills. They could become lead fi nancial institutions, sellingChinese government bonds in the international market.

The Chinese capital market is not a homegrown marketplace. Its architecture and legislation are borrowed from major American and European markets. It is Chinese securities fi rms that apply the borrowed rules in China and push the market to grow by means of product inno-vation and business optimization. Like every stream that feeds the sea, every effort and every innovation made by Chinese securities fi rms will contribute to the sound growth of the Chinese capital market. Chinese securities fi rms will become an important driving force for the change of the Chinese fi nancial structure, helping build a market-oriented fi nancial system in China.

FIGURE 9.4 A Comparison between Bank Loans and Corporate Debentures in Terms of Financing Costs Source: Wind Information Co.

9876543210

Weighted Average Intersts Rate on CNY Credit Offered by Financial Institutions: General LoansWeighted Coupon Rate on Corporate Debentures (public institutions or government-owned companies)Weighted Coupon Rate on Corporate Debentures (private companies)

Sep

t 200

8

Nov

200

8

Jan

2009

Mar

ch 2

009

May

200

9

July

200

9

Sep

t 200

9

Nov

200

9

Jan

2010

Mar

ch 2

010

May

201

0

July

201

0

Sep

t 201

0

Nov

201

0

Jan

2011

Mar

ch 2

011


An Innovator in Financial Products

Investment banking is powered by innovation. Investment banking history is entirely a history of innovation. For securities fi rms, innovation skills have become a core competency. Invincibility in intense competition requires con-stant product innovation for the purpose of enhancing competitiveness. A company that blindly clings to old-fashioned ideas and practices will be ruth-lessly washed out of the market. After an upcoming wave of consolidation in the industry in the foreseeable future, Chinese securities fi rms will become pro-fessional capital operation organizations. They will combine multiple strengths in knowledge, information, technologies, human resources, and funds and willoffer innovative fi nancial products and services to the community.

Many factors determine the ability of securities fi rms to become initia-tors, organizers, and pioneers in product innovation. Four of these factors are as follows:

1. Securities fi rms earn revenue and make a profi t from securities-related products and services for which they can more easily create innovation. Commercial banks, on the other hand, have to rely on conventional credit operations, where there is basically a full range of well-establishedproducts and services. Therefore, compared to conventional commer-cial banks, securities fi rms are more active in innovation.

2. The securities market is inherently a high-risk environment. Securities fi rms are expected to help transfer and spread the risk, which requires securities fi rms to design various risk-hedging tools and products. This requires higher innovation skills from securities fi rms.

3. Investors have diversifi ed demand for fi nancial products. As “seller-side” intermediaries offering securities products and services in the securitiesmarket, securities fi rms are sensitive to market change and are good atidentifying the real needs of customers. They are thereby able to designsuitable products and explore potential innovation opportunities.

4. Securities fi rms have outstanding qualities in human resources: young, aggressive, creative, dynamic, and energetic employees. Their employeeswill gradually gain real-world experience in the market and grow into real investment bankers, pushing forward innovation in Chinese securi-ties fi rms.

In a mature securities market with more appropriate regulatory con-straints, securities fi rms can apply innovation more freely to products and business activities. They can offer investors in the fi nancial market a great variety of fi nancial products and services. Various investment products and diversifi ed means of investment will enable securities fi rms to meet the


diversifi ed needs of customers, provide differentiated services to investors, and further diversify their own sources of revenue. This will lay the founda-tion for an optimized revenue structure. In this way, both securities fi rmsand investors are winners. The Chinese securities market is still considerably under the infl uence of a planned economy in terms of market regulation.As innovation is curbed in product and business development, a limitednumber of fi nancial products will be available in the market. Althoughregulatory authorities have allowed some risk-hedging mechanisms such as margin trading, short selling, and stock index futures, they have set high thresholds for such investments. As a result, securities fi rms are running outof options in sell-side business. This also explains why the Chinese securities industry has long been following a simple business model largely based onbrokerage.

As evidenced by the evolution of international fi nancial centers, there is a positive correlation between innovation and the development of fi nancial markets. Fewer constraints on innovation lead to greater market dynamics and faster market development, whereas more constraints on innovation lead to less market dynamics and slower market development. Of course,fi nancial oversight is very important, and greed-driven fi nancial speculation that disregards morals and risks is not condoned. Financial innovation com-plying with the macroeconomic climate and the development of the fi nan-cial market, however, is strongly encouraged. Such innovation is expectedto be one step ahead of the market, to a tolerable degree, helping guide the allocation of resources. It cannot veer too far outside the range that fi nancial regulators can control and the macroeconomy can support. Chinese regu-latory authorities should remove institutional constraints on product and business innovation and develop policy to encourage innovation. For thepurpose of the macrostrategy to build an international fi nancial center in China, Chinese regulatory authorities particularly need to make unconven-tional plans to help securities fi rms improve their innovation skills and inter-national competitiveness.

Innovation in fi nancial products can serve the following purposes:

■ Increase liquidity: Create liquidity for illiquid fi nancial instruments soas to increase the velocity and effi ciency of money. Typical productsinclude asset-backed securities.

■ Transfer risks: Through regrouping and reallocation, transfer risks between investors of different risk tolerances. Typical products includeforwards, futures, options, credit, currency, and interest rate swaps.

■ Create rights: Cause some rights to be attached to ordinary fi nancial products so as to meet the demand of investors. Typical products include convertible bonds and bonds with warrants.


Securities fi rms can take credit for all these products. As regulatory con-straints weaken, Chinese securities fi rms will compete in innovation skills. Those with low innovation skills might be eliminated, whereas those with great innovation potential will become the leaders in the industry.

Asset securitization is an important tool in product innovation. It will open a new world in which Chinese securities fi rms will grow. As a struc-tured, nondebt fi nancing means with low fi nancing costs and great adapt-ability, it is widely used by international investment banks. It was not the cause, although it was a contributing factor, of the U.S. subprime mortgage crisis, which resulted from the abuse of fi nancial instruments in regula-tory negligence. Chinese securities fi rms will mostly apply securitization totwo kinds of assets: commercial bank credits and toll infrastructure. These two assets share the common characteristic of stable and predictable cash infl ows during the existence stage, but face some fi nancial pressure in earlierstages. Two examples are:

■ In terms of bank credits: As the Chinese residents’ savings rate lowers dueto the diversion effect of the capital market, commercial banks face a grow-ing pressure to absorb deposits. They are therefore eager to fi nd a way to expand business, increase income, and improve the velocity and effi ciency of money in circulation, with a limited amount of deposits available.

■ In terms of toll infrastructure: Along with the progress of urbanizationin China, fi nancial demand will rise sharply in infrastructure invest-ment, where private capital can be a helpful addition.

In both cases, securities fi rms are intermediaries that create leverage. They can play an important role by causing future cash fl ows to be structured andsecuritized. They can also apply necessary and appropriate risk identifi ca-tion to the structured and securitized products to meet the needs of investors with different risk appetites.

The liberalization of interest rates and exchange rates will be an impor-tant subject for the future fi nancial reform in China. Microeconomically, the RMB liberalization will mean that individuals and business entities are exposed to greater risk in interest rate and exchange rate–fl uctuations. For securities fi rms, such liberalization will allow for interest rate– and exchange rate–related fi nancial innovation and business opportunities. A range of related fi nancial products, such as interest rate swaps and futures, FX futures, options, and forwards, will greatly diversify the investment and hedging options of Chinese residents and companies. By creating sub-sidiaries to invest in related fi nancial products, securities fi rms will also isolate risk and have more freedom for innovation. As regulators, they could have greater tolerance for an innovative product proposal submitted


by a subsidiary. Some product innovation will be done better by way of subsidiaries, helping address the serious shortage of investable products in today’s market.

In fact, product innovation and risk prevention are not in confront-ing positions. Product design requires innovation, and many products aredesigned to ward off risk. Chinese securities fi rms are expected to build and maintain a sound risk-management system in the following ways:

■ Improve corporate governance structure. In accordance with the require-ments of the Companies Act, securities fi rms should build a modernbusiness system, improve corporate governance structure, and developfunctional decision-making and supervisory mechanisms.

■ Develop an effective incentive mechanism that promotes innovation. Also, introduce an accountability system to prevent excessive specula-tive activities.

■ Create a functional risk-management department and a sound risk-management system of checks and balances among management, middle-level offi cers, and general employees. This will ensure that the fi rm is able to identify, oversee, and control various risks.

There is no doubt that Chinese securities fi rms will be leading innovators of fi nancial products. They need to fi nd the path where they can best combine product innovation and risk prevention, and then exercise risk management throughout the whole process of innovation in order to make the innovationworthwhile. Along with product innovation will come business innovation. A range of new activities, including margin trading, short selling, stock index futures, investment consulting, wealth management, trading, and direct invest-ment services, will greatly improve the current profi t model that relies mainly on commissions. With innovation toward business diversifi cation, Chinese securities fi rms will continue to improve their business and management skills and provide a better service to an open fi nancial system in China.

Risk Allocator

The conventional fi nancial system has intrinsic risks. As a typical example, a commercial bank takes risks upon itself. It is exposed to little risk whenabsorbing deposits. It is then exposed to some risk when granting credit.The risk increases along with the expansion of credit. The bank has the net interest spread in return for consideration of its assumption of risk. In China, for a 3.33 percent spread on average, a commercial bank has to take huge unpredictable credit, moral, and market risks. Such risks and returns are largely unwarranted. The situation deteriorates because of a


far-from-perfect Chinese national credit system. Modern fi nancial inno-vation aims to put risk and return back to the market. Although a bank-based fi nancial system is the reality in China, an international fi nancial center will help consolidate market forces in an unprecedented way and enable Chinese securities fi rms to become the main fi nancial institutions that allocate risks.

In today’s securities market, there is a three-tier risk allocation system, as follows:

1. Tier 1: Risk is subject to primary allocation at the IPO market wherecompanies raise money, divide corporate equity and debt and spreadbusiness risks to different investors who share all the business risks the company may be exposed to.

2. Tier 2: Risk is subject to further allocation at the trading market, which serves the purposes of risk trading and pricing, and enables primarily-allocated risk to be traded repeatedly.

3. Tier 3: Risk can be hedged with a range of tools, such as margin trad-ing, short selling, futures, and options, at the hedge market. Investors can make reverse transactions to avoid and hedge the risk if they believe that the risk-adjusted premium is too high.

Chinese securities fi rms are active in the market at all the three tiers. They will play a part in risk allocation in the following aspects:

■ Risk diversifi cation: The real economy runs in cycles. Every industry hasits own business cycle. Such a cycle could pose a risk to business man-agers, and such risk could be unbearable for business owners if there were only a few of them. Therefore, it will be good for a company tospread its business risk to more investors who invest in its stocks and/or debentures. In times of bad economy or business distress, a company could also use equity and/or debt fi nancing to ease business diffi culties. The Chinese economy will still have huge potential to accommodatemany small and medium companies with rosy prospects. Along with theexpansion of the GEM and the deregulation of corporate debentures, Chinese securities fi rms will double stock and debenture underwriting volumes and further help companies to diversify risk.

■ Risk pricing: In their equity or debt fi nancing activities, companies withdifferent business performance and in different industrial climates could be faced with the overall risk in different sizes. Such difference would need to be refl ected in the stock or debenture prices. To cope with theincreasingly complex macroeconomic situation at home and abroad and the growing market-oriented competition, Chinese securities fi rms


must continue to improve their risk pricing skills. They can do so in thefollowing ways:

■ All around improvement of professional business valuation skills and pricing effectiveness

■ Functional mechanism to prevent or circumvent confl icts of interest and to ensure due diligence and honest practice in business valuation

■ Effective guidance to help investors stay rational, mature, professional, and self-disciplined (this is the key to reasonable market valuation)

■ Structuring risk: Chinese residents with growing wealth show increas-ing willingness to invest in and hold fi nancial assets. To meet the needsof investors with different risk appetites, Chinese securities fi rms are expected to use their product innovation skills to structure differentrisks and returns into fi nancial products, with the help of asset securiti-zation and structuring tools. In the course of risk structuring, one must be aware of potential risks. The risk-structured products are usually more complicated. In the absence of appropriate regulatory oversight,there is excessive innovation, which can lead to a fi nancial bubble. Secu-rities fi rms are also expected to identify risk, helping investors avoid being misled into any investment decision due to the misjudgment of a product.

■ Risk transfer: Risk diversifi cation is not nearly enough. Investors investin risky assets for promising returns. Therefore, they will hold fi nancialassets for some time and request the monetization of return on invest-ment. An illiquid secondary market where asset holders cannot realize their assets at reasonable prices will discourage investors in the primary market. Chinese securities fi rms need to create suffi cient liquidity in themarket, enabling asset holders to realize their assets in a timely andeffi cient manner in the Chinese capital market. Therefore, securities fi rms need to constantly invest in marketing efforts and expand trading channels to attract more participants. As underwriters, they also need toexplore available information and discover the real value of a company.As main players in long-term investment activities, they can also partici-pate in and grow along with the Chinese capital market.

■ Risk regrouping: Chinese securities fi rms can cause risk to be regroupedby restructuring assets available in mergers and acquisitions. Public companies are deemed to be at the core and regarded as the foundation of the capital market. Restructuring their assets is believed to have the magic needed to maintain dynamics in the securities market. Asset restructuring enables public companies to strip off inferior assets and encourage better assets to complement each other. The evolution of public companies is, in a sense, a history of asset restructuring. Complex


and highly specialized, mergers and acquisitions involve numerousissues about assets, fi nance, law, policy, and others. Target search, duediligence, asset assessment, fi nancial audit, price bargaining, fi nancingarrangement, and legal matters are some examples. Companies involved in mergers and acquisitions can use professional help. As fi nancialadvisers, Chinese securities fi rms can participate in M&As, offeringspecifi c services in M&A planning and implementation, acquisitionstrategy, and fi nancing arrangements, among others.

■ Risk hedging: The market is prone to asset bubbles when capital fl owsconverge. Today’s risk premium is very high, and the potential risk ishuge. Securities fi rms can provide investors with risk-hedging tools(including margin trading, short selling, and stock index futures) to help them hedge the risk of a possible market decline in the future. Chinese securities fi rms, as main market players, can also directly participate in the market and make reverse transactions. In this way, they can provide signs of economic overheating or a potential bubble, guide investors to stay rational, and steer private capital out of the industries with signs of overheating. Risk hedging enables Chinese securities fi rms to reduce risk and bring resources and capital fl ows to where they are really needed.

In the modern fi nancial system, Chinese securities fi rms can make the best of their professional advantages to further promote risk allocation and risk structure optimization. Once risk starts moving around, the Chinese economy and fi nancial system can switch into the fast lane.

Wealth Manager

At a low income level, most participants in the economy have low expec-tations of fi nancial products and services. They generally refer to fi nancial intermediaries for products and services that will safely maintain their assets without concerns. When income reaches a higher level, people look for fi nan-cial products and services that provide more than just safety for their assets. They may seek integrated fi nancial services that allow for wealth creation, risk hedging, and portfolio management. Over the economic reform of more than 30 years, the income of Chinese residents has grown. They now have higher requirements and expectations from functionalities of the capital mar-ket and securities fi rms. This leads to the emergence of wealth management.

Wealth management consists of personalized fi nancial services provided by fi nancial institutions to high-net-worth clients. It serves the purpose of infl ation-proofi ng and wealth creation. Services include asset investment,


risk management, legal and tax advisory services, retirement plans, and estate arrangements, among others. A growing number of investment bankshave dedicated wealth management teams, working to satisfy the particular needs of high-net-worth clients. For Chinese securities fi rms, the transitionfrom the channel-based profi t model to the service-based model requires a wide range of services to be available to customers. Undoubtedly, wealthmanagement is an important part of their future business activities. Securi-ties fi rms manage wealth by matching risk and return for the purpose of wealth creation. In the modern fi nancial system, they create value mainlythrough fi nancial products and services and by portfolio management that focuses on the risk and return of fi nancial assets.

Unlike commercial banks, securities fi rms come together with the capi-tal market to create a new wealth-growth model. More precisely, they create a highly leveraged, market-oriented functional relationship between fi nan-cial assets and economic growth, where everyone is entitled to a fair amountof benefi t from the wealth effect of economic growth. The formula for this relationship is as follows:

w f g w g= = =( ) financial assets and economic growth,where

of fi nancial assets to increase signifi cantly with the development of the capi-tal market. To a certain extent, this enhances the level of benefi t in economicgrowth. Commercial banking and other fi nancial systems seem unable to generate such an incremental functional relationship between economicgrowth and social wealth (mainly in terms of fi nancial assets) to allow for a fair amount of wealth growth with economic growth.

Chinese securities fi rms are able to conduct diversifi ed global wealth management along with global economic integration and free capital fl ows around the world. Chinese residents need a variety of investment fi elds for their growing wealth, which has grown beyond a level that the domestic market can accommodate. They need the help of securities fi rms in specialized investments for their pursuit of profi t around the world. Chinese securities fi rms must thus prioritize team building to effi ciently integrate the best investment minds in enhancing the comprehensive strength of investment and research. Chinese capital may fl ow into U.S. and European markets and earn profi ts in high-tech sectors in developed countries. It may also fl ow into emerging economies and share the fruits of rapid economic growth. Chinese capital can be invested extensively in many fi elds including stocks, bonds, foreign exchange, real estate, precious metals, antiques, luxury goods, and even international commodities. It can become an important driving force


behind the global allocation of resources, generating an appreciation for Chinese capital.

Risk control will be of great importance to Chinese securities fi rms during the course of global wealth management. Risk control helps with infl ation-proofi ng and raising value of assets. Personal judgment can sometimes serve adequately enough for the management of assets on a small scale. However, a greater level of wealth management requires a pro-fessional risk management team with expert technical support. Expanding investment fi elds and increasing sizes of assets under management demand higher risk-management skills from Chinese securities fi rms. Sophisticated levels of wealth management make it necessary for securities fi rms to con-stantly invest in scientifi c approaches to risk management through train-ing, and advanced risk-management models, software, and systems, as well as regular risk checks and dynamic risk monitoring performed on every investment project. They need to measure and control the overall risk of all assets and determine how to handle extreme risks, in addition to reduc-ing general risks.

