The Restructuring of China's Securities Industry
Takeshi Jingu and Suiyo Ri

I.

Introduction

The recent period of radical change in the environment for China's securities firms
has exposed a number of problems those firms are facing. The long period of stock
market stagnation that began in 2001 has weighed particularly heavy on the securities
firms' management. Since the industry recorded its first overall loss in 2002 thoselosses have continued to mount, reaching 9.4 billion yuan in 2003, 10.36 billion yuan
in 2004, and approximately 11 billion yuan in 2005.1
Meanwhile, China joined the World Trade Organization (WTO) on 11 December
2001. One of the conditions for joining the WTO was that China had to completely
open its banking sector to foreign firms within five years, and the securities industry
also had to allow in foreign capital, albeit with conditions attached. This prompted
foreign-capitalized banks to accelerate their equity participation in Chinese banks, andsecurities house joint ventures were also established between foreign-capitalized andChinese securities firms. This influx of foreign funding power and management
expertise is expected to strengthen China's domestic financial institutions, but it has
also created concern that the markets will be dominated by foreign-capitalized firms.
In response, the Chinese government proposed guidelines for a broad
reorganization and restructuring of domestic securities firms, providing support to thestrongest ones while reorganizing and restructuring those with problems. With shareprices also recovering, earnings for the industry overall finally recovered in H1 2006,
but there is now a need to make serious improvements in the firms' viability.
In this paper, we analyze the problems in China's securities industry thus far andwhat may be behind those problems, and then project future industry issues and the
direction of development once restructuring over the next few years is complete.

1

Figures for 2004 are as announced by the Securities Association of China (SAC). Figuresfor 2003 and 2005 are from the 21st Century Business Herald, dated 18 July 2006. The
data was aggregated from 122 securities firms in 2003, 114 firms in 2004, andapproximately 110 firms in 2005.

The Restructuring of China's Securities Industry 51

II. China's securities industry: Overview and problem areas
1. Problems with China's securities sector and what may be behind those
problems
China's securities industry has grown rapidly since its first securities firm wasestablished in the Shenzhen special economic zone (SEZ). As of end-December 2004,
there were 133 securities companies in China with 3,075 business locations and over
120,000 employees. Based on the latest published statistics, at end-2004 the total
assets of 130 securities firms (excluding three that were either newly formed or ceased
operations) were 401.5 billion yuan, and net assets were 96.3 billion yuan.
Although the securities industry has grown rapidly, it also has many problems.
Many of these problems have become particularly evident since June 2001, whenshare prices entered a sustained period of weakness. Illegal activities were rampant,including the misappropriation of client funds, the guaranteeing of yields indiscretionary accounts, proprietary trading in violation of rules, and market
manipulation. When share prices were climbing, these illegal activities brought
massive profits to securities firms, but during the period of sustained share priceweakness, large losses resulting from illegal behavior have weighed heavily on thefirms and put pressure on management. This also hurt the interests of investors anddrove them away from the market, causing share prices to fall even further in a
vicious cycle.
The problem of misappropriation of client funds and government bonds held on
deposit was one of the most serious of the securities firms' illegal actions. Since 2002,
approximately 30 securities firms have been shut down by the China Securities
Regulatory Commission (CSRC), nearly all of them for the primary reason of losses
generated by such illegal activity as misappropriation of client funds and government
bond deposits as well as illegal discretionary accounts. A typical case involves
securities firms trading on their own account by diverting client funds, and because of
the sustained weakness of share prices, not only did the firms incur huge losses onthese proprietary trades, some became unable to return the funds to client accounts.
Under the old rules, securities firms could only trade on their own account with theirown funds, but since the diversion of client funds made it possible for them to do suchtrading on a much larger scale, it also paved the way for them to manipulate the priceof certain shares, manipulate the market, and engage in other illegal activities.
Although the guarantee of yields in discretionary accounts is prohibited, somesecurities firms agreed to guarantee yields to attract customers. But with share prices
declining, securities firms became unable to earn the yields guaranteed to clients byinvesting in stocks, and were forced to make up the difference with their own funds.
This problem can be attributed to insufficient internal controls at the securities
firms as well as to limitations in the old securities laws and institutions (trading
systems and oversight/management mechanisms).
We look first at the internal controls at securities firms. Many of China' securities
firms have been spun off from state-owned financial institutions (including banks and52