As opportunities for wealth increase for customers, Chinese securities fi rms need a better understanding of the needs and behavioral characteristics of their customers. Accordingly, they need to offer appropriate professional advice and investment opportunities. Securities fi rms need to take intoaccount the size of their clients’ existing wealth, expectations of return, risk appetite, and tolerance. They then need to customize portfolios that meet the needs of their customers. They also need to guide investors toward developing a mature and rational investment philosophy andprovide suitable information for investors on the types of risks they might be exposed to.

Chinese securities fi rms also need to diversify their approaches to wealth management. Although services have been generally delivered at physical business offi ces in the past, the Internet, mobile terminals, and information technology now provide new channels and platforms for the delivery of wealth management services. Chinese securities fi rms may need to develop a variety of wealth management tools and fi nancial toolboxes, enabling inves-tors to have a clear understanding of their assets, including investment fi elds and trends for total net asset value. New wealth management tools can have great potential in China’s future in wealth management.

The Chinese wealth management market will continue to grow at a rapid speed. With a growing middle class, this market has the potential tobecome the largest of its kind in the world. Wealth management can create vast opportunities for interactive activities in the institutional and ecological development of a fi nancial system, which could help create a global fi nancial center in Shanghai by 2020.


SOME PRIORITIES OF FUTURE REFORM IN CHINESESECURITIES FIRMS

Create an International Vision

The Irreversible Trend of Economic and Financial Globalization It has been more than a decade since China’s accession to the WTO. The global economic integration continues and the Chinese economy is more prone to global economic fl uctuations, as well as having a considerable impact on the global economy. According to World Bank statistics, the 2010 global GDP based on purchasing power parity (PPP) was 76.28 trillion international dollars. China had a GDP of 10.08 trillion international dollars (13.21 percent of the global GDP) and ranks second to the United States. According to WTO statistics, the 2010 world merchandise exports and imports totaled up to USD 30.61 trillion. Chinese merchandise exports and imports totaled USD 2.97 trillion (9.71 percent of the world’s total) (Li and Chen 2011 ). TheChinese economy has been deeply integrated into the global market and closely connected to the global economic climate. Financial globalizationcomes parallel to economic globalization and goes even faster and deeperand with greater infl uence. From the perspective of a long cycle, countries that use fi duciary money are overall of suffi cient liquidity. In particular, the USD and Euro-based international monetary system results in a relative sur-plus of global liquidity, and there is a tendency for accelerated and growinginternational capital fl ows. In this context, any economy that is a part of theworld economy is inevitably affected by fi nancial globalization, and China is no exception.

The 1998 Asian fi nancial crisis, the 2008 global fi nancial crisis, and the continuing European sovereign debt crisis, among others, have had or con-tinue to have signifi cant negative impacts on the Chinese economy, and aneven more pronounced impact on the Chinese fi nancial market. For example, any progress of the European debt crisis will trigger an instant reaction in the Chinese capital market. On the other hand, China is the world’s second-largest economy. It has great impact on the global economy. The 4 trillionRMB stimulus plan the Chinese government adopted in the 2008 global fi nancial crisis has greatly helped global economic recovery. Australia and some other resource-exporting countries have benefi ted considerably from the plan. As the Chinese economy continues to grow at a fast speed, and as the RMB internationalization accelerates, international economic fl uc-tuations will have a greater impact on the Chinese economy. The Chineseeconomy, in turn, can also have a greater impact on the global economy. An increasing number of international factors can affect the Chinese fi nancial market. Therefore, Chinese securities fi rms need to have an international


vision that allows for a higher perspective on the development trends in theChinese fi nancial market.

Financial Globalization Gets Chinese Securities Firms Involved Economic and fi nan-cial globalization involves the Chinese fi nancial market, let alone securities fi rms. For Chinese securities fi rms, fast growth in fi nancial globalization requires action as well as international vision. Companies that limit them-selves in established business activities and cling to old business strategieswill be washed away from the market. Specifi cally, a globally leading secu-rities fi rm must be able to analyze the capital markets from a global per-spective, conduct global asset management, and offer investment banking services around the world.

A Global Perspective of Capital Markets The domestic market will remain the main arena in which Chinese securities fi rms earn income for a very longtime. International economic and political change will have an increasingly signifi cant impact on the Chinese capital market. Chinese securities fi rms need to analyze the domestic capital market from a global perspective and act prudently and conscientiously in asset allocation and customer servicesin order to grow in the intense market competition. For example, securitiesfi rms must adjust asset allocation or offer a full range of customer services in an effi cient manner in any case that may affect the Chinese economy and capital market. Such cases may include the global fi nancial crisis, Europeansovereign debt crisis, government bailouts, and the unrest in North Africaand the Middle East. A securities fi rm with customers around the world also needs to have a deep understanding of the global economic situation and changes, and must maintain timely and effective communication with customers. In particular, what international investors want most from Chi-nese securities fi rms is their understanding of the impact of the Chinese eco-nomic change and policy adjustment on the global economy. For example,in 2006, Morgan Stanley’s Global Wealth Management Group had over 8,000 business representatives in more than 500 regions around the world. It provided a full range of fi nancial services to customers in places includingthe United States, Europe, the Middle East, Asia, and Latin America, and managed major client assets of more than USD 686 billion. Therefore, for Chinese securities fi rms, a global perspective of global capital markets is a prerequisite for any further development.

Global Asset Management As Chinese investors and securities fi rms move toward the international market and international investors move toward the Chinese capital market, business opportunities arise in global asset management. This could become one of the pillar business activities


of securities fi rms. For example, in 2006, Morgan Stanley managed assets worth USD 478 billion and had customers in the United States, Europe, Japan, India, China, Brazil, and other major economies around the world. In China, there is a need for diversifi ed international investment along with increasing foreign-exchange reserves due to trade surpluses and capital infl ows over years. The RMB could fl ow around the world on a more frequent basis with internationalization, after being recognized as a reserve currency. Chinese securities fi rms could become major players in global investment on behalf of Chinese investors. A rapid economicgrowth, a growing fi nancial market, and the improvement of liquidity in China could also attract more international investors. Chinese securitiesfi rms are already seen as top choices in asset management companies. The QDII pilot program has, for the fi rst time, offered Chinese securities fi rms a chance to practice global asset allocation. However, there is still a long way ahead, considering the scale of the QDII program and the lack of skilled professionals and experience.

Global Investment Banking Services After the launch of the internationalboard in the Chinese stock market, a number of high-performance foreign companies will be lining up for IPOs in the A-share market. This could pro-vide an opportunity for Chinese securities fi rms to start their international investment banking services. After that, Chinese securities fi rms could go further by offering companies around the world securities underwriting and fi nancial advisory services in the international market. Chinese compa-nies with an international business strategy currently have a huge demand for fi nancial advisory services in their international acquisitions. However, due to the gap in business strength and experience, few Chinese securi-ties fi rms have received offers. Instead, renowned international investment banks have been approached and hired as fi nancial advisers in such acqui-sitions. For example, Goldman Sachs managed Lenovo’s USD 1.75 billion acquisition of IBM’s global PC business. Rothschild managed Geely’s USD 1.8 billion acquisition of Volvo. J.P. Morgan Chase handled Sinosteel’sUSD 1.3 billion acquisition of a 50.97 percent stake in Midwest and inChina Merchants Bank’s USD 4.66 billion acquisition of the Wing Lung Bank. Lehman Brothers handled Chinalco and Alcoa’s USD 14.1 billion acquisition of a 12 percent stake in Rio Tinto (UK). Morgan Stanley man-aged CIC’s USD 1.581 billion acquisition of a 15 percent stake in AES Corporation. In 2010, Chinese companies completed 188 overseas merg-ers and acquisitions with a total contract amount of USD 55.4 billion, 37 percent more than the 2009 amount. These overseas M&As will con-tinue to increase at a rapid speed. To become qualifi ed fi nancial advisers in such M&As and promote business growth, Chinese securities fi rms have


to build on their own rapid growth and become familiar with related leg-islations as soon as possible.

Accelerate the Concentration of Capital for BusinessGrowth and Expansion

Securities fi rms are nonbanking fi nancial institutions mainly in capital market activities in a knowledge- and capital-intensive industry. When the securities market and the corporation system grow to a certain stage, large securitiesfi rms emerge as a key symbol of a well-developed capital market and a mature fi nancial system. The Chinese securities industry’s main task for the future is to help Chinese securities fi rms accelerate the centralization of capital andgrow bigger and stronger into large, internationally competitive companies through constant business expansion, innovation, and integration of usefulresources inside and outside the industry.

As a priority in the future reform, and the only way to development, mergers and acquisitions should be encouraged and supported in the Chi-nese securities industry for higher industrial concentration. Internationalexperience tells us that the investment banking in developed countries has experienced the evolution from small to large and from fragmentation to conglomeration. The American evolution is the most typical. Although mostAmerican independent investment banks shut down or had to undergo restructuring in the 2008 fi nancial crisis, capital remains just as important for securities fi rms. In fact, capital is always the necessary cushion against risk. From the perspective of industrial development, the competition in a highly fragmented industry is usually chaotic and ineffi cient. Moderate con-centration can bring about the economies of scale in terms of capital.

After several milestone regulatory programs (e.g., the split-share structure reform), as well as the overall improvement initiative for securities brokers and the transparency initiative for public companies, the Chinese securities industry has experienced rapid growth. However, the industry is still in an early stage of development. In particular, there is no substantial change in the brokerage-based profi t model of Chinese securities fi rms. The apparent causes of business diffi culties in Chinese securities fi rms have been the same-old profi t model and weak competitiveness for some time. The real causes are narrow-minded institutions and chaotic competition, which led to the generally low profi t level in the industry as a whole. Faced with a changing domestic and international economic climate and the high volatility in the Chinese securi-ties market, Chinese securities fi rms can hardly maintain vitality with a profi t model that relies heavily on brokerage and is at the mercy of the market. They have to build their business growth and expansion upon the concentration of capital, whereby they can transform their business model.


Over the past 25 years, global investment banking experienced an unprec-edented wave of mergers and acquisitions. A series of M&As in the inter-national securities industry dominated by the United States and Europe helped improve market concentration, shape some global investment bank-ing giants (e.g., Goldman Sachs and Morgan Stanley), and consolidate the crossover business model. Although independent investment banks still exist in the United States, there is no change of tendency toward the concen-tration of capital. Securities fi rms have to maintain considerable capital to withstand fi nancial risks and bring about the economies of scale in terms of capital, human resources, and customer bases. The Chinese securities industry should gradually move toward concentration and eventually shape a pyramid-like structure. The structure should have a small number of large investment banks (about fi ve) with super strength that offer a full range of services at the top in an oligopolistic competitive landscape. A medium num-ber (about 30) of securities brokers/dealers of particular innovation skills and a comparative advantage in cost will hold the middle or bottom posi-tion, competing with each other in segment markets. In the course of shap-ing such an industrial structure, a large number of securities fi rms will go bankrupt or be taken over. Others will go through mergers and acquisitions and become large investment banks with strong innovation skills and capital strength, holding the balance in the Chinese capital market. Of course, the industry will have some short-term pain in the process, but will be more healthy and vibrant overall thereafter.

There are several ways for securities fi rms to realize the concentration of capital and grow bigger and stronger. Three scenarios are detailed here:

1. The “trusteeship + M&As” model: A securities fi rm on the brink of bankruptcy or a fi nancial crisis is fi rst placed into trusteeship and becomes subject to restructuring. (In China, such arrangement is a dis-tinctive arrangement for securities fi rms in trouble. A trustee could be another securities fi rm, a regulatory agency, or asset management com-pany.) It will then be sold to one or more solid securities fi rms for fur-ther restructuring.

2. Direct M&As model: A capable securities fi rm grows bigger and stron-ger by active horizontal and/or vertical mergers and acquisitions, plusintegration of resources in a market downturn. Alternatively, two solidsecurities fi rms merge with each other and integrate their business andresources in a mutually benefi cial cooperation.

3. Flotation: A securities fi rm can consolidate its capital strength by absorb-ing public funds in a public offering. It can also place itself under the oversight of public shareholders and introduce strategic investors, an advanced management philosophy, and a business model.


After industrial consolidation, Chinese securities fi rms could be inde-pendent securities entities or securities subsidiaries of fi nancial holdinggroups. Both kinds of securities fi rms have their own strengths. An inde-pendent securities fi rm has more independent and fl exible decision-making power and makes a quicker response to market changes. It therefore maybe more competitive than a securities subsidiary in regard to specialized and innovative skills. A securities fi rm as a subsidiary of a fi nancial holding group, however, can integrate in an effi cient and effective manner all the elements available in the group, develop integrated fi nancial products, and provide a range of fi nancial services on a single platform. In the future, even after industrial consolidation, both types could continue to coexist, provid-ing a wide range of choice for investors.

Restructuring in the securities industry could be an important driving force to help securities fi rms and the industry improve competitiveness. But other than simple business expansion in size and scale, the goal of such restructuring should be the integration of business philosophy and corpo-rate culture and the improvement of management skills, making the strong stronger and causing strengths to complement each other. Blind business expansion and M&As could offer no help. Or worse, they could lead to the depreciation of brand value. Such industrial consolidation should be a spontaneous market behavior more than anything else. The government should intervene less and allow integration to continue, provided that compliance requirements are satisfi ed. China has not yet had a case of thebankruptcy of a securities broker in a true sense. All “bankrupt” companies were forced out by government or administrative order. This arrangement will result in the accumulation of risk at the government level and give rise to moral hazard, because it cannot serve as a warning to other securities fi rms where government-owned assets constitute an overwhelming chunk of the ownership structure. For securities fi rms, the most important thing in restructuring is to improve, while expanding capital size, business scale, risk awareness, and prevention to a degree that matches the capital size and risk management.

In the new round of restructuring and integration in the securities industry, competent authorities are expected to create a supporting system, give some fi nancial assistance, and enable the securities industry to be enti-tled to the same degree of attention and policy support as other industries in the fi nancial sector. As a market-oriented mechanism phases in, only the fi ttest will survive. Improvement of restructuring effi ciency will help shape Chinese securities fi rms into a new force that optimizes the alloca-tion of resources, connects the capital market, facilitates the adjustment of industrial structure and functionality, and promotes the economic growth of China.


Promote Differentiation-Based Management and Competition

The chaotic competition in the Chinese securities industry is manifested in the realities that available products and services are of low added value, andthere is too much homogeneity in the profi t model. Due to almost market saturation and increasing marketization of brokerage, the profi t margins in conventional activities have been squeezed to a critical point by intensehomogenous competition. However, there is a market vacuum of innovativeproducts and services. This situation leads to vicious competition, which greatly hinders securities fi rms from growing bigger and stronger. Therefore,competitive differentiation that builds upon comparative advantages could be an important means for Chinese securities fi rms to produce mutual harmony. In the future, the surviving securities fi rms in the industry will have their own business advantages and core competencies. They will focuson their own competitive products and services in differentiation-based competition. They will also actively pursue an extensive expansion whilemaintaining the competitiveness of their distinctive products and services.

For many securities fi rms facing business transformation, differentiation-based management with certain characteristics is an inevitable choice. Com-petitive differentiation in which a company differentiates its products andservices from others and creates something special in the whole industry can be achieved in many ways. Some examples include special brands, products, technologies, customer services, and business networks. Using market seg-mentation, securities fi rms can make the best of their strengths, provide per-sonalized products and services, improve customer satisfaction, and avoidthe most intense head-on competition. The diversifi cation of industrial orga-nization and the differentiation of business models in the securities industry can help the entire industry improve its resilience and disperse the shock wave in all directions in case of external impact.

The execution period of the 12th Five-Year Plan could be a critical period for the transformation of the Chinese securities industry. The Chinesefi nancial market is becoming more open and an international fi nancial cen-ter is taking shape. During this period, the Chinese securities industry willface unprecedented challenges and opportunities. Opportunities will come from a huge demand for innovative, securities-related products and services in a Chinese market with enormous potential. Challenges will be in the form of increasingly market-oriented competition in an increasingly open capital market. The securities industry will have another round of reshuffl ing, and securities fi rms without core competencies will be washed away from the market. The Chinese regulatory authorities will also make an effort to cause securities fi rms to consolidate their compliance management and will guide them in the improvement of customer-oriented differentiation and industrial competitiveness. Competitive differentiation will be mostly refl ected in


market positioning, marketing products and services, and business regions, among others.

Differentiated Market Positioning Every securities fi rm has its own historyand distinctive corporate culture and should choose the market positioning that fi ts its own characteristics. In the right position, a company can make the most of its advantages. Market positioning is about defi ning prod-ucts, services, and business image, and identifying competitors and target consumers. For example, CICC and CITIC compete in research and human resources and also compete for cooperation and collaboration with large companies. They usually get large underwriting contracts, serve major cli-ents, and build on quality-based growth. However, Guoxin, Ping’an and CMS have a large number of employees but receive mainly small and medium underwriting contracts, serve ordinary companies, and build on quantity-based growth. These two types of securities fi rms will be comple-mentary in the IPO market.

Differentiated Marketing Market segmentation and branding into the target consumer group are at the core of differentiated marketing. Based on market segmentation and by means of branding activities, a company identifi es individual needs in the target market, adds a special value to its brand, creates a distinctive image, and builds brand differentiation for its own core competitive advantage. The fact that consumers have different hobbies, personalities, values, incomes, and spending patterns determines different brand preferences. This is the reason behind dif-ferentiated marketing. Through marketing, securities fi rms can convey different brand values to the public. Some advertise people-oriented care and considerate service, whereas others boast professional investment and quality service.

Differentiated Products and Services Product differentiation is refl ected in the process of fi nancial innovation. For example, some securities fi rms are good at designing debt derivatives, some are better at equity derivatives, and some excel at interest rate derivatives. Particular strengths in specifi c product innovation and pricing enable different securities fi rms to attractinvestors of different risk appetites. Service differentiation refers to relative strengths a securities fi rm may have in one of several fi nancial services on offer (including brokerage, equity/debt fi nancing, M&As and restructuring, investment consulting, and wealth management). A fi nancial holding group can build on the relative strengths of each subsidiary and provide one-stop services in banking, insurance, and securities. An independent securities fi rm can make the best of its relative strengths in specialization and fl exibility and provide personalized fi nancial services.