Nomura Capital Market Review Vol.9 No.4

investment trusts), and thus securities firms in the initial stages were basically 100%
state-owned enterprises. Although they have since been converted into joint-stock
corporations, the management mechanisms and practices formed during their many
years as state-owned enterprises remain. Consequently, many securities firms are joint
stock corporations in name only, but have yet to institute the management structure togo with it. For example, although the representative directors are nominally chosen by
the Board of Directors, they are effectively government appointees.
We look next at the limitations of the laws and institutions. These limitations have
two aspects: delays in putting the laws and institutions in place, and limitations on thecontent of the laws and institutions that are in place. First, although the first securities
firm was established in 1988, a securities law was not promulgated until 1998, 10
years later (the old Securities Law of the People's Republic of China, implemented in
1999, and the new Securities Law, which took effect in January 2006), while theMeasures on the Administration of Securities Companies, the administrative
regulations on the supervising and administration of securities firms, was not
implemented until March 2002. Prior to implementation of the Securities Law, theState Council and regulatory authorities wrote and promulgated a large number ofadministrative regulations and notices, but they were not very legally binding, andbecause so many different government agencies were involved in writing and issuing
the regulations, there was tendency for the regulations and notices to either be
inconsistent with one another or leave loopholes.
Second, limitations stemming from the content of the laws and institutions haveshown up starkly in (1) limitations on funding methods for securities firms and (2) the
simplicity of business and earnings structures.
China's securities firms operate almost entirely on internal funding, and theiroptions for procuring outside funding are extremely limited. In the 1990s, China's
securities firms had almost no other way to procure funding besides government bondrepos and privately placed capital increases. The reason for this severe limitation on
outside funding was that because many banks owned stakes in securities firms, it waseasy for the securities firms to procure loans from the banks, and this led to an
outbreak of irresponsible loans and other problems. It also created a very cautious
attitude toward bank lending to securities firms within the Chinese government, which
since the Asian financial crisis in 1997 has been concerned over the negative impactthat the bankruptcy of securities firms could have on the banking system, and has
tried to keep stock market risk from propagating to the banking system.
The situation stayed like this until around 1999. Since then, a variety of measures
have been proposed to relax rules on funding by security firms, including approval for
securities firms to enter the inter-bank market, to list their shares, to make loans
collateralized by stocks, and to issue bonds. In fact, however, standards for issuingbonds and listing stock are so strict that very few securities firms can meet them, andthere has yet to be a fundamental solution to the funding problem of securities firms.
Regarding the simplicity of business and earnings structures, Chinese securities
firms are highly dependent for their earnings on the traditional security businesses as

The Restructuring of China's Securities Industry 53

brokering trades, proprietary trading, and underwriting. On an overall basis, it appears
that about 70% of revenues come from brokerage commissions, 20% fromunderwriting, and about 5% each from proprietary trading and fund management.
Other businesses, such as M&A, financial advisory, and securitization, have been
virtually nonexistent.
Because brokerage is the primary source of earnings for the securities firms, thoseearnings swing widely in reaction to share price trends. Furthermore, under the old
Securities Law, securities trading in China was limited to cash trades only, and futurestrades and margin trades were not allowed. Consequently, investors only generated
profits when share prices were rising, making it likely that trading volume would
shrink when share prices were heading downward, and this had an immediate impact
on securities firm earnings.

III. Restructuring of securities sector at a fever pitch
1. Basic policy toward restructuring: "supervision by category" and "feed-thestrong, starve-the-weak"
During the stock market weakness since mid-2001, a variety of problems facing
securities firms came to light, and the CSRC responded with a proposal to consolidate
the securities sector. After a number of bankrupt securities firms were closed in 200203, policy congealed around a "supervision/administration by category" and "feedthe-strong, starve-the-weak" approach, and serious consolidation got underway.
Under "supervision/administration by category," each of the securities firms are
categorized by their level of risk, extent of illegal activity, and development potential,
while the strongest securities firms are helped (feed the strong) and the companies
with high-risk, serious problems with illegal activity, and little hope for improvement
are weeded out (starve the weak). The CSRC evidently classifies securities firms into
four categories (A, B, C, and D) by their level of risk, with A being the lowest risk
category, although specific criteria for these ratings have not been disclosed. In
general, A firms are the strongest with almost no risk or illegal activity, B firms areslightly weaker than A firms, C firms have roughly an average risk level, and D firms
are at high risk of seeing a deterioration in their business. A and B firms receive
assistance, D firms are targeted for liquidation and closure, and the treatment of C
firms seems to depend on conditions.
On 29 July 2005, the State Council (central government) announced a plan toreorganize and restructure securities firms including specific targets, naming the plan
the Comprehensive Plan for Consolidation of Securities Firms, aimed at eliminating
the existing risk at securities firms and implementing new supervisory andadministrative mechanisms during the two-year period that began with the full-scalelaunch of consolidation in 2004.

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The organizations actually in charge of implementing the consolidation plan
include Central Huijin Investment 2 , the China Construction Bank Investment
Company (CCB Investment), the China Securities Investor Protection Fund (CSIPF),
the asset management companies that have been taking care of the non-performing
loans of big four state-owned banks, and securities firms.
In addition to government-led restructuring, the strongest securities firms areactively engaged in their own efforts to make acquisitions and restructure operations.
Recently, there has also been an increase in the number of securities firms seriously
considering listing their own shares, apparently as a way to become more competitiveand increase their market share after restructuring.