Differentiation of Business Regions Chinese securities fi rms will be categorized as large, nationwide companies, as well as small and medium regional ones. Large fi rms conduct business across the country and create a link between business activities on a nationwide, or even international, scale. Regionswhere local economy is relatively developed and the local market is vibrant provide a large number of potential corporate clients. Small and medium fi rms committed to the service of local economies and investors, as well as the development of regional capital markets, have a better understanding of local companies and work intensively rather than extensively. They can fi nd their own way to success and be more recognized by local customers.

Differentiation-based management and competition is a major industrial reform topic and also an inevitable trend in the Chinese securities industry to achieve market-oriented development. Such management and competi-tion can help shape a sound multilevel structure, bring about healthy com-petition, and improve the effi ciency and resilience of the entire industry.

Transform Business Models

For a long time, Chinese securities fi rms relied heavily on brokerage as a source of revenue. This resulted in too much homogeneity in business activities, low added value, weak risk resilience, and a type of profi tabil-ity that is highly affected by market volatility in the industry as a whole.Another reform priority for Chinese securities fi rms is the business modeltransformation from a channel-based profi t model to a service-based model.Securities fi rms can then build business growth on diversifi ed and personal-ized services. Such transformation will bring change to business philosophy, business rules, product mix, profi t structure, and the risk-return matchingmechanism. Specifi cally, Chinese securities fi rms need to achieve the follow-ing goals:

■ Restructure existing brokerage services and place broker services at the core.

■ Consolidate securities underwriting services. ■ Promote restructuring and M&A services. ■ Explore new business models in asset management services.

Each of these goals is discussed in detail below.

Restructuring Existing Brokerage Services and Placing Broker Services at the Core As a result of the impact of marketization, standardization, and internationaliza-tion, the lucrative golden age is now gone. Faced with the need for a market-oriented transformation and more intense competition in specialization,


Chinese securities fi rms have to change their homogenous fi nancial servicesand extensive business model as soon as possible.

Change the Brokerage Competition Chinese securities fi rms need to change their business offi ces from trading channels to fi nancial supermarkets. Due to the commission rate liberalization and lowering access barriers, the value of business offi ces as trading channels has fallen rapidly. Customers have increasingly higher requirements of personalized transactions. This requires business offi ces to change their role and become providers of inte-grated services, rather than simply trading channels. By doing so, they can identify valuable customers, improve customer services, and consolidate customer relationship management. On the other hand, Chinese securities fi rms also need to introduce the broker-based marketing model that Western securities fi rms have already created with an idea borrowed from the agent-based model in insurance. As they further their exploration into broker management, assessment, and incentive mechanisms, Chinese secu-rities fi rms have been improving the conditions that allow for the broker-based marketing model.

Transform the Brokerage Management Model The fl attening of profi t margins brings attention to business management by scientifi c methods. After a painful price war, Chinese securities fi rms have to reexamine their management model and fi nd a way toward low-cost expansion through process reengineering and technological innovation. They need to integratecorporate resources and reengineer business processes according to a customer-centric model. Reengineering conventional brokerage business processes and conducting customer and market-oriented process management need to become regular activities among securities brokers. On the other hand, secu-rities fi rms are also expected to replace the decentralized trading model with a centralized one. Conventional securities brokerage basically builds on a business-offi ce-based, decentralized trading model. It is hard for a securities fi rm to control the risk in independent business offi ces. A centralized trading model enables the securities fi rm to integrate the back-offi ce systems of all the business offi ces into one trading platform, where business offi ces share resources and have an advantage of integrated cooperation.

Transform Brokerage Activities While integrating and reducing the num-ber of physical business offi ces, securities fi rms need to make an effort toexpand off-site trading, particularly online transactions. Online and tele-phone transactions now contribute about 50 percent of the total transaction volume of an average business offi ce, whereas over-the-counter trading andother on-site trading have been declining. Along with the development of


network information technology, new trends of brokerage expansion willemerge in which Chinese securities fi rms may enter into a strategic alliancewith banks and other fi nancial institutions whose customers are potentialinvestors.

Consolidating Securities Underwriting Services The Chinese economy is still inan early stage of its rise. A large number of growth companies may need fl o-tation or issue of debentures to grow bigger and stronger on an acceleratedbasis. Chinese securities fi rms need to consolidate securities underwriting services and improve pricing skills and underwriting effi ciency. Such efforts may boil down to human resources development. Although innovation ininvestment banking is driven by a request within for the improvement of operating effi ciency, it is creative investment bankers who actually push innovation forward. In fact, innovative activities in investment bankingare probably the collective efforts of investment bankers. Sponsorship has higher requirements of an investment bank in terms of its comprehensive business skills. In China, the high turnover of sponsors has impaired thereputation of securities fi rms as well as the consistency of service quality. For the purpose of investment banking activities, Chinese securities fi rms shouldlearn from their international counterparts in business process optimization and organizational restructuring. They should change strategy from soloplay to group play, and make a real effort to improve incentive and restraint mechanisms. This will help reduce the chance of job-hopping and the fre-quency of turnover of sponsors, and shape a new business model that builds on good practice.

Promoting Restructuring and M&A Services Securities fi rms can earn a lucrative income by offering professional advice on corporate restructuring, mergers and acquisitions, general planning, and others. Compared with other invest-ment banking activities, M&A services are not heavily money-dependent, but they rely greatly on professional teams. What drives the business is notthe size of funds, but the skills of employees in solution design, fi nancialinnovation, and communication (e.g., communication between buyers and sellers). M&A consulting services, which involve low risks and generate high revenues, are regarded as a “cash cow” in the United Kingdom, the United States, and other developed countries. Chinese securities fi rms aresupposed to aggressively expand the business, offering advisory services in investment, fi nance, and M&As.

M&As involve some adjustments in corporate ownership structure, asset structure, and business strategy, among others. Those that push forward such change are mostly so-called key persons (including high-ranking economic offi cials and members of the management, such as chairmen, presidents, and


CFOs). They constitute the main circle that investment bankers approach and with whom they communicate, negotiate, and maintain business contacts for the purpose of M&A services. M&As are seen as the natural high-society club business and the top-level investment banking activities. In the business system of investment banking, M&A services can stimulate or initiate other business activities due to their particular business nature. For example, along with an M&A project, substantial fi nancial needs sometimes lead to bridge facility agreements and provide considerable interest income for securities fi rms. In today’s well-developed direct fi nancing market, most M&A clients raise money to satisfy their fi nancial needs by issuing securities (e.g., stocks, debentures, preference shares, and derivatives). These may provide investment banks with business opportunities in underwriting and issuance. Also, an M&A plan usually involves fi nancial innovation and derivatives, which may benefi t the derivative business of investment banks. In China, M&As have made for exciting news in the market. Securities fi rms may take advantage of such attention to quickly build a reputation and effectively promote their consulting and asset management activities.

Exploring New Business Models in Asset Management Services Objectively speak-ing, thanks to the wealth effect and the possibility of wealth creation in the capital market, investment banks serve as fi nancial intermediaries of wealthmanagement. Chinese securities fi rms are expected to constantly explore new business models in asset management services. This helps clients withinfl ation-proofi ng and wealth creation by means of investment and wealth management activities. Compared with banks, insurance companies, andtrust companies in the fi nancial sector, securities fi rms have a signifi cant edge in professional securities investments. They enable many investors to infl ation-proof and increase their wealth beyond the barriers of capital, knowledge, and technology.

Chinese securities fi rms need to create sound risk aversion and a mecha-nism for hedging against the risk of a market downturn. One reason securi-ties fi rms in developed countries manage to earn a trading profi t even in a market downturn is that they have a more accurate and reliable judgmentof the market. They make good use of short selling and hedging tools, which enable them to make a profi t when the market is going down.

Chinese securities fi rms are also supposed to create a virtual cycle in which they can grow with the development of capital market. Instead of sim-ply attracting more investors, securities fi rms (including securities investmentfund management companies) should be committed to the improvementof the capital market in terms of effi ciency and functionality. As institu-tional investors, they are expected to make the best of their infl uence to helpimprove corporate governance, encourage market innovation, advocate value


investing, and steer toward the rational allocation of resources. Such invest-ment guidance will bring along a virtual cycle and a mutually stimulating interaction in which institutional investors can improve their profi tability and the capital market can further develop.

Along with the transformation from the channel-based profi t model to the service-based model in Chinese securities fi rms, the degree of depen-dence on revenue from the secondary market will be greatly reduced. The existing risk-and-return structure in the Chinese securities industry will be signifi cantly improved because service products are generally involved in little risk.

Creating a Harmonious Financial Investment Culture for a Mutually Benefi cial Outcome

Securities fi rms have been evolving over hundreds of years from Amsterdam’s fi rms in the seventeeth century through London’s companies in the eighteenth and nineteeth centuries, to New York’s fi rms in the twentieth century. They have become more and more complex and have been of increasing infl uence in fi nance and economy. Along with increasing public attention comes rising criticism. The Mississippi Bubble in France caused public hatred of a culture of fi nancial speculation. The Great Depression in the United States led to the separation of commercial and investment banking. Securities fi rms continue to move forward on a road full of boos and hisses, behind which is the con-stant refl ection of the fi nancial culture in the securities industry. In 2011, the Occupy Wall Street protest movement in the United States again brought neg-ative global attention to securities fi rms. Wall Street became synonymous with greed, corruption, and selfi shness. In China, insider trading and “rat trading” in securities fi rms triggered some questions about the fi nancial culture. What kind of fi nancial investment culture do we need? What kind of role should securities fi rms play? These are questions worthy of serious consideration. The sound growth of securities fi rms in the long run, and the healthy and stable development of the fi nancial industry, will lead to a harmonious fi nan-cial investment culture with a mutually benefi cial outcome. Specifi cally, the desired culture should help in the following four ways:

1. Increase social wealth (the ultimate goal): The capital market, as themedium for the creation of social wealth, builds on market forces andserves the fundamental purposes to supply funds, optimize the alloca-tion of resources, diversify and transfer risk, and provide diversifi edfi nancial products. It liquidizes social wealth and improves its effi ciency for infl ation-proofi ng and wealth creation. Securities fi rms, as boosters for the growth of social wealth, enable the majority of investors to


participate in the capital market, to infl ation-proof and increase theirwealth beyond the barriers of capital, knowledge, and technology.Regardless of the size of their capital, investors may invest in the mar-ket on expert advice or via pooled investment vehicles, fi nancial lever-age tools, wealth management plans, and other products provided bysecurities fi rms. Along with the emergence of an international fi nancialcenter in China, the Chinese capital market will gain more infl uence,play a bigger role, and provide great opportunities for Chinese securi-ties fi rms. To seize such opportunities, securities fi rms must make it their ultimate goal to increase social wealth. They must continue to improveproduct innovation, risk management, and professional ethics in orderto prove their value while creating social wealth.

2. Guide the fi nancial community in the pursuit of reasonable profi t within a legal and ethical framework: For securities fi rms, as commer-cial organizations, profi t maximization is warranted provided that itis under a legal and ethical framework. Everyone understands that compliance with law in business activities is the fundamental rule by which every business must abide. Insider trading and rat trading allowa small number of people in the fi nancial community take advantage of asymmetric information to gain high returns and transfer wealth. These activities cause damage to the interests of securities fi rms andto the development of the securities industry as a whole. All securities fi rms and their employees are expected and required to comply with applicable laws and regulations. Securities fi rms and their employees should also be encouraged to subject themselves to moral and social constraints. Although less mandatory, they are the appearances of a har-monious fi nancial investment culture of integrity, equality, fairness, pro-fessional attitude, and professional practice. Everyone in the communityis expected to conduct due diligence in sponsorship activities, treat cus-tomers equally, give full disclosure of risk, and provide professional rec-ommendations of rational investment. They must avoid following hype, never participate in malicious competition, and stay clear of defama-tion. People with integrity acquire wealth by honest and decent means. Securities fi rms should equally conduct business and make innovationwithin a legal and ethical framework.

3. Keep employee benefi ts and compensation in proportion to contribution and redeem the honor of the industry: In China, where the securities industry is lucrative, employees of securities fi rms earn a relatively high income. The income of offi cers, fund managers, sponsors, and star ana-lysts is particularly higher than the national average, considering thesize of contribution to the community. This draws much criticism fromthe general public. While incentive programs with high benefi ts and


compensation help attract the best employees and motivate their cre-ativity, securities fi rms should create a compensation structure based on the principle that return is proportional to risk. It should also con-sider the contribution to the increase of social wealth, the national and industrial average salary, and specifi c jobs and positions. The Occupy Wall Street movement never accused Warren Buffett of unjust enrich-ment. Buffet makes money fairly. He is one of the greatest American philanthropists and public fi gures. He agrees with government bills thatimpose higher taxes on the rich. In China, people related to the securi-ties industry are often accused of greed and ruthlessness. Joint efforts across the industry should link employee benefi ts and compensationwith contribution to the community. High-income earners in the indus-try should actively participate in charitable activities. This will help heal a negative reputation and achieve a higher social value.

4. Bring good practices to corporate governance and professional service for mutually benefi cial harmony among companies, investors, and securi ties fi rms: To such an end, securities fi rms are expected to continueto consolidate their business foundation by improving corporate gov-ernance structure, cutting off tunneling, and preventing internal oper-ational risks. They should also continue to attract the best employees and provide professional fi nancial services, helping high-performance companies raise money, and investors discover the companies worthy of investment. Business diversifi cation may result in confl icts of interest between departments of a securities fi rm. For example, confl icts may arise between asset management and proprietary trading departments, or between investment banking and direct investment departments. Only a sound corporate governance structure that builds on good practices can cut off tunneling and protect the interests of companies and custom-ers. Securities fi rms need to conduct due diligence and offer reasonable investment recommendation. This helps companies grow and removes the stigma of “irresponsible fi nancing” while helping investors fi nd com-panies worthy of investment. All these efforts will promote the interests of companies, investors, and securities fi rms and ultimately create a har-monious fi nancial investment culture for a mutually benefi cial outcome.

REFERENCES

Huang , Taiyan . 2005 . New Economic Hotspots in China . Beijing : Economic Science Press .

Li , Yongsen . 2011 . “ New Breakthroughs in Margin Trading and Short Selling by Securities Firms .” China Finance 20 .


Li , Yong , and Yaogang Chen . 2011 . “ A Study of Investment Banking Models in the Global Financial Crisis .” Financial Forum 4 .

Ma , Hongxia , and Guohua Sun . 2009 . “ An Analysis of the American Investment Banking Crisis and Transformation of American Investment Banks .” Interna-tional Financial Research 3 .

Sun , Qing . 2009 . “ A Theoretic Comment on Risk-Adjustment-Based Capital Alloca-tion .” Economic Perspectives 10 .

Wu , Xiaoqiu . 2010 . “ The Path to an International Financial Center in China .” Finan-cial Research 8 .

Wu , Xiaoqiu . 2011 . “ The Chinese Economic Growth and Choice of Financial Model in the New Century .” Modern Finance 1 .

Yao , Yuan , and Jinqing Zhang . 2010 . “ On the Goldman Sachs Model and the Chinese Investment Banking .” Research on Financial and Economic Issues 11 .

Zeng , Wei , and Shou Chen . 2009 . “ Some Progress in the Studies of the Impact of Financial Oversight on Financial Product Innovation .” Economics Perspectives 10 .

Zhou , Lingling . 2011 . “ On the Business Structure of Chinese Securities Firms .” Economic Herald 7 .d

513

WU XIAOQIU

Wu Xiaoqiu, born in 1959, is known as a renowned economist of China and an expert on fi nance and securities in China. He received his PhD in econom-ics from Renmin University of China (RUC) in 1990. Professor Wu is the assistant president, professor of fi nance, PhD supervisor, executive deputy dean of the graduate school, and director of the Finance and Securities Insti-tute of Renmin University of China (FSI); he is also a Changjiang Scholar Professor, a member of the Academic Degree Committee of the State Council, and a member of the Ninth Issuance Examination Committee of China Securities Regulatory Commission. He is also member of the AcademicCommittee of RUC.

Professor Wu Xiaoqiu conducts in‐depth studies in such areas as the macroeconomics, fi nancial reform, capital market, and others. In each critical period during China’s capital market development, he invariablyputs forward his own theoretical ideas and policy suggestions concerning the major issues, winning favorable comments from all parties. He is one of the most infl uential experts on the fi eld of capital markets in China’s economic circle.

Professor Wu’s publications include: “Understanding the Capital Market” (2002), “China’s Capital Market at the Crossroad” (2002), “Securities Invest-ment” (2004), “China’s Capital Market: Split Share and Liquidity Reform” (2004), “Market‐Oriented Financial System: China’s Strategic Selection” (2005), “China’s Capital Market Analysis Essential” (2006), “China’s Capi-tal Market after Split Share Reform” (2006), “Dream—Wu Xiaoqiu’s Works on Capital Market Analysis” (2007), “China’s Capital Market: From Sys-tem Reform to Strategic Transformation” (2007), “China’s Capital Market: Global Vision and Leap‐Forward Development” (2008), “Lessons from the Financial Crisis” (2009), “China’s Financial and Capital Market in Global Financial Reform” (2010), “Reform and Rise—Searching for the Rise of China’s Finance” (2011), “China’s Venture Market: Development and Risk” (2011), “China’s Securities Companies: Present and Future” (2012), “China’s

About the AuthorAbout the Author

514 ABOUT THE AUTHOR

Capital Market: 2011–2020” (2012), “China’s Capital Market: Analysis of the System and Rules” (2013), “China’s Capital Market: Institutional Reform and Policy Adjustment” (2013), and “China’s Capital Market System Reform Research” (2013).

His social media sites can be found at: http://t.qq.com/wuxiaoqiu (Tencent Microblog) and http://weibo.com/u/1885355607 (Sina Microblog).

http://t.qq.com/wuxiaoqiu

http://weibo.com/u/1885355607

515

ABC (Shenzhen) Trust and InvestmentCorp., 76, 77

ABN AMRO, 181, 407Accepting House Committee (AHC), 404Accepting houses, in London, 403Accounting systems, relevant, for

asset management business, 302–303

Active shares, 426Administration and rectifi cation phase

of Chinese securities, 2001–2005, 35, 38

Administrative Measures for theSponsorship Business of theIssuance and Listing of Securities, 369, 378, 380, 381, 385

Administrative Measures on RiskControl Indicators of SecuritiesCompanies, 270, 272, 277, 312

AES Corporation, 498Affi liates to fi nancial holding

companies, 170Agricultural Bank of China (ABC), 29,

53, 114AIG, 267Alcoa, 498Algorithmics Company, 461Allen, F., 46Alternative Investment Market (AIM),

in United Kingdom, 349–350American banking, current crossover

in, 178American International Group (AIG), 108American investment banks:

comparison of net assets of Chinesesecurities fi rms and, 68

major, statistical analysis of ownership structure in, 70

American Model, of investment banks, 153

American securities fi rms, top 10, activity-specifi c revenue curves of, 105

American securities industry, revenuestructure shift in, 1980–2010, 72

An, Qingsong, 49An, Xuemei, 66Anshan Securities, 35, 36, 114, 115Apprenticeship programs, 100Approval policies, 208–209Arbitrage pricing theory, 458Asian fi nancial crisis (1998),

241, 496Asia Securities, 36Askari Company, 462Asset appreciation, risk portfolios based

on, 46Asset assessment, 493Asset-backed fi nancing, 116, 118Asset-backed securities (ABS), 106Asset management, 23, 101, 147, 149Asset management accounts, in China

compared with U.S. securitiestraders, 448

Asset management business of securitiescompanies:

adoption of risk managementtechniques by, 304–305

capital liquidity design and, 303–304

connected transactions, interesttransmission risks, and, 301

IndexIndex

516 INDEX

Asset management (continued)contract risks and, 301–302description of, 222design of reload option models and,

304developing in China, 472dynamic monitoring of risks for, 305guaranteed return risks and, 300–301investment research talent and, 322malpractice in investment operation

risks and, 301management of risks associated with,

300–305market risks and, 302product innovation in, 245–246profi tability models of, 223–225provisions of laws observed and

clearly specifi ed responsibilities for, 303

relevant accounting systems for,302–303

revenue of publicly listed securitiestraders’ for, and its percentageof total revenue 2007–2011 andquarters 1–3, 2011, 224

revenues of publicly listed securitiestraders’ for, and their percentagesin total revenue quarters 1–3, 2011, 225

sources of risks in, 300–302stringent business separation

mechanisms for, 302uniformity and, 235

Asset management companies (AMC), 193, 195, 497–498

Asset management services:exploring new business models in,

507–508wealth management and, 331

Asset management theory, 458Asset pricing function, fi nancial system

and, 45–46Asset securitization:

capabilities of securities fi rms and, 106–108

exploring, in China, 473product innovation and, 489rationale for, 106, 107

Assorted sponsor system, NASDAQ market, U.S., 350–351, 357

Asymmetric information problem, 96–97

Attributes, investment banks and, 151Audit committee:

board of directors in investmentbanks and, 427, 431

risk-management units and, 274Authorization management, 282Automated trading, kick-off in China,

28Automatic order marching (AOM)

trading system, 28AXIOM Software Company, 461

Backdoor listing, 121, 168, 182Bank-based fi nancial systems, 482Bankers Trust, acquisition by Deutsche

Bank, 401Bank/fi nancial holding companies, 145Bank Holding Company Act, 421Bank holding company (BHC), 172Bank Holding Company Incorporation

Special Case Law (Japan), 421Banking Law (Japan), 421Banking Oversight Act, 192Bank loans:

amount fi nanced in China, 1997–2011, 483

corporate debentures compared to, interms of fi nancing costs, 486

Bank of America, 401, 421Bank of America Merrill Lynch, 105,

111–112Bank of China (BoC), 53, 114, 164,

410Bank of Communications (BoComm),

114, 164Barclays Bank, 404, 421Barclays Capital, 112Barings Bank, 403, 459

Index 517

Basel Committee on BankingSupervision, 170, 420

BCG Matrix, 206Bear Stearns, 145, 149, 176

collapse of (2008), 96, 106, 117, 118, 279, 401

Beifang Securities, 36Beijing Friendship Store Group, 182Beijing Mercantile Exchange, 74Beijing Securities, 29Beijing TIANYIN Law Firm, 381Beijing Xinmin Financial Advisors, 182Benston, G. J., 45Bidirectional Chinese capital market,

international horizons and, 21Big Bank reform (United Kingdom),

174Bilateral trade profi tability model, 228BlackRock, 111Blankfein, Lloyd, 190Block trading, 116BNP Paribas Euronext, 407BNP Paribas Peregrine, 335Board of directors:

governance structures of investmentbanks and, 422, 427–429, 431

risk-management units and, 274top fi ve investment banks in terms of

total market value, 428Board of directors (BOD) report, items

within, 54Board of supervisors and management,

governance structures of investmentbanks and, 422, 429–430, 431

Body risks, issuing, 297Bond-based funds, 322Bond market:

China compared with U.S. in terms of size of, 485

Chinese, 484Bonds:

infancy phase, 1987–1990, 26, 27issuance statistics (RMB in billions),

57outstanding in China, statistics of, 59

Bond services, in internationalcompared with Chinese investmentbanking business, 448

Bond underwriting market, 221Book-building pricing mechanism, 244Boutique investment banks, 154Boyd, John, 45Brazil, government regulation system

in, 410Bright Group, 83British Empire, 479Brokerage activities, transforming,

505–506Brokerage business of securities

companies:competition risks outside of industry,

291–292compliance risks, 293–294credit risks, 294establishing three lines of defense for

risk control, 294examination indexes established for,

294–295horizontal competition risks,

292–293internal management risks, 293legal and policy risks, 294management of risks associated with,

291–295monitoring data-screening

procedures, 295risk-control management KPI set up

for, 295Brokerage commission business:

innovation in, 242–243profi t methods of, 218–219revenue of publicly listed securities

2007–2010 and quarters 1–3, 2011, 219

trends in, 242uniformity and, 235

Brokerage-commission liberalization, global, 105

Brokerage commissions, 207Brokerage competition, changing, 505

518 INDEX

Brokerage management model, transforming, 505

Brokerage services:listed and nonlisted, 19restructuring, 504–506

B-share market of Shanghai, launchof, 28

Buffett, Warren, 510Business innovation risk management,

277Business model, profi t model at core of,

206Business model transformation,

504–508consolidating securities underwriting

services, 504, 506new business models in asset

management services, 504, 507–508promoting restructuring and M&A

services, 504, 506–507restructuring of brokerage services,

504–506Business separation mechanisms,

stringent, for asset managementbusiness, 302

Business structures of investment banksin mature markets, 435–448

Chinese securities industry andmessages in terms of, 471–473

Goldman Sachs case study, 437–440Lehman Brothers case study, 444–447Merrill Lynch case study, 442–444Morgan Stanley case study, 440–442in United States, general analysis,

435–437what China can learn from business

structures of American investmentbanks, 447–448

“Buy back punishment,” 300

Campbell, Tim, 45Canada:

government regulation system in, 410sponsor qualifi cations in, 355, 356sponsor structure in, 354

Cao, Yijian, 62Capital intensifi cation, fi nancial holding

companies and, 184Capital liquidity design, improving,

for asset management business, 303–304

Capital market division, in investmentbanks in mature internationalmarkets, 430

Capital market in China:Chinese securities fi rms and, 47improved money-raising function

of, 49mature U.S. market compared with,

102Capital markets, global perspective

of, 497Capital power, weakness of, with low

risk tolerance, 67–68Capital scale of securities companies,

raising, in China, 471–472Capital strength, competitive edge of

securities companies and, 19Capital suffi ciency, securities companies

and, 319Capital use policies, formulating, 311Career planning, for high-caliber

personnel in securities industry, 340CCB Investment Securities Co. Ltd.,

115Central bank bills, issuance statistics

(RMB in billions), 57Central Huijin Investment Co. Ltd., 88,

193CFA Asia Pacifi c Association, 325CFSB, 461Change, promoters of, in Chinese

fi nancial system, 482, 484–486Changjiang Securities, 41, 114Changjia Paris Perigrine, 38Channel profi tability model, of Chinese

securities companies, 234Channels:

transitioning to services from, 241underwriters and access to, 125, 126

Index 519

Channel system stage, Chinese stockmarkets and, 353

Chartered fi nancial analysts (CFA), 324–325

Chemmanur, T. J., 45Chen, Min, 62Chen, Zhangwu, 62Chen, Zhengrong, 124Chen, Zhiguo, 62Cheung Kong Holdings Ltd., 74Cheuvreux, 257Chief information offi cer (CIO),

326–327China. See also Securities companies in

China; Securities fi rms in Chinaaggregate amount of government debt

to GDP ratio, U.S. compared with, 485

amount fi nanced in bank loans andvia issuance of stocks, bonds, anddebentures in, 1997–2011, 483

bank-based fi nancial system in, 482business structures of American

investment banks and lessons for,447–448

changing number and market valuesof listed companies in, since 2005, 48

China-USA GDP comparison(2011–2020), 4

commercial bank-controlled fi nancialholding companies in, 189–191

development of investment banks inmature international markets andlessons for, 467–475

development paths of overseasinvestment banks as inspirationsfor, 408–410

driving force behind emerginginternational fi nancial center in, 480–482

economic growth in, and globalrankings (2000–2011), 2

evolution of economic monetizationin, 17–18

government bond market in, 485–486government regulation system in, 410imports and exports in (2000–2010),

8internal control of investment banks

in mature international marketsand lessons for, 463–466

investments in, 2000–2010, 8main index of sectors of listed

companies in, 52middle class population in, 335–336national income distribution in

(2000–2010), 6organizational structures of

investment banks in maturemarkets and lessons for, 430–432,434

overseas investment bank regulationand areas to emphasize in, 414–415

securitization ratio in, 325sponsor duty system in, 358sponsor qualifi cations in, 356sponsor terms in, 357stock market cap to GDP ratio, U.S.

compared to, 482, 483structural changes of three industries

in, since 2006, 51term of sponsors in, 357twenty-fi rst century as century of, 479understanding economic trends of,

1–11China AMC, 257China Banking Regulatory Commission

(CBRC), 171, 196, 197, 432China-Belgium Direct Equity

Investment Fund, 232China Biochemical Pharmaceutical

Industry Association, 384China Cinda Asset Management, 165China CITIC Group, 91China Construction Bank (CCB), 29,

53, 87, 88, 89, 114, 164, 165China Eagle, 268China Economic Development Trust

and Investment Co., 75

520 INDEX

China Euro Securities, 38China Everbright Group, 29, 164, 165,

192, 195China Guangfa Bank, 29China Huarong Asset Management,

165China Insurance Regulatory

Commission (CIRC), 172, 197, 432China International Capital Corp. Ltd.

(CICC), 29, 38, 209, 230, 410, 503China International Capital Corp. Ltd.

(CICC) case study, 87–90appeal to upscale clients, 89–90background, 87–88lessons learned, 90

China International Trade Co., 89China Investment Corporation, 193, 195China Investment Securities, 385, 386China Jianyin Investment Co. Ltd., 88,

91, 381Chinalco, 498China Life Insurance Co. Ltd., 91China Merchants Bank, 336, 498China Merchants Group, 164, 165,

192, 195China Merchants Securities, 41China National Investment and

Guaranty Co. Ltd., 88China National Offshore Oil

Corporation (CNOOC), 300China New Tech Venture Investment

Corp., 74China Orient Asset Management, 165China Securities Finance Corporation

Ltd., 91, 249China Securities Investor Protection

Fund Corp. Ltd., 38China Securities Regulatory

Commission (CSRC), 29, 34, 35, 38, 39, 53, 66, 67, 82, 114, 115, 121, 161, 171–172, 188, 197, 228, 231, 246, 251, 349, 432

Circular on Release of Net CapitalCalculation Standards for SecuritiesFirms, 168

comprehensive reordering of securities companies (2004), 267, 269

direct investment pilot projects and,313

Guidelines for IPO Pricing AnalysisReport, 125

Provisional Assessment Measuresfor Securities Firms in CreativeActivities, 168

punishment for rule-breachingsponsors imposed by, 359, 369, 370, 373, 379, 380, 381, 385, 389–390

Regulation on the Supervisionand Administration of SecuritiesCompanies, 272

Risk Control Indicators-BasedRegulatory Measures for SecuritiesFirms, 168

Securities Company Internal ControlGuide, 475

sponsor duty system and, 358sponsor structure and, 354

China Securities Research, 232China Shenhua, 89China Southern Asset Management Co.,

85China Telecom (Hong Kong), 89Chinese bond market, 484Chinese capital market, securities

companies and, 25Chinese economy, general growth trend

of, 2–3Chinese fi nancial institutions, sources

and application structure of fundsat, 1999, 54

Chinese fi nancial structure:evolution of, in future, 11–13, 16–18fl uctuation of S/F, 13, 16historical data on, 11internal incentives for market

evolution of, 17–18predicted values of F/G, S/G, and S/F,

16–17

Index 521

rise of F/G, 12rise of S/G, 12–13

Chinese fi nancial system, sources andapplications of funds in, 55–56

Chinese fi nancial system reform, 24–2511th Five-Year Plan and, 180goals of, 51

Chinese securities fi rms. See also Futuredevelopment of Chinese securitiesfi rms

capital and profi tability of, 69case studies, 72–93comparison of net assets of American

investment banks and, 68diverse social assets, citizens’

investment options, and, 53fi nancial system reforms and, 24–25,

51, 53, 180historic contributions of, 46–47,

49–51, 53–54, 61–63, 66–68, 71

old-fashioned profi t model in, 71ownership concentration in, 69social assets, improved overall

operational quality of nationaleconomy, and, 49–51

stock reforms of state-ownedcompanies and, 47

transparency of capital market and, 53–54, 61–62

Chinese stock market, 498from quota management to sponsor

system in, 353rapid growth of, 482, 484

Choice, employees and sense of, 341CICC JIATAI Industrial Integration

Fund, 231Cinda asset management company,

195Cinda Securities, 251, 252Cinda XIANJINBAO, 251, 252Circular on How to Implement

the Provisional Regulationson Intermediate Business of Commercial Banks (2002), 179

Circular on Separating PBC-Affi liatedSecurities Firms from All Levels of PBC Branches, 34

Citibank, 177, 469CITIC Construction, 257CITIC direct investment unit, projects

funded by, since 2010, 64–65CITIC Group, 29, 82, 164, 165, 192,

195, 237, 503CITIC Industrial Bank, 76, 77CITIC JINTONG, securities operation

outlets, distribution pattern of, 256

CITIC Securities, 41, 63, 66, 71, 212, 214, 221, 230, 231, 253

organizational framework andmanagement structure of, 163

revenues structure 2007–2010 andquarters 1–3, 2011, 214

CITIC Securities case study, 90–93,254–260

background, 90–91brokerage business revenue, 254cultivation of cross-border business,

260distribution of business channels,

254, 255equity control of JINTONG and WT,

254farsighted development strategy and

effi cient capital operation, 91–92internationalization of CITIC

Securities, 259investment banking business, 255investment business, 255, 257investment in overseas securities

traders, 257lessons learned, 92–93overseas fi nancing, 257, 260percentage of investment banking

business in total revenue in, 258percentage of investment business in

total revenue in, 259percentage of securities brokerage

business in total revenue in, 258

522 INDEX

CITIC securities industry, revenue structure shift in, 73

CITIC WT, securities operation outlets,distribution pattern of, 257

Citigroup, 150, 153, 177, 181, 401, 402, 403, 421

Citigroup Model, 153, 400, 401–403comparative advantages of, 402exemplars of, 401

Classifi ed Oversight Regulations forSecurities Firms (CSRC), 121

Client fund safeguard systems, 276Client group analysis, in wealth

management environment, 335–336

Client margin management, 251–252Client trading, 147Closed-end funds, 322CLSA, 257CMS, 503Collaboration, securities companies

and, 320Collateralized debt obligations (CDOs),

106Commercial bank credits, asset

securitization and, 488Commercial Banking Act, 160, 161,

167, 178, 179, 192, 194Commercial Banking Law and

Insurance Law (1995), 29, 34Commercial banks, 164, 175, 490, 494

fi nancial crisis of 2007–2008 and, 469, 470

in Germany, 405Glass-Steagall Act and, 148, 149, 153indirect fi nancing activities and, 480information superiority of, 181innovation and, 487investment banks acquired by, 189“modern mixing” phase in U.S. and,

400separation phase in United States and,

399Commercial credit, 191Commerzbank, 407, 470

Commissions and revenue from sale of funds, 72

Commissions proportionate to totalrevenue, in American investmentbanks, 447

Committee of SponsoringOrganizations of the Treadway Commission (COSO), 448–449, 456

Communist Party of China (CPC), 32Companies Act (1994), 120, 160, 167,

490Company Law (UK), 412Compensation structure, keeping

in proportion to contribution, 509–510

Competence, employees and sense of, 341

Competition:core, hard-to-replicate, 20differentiation-based management

and, 502–504human resource and, 340human resource management and, 347innovation and, 487risks outside of brokerage industry,

291–292in securities industry, 318, 319for talent, 322underdeveloped, in securities

companies, 67–68wealth management fi eld and, 328

Competitive arrangement of fi nancialfunctions, 174

Competitive capability, 209Compliance directors, 274Compliance management system, 276Compliance risks, 270

brokerage business of securitiescompanies and, 293–294

investment banking business and, 296Comprehensive risk management:

for Chinese securities companies, 465defi ned, 456description of, 461

Index 523

Concierge services, wealth managementand, 332

Conduit services, 325Confl ict of interest risks, research and

investment consultancy businessand, 305–306

Confl icts of interest, businessdiversifi cation and, 510

Conglomerate organizationalmanagement model, 143

Conglomerates, basic groups of, 192–193

Conglomeration, 169, 172Connected transactions risks, asset

management business of securitiescompanies and, 301

Consumer market division, ininvestment banks in matureinternational markets, 430

Consumption, Chinese economicgrowth and, 4, 7, 10, 11

Content and Format of InformationDisclosure by Companies IssuingSecurities to the Public No. 10—Application for Issuance of New Shares by Listed CompaniesProspectus, 369

Continental European model (universalbanking), 152–153, 169

Continuous supervision stage, sponsorduty system and, 357, 358

Contract management, standardizationof, for asset management business, 303–304

Contract risks, asset managementbusiness of securities companiesand, 301–302

Contract term structure, optimizing, forasset management business, 304

Control activities, 449, 450–451defi ned, 450overview of, in investment banks in

mature international markets, 452Convertible debts, issuance statistics

(RMB in billions), 57

Convexity analysis, 461Coordination principle, in regulation of

investment banking, 414Core competitiveness, hard-to-replicate,

20Core competitive strength, of securities

companies, 319–321Corporate bonds, 27

issuance statistics (RMB in billions), 57

Corporate culture:emphasizing, in Chinese securities

companies, 464–465internal control and, 449

Corporate debentures, bank loanscompared to, in terms of fi nancingcosts, 486

Corporate governance:good practices brought to, 510improvement needed in structure

of, 68messages for Chinese securities

market in terms of, 473–475standardization of, in wake of

fi nancial crisis of 2008, 281Corporate operations, Chinese

securities fi rms and improvedquality of, 47, 49

Corporate stocks, fi rst in China, 26Corrective risk disposition, 291Corruption, in investment banking,

66–67COSCO Group, 182Credibility of market, 24Credit, investment banks and need for,

191Credit default swaps (CDS), 108Credit derivative products, 467Credit rights, fi nancial products

innovation and, 488Credit risks, 461

brokerage business of securitiescompanies and, 294

investment banks and, 453, 454–455securities margin trading and, 308

524 INDEX

Credit Suisse, 181Credit Suisse First Boston, 401, 407Crossover in fi nancial services:

fi nancial holding company model,separation of activities, and,177–179

increasing popularity of, 177reform of fi nancial sector and, 176

Crossover models:fi nancial crises and resiliency of, 189fi nancial practice, policy framework,

and, 194Crystal Ball Award, 323CSRC Circular on Issues Concerning

the Trial Reform for Equity Division of Listed Companies, 38

Culture, internal control in Chinesesecurities companies and, 475

Culture management, 345–346Customer relationship management

(CRM) system, perfecting, 243Cyberspace, employee recruitment in,

344Cybertechnologies, 343–344Cybertests, 344

Dai, Xiaofeng, 62Daiwa Bank, 459Daiwa SSC Securities, 38Dalian Securities, 35, 36Dapeng Securities, 29, 36, 114Data-screening procedures, monitoring

for brokerage business, 295Debt underwriting:

market for, in China, 102, 104top 10 investment banks regarding

revenue from, 103Decentralized equity, of investment

banks in mature internationalmarket, 426

Decision implementation committee, board of directors in investmentbanks and, 427, 431

Decomposed sponsor roles, GrowthEnterprise Market in Hong Kong, 352–353

Deheng Securities, 36Demand, external factors, profi t model,

and, 206, 207Deng, Xiaoping, “Speech of the South

Tour” (1992), 27Depository system in China, reform of,

118–120Deregulation, 485Deregulation Act (1980), 400Derivative fi nancial instruments,

101, 267global OTC, notional amount of,

107, 108hedging with, 300innovation and, 473some publicly listed securities

companies’ return on investmentthrough, 252

strengthening regulation on, 467–468

Design of reload option models, forasset management business, 304

Detailed Rules for Securities MarginTrading Operation, 228

Deutsche Bank, 152, 170, 181, 401, 406, 470

Deutsche Bank model, exemplars of, 407

Diamond, Peter, 45Differentiated services, launching, in

China, 473Differentiation:

independent securities fi rms and, 198–199

of profi tability models, 205Differentiation-based management and

competition:differentiated marketing, 503differentiated market positioning,

503differentiated products and services,

503differentiation of business regions,

504promoting, 502–504

Digital economy, 155–156

Index 525

Direct investment business of securitiescompanies:

control for investment decisionmaking, exit plans, and, 315

control of spread of risks, 315–316future development of, 249–250information disparity risks and, 314liquidity risks and, 313management of risks associated with,

313–316prevention of moral risks in, 316profi tability model of, 230–232profi t fl uctuation risks and, 313publicly listed securities traders’

expected profi ts from, 231risk management in fi nancing and,

314–315spread of risks in, 314

Direct investments, tunneling caused by,24, 63, 66

Direction, motivation and, 340, 341Direct M&As model, 500Discount brokers, 105Disposable income, 1, 2

changes in, 3–5, 7, 9, 11growth for Chinese citizens (2011–

2020), 7Distributors, vetting and controlling,

299–300Diversifi cation-induced coupling effect,

fi nancial holding companies and,184–185

Diversifi ed operation model, American investment banks and, 447

Domestic and international business, developing in parallel, 473

Domestic consumption demand, growthof (2000–2010), 9

Dongbei Securities, 41Dresdner Bank, 407Drexel, 485Dreyfuss, Ludwig, 416Dual sponsor system, in China, 356Due diligence, 98, 99, 387, 493, 510

Hepalink case and failure inperforming, 381, 385

sponsoring stage, sponsor dutysystem, and, 357

Suzhou Hengjiu Photo-ElectronicScience and failure in performing, 378, 379, 381

Duration analysis, 461Dushi Corp., 82, 83, 84Dynamic capital strength, 19Dynamic risk-management system,

275

“Early mixed operation” phase, forinvestment banks in United States, 399

Economic capital, allocation andassessment of, 285–286

Economic globalization, irreversibletrend of, 496–497

Economic growth, formula for wealtheffect of, 494

Economic growth in China, contribution from investments, consumption, and imports andexports, 10, 11

Economic indexes, 278Economic monetization (M2/GDP),

evolution of, in China, 17–18Economic value added (EVA),

278Effi ciency principle, in regulation of

investment banking, 414Embezzlement:

of customers’ margin funds, 95violations, 35, 36–37

Emergency risk disposition, 291Employee benefi ts and compensation,

keeping in proportion tocontribution, 509–510

Employees, internal motivation theoryand, 341

Enterprise bonds, issuance statistics(RMB in billions), 57

Enterprise counseling services, ininternational compared withChinese investment bankingbusiness, 448

526 INDEX

Enterprise M&A Expert Panel (UK), 413

Enterprise-wide risk management(ERM), 271

Enthoven, A. C., 45Equity concentration, overview of top

fi ve investment banks in terms of total market value, 425

Equity division reform (2007), 11, 12Equity structure of investment banks:

governance structures and, 423, 426institutional investors and, 423, 426internal control structure and, 475

Escrow depository system, 118–119Estate planning, wealth management

and, 332e-trade, 155Europe:

sovereign debt crisis in, 241, 496, 497universal bank model in, 407

European model of investment banking, 404

Evaluation:of employees in cyberspace, 344solid, wealth management business

and, 331Everbright Securities, 41, 63, 66, 222,

246Examination indexes, brokerage

business of securities companiesand, 294–295

Exchange rates, future fi nancial reformin China and liberalization of, 489

Execution risks, stock index futurebusiness and, 312

Exit plans, direct investment businessand, 315

Expertise, core competitive strengthand, 320–321

Exports:in China (2000–2010), 8Chinese economic growth and, 5, 7,

10, 11External factors and profi t model,

206–209

demand and, 206, 207market environment and, 206,

207–208policies and, 206, 208–209

Extreme value theory, 278

Fabozzi, Frank J., 106Fairness, 509Fair Trade Stature (UK), 412Family business and partnership,

416–417, 422Fast-development phase of Chinese

securities, 1996–2001, 32–34enhanced profi tability of security

fi rms, 32–33securities regulation system

streamlined, 32, 34stabilized number of securities

companies, 32, 33–34Federal Deposit Insurance Corporation

Improvement Act (1991), 400Federal Reserve, 402Feng, Licheng, 62F/G, 11

fl uctuation of, since 1990, 12, 13predicted values of (2011–2020), 16,

17rise of, 12

Fidelity Investments, 112Fiduciary services, wealth management

and, 331Financial asset management company-

based fi nancial holding model, regulatory framework for, 196–197

Financial audit, 493Financial bonds, issuance statistics

(RMB in billions), 57Financial conglomerates, conditions

met by, 171Financial Conglomerates Directive

(EC), 171Financial consultancy, innovations in,

244Financial Engineering Associates, Inc.,

462

Index 527

Financial engineering methods, 462Financial engineering technologies, 156Financial functionality, theoretic

analysis of, 96–101Financial globalization, irreversible

trend of, 496–497Financial groups, developing, in China,

471–472Financial holding companies, 169

advantages of, 184–185as best choice for large Chinese

investment banks, 177–180Chinese, emerging to the surface,

179–180Chinese, overview of, 433Chinese securities fi rms affi liated to,

165competitiveness in investment banks

and: Chinese practice, 185–189in conglomerate arrangement, groups

of, 164defi ning, 170, 171, 172focusing on cultivation of, in keeping

with trend of the time, 431–432investment banks, integration, and,

173–177modern, 416, 420–422system risk and, 454

Financial Holding CompanyDeregulation and ReorganizationLaw (Japan), 421

Financial holding company model, 143, 401, 402

Financial holding model:fi nancial asset management company-

based, regulatory framework for,196–197

operations/oversight based onseparation of activities and, 192–197

selection of landing site for, 193–195Financial innovation, Wall Street

investment banks and, 190Financial Institutions Regulations, 120,

160, 167

Financial intermediaries, informationdissymmetry problem and, 45

Financial legislation, expediting, inChina, 434

Financial products innovation, purposesbehind, 488

Financial Reform Planning, in Japan, 421

Financial risks, 270Financial Service Law (UK), 412Financial Services Modernization Act

(1999), 149, 174, 176, 400, 421Firewalls, 160, 179, 282, 316, 402First Boston, acquisition by Credit

Suisse, 401First World War. See World War I“5/19 blowout market,” emergence of,

32Five mechanisms framework, for

human resource management insecurities companies, 344, 346

Five-Year Plan, 12th, execution of, 502

Flotation, 120–121, 500Fluctuation analysis, 278Ford Motor Co., 99Founder Securities, 41Four bodies framework, for human

resource management in securitiescompanies, 344, 346

France, Mississippi Bubble in, 508Fraudulent listings, collusion between

issuers and sponsors in, 387, 390French banks, European bank crisis

and, 454Fujian Industrial Securities Co., 84Fuld, Dick, 449, 474Fulghieri, P., 45Fullgoal Fund Management Co., 81Full-service banks, 145, 152, 153Fund industry, development scale of, 58Future development of Chinese

securities fi rms, 480–495emerging international fi nancial

center in China, 480–482

528 INDEX

Future development (continued)innovation in fi nancial products in,

487–490promoters of change in Chinese

fi nancial system, 482, 484–486risk allocation system and, 490–493wealth management and, 493–495

Future reform in Chinese securitiesfi rms, 496–510

accelerating concentration of capitalfor business growth and expansion, 499–501

creating a harmonious fi nancialinvestment culture, 508–510

creating an international vision, 496–499

promoting differentiation-basedmanagement and competition, 502–504

transforming business models, 504–508

Fuyou Securities, 36

Gale, Douglas, 45Gansu Securities, 37, 81Gao, Yangcai, 67Gap analysis, 461GDP ratio, stock market cap to, China

compared with U.S., 482, 483Geely, Volvo acquisition, 498GE Financial, 420GE Matrix, 206General partners, 417German banks, international fi nancial

banks and, 470Germany:

bank-based fi nancial system in, 482evolutionary history and structural

patterns of investment banks in, 405–407

intermediate regulation system in, 411

universal banking model in, 189, 470GF Securities, 41, 63, 66, 222, 231GF Securities case study, 78–81

business growth driven by innovationin, 80–81

hard-earned success, 78–79strategy vital to success in, 79–80sustainable development mechanism,

81GF Securities Co. Ltd., 378, 380Glass-Steagall Act (1933), 144, 148,

149, 153, 399, 400Global assets management, 497–498Global investor’s services, future of

Chinese securities fi rms and, 480–481

Globalization:investment banking and, 151–152,

155irreversible trend of, 496–497

“Golden rules for investment,” 204Goldman, Marcus, 416Goldman Sachs, 96, 99, 100, 112, 144,

149, 170, 176, 181, 183, 185, 209, 279, 384, 398, 401, 402, 403, 416, 417, 426, 428, 442, 447, 470, 482, 500

business restructuring into fourblocks, after 2010, 439

business unit division, 2010, 437comparison of various revenues of,

2001–2009, 438global investment banking services,

498group risk-management

organizational architecturediagram, 458

internal control mechanisms of, 283internal environment of, 449investment bank business structure

case study, 437–440percentage of total income

attributable to investment bankingfor, 448

revenue structure, 2001–2009, 439revenue structure, 2010, 440sound corporate governance of, 281

Goldman Sachs Group, 421

Index 529

Goldstone Investment Ltd., 63Goodwill. See also Underwriter’s

goodwill empirical studyclassifi ed oversight and, 122historical performance of function of,

123–126of securities fi rms, fl otation and,

120–121shaping function of, 122–123

Governance structures, optimizing, inChina, 434

Governance structures of investmentbanks in mature markets, 422–430

board of directors, 427–429board of supervisors and

management, 429–430equity structure, 423, 426functional divisions, 430general framework diagram of, 431overview, 422–423

Government bond market, Chinese, 485–486

Government bonds, 26, 27issuance statistics (RMB in billions),

57Government debt to GDP ratio, China

compared with U.S., aggregateamount of, 485

Government initiatives, consumptioncontribution and, 9, 11

Government of Singapore InvestmentCorp., 88

Government regulation system, 410Great Depression (1930s), 175, 508

family business and partnershipduring, 416

investment banking in UnitedKingdom during, 403–404

“modern separation” phase in wakeof, 399–400

separated service model adopted inwake of, 407

Greenhill, 154Gross domestic product (GDP), 2

changes in, 3–5, 7, 9, 11

China-USA comparison (2011–2020), 4

per capita increase in China, 2000–2011, 1, 3, 5

relevancy between lending, stockmarket, and, 50

Growth Enterprise Market (GEM), 96, 352–353

Growth Enterprise Market (GEM)Board, 63, 66, 102, 251, 484

Guan, Jinsheng, 73Guan, Yawei, 67Guangdong Development Bank, 79Guangdong Securities, 37Guaranteed return risks, asset

management business of securitiescompanies and, 300–301

Guideline for Risk Control IndexDynamic Monitoring System of Securities Companies, 278

Guidelines for Oversight Basedon Consolidation of FinancialStatements in Financial AssetManagement Companies, 196

Guidelines on Dynamic Risk ControlIndicators Monitoring System forSecurities Firms, 198

Guidelines on the Participation in StockIndex Futures Trading by Securities Companies, 245

Guo, Haixing, 124Guo, Hong, 124Guohai Securities, 41GUOSEN Securities, 231Guotai security company, 29Guoxin, 503Guoyuan Securities, 41Gurley, J. G., 45

Hainan Securities, 36Haitong Kaiyuan Investment Co. Ltd.,

82Haitong Securities case study, 81–84

accounting treatment of loss, 84business valuation, 84

530 INDEX

Haitong Securities (continued)consolidation of fi nancial statements

and information disclosure, 83–84goodwill in reverse takeover deal,

83history behind, 81–82low-profi le reverse takeover deal-

making, 82–83Haitong Securities Corp. Ltd., 26, 33,

41, 63, 66, 73, 82, 158, 162, 212, 237

Hang Tang Wealth, 338Hantang Securities, 36, 115Haobuy Fund, 338Harbin Finance Securities, 27Hard control tools, 475Harmonious fi nancial investment

culture, creating, for mutuallybenefi cial outcome, 508–510

HBC, 401Hebei Securities, 37Hedge funds, 109, 111, 116, 117, 280,

315Hedging risks, with derivative

instruments, 300Hellwig, Martin, 45Hengxin Securities, 36Hepalink Pharmaceutical Co. Ltd. ,

rule breaking sponsor case study,381–386

Heparin sodium market, Hepalink caseand, 381–386

Heterogeneous fi nancial conglomerates(HFC), 170–172

HFT Investment Management Co. Ltd., 81

High-caliber personnel, human resourcemanagement and, 340–341

High-effi ciency operation, securitiescompanies and, 320

Hong Kong:Growth Enterprise Market in,

352–353sponsor duty system in, 358sponsor qualifi cations in, 355, 356

sponsor structure in, 354term of sponsors in, 357

Hong Kong Convoy Wealth Management, 338

Hong Kong Securities RegulatoryCommission, 352

Hong Kong Stock Exchange, 74, 90, 352

Hongpu, 67Hongyuan Securities, 29, 41Horizontal competition risks, for

brokerage business, 292–293Hostile takeovers, 110, 111HSBC, 177, 181, 403, 404, 421, 426,

469Hu, Bo, 62Hu, Xuyang, 123Huan, Guangyu, 67Huang, Chunling, 124Huang, Liang, 62Huang, Lin, 66Huang, Suxin, 62Huanghai Futures Co., 81Huarong asset management company,

195Huashang Futures. See Industrial

FuturesHuatai Securities, 41, 63, 66, 84Huaxia Fund Management Co. Ltd., 92Huaxia Securities, 29, 91Hubei Securities, 29Human capital, at core of competitive

strength in securities industry, 342“Humane” approach, thoughtful wealth

management services and, 334Human resource management, 317

“buyer’s market” of talent and, 342defi ned, 340development trend in securities

companies in future and, 342–344diversifi ed business categorization

and, 341high-caliber personnel and, 340–341high personnel mobility and double-

edge sword in, 341–342

Index 531

information, business competition, and, 342

theoretical frameworks for, insecurities companies, 344–347

Hybrid funds, 322Hypothecation services, 116, 118, 150,

161

Imports:in China (2000–2010), 8Chinese economic growth and, 5, 7,

10, 11Incentives:

sponsor’s duties and, 391–392wealth management business and,

331Income growth, for Chinese citizens

(2011–2020), 7Independent business model:

large investment banks andlimitations with, 181

private investment banks and, 182–184

small and medium-sized investmentbanks and, 180–181

Independent investment bank model, 170, 180–181, 197, 401

Independent investment banks, 416Independent securities fi rms:

differentiation and, 198–199multilevel, diversifi ed, 197–198strengths of, 501

Index control systems, 278Index management stage, Chinese stock

markets and, 353Industrial and Commercial Bank

of China (ICBC), 29, 53, 114, 164

Industrial and Commercial Bank of Shanghai, Jing’an Trust of, 26

Industrial Futures, 87Industrial Securities, 41Industrial Securities case study:

innovative transformation 1: fromshopkeeper to peddler, 85–86

innovative transformation 2: frompeddler to service provider, 86–87

lessons learned, 87robust management, 84–87

Infl ation-proofi ng:risk control and, 495wealth management and, 493

Information:business competition and essential

role of, 342recruitment quality control and, 344

Information communication, internalcontrol and, 451

Information disclosure:CSRC and, 53–54, 61–62strengthening, in Chinese investment

banks, 415Information disparity risks, direct

investment business and, 314Information dissymmetry theory, 45Information management talent,

326–327Information marketplaces, functions of,

97–99Information network, investment banks

and, 100Information technology (IT), 100, 466ING, 407Initial public offerings (IPOs), 99, 101,

102, 167, 168in China, 120–121investment banking business and, 220tunneling caused by, 24, 63, 66

Innovation, 238active, in business varieties for

Chinese securities companies, 472–473

in asset management business, 245–246

in brokerage commission business, 242–243

Chinese investment banks and pathto, 409–410

comprehensive, in securitiescompanies, 318–319

532 INDEX

Innovation (continued)core competitive strength and, 320,

321development of fi nancial markets

and, 488in Industrial Securities business

growth model, 87in investment banking business,

243–244investment banking history and

history of, 487in proprietary business, 244–245regulation and, 467in traditional business, 241–246undermotivated, at securities

companies, 67–68Innovative business:

client margin management and, 251–252

cultivation and growth of, 246, 249–253

direct investment and, 249–250major events in securities industry,

2011, 247–248“new third board” business and, 251risk management associated with,

307–316securities margin trading and, 246, 249stock index future business and, 250synergism between traditional

business and, 252–253Innovative business analysis, 227–232

direct investment, 227, 230–232securities margin trading business,

227–230stock index futures, 232–233

Innovative business revenues, of somesecurities companies, 238

Insider control, curbing, 475Insider trading, 66–67, 508, 509Institutional investors:

equity structure of investment banksand, 423, 426

shares held by, top fi ve investment banks in terms of total market value, 424

Insurance Act, 160, 167, 192Insurance holding company,

172Insurance services, wealth management

and, 331Integrated model, 105Integration, 155, 178, 180

endogenous forces driving investmentbanking to, 173

of global economy, talents and,321–322

investment banking and inevitabilityof, 173–176

Integrity, 509Interdisciplinary talent, 327–328

for both operation management andsecurities business, 322

description of, 327marketing service management talent,

327–328senior managers, 327

Interest rate risk-management methods, 461

Interest rate risks, 459Interest rates, future fi nancial reform in

China and liberalization of, 489Interest transmission risks, asset

management business of securitiescompanies and, 301

Interim Measures for the Stock Issuanceand Listing Sponsor System, 359, 369, 391

Interim Measures on Administration of Initial Public Offering and Listingon Growth Enterprise Board, 379

Interim Regulations for CorporateBonds Management (1987), 27

Interim Regulations of Shanghai forStocks (1987), 27

Intermediate regulation system, 411Internal audit division, 275Internal control:

control activities and, 449, 450–451culture and, in Chinese securities

companies, 475

Index 533

defi nition and objective of, 448fi ve factors of, 448–451, 453fi ve major ingredients of, 463improving understanding of systems

of, 474information communication and,

449, 451internal environment and, 449of investment banks in mature

international markets, 448–456, 458–459, 461–466

messages for Chinese securitiesmarket in terms of, 473–475

proprietary business and, 288–289risk assessment and, 449–450setting objectives in dynamic way for

different periods of time, 474spreading out equity and enhancing

foundation of, 475strategic goals for, in Chinese

securities companies, 474–475stringent, securities companies and, 320supervision and, 449, 451, 453what China can learn from

investment banks in matureinternational markets, 463–466

Internal Control Framework, 448Internal environment, internal control

and, 449Internal factors and profi t model, 206

capabilities and, 206, 209strategies and, 206, 209

Internally held shares, in top fi veinvestment banks in terms of totalmarket value, 426, 427

Internal management risks, inbrokerage business of securitiescompanies, 293

Internal motivation theory, 341International and domestic business,

developing in parallel, 473International Association of Insurance

Supervisors (IAIS), 171, 421International board, launch of, Chinese

stock market, 498

International customers, identifying, 239, 240

International Finance Center,239

International fi nance center, in China,driving force behind emergence of,480–482

International horizons, developing, 21Internationalization:

of capital market, promoting, 240of Chinese economy, 321Chinese investment banks and, 410of CITIC Securities, 259future of Chinese securities fi rms and,

480investment banks and, 155

Internationalized fi nancial services, forces driving demand for, 238

Internationalized vision, internationaldemand giving rise to, 238–239

International Organization of SecuritiesCommissions (IOSCO), 170–171, 420

Internet, 344banking industry and, 155–156wealth management services and,

495Introducing broker (IB) business, 232,

233Investment Advisor Act, 411Investment bank associations, 411Investment banking:

average market IPO fi nancing amount2008–2010 and quarters 1–3, 2011, 222

categories in, 147global services in, 498–499inevitability of integration in,

173–176innovation in, 243–244market IPO fi nancing structure 2008–

2010 and quarters 1–3, 2011, 221profi t methods of, 219–222relative importance of tacit and

technical skills for, 101

534 INDEX

Investment banking (continued)revenue of publicly listed securities

traders’ underwriting business2007–2010, quarters 1–3, 2011, 220

revenues of publicly listed traders’s securities underwriting businessand its percentage in total revenuequarters 1–3, 2011, 223

types of management models in, 170Investment banking business of

securities companies:compliance risks and, 296early-stage project implementation

capability for, 298fl exible pricing and selling models,

298–300hedging with derivative instruments,

300improving internal architecture of,

297–298internal control design step

optimization, 298issuance underwriting risks and,

296–297management of risks associated with,

295–300sources of risk for, 296

Investment banks, 96. See alsoRegulation of investment banks;Risk management of investmentbanks; Securities companies;Securities fi rms

American, infl uence of marginfi nancing on leverage in, 115–118

changes in organization andmanagement in, 1980–2007, 155–156

determinants of organization andmanagement of, 150–152

distribution in global investmentbanking and (2010), 157

in economically developed countries, as inspiration for China,408–410

fi nancial holding companies andcompetitiveness in, 184–185, 188–189

functional orientation of, 147–150in Germany, evolutionary history and

structural patterns of, 405–407Glass-Steagall Act and, 144, 148, 149,

153information marketplace around, 148information network and, 100institutional positioning and business

activities of, 151–152in Japan, evolutionary history and

structural patterns of, 407–408levels in defi nition of, 397–398liquidity and, 190management models of, 152–155separation of activities and, brief

survey of, 146–147in United Kingdom, history and

structural patterns of, 403–405in United States, history and

structural patterns of, 398–403Investment banks in mature

international markets:business structure of, 435–448characteristics of, 430–431development history of, 397–410evolution of, 457internal control of, 448–466organizational structure of, 416–434regulation and, 410–415what China can learn from

development of, 467–475Investment banks (U.S.) and fi nancial

crisis of 2008:defi ciencies in corporate governance

mechanism, 280overly concentrated asset allocation,

280–281speculation, leverage, and explosion

of risks for, 280Investment Company Act, 411Investment consultancy service, 243Investment counseling business, 325

Index 535

Investment plans, wealth manager andsupervision of, 333–334

Investment research talent, 322–324Investments:

in China, 2000–2010, 8Chinese economic growth and, 7, 10,

11Investors, equal treatment of, 307Investors, managing opening of margin

account for, 309–311IPO companies, goodwill of

underwriters and performance of, 123–126

IQ Financial Systems, 462“Irresponsible fi nancing” stigma,

removing, 510Issuance channels, 234Issuance price, innovations in, 244Issuance underwriting risks, investment

banking business and, 296–297Issuer expectation management,

strengthening, 299Issuers, specifying rights/responsibilities

between sponsors and, 393Italy, intermediate regulation system in,

411

Japan:evolutionary history and structural


fi nancial holding companies in, 185fi nancial holding company model in,

421government regulation system in,

410Japanese Model, of investment banks,

154–155Jia, Quan, 62Jianqiao Securities, 37Jiashi Fund, 338Jintong Securities, 91Job hopping, 341–342, 506J.P. Morgan, 181, 401, 402, 403, 416,

461, 482

J.P. Morgan Chase, 117, 118, 148, 149,150, 421, 498

Jun’an Benefi t, 76Jun’an Property Management Co., 77Jun’an Securities case study, 76–78

coup, 76–78early glory, 76lessons learned, 78

Junan Securities Co. Ltd., 29, 33Junk bonds, 110, 485Junk tranches, 106, 107

Kiamusze Securities, 36Kidder Peabody, 420Knowledge-enhanced services, 156Korea, fi nancial holding companies in,

185Kracaw, William, 45KTV company, 461Kuala Lumpur Stock Exchange, 351Kunlun Securities, 37

Lazard, 100, 154Legal environment for securities

companies, improving, in China, 434Legality principle, in regulation of

investment banking, 414Legal person’s property right, publicly

held companies and, 418–419Legal risks, brokerage business of

securities companies and, 294Lehman Brothers, 145, 149, 176, 181,

267, 280, 404, 419, 447, 450, 474, 498

business categories of, 445collapse and bankruptcy of, 96, 106,

118, 279, 281, 401, 444, 449, 454comparison of various revenues of,

2001–2007, 445investment bank business structure

case study, 444–447percentage of total income


revenue structure of, 2001–2007, 446

536 INDEX

Leland, Hayne, 45Lending, relevancy between GDP, stock

market, and, 50Leveraged buyouts, 109, 110Lewis Turning Point, approach of, 240Li, Xiaoming, 62Li, Xue, 62Li, Xuli, 66Lian, Yan, 378, 381Liaoguo Securities, 75Liaoning Securities, 36License system, independent securities

fi rms and, 199Lifelong sponsor system, U.K. Alternative

Investment Market, 349–350Lifelong sponsor terms, implementing,

391Limited liability companies, 419Limited partners, 417Lin, Tao, 62Liquidation line of client’s account,

monitoring, 311Liquidation notifi cation, 311Liquidation scope, 311Liquidation timing, 311Liquidity:

of equity, in mature internationalmarkets, 426

fi nancial products innovation and, 488

guaranteed, future of Chinesesecurities fi rms and, 481

investment banks and, 190Liquidity risks, 269, 272

direct investment business and, 313investment banks and, 453, 455

Listed brokerages, 19Liu, Baochun, 67Liu, Jianghui, 124Liu, Xiaoliang, 124Liu, Xuyang, 378, 381Lloyds TSB, 421Lock-up period, 300London Securities Exchange, 352, 356,

404

London Stock Exchange, 349, 358“Lone wolf” approaches, avoiding, in

Chinese securities companies, 464, 465

Lu, Rong, 62Luo, Wei, 124

Ma, Qiang, 385M&A Advisory Service, 100, 101Macroeconomic policies, profi tability

models of securities companies and, 208

Magnitude, motivation and, 340–341Main Board, in China, 484Malaysia:

MESDAQ market in, 351–352, 354sponsor structure in, 354term of sponsors in, 357

Malpractice in investment operationrisks, asset management business of securities companies and, 301

Management, core competitive strengthand, 320, 321

Management model, phases in, 143Management Regulations for Special

RMB Shares (B Shares), 28Mao, Youhua, 381Margin fi nancing on leverage, American

investment banks and, 115–118Margin insuffi ciency risks, stock index

future business and, 312Margin trading, 488Margin trading account risk control,

310Market environment:

external factors, profi t model,and, 206, 207–208

investment banks and, 151Marketing, differentiated, 503Marketing service management talent,

327–328Marketization, emerging private

securities fi rms and, 199Market liquidity, guaranteed, future of

Chinese securities fi rms and, 481

Index 537

Market maker transactions, inAmerican investment banks, 447

Market-oriented fi nancial system, 482Market positioning, differentiated, 503Market risk, 268–269, 272, 459, 461

asset management business of securities companies and, 302

investment banks and, 453–454securities margin trading and, 309

Market speculations, securities margintrading and, 309

Mature international markets:business structures of investment

banks in, 435–448development of investment banks in,

397–410internal control of investment banks

in, 448–466investment bank regulation in,

410–415organizational structures of

investment banks in, 416–434what China can learn from

development of investment banksin, 467–475

McKinley model, 461Measures for the Administration of

Initial Public Offering and Listingof Stocks, 369

Meiji Reform, in Japan, 408Meilun, 182Memorandum on Cooperation and

Separation of Duties in FinancialRegulation, 171–172

Merchant banks, in United Kingdom, 398, 403, 404

Merchants Securities, 222Mergers and acquisitions (M&A), 471,

493, 499Chinese securities fi rms and, 19,

49–50, 110–111global, 109, 498, 500Merrill Lynch model and, 401promoting restructuring of services,

506–507

securities fi rms and services in, 108–111

of U.S. investment banks in the1980s, big events tied to, 418

Merrill Lynch, 145, 149, 170, 176, 181, 209, 267, 335, 401, 403, 447, 454, 470, 482. See also Bank of AmericaMerrill Lynch

comparison of various revenues of, 2003–2006, 443

investment bank business structurecase study, 442–444

percentage of total incomeattributable to investment bankingfor, 448

revenue structure, 2003–2006, 444three parts in business of, 443

Merrill Lynch Investment Managers(MLIM), 111

Merrill Lynch model, 400, 401Merton, Robert C., 45, 46MESDAQ market, in Malaysia,

351–352, 354Mezzanine tranches, 106, 107Mianyang Scientifi c and Technological

City Industrial Fund, 232Middle class:

population in China, 335–336wealth management market for, in

China, 495Milken, Michael, 110Millionaires, in China, 336Minan Securities, 36Minfa Securities, 36, 114Mingly Holdings Ltd., 88Misappropriation of clients’ security

deposits:case study of, 114–115Chinese depository system reform

and, 118–120before overall improvement initiative,

190by securities fi rms and industry-wide

crisis, 113–114statistics on, 116

538 INDEX

Mishkin, Frederic, 45Mississippi Bubble, in France, 508Mixed companies, 416, 418, 422Mixed-operation banks:

in Germany, 405system risk and, 454in United States, end of, 399–400

Mixed operation in fi nancialinstitutions:

dominant position of, 470modern fi nancial holding companies

and, 420Mizuho group (Japan), 421Mizuho Holdings, 177Mobile terminals, wealth management

services and, 495Mobility of personnel, human resource

management and, 341–342Model risks, 462“Modern mixing” phase, for investment

banks in United States, 400Moral hazard, 123, 501Moral risks, prevention of, 316Morgan, John, 108, 109Morgan Consortium, 109Morgan Stanley, 89, 96, 105, 110, 112,

144, 148, 149, 170, 176, 185, 279, 398, 401, 402, 403, 416, 423, 447, 500

business structure case study, 440–442comparison of various revenues of,

2001–2009, 441global asset management and, 498Global Wealth Management Group,

497group risk-management

organizational architecturediagram, 459

organizational structure of, 440percentage of total income


revenue structure, 2001–2009, 441Morgan Stanley International Corp.,

87–88

Morgan Stanley Model, 153–154Mortgage-backed securities (MBS), 106,

279–280Motivation, defi ned, 340Multilateral netting, 113Multilevel, diversifi ed independent

securities fi rms, 197–198Multiservice banks, in Germany, 405,

406Multiservice model, advantages and

disadvantages of, 406–407

Nanfang Securities, 29, 36NASDAQ market, in United States,

350–351, 354National income, distribution of (2000–

2010), 6, 7National People’s Congress, 192National Planning Committee (CSRC),

104National Statistics Bureau, 335NatWest Group, 421Net asset regulatory system, in wake of

2008 fi nancial crisis, 283Net capital, 188Net Capital Calculation Standards for

Securities Firms (CSRC), 188Net capital regulatory system, for

Chinese securities companies, 283Netherlands, 407New Fortune Award, 323“New third board” business, innovative

business and, 251New York Stock Exchange, 417, 419Noah Wealth Management, 338, 339Nomination committee, board of

directors in investment banks and, 427, 431

Nomura Securities, 73, 181Noneffi ciency theory, in Chinese stock

market, 62Nonlisted brokerages, 19Normalized development phase of

Chinese securities companies, (2005–2011), 38–39, 41

Index 539

Northeast Securities, 212, 214revenues structure 2007–2010 and

quarters 1–3, 2011, 214

Occupy Wall Street protest movement,508, 510

One system framework, for humanresource management in securitiescompanies, 344–345

Operation division general managers, in wealth management business, 330–331

Operation effi ciency, improving, inChina, 434

Operation risks, 269, 272, 282, 453, 455–456

Option pricing model, 459Options, 101Organizational forms of investment

banks in mature markets, 416–422evolution of, 422family business and partnership,

416–417, 422mixed companies, 416, 418, 422modern fi nancial holding companies,

416, 420–422publicly held companies, 416,

418–420, 422Organizational structure:

of investment banks in matureinternational markets, 416–434

messages for Chinese securitiescompanies in terms of, 469–470

Orient Securities, 246OTC market:

focus on development of, 472strengthening regulation of, 468–469

Overseas securities companies, riskmanagement for, 270–271

Over-the-counter (OTC) derivatives,global, notional amount of, 107, 108

Pacifi c Securities, 41Pan-banking characteristics, in Chinese

fi nancial institutions, 235

Paris School of Business, 204Partnership model, 143Partnerships:

employee cohesion, loyalty, and, 100features of, 417, 422investment banks and, 182–184

Patent status, in Suzhou Hengjiu Photo-Electronic Science case study, 379, 380

People’s Bank Act (1995), 160, 167People’s Bank of China (PBC), 26, 27,

28, 29, 34, 77, 158, 161, 179, 432People’s Insurance Company of China

(PICC), 114Performance assessment, in securities

companies, 347Performance evaluation of employees,

in cyberspace, 344Persistence, motivation and, 340, 341Personnel mobility rate, 341–342PetroChina, 89Pet services, wealth management and, 332Philippines, government regulation

system in, 410Pilot Implementation Scheme for an

Open Market for the Transfer of Treasury Bonds, 74

“Piloting before spreading” policy, ininnovation business, 308

Ping’an, 503Ping An Group, 164, 165, 432Pledge ratio of client’s account,

monitoring, 311Policies, external factors, profi t model,

and, 206, 208–209Policy risks, 269–270, 282, 294Portfolio management, 493, 495Post-depression “modern separation”

phase, for investment banks inUnited States, 399–400

Preliminary phase of Chinese securitiescompanies:

infancy phase, 1987–1990, 26–27quick startup phase, 1990–1995, 26,

27–29

540 INDEX

Prescott, Edward, 45Price bargaining, 493Price expectations, reasonable,

investment banking business and, 298–299

Price-limit mechanism, market risksand, 309

Price-related information, covenantsand, 97, 99

Pricing power, future of Chinesesecurities fi rms and, 481–482

Pricing risks, stock index futurebusiness and, 312

Primary clearing, 113Primary crossover stage in Chinese

securities fi rms (1987–1994), 158–159brokerage, issuance, and proprietary

trading (1990–1994), 158, 159brokerage phase (1987–1990), 158, 159

Prime brokerage, 116, 117, 118Principal guaranteed funds, 322Principles on Supervision of Financial

Holding Companies, 420Privacy, wealth management and, 334Private equity (PE) funds, 109Private funds in China, “2–20” model

and, 316Private investment banks, independent

business model and, 182–184Private securities fi rms:

emerging, marketization and, 199fair and equitable treatment principle

and, 200growth of, regulators and conditions

for, 200–201sound regulatory policy framework

for, 199–200“Privilege abolishing” measures, 300Product creation function, fi nancial

system and, 45, 46Product differentiation, 503Product innovation:

asset securitization and, 489securities fi rms and, factors related

to, 487subsidiaries and, 489–490

Product line analysis, in wealthmanagement environment, 336–337

Product pricing, future of Chinesesecurities fi rms and, 481–482

Professional talent:categories of, 322chartered fi nancial analysts,

324–325description of, 322high-caliber, in Chinese securities

market, 322–327information management talent,

326–327investment research talent,

322–324risk management talent, 326sponsor representatives, 324wealth managers, 325

Profi tability:continuous growth in securities

companies and, 320tying to duties performed by a

sponsor, 391–392Profi tability model of securities

companies:background and signifi cance of

studies on, 204–205channelized, 234characteristics of, 234–237differentiation of, among securities

traders, 237–241fundamental changes in, 318for investment counseling services,

325meaning of, for securities companies,

205–206new, construction of, 237–246,

248–253pan-banking characteristics, 235reasons for special nature of,

204–205signs of a transition in, 237of third-party wealth management

fi rms, 338–339

Index 541

uniformity, 235–236varying service capabilities and

overall need for improvement, 236–237

wealth management and cleardefi nition of, 329

Profi tability structure of Chinesesecurities companies, 210–218

enterprise scale and effect on, 212, 214–215

geographical distribution of sampledcompanies, 216

location and effect on, 215–218overall structure, 210–212percentage revenue structures in

different regions, quarters 1–3, 2011, 218

publicly listed securities companies byprovince, 215

revenue structure of publicly listedsecurities traders, quarters 1–3, 2011, 210

revenue structures in differentregions, 2007–2010 and quarters1–3, 2011, 217

revenue structures of publicly listedsecurities traders, 2007–2010, andquarters 1–3, 2011, 211

revenue structures of publicly listedsecurities traders, quarters 1–3, 2011, 213

revenue structures of publicly listedsecurities traders 2007–2010, andquarters 1–3, 2011, 212

sources of profi t, 210total revenues in different regions

2007–2010 and quarters 1–3, 2011, 216

Profi t fl uctuation risks, directinvestment business and, 313

Profi t maximization, guiding, withinlegal and ethical framework, 509

Profi t methods of securities companies, 206, 218–233

asset management business, 222–225

brokerage commission business, 218–219

investment banking business, 219–222

proprietary business, 225–227Profi t models:

factors affecting, 206–209old-fashioned, in Chinese securities

companies, 71peculiarities in Chinese securities

companies, 203unquestionable importance of,

203Profi t structure, of securities company,

205–206Progress, employees and sense of, 341Project fi nancial risks, issuing, 297Project risks, investment banking

business and, 296Property right entities, promoting

diversifi cation of, 475Proprietary business:

innovation in, 244–245internal control management system

for, 288–289profi tability model for, 225–227publicly listed securities traders’

revenues from, fi rst three quarters,2011, 226

revenues of publicly listed securitiestraders from, 2007–2010 and fi rstthree quarters, 2011, 227

risk-management system for,288–290

risk-monitoring reports for, 290risk oversight for, 289risk warning and real-time

monitoring systems for, 289–290uniformity and, 235

Proprietary trading, 147, 149Provisional Regulations on Intermediate

Business of Commercial Banks(2001), 179

Provisional Regulations on theOversight and Management of Securities Financing Business, 228

542 INDEX

Provisions for Trial Implementation of the Compliance Management of Securities Companies, 273, 274

Public (government) credit, 191Public International Ltd., 74Publicly held companies, 416, 418–420,

422U.S. investment banks going public

1970s–1990s, big events tied to, 419Punishment for rule-breaching

sponsors:analysis of, by regulatory measures, 370analysis of annual frequency of

punishments against sponsors, 370analysis of market boards of

breaching sponsors, 370analysis of sponsor institution and

representative credit regulation byregulatory measures, 370

by CSRC, 359, 369, 370, 373Hepalink case, 381–386improving mechanism for, 389–390Suzhou Hengjiu Photo-Electric case,

378–381tougher penalties and, 394

Purchasing power parity (PPP), globalGDP based on (2010), 496

Pyle, David, 45

QDII pilot program, 498Qian, Xiao’an, 190Qin, Chijiang, 62Qualifi ed Domestic Institutional

Investor (QDII) funds, 322Quantitative analysis of talent

demand, in wealth managementenvironment, 335

Quantitative risk-management method,271

Quasi-investment banks, partnershipsand, 182, 183

Quick startup phase of Chinesesecurities companies:

major features of, 27preliminary formation of separated

regulation model, 27, 29

rapidly expanding stock market and, 27–28

sharp rise of securities companiesand assets under management, 27, 28–29

Quiet periods, setting, 307

Quota management stage, Chinesestock markets, 353

“Rat trading,” 66–67, 508, 509Real estate counseling, wealth

management and, 332Recruitment, human resources and,

344Refi nancing companies, introduction

of, 249Reform. See also Chinese fi nancial

system reform; Future reform inChinese securities fi rms; Sponsorsystem reform

of Chinese depository system, 118–120

of sponsor system, direction for,390–394

Regulation of investment banks:categorization of international

systems of, 410–411in United Kingdom, 412–413in United States, 411–412what China can learn from overseas

systems of, 414–415Regulation(s), 34

China’s accession to WTO and, 168of Chinese fi nancial holding

companies, 179classifi ed, post-purge policy

environment characterized by,271–272

of commercial banks, 470concurrence of separation and

crossover and, 161on derivatives, strengthening,

467–468of direct investment business,

230–231

Index 543

of fi nancial holding companies, 172innovative business of securities

companies and, 307–308insider trading and, 66main management measures and, in

securities industry, 30–31of OTC market, strengthening,

468–469primary formation model in securities

industry and, 29for private security fi rms, 199–201references for, in Chinese securities

market, 467in securities industry (2005–2011), 40strict separation of activities and, 160

Regulations for Administration of Clients’ Trading and SettlementFunds (2002), 38

Regulators:ambiguous rights and responsibilities

between sponsors and, 389specifying rights/responsibilities

between sponsors and, 393Regulatory indexes, 278Regulatory system, investment banks

and, 151Relay sponsor system, MESDAQ

market in Malaysia, 351–352, 357Reload option models, design of, for

asset management business, 304Remuneration committee, board of

directors in investment banks and, 427, 431

Renaissance Technologies, 117Renminbi (RMB):

Chinese government bonds and, 485internationalization and, 496, 498liberalization of, 489

Republic of Korea, governmentregulation system in, 410

Reputation management, 99Research and investment consultancy

business of securities companies:confl ict of interest risks, 305–306ensuring independency, measures for,

306–307

management of risks associated with, 305–307

other behaviors in violation of lawsor duty of care, 306

Research division, in investment banksin mature international markets, 430

Research teams, building up, 299

Resource input analysis, in wealthmanagement environment, 337

Restructuring, going public after,471

Retail investment services, 101Revenue from investment banking, 72Rhine Wealth, 338Riley, Karen, 384Rio Tinto, 498Risk, coordinated management of,

284Risk accountability, 282Risk-adjusted return on capital

(RAROC), 271, 278, 279, 285, 286, 461

Risk allocation system, Chinesesecurities fi rms and activity in threetiers of, 491–493

Risk assessment, 449–450, 463

Risk-based performance evaluation, 278–279

Risk book model, 462Risk control, Chinese securities fi rms,

global wealth management, and, 495Risk-control committees, 274Risk control feedback, securities

proprietary business and, 290Risk Control Indicators-Based

Regulatory Measures for SecuritiesFirms (CSRC), 188, 198

Risk-control management KPI, forbrokerage business for securitiescompanies, 295

Risk-control system, for proprietarybusiness of securities companies, 288

544 INDEX

Risk disposal capacity, swift and effective, 20

Risk disposition, 282, 290–291Risk diversifi cation, Chinese securities

fi rms and, 491Risk fi ltering, 23Risk fi ltration function, fi nancial system

and, 44–45, 46Risk hedging, Chinese securities fi rms

and, 493Risk identifi cation, for Chinese

securities companies, 474–475Risk IQ model, 462Risk levels, fi nancial holding companies

and, 185Risk management, 271–279

analysis of, in Chinese securitiescompanies, 267–316

for asset management business of securities companies, 300–305

for brokerage business of securitiescompanies, 291–295

business innovation risk management, 277

Chinese securities fi rms and soundsystem of, 490

compliance management systems and, 273

comprehensive, 268, 281–282construction of risk-management

organizational systems, 274–276for direct investment business of

securities companies, 313–316for innovative business of securities

companies, 307–316internal control of investment bank

and, 463for investment banking business

of securities companies, 295–300

major functions of, 326managing sum of risks in wake of

2008 fi nancial crisis, 283–284post-purge policy environment for,

271–273

for research and investmentconsultancy business of securitiescompanies, 305–307

risk-control systems, 272–273risk-management philosophy and

compliant operation awareness, 273–274

risk-management system and process, 276–277

scientifi c concepts of, establishing inChina, 474

in securities companies post fi nancialcrisis, 279–280

securities fi rms and stringentmechanisms of, 20

for securities margin trading, 308–311

for securities proprietary businesses, 286–291

sources of risk facing securitiescompanies, 268–270

status quo and trend analysis of, insecurities companies, 268–286

for stock index futures business, 311–312

strategic planning for, 285third-party wealth management fi rms

and, 339utilization of risk-monitoring

techniques, 278–279Risk-management architecture, 275,

466Risk-management committee, board of

directors in investment banks and, 427–428, 431

Risk-management methods of investment banks:

major risk-management techniquesand methods, 458–459, 461–462

risk-management processes, 458, 460Risk-management models, intrinsic

fl aws of, 462Risk management of investment banks,

453–456, 458–459, 461–466credit risks, 453, 454–455

Index 545

liquidity risks, 453, 455market risks, 453–454operational risks, 453, 455–456operation risks, 453, 455risk-management architecture,

ingredients in, 456–458system risks, 453, 454

Risk management of overseas securitiescompanies, 270–271

advanced risk-management concepts, 270

design-rigorous risk-managementsystems, 271

quantitative risk-managementmethod, 271

well-rounded organizational structurefor, 271

Risk-management system and process:client fund safeguard systems, 276compliance management system, 276insuffi cient coverage of risk

management, 277risk-monitoring system, 277standardized brokerage business and

operation outlet management, 276Risk-management systems, for

proprietary business of securitiescompanies, 287–291

Risk-management tactics, strategic, 285–286

Risk-management units, 274Risk managers, 326Risk-measurement models, limitations

of, 282–283Risk-monitoring reports, for

proprietary businesses, 290Risk-monitoring system, description of,

277Risk-monitoring techniques, utilization

of, 278–279Risk monitor model, 461Risk portfolios, based on assets

appreciation, 46Risk prevention, core competitive

strength and, 320, 321

Risk pricing, Chinese securities fi rmsand, 491–492

Risk regrouping, Chinese securitiesfi rms and, 492–493

Risk reports, 282Risk signals, gathering and processing,

289Risk-structured products, Chinese

securities fi rms and, 492Risk supervision, strengthening, in

Chinese investment banks, 415Risk tolerance, 332Risk transfer:

Chinese securities fi rms and, 492for proprietary businesses,

implementation of, 290–291Risk warning and monitoring system,

for proprietary business of securities companies, 289–290

Risk watch model, 461Road show promotion, 299Robustness principle, 475Rothschild, Geely’s Volvo acquisition

managed by, 498Rothschild family, 403Royal Bank of Scotland, 404, 407, 413Rules for the Establishment of Foreign-

Shared Securities Companies(2002), 38

Runaway business scale risks, securitiesmargin trading and, 308

Sachs, Samuel, 416Safe operation, securities companies

and, 320Salaries, investment talents and, 323Sales teams, building up, 299Salomon Smith Barney, 401, 449, 454Sandler, O’Neill, 154Santomero, A. M., 46Savings deposits, of Chinese urban and

rural residents, 325Scenario analysis, 271, 461Scholes, M., 45Scholtens, B., 46

546 INDEX

Schroders, 402, 404Schwab, 105Scientifi c management, securities

companies and, 320Scientifi c profi t models, establishing,

311Secondary clearing, 113Secondary market, proprietary business

in China and, 226Secondary market trading, 100–101Second World War. See World War IISEC Rules for Asset-Backed Securities,

106Securities Act (1999), 118, 160, 167,

178, 179–180, 192, 197, 411Securities and Exchange Commission

(SEC), 351, 411–412Securities Association of China (SAC),

145Securities-based funds, 322Securities brokerage, 104Securities companies. See also

Investment bankseffective talent management in,

339–347fundamental functions of, 23in Japan, 407–408

Securities Companies Classifi edRegulation Guideline (“theguideline”), 272

Securities companies in China:administration and rectifi cation phase

of, 2001–2005, 35, 38basic profi les of (in billion RMB), 41birth and growth of, 25–29, 32–35,

38–39, 41broad international perspective and,

20–21capital strength and, 19changes in number of service outlets

and (1996–2004), 33expansion in scale and diversifi cation

of, 24factors determining competitive edge

of, 18–21

fast-development phase of, 1996–2001, 32–34

four important stages of, 23growth traits of, 43–44hard-to-replicate core competitiveness

and, 20high growth prospects in the future,

43, 44income structure variations within, 42infancy phase of, 1987–1990, 26–27normalized development phase of,

2005–2011, 38–39, 41passiveness of development, 43–44phases in management model of, 143phasing characteristic of development

of, 43preliminary phase of, 1987–1995,

26–29products creation and asset pricing

function and, 45–46quick startup phase of, 1990–1995,

26, 27–29risk fi ltration function and, 44–45risk portfolios based on assets

appreciation and, 46stringent risk-management and, 20subordinate position in fi nancial

system, 43, 44theoretic and practical judgment

based on functions of, 43wealth management products

statistics for, 60Securities Companies Risk-Management

Capability Evaluation Indexes andStandards, 272

Securities Company Internal ControlGuide, 475

Securities credit trading, 227Securities Exchange Act, 411Securities Exchange Association (UK),

413Securities exchanges, 411Securities fi rms. See also individual

fi rmsabilities needed by, 1

Index 547

asset securitization and, 106–108direct fi nancing and, 480factors related to product innovation

and, 487functional orientation for, 101–102,

104–113functions of, 97–99long history of, 96reputation management for, 99understanding China’s economic

trends from perspective of, 1–11Securities Firms Classifi cation

Regulations, 198Securities fi rms in China, 156–162, 164,

166–169change of activities in organization

and management in, 157–162, 164classifi ed oversight and impact on,

121–122concurrence of separation and

crossover (since 2000), 158, 161–162, 164

impact of, as public companies, 120–121

internal logic for organizational andmanagement evolution in, 164, 166–169

primary crossover (1987–1994), 158–159

strict separation of activities (1995–1999), 158, 159–161

Securities holding company, 172Securities industry:

core competitive strength in, 318, 319–321

demand for talents in development of, 321–328

development trends in, 317–319redeeming honor of, 509–510restructuring in, 501structural adjustment period within,

307–308talent-intensive nature of, 340

Securities Industry and FinancialMarkets Association (SIFMA), 67

Securities Industry Council (UK), 413Securities industry in China, evolution

of total assets, business revenue, and net profi ts in, since 2008, 42

Securities Investor Protection Act, 411Securities Law, loosening interpretation

of, in U.S., 400Securities Law of the People’s Republic

of China, 34, 369, 378, 432Securities margin trading, 39, 227–230

clarifying risk liabilities, 311credit risks, 308, 309features of, 228growth of, 229innovative business and, 246, 248integrated utilization of various risk-

control measures, 311management of risks associated with,

308–311managing opening of margin account

for investors, 309–310managing securities trader margin

trading limits, 310margin trading account risk control,

310market risk, 309runaway business scale risks, 308standardizing forced liquidation

system, 311volume of, 229

Securities market litigation system, improving, 390

Securities proprietary business riskmanagement, 286–291

construction of risk-managementsystems, 287–288

description of, 286major sources of risks, 286–287risk-control systems, 288

Securities Regulatory Commission, 385, 388

Securities subsidiaries of fi nancialholding groups, strengths of, 501

Securities Supervision Commission, 232

548 INDEX

Securities trader margin trading limits,management of, 310

Securities traders, top-fi ve, in termsof number of investment bankingprojects since 2006, 256

Securities Trading AutomatedQuotations System (STAQ), 27

Securities Trading Law (1948), inJapan, 408

Securities underwriting:Chinese brokers’ net income from,

102, 103top 10 investment banks regarding

revenue from, 103uniformity and, 235

Securities underwriting services, consolidating, 506

Securitized banking systems, 149, 150Security, wealth management and,

334Security Firms Regulations and

Regulatory Measures, 197Self-regulation system, 410–411,

412–413Senior managers, 327Senior tranches, 106–107Sensitivity analysis, 278Separated service model, Great

Depression and adoption of, 407Separate operation, modern fi nancial

holding companies and, 420Separation of activities principle, 160,

167, 172, 174, 177, 179, 180fi nancial holding company model,

crossover, and, 177–179regulatory coordination mechanism

and, 197underwriting of corporate debentures

and, 484Separation phase, for investment banks

in United States, 399Service capability analysis, in wealth

management environment, 337–338Service differentiation, 503Service profi tability model, 241

Service quality, enhancing, securities companies and, 320

S/F:fl uctuation of, 13, 15, 16predicted values of (2011–2020), 16,

17S/G, 11

fl uctuation of, since 1990, 13, 14predicted values of (2011–2020), 16,

17rise of, 12–13

“Shadow banking” system, 149, 338, 339

Shangfang Group, 182Shanghai Asian Business Investment

Consulting Co. Ltd., 182Shanghai Feilo Acoustics Co. Ltd., 26Shanghai Finance Securities, 27Shanghai International Group, 164, 165Shanghai International Trust and

Investment Corp., 73Shanghai Stock Exchange, 27, 28, 74,

75, 76, 82, 90, 159, 228Shanghai Stock Market, 28, 166Shanghai Yanzhong Industrials Co.

Ltd., 26Shanghai Zulong, 67Shanxi Securities, 41Share price index futures (SPIF), 39, 41Shaw, E. S., 45Sheaxson, 420Shenyin and Wanguo Securities Co., 72Shenyin Securities, 26, 158Shenzhen Exchange, Hepalink share

prices on, 381, 382Shenzhen Hemu Investment Co., 77Shenzhen Heneng Real Estate

Development Ltd., 76, 77Shenzhen Minyifu Industrial Co., 77Shenzhen Securities, Inc., 26Shenzhen SEZ Securities Co., 120, 145,

158Shenzhen Stock Exchange, 76, 228

AOM bidding system of, 28inauguration of, 27, 28, 159

Index 549

Shenzhen Stock Market, 166Shenzhen Taidong Industrial Co. Ltd., 77Shenzhen Xinchangying Investment and

Development Co. Ltd., 77Short selling, 488, 507Signifi cance, employees and sense of,

341SinoLink Securities, 41Small- and Medium-Sized Enterprise

(SME) Boards, 63, 102, 251, 471, 484

Smith, C. W., 45Social assets, idle, Chinese securities

fi rms and activation of, 49–51Social wealth, increasing, 508–509Soft control tools, 475Solomon, 177Soochow Securities, 253, 254Soochow Securities case study, 260–264

asset management business, 263, 264distinctive features, 260distribution pattern of proprietary

business, 261investment business, 263IPOs sponsorship, 263percentage of return-from-investment

in total revenue in, 263percentage of securities brokerage in

total revenue in, 262percentage of securities investment

banking in total revenue in, 262total transaction volumes, in

Soochow Region, since 2006, 261Southern Securities, 72–73, 118Southern Securities Corp. case study, of

misappropriation of client securitydeposits, 114–115

Specialized investment banks model, 154

Special purpose banks, 159, 166, 167Special purpose vehicle (SPV), 106Specialty services, launching, in China,

473Speculation in markets, securities

margin trading and, 309

Split-share structure reform, 499Sponsor credit regulations:

list of, by market boards, 374–376list of, by regulation measures,

371–372list of, by years, 377

Sponsor credit regulatory breaches, 360–368

Sponsor duty system, in variouscountries, 357–358

Sponsor institution credit regulation, list of, by regulation measures, 373

Sponsor institutions:ambiguous rights and responsibilities

between other intermediaryinstitutions and, 389

ambiguous rights and responsibilitiesfor, 387–388

specifying rights/responsibilitiesbetween other intermediaryagencies and, 393–394

specifying rights/responsibilitiesbetween sponsor representativesand, 392–393

Sponsor qualifi cations:absolute independence, 356accession criteria, 356complete internal control

mechanisms, 355–356requirements in terms of investment

bank business experience, 355rich experience in industry and

complete business board, 355in various countries, 355–356

Sponsor regime for Chinese securitiescompanies, 349–394

direction for reform in, 390–394imbalance between profi t and risk in,

386–390origin and development of, 349–358punishments imposed by CSRC on

rule-breaching sponsors, 359, 369–370, 373, 378

rule-breaking sponsor-case studies, 378–386

550 INDEX

Sponsor regimes in overseas securitiesmarket, 349–353

Hong Kong Growth EnterpriseMarket: system of decomposedsponsor roles, 325–353

Malaysia MESDAQ market: relaysponsor system, 351–352

U.K. alternative investment market:lifelong sponsor system, 349–350

U.S. NASDAQ market: assortedsponsor system, 350–351

Sponsor representative creditregulation, list of, by regulationmeasures, 373

Sponsor representatives:ambiguous rights and responsibilities

for, 387–388specifying rights/responsibilities

between sponsor institution and, 392–393

trends in fl ow of, 324Sponsors:

ambiguous rights and responsibilitiesbetween issuers and, 388

ambiguous rights and responsibilitiesbetween regulators and, 389

fraudulent listings and, 387incompetence of, 386reducing turnover frequency, 506specifying rights/responsibilities

between issuers and, 393specifying rights/responsibilities

between regulators and, 393unreasonable sources of income for,

386–387Sponsorship system:

Chinese stock markets and, 353imbalance between profi t and risk in,

386–390insider trading and, 66launch of, 167underwriters, IPO companies, and,

126Sponsor structure, in various countries,

354–355

Sponsor system reform, 390–394improving stock issuance pricing

system and securities marketlitigation system, 390

specifying rights/responsibilitiesbetween sponsor and issuer, 393

specifying rights/responsibilitiesbetween sponsor and regulators, 392

specifying rights/responsibilitiesbetween sponsor institution andother intermediary agencies, 392–393

specifying rights/responsibilitiesbetween sponsor representative andsponsor institution, 392–393

sponsor competence standardization, 390–391

tougher penalties for law-breachingsponsors, 394

tying profi t to duties performed by asponsor, 391–392

Sponsor systems, comparison of variouscountries, 354–358

sponsor duty system, 357–358sponsor qualifi cations, 355–356sponsor structure, 354–355term of sponsors, 357

Sponsor terms, in various countries, 357

Spread trading of stock index futures, risks with, 312

Standardization, market developmentand, 270

State Administration of Taxation (SAT), Notice on Adjustment of StandardSecurities Trading Commission Rates, 104

State Council of China, 27Financial Asset Management

Companies Regulations, 196pilot programs approved by, 192Securities Committee, 29, 34

State Intellectual Property Offi ce, 380

Index 551

State-Owned Assets Operation Co., Ltd. (SSAOCORP), 164, 165

State-Owned Assets Supervision andAdministration Commission(SASAC), 47

State-owned companies, Chinesesecurities fi rms and stock reformsof, 47, 49

State-owned-enterprises (SOE)restructuring, 182

State-owned industrial companies, proportion shifts of assets andprofi ts of, compared to allindustrial companies, 48

Static capital strength, 19Statistical analysis, in comprehensive

risk management, 461Statute of Fraud (UK), 412Stock index future business:

constructing solid risk-managementprocesses in, 312

innovative business and, 250management of risks associated with,

311–312risk control systems for, 312sources of risks in, 311–312

Stock index futures, 488procedure fees and, 233profi tability of securities companies

and, 232securities margin trading volume and,

233Stock issuance pricing system,

improving, 390Stock market:

Chinese, from quota management tosponsor system, 353

conclusions by Chinese scholarsabout, 62

rapid expansion of, 1990–1995, 27–28relevancy between GDP, lending,

and, 50Stock market cap to GDP ratio, China

compared to U.S. in terms of, 482, 483

Stock market crash of 1929, 399Stock reforms of state-owned

companies, Chinese securities fi rmsand, 47, 49

Stocks:citizens’ stock accounts and

transactions, 61infancy phase, 1987–1990, 26, 27

Stock underwriting business:compliance risks and, 296sound internal structures, control

mechanisms, and, 297Stock values, total, proportion of,

against all fi nancial assets, 59Stop-loss transaction mechanism, in

stock index futures trading, 312Strategic planning, management of risks

in, 284–285Strategic risk management:

meaning of, 284–285tactics in, 285–286

Stress tests, 278Subprime mortgage crisis (2008), 71,

96, 108, 117, 144–145, 149, 181, 241, 279, 280, 282, 401, 404, 437, 446–447, 467, 468. 469, 469, 473, 488

Subsidiaries of bank holding companies, 170

Supervision, internal control and, 449, 451, 453

Suzhou Hengjiu Photo-ElectronicScience and Technology Co. Ltd.,rule breaking sponsor case study,378–381

Suzhou Securities, 260Swaps, 101Swiss Bank, 407Switzerland, universal banks in,

407Systematic decision making, Chinese

securities companies and need for, 465

System risks, investment banks and, 453, 454

552 INDEX

Tacit skills, 100, 101Taifook Securities Group Ltd., 82Talent, 21

competition for, 322core competitiveness and, 20demand for, in development of

securities industry, 321–328effective management of, in securities

companies, 339–347interdisciplinary, 322, 327–328professional, 322–327unique specifi c nature of, 317wealth management talent

environment analysis, 335–339Tang, Qiming, 62Target search, 493Taxation planning, wealth management

and, 331Team building, wealth management

and, 330–331TEDA, 182Third-party wealth management,

328Third-party wealth management

companies, 338–339Thomas, K., 341Three levels framework, for human

resource management in securitiescompanies, 344, 345–346

327 Treasury bond incident, 74–75Tian, Jia, 123Tianle Securities, 37Tiantong Securities, 37Toll infrastructure, asset securitization

and, 488“Too big to fail,” global fi nancial crisis

and, 196Total profi t, 205Trading:

client, 147proprietary, 147, 149

Trading channels, 234Trading mechanism, special nature of,

311–312Trading revenue, 72

Traditional business:innovation in, 241–246synergism between innovative

business and, 252–253Tranches, 106–107, 150Transaction records, 101Transfer risks, fi nancial products

innovation and, 488Transparency, 46, 53–54, 61–62Transparency principle, in regulation of

investment banking, 414Travelers Group, 177, 401, 402Treasury bonds, Wanguo Securities and,

73–75Trial Implementation Measures for

the Customer Asset ManagementBusiness of Securities Companies(CSRC), 246

Trial model, 194Trust, interpersonal, wealth

management and, 334Trust Act, 178“Trusteeship + M&As” model, 500Tunneling, caused by direct investments

and IPOs, 63, 66“Tutors,” in wealth management

business, 3302007–2008 fi nancial crisis, 267, 268,

401, 402American independent investment

banks and, 499analysis of problems in risk

management of U.S. investmentbanks during, 280–281

bank-backed fi nancial holdingcompanies and, 189

Chinese securities fi rms in wake of, 145

debate over causes of, 117inspiration drawn from, for

risk management of securitiescompanies, 281–284

insuffi ciency of regulation and, 467–468

investment banks and, 156, 176

Index 553

risk management in securitiescompanies in wake of, 279–280

universal banks and, 469, 470“2–20” model, private funds in China

and, 316Two strategies framework, human

resource management and, 344, 345

UBS, 177, 469Underwriter’s goodwill, performance of

IPO companies and, 123–126Underwriter’s goodwill empirical study:

conclusions in, 139–140correlation coeffi cients among

variables in Main Board market, 133

correlation coeffi cients amongvariables in SME Board market, 132

correlation coeffi cients amongvariables in the GEM, 131

correlation test and results, 130–134impact of goodwill and signifi cance

for each subsample, 138regression analysis, 134, 138–139regression model, 126regression test results, 134regression test results for functional

activeness of goodwill in GEM, 135regression test results for functional

activeness of goodwill in MainBoard market, 137

regression test results for functionalactiveness of goodwill in SMEBoard market, 136

results of hypothesis test for the meanin GEM, 129

results of hypothesis test for the meanin Main Board market, 130

results of hypothesis test for the meanin SME Board market, 129

sample and data, 128–130variables: selection and defi nition,

126–128

Underwriting, 102, 103, 104, 485Underwriting business, 220, 221,

222Underwriting services, consolidating,

506Uniformity:

in Chinese profi tability models, 235–236

fi nancial, removal of, 24, 51Union Bank of Switzerland, 170, 407

merger of Warburg into, 401, 404Unisplendour Investment Consulting

Co., 182United Kingdom, 479

Alternative Investment Market in, 349–350

evolutionary history and structuralpatterns of investment banks in, 403–405

fi nancial holding company model in,421

investment bank regulation in, 412–413

merchant banks in, 398self-regulation system in, 411,

412–413sponsor duty system in, 358sponsor qualifi cations in, 355–356sponsor structure in, 354term of sponsors in, 357

United States, 479aggregate amount of government

debt to GDP ratio, China comparedwith, 485

aggregate capital of securitiesindustry in, 67

bond market in, 484business structures of investment

banks in, 435–437China-USA GDP comparison

(2011–2020), 4commercial banks and acquisition of

investment banks in, 189commission rate liberalization reform

in, 181

554 INDEX

United States (continued)evolutionary history and structural


fi nancial holding company model in,421

investment bank regulation in, 411–412market-oriented fi nancial system in,

482NASDAQ market in, 350–351, 354revenues of various business lines of

securities industry, 2003, 435sponsor structure in, 354stock market cap to GDP ratio, China

compared to, 482, 483subprime mortgage crisis in, 71,

96, 108, 117, 144–145, 149, 181, 241, 279, 280, 282, 401, 404, 437, 446–447, 467, 468, 469, 473, 488

trend of percentages of commissionand asset management revenuesin total securities industry, 1980–2003, 436

trend of percentages of underwritingand market maker revenues in totalsecurities industry, 1980–2003, 436

Universal bank model, 407Universal banks, 46, 146, 152–153,

155, 409, 469in Germany, 406, 470in Switzerland, 407

U.S. Department of Treasury, 400USB Warburg, 407

Value-added services, individualized, wealth management and, 334

Value at risk (VaR), 271, 278, 461Values appreciation, 46Vanguard Group, 112van Wensveen, D., 46VaR Delta model, 462Venture capital and private equity (VC/

PE) institutions, average return oninvestments in, 63, 66

Venture capital investment, in China, 472–473

Violations by securities companies, 35, 36–37

Volvo, 498

Wall Street investment banks, fi nancial innovation and, 190

Wan, Difang, 124Wang, Shaoping, 62Wang, Tao, 381Wanguo Securities, 26, 35, 158Wanguo Securities case study, 72–76

history behind, 72–74lessons learned, 75–76327 Treasury bond incident, 74–75

Wantong Securities, 91Warburg, merger into Union Bank of

Switzerland, 401, 404Warning indexes, selecting, 289Warning line of client’s account,

monitoring, 311Wealth concentration, in China,

335–336Wealth effect, 507Wealth effect of economic growth,

formula for, 494Wealth management:

Chinese securities fi rms and, 493–495competencies required for, 334diversifi ed approaches to, 495overview of, 328–329

Wealth management business, 245, 246contents of, 331–332evaluation and incentive mechanisms

for, 331profi tability models and, 329team building and, 330–331

Wealth management products, statistics of securities companies and, 60

Wealth management service personnel:evaluation of fi nancial condition of

individual at present by, 332–333functional requirements for, 332–334identifying client purposes and goals,

333possible solutions recommended by,

333

Index 555

potential problems identifi ed by, 333suggestions provided and

implemented by, 333wealth management plan supervised

by, 333–334Wealth management services, 111–113

business model A, 111–112business model B, 111, 112–113

Wealth management talent, comparative advantages/disadvantages of, insecurities industry, 328–339

Wealth management talent environmentanalysis, 335–339

client group analysis, 335–336product line analysis, 336–337quantitative analysis, 335resource input analysis, 337service capability analysis, 337–338third-party wealth management

companies, 338–339Wealth management team, members of,

332Wealth managers, 325Wing Lung Bank, 498World Bank, 496World Trade Organization (WTO), 432,

496China’s entrance into, 5, 38, 120, 168transition period after China’s

accession into, 434World War I:

investment banking in UnitedKingdom after, 403

United States and, 479World War II, 479

end of mixed operation of investmentbanks after, 400

investment banks in Germany after,405–406

securities companies in Japan after, 408

Wu, Shinong, 62Wu, Zhenxiang, 62

Wu, Zuguang, 124Wuhan Securities, 37Wuhan Yihui Economic and Trading

Co., 77Wuzhou Securities, 36

Xia, Bin, 164Xiangjiang Industrial Investment Fund,

232Xiao, Jun, 62Xibei Securities, 37Xidan Shopping Mall, 182Xie, Fanghua, 66Xinan Securities, 37, 41, 81Xinhua Securities, 36, 114, 115Xinjiang Securities, 37Xu, Haoping, 124Xu, Kangsheng, 384Xu, Longbing, 62Xu, Xiaolei, 62Xu, Xinzhong, 62

Yang, Jisheng, 62Yang, Jun, 77Ye, Zhonghang, 62Yi, Xingjian, 124Yin, Bocheng, 124Yin, Ke, 77Yu, Qiao, 62

Zhan, Weihua, 123Zhang, Bing, 62Zhang, Guoqing, 76–77, 78Zhao, Zhenyu, 124Zheshang Securities, 302Zhongcheng, 182Zhongchuang Investment, 35Zhongfu Securities, 36Zhongguancun Securities, 37Zhongke Securities, 37Zhongrong Trust, 338Zhou, Wenhai, 62ZPUG, 67

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