2. Progress toward restructuring
1) Measures to "feed the strong" include enhancing liquidity and offering the "pilot
securities firm" qualification," etc."
Measures to feed the strong thus far can be classified as one of two types, (1)business-related measures and (2) liquidity enhancing measures.
The focus of business-related measures has been on awarding securities firms withqualifications as either a "pilot" or a "standard" firm. The CSRC and the SAC
published documents concerning certification in August 2004 for pilot securities firms
and in April 2005 for standard securities firms.3 Based on these documents, securities
firms meeting certain requirements can apply for qualification as either a firm doing"innovative pilot activity" or as a standard securities firm. The requirements for thepilot qualification are that the securities firm must design and implement a system forthe separate management of client funds, prepare reports on the administrative statusof client assets, government bond repos, and proprietary trading, and have net capitalfor the past year of at least 1.2 billion yuan. Securities firms with the pilot
qualification are able to enter new securities businesses first.
The requirements for submitting an application as a standard securities firm arefundamentally the same as for the pilot qualification, including the need to design andimplement a system for the separate management of client funds and prepare reports
on administrative status of client assets, government bond repos, and proprietary
trading, but are somewhat easier to meet, including a need to only have net capital ofat least 200 million yuan and to have not been fined for a serious violation over the
past year (versus three years for the pilot qualification). As soon as a standard2

3

In 2003, the Chinese government injected funds into state-owned commercial banks andthen established this entity as a wholly owned subsidiary to manage the injected funds.
The official name of the organization is the Central Huijin Investment Company Ltd.
In August 2004, the CSRC issued its Circular on Issues Concerning the Boosting of
Securities Industry Innovation and SAC issued its Provisional Measures on Evaluatingand Approving Pilot Securities Companies, then in 2005, the CSRC announced its
Circular on Issues Related to Assessing, Inspecting, Supervising, and Administering
Standard Securities Companies, while SAC announced its Provisional Measures
Concerning the Assessment and Inspection of Standard Securities Companies.

The Restructuring of China's Securities Industry 55

securities firm meets the qualifications for pilot, they can submit an application to
upgrade their status.
As of August 2006, 18 companies were qualified as pilot securities firms and 25
were qualified as standard firms.
Measures to enhance liquidity include, in their order of implementation, approval
to issue short-term bonds, get low-interest loans, receive capital infusions, and issue
subordinated debt.
In October 2004, the People's Bank of China promulgated its Measures for
Administering Short-term Lending by Securities Companies, and the law went into
effect on 1 November. Under this law, securities firms that meet the conditions areallowed to issue short-term bonds up to 91 days in maturity. Both pilot and standard
securities firms are exempt from credit ratings. So far, short-term bonds have been
issued by Guotai Junan Securities, China International Trust Investment Company(CITIC), China Merchants Securities, and Haitong Securities.4
On the low-interest financing side, in July-August 2005, the People's Bank of
China provided a one-year central bank loan totaling 10 billion yuan, at an interest
rate of 3.87%, to five of the pilot securities firms, (GF Securities, Orient Securities,
Huatai Securities, Citic Securities, and Haitong Securities). These loans had to be
used to improve management capabilities and to develop pilot businesses and services
related to the reform of nontradable shares.5 The securities firms have already entirely
paid back the loans.
In September 2005, Central Huijin Investment injected capital of 2.5 billion yuan
into Shenyin Wanguo Securities and 1 billion yuan into Guotai Junan Securities.6
Regarding the issuance of subordinated securities, on 16 December 2005 the CSRC
issued its Circular on Relevant Issues concerning Securities Companies' Borrowing
Subordinated Debt. The notice allows securities firms to issue subordinated debt andcount it as part of its net capital up to a certain percentage. At end-2005, Great Wall
Securities issued the first subordinated securities, amounting to 642 million yuan. On
22 June 2006, Industrial Securities' proposed subordinated debt issue (a total of 800
million yuan in two tranches) was approved at its general shareholders meeting. Afterissuance of the first tranche, Industrial Securities, currently a standard securities firm,
will meet the net capital requirements for applying to be a pilot securities firm.

4
5

6

56

Because there are few securities firms that meet the conditions stipulated in theregulations, the market for short-term bonds from securities firms is not very active.
During this time, however, share prices were also weak, and the view within China is that
low-interest financing was provided by government as a way to prop up share prices byenabling securities firms to buy stocks on their own account.
This gave Central Huijin a 37.3% stake in Shenyin Wanguo Securities, making it theleading shareholder, and a 21.0% stake in Guotai Junan, making it the second leading
shareholder.

Nomura Capital Market Review Vol.9 No.4

2) Starve the weak means either receivership and closure or capital injection andrevivalLooking at examples thus far of the "starve the weak" policy, i.e., the handling of
problem securities firms, we see that those firms deemed hopeless and incapable ofsurvival are first put under receivership ("tuoguan" in Chinese) and then shut down,
while those deemed viable are injected with capital and revived.
Receivership is a method whereby the authorities entrust the management of aproblem securities firm to another financial institution, which cleans up the problem
firms assets and liabilities and restructures the organization and its staff. The receiving
institution is without exception a relatively sound company with considerable
financial resources, and in many cases it winds up acquiring all or a portion of the
problem firm's securities business, office locations, staff, and customer accounts, after
which the problem firm is shut down. There were several of these receivership casesin 2002-03, but the number has been increasing since 2004, and from 2004 until mid2006, approximately 20 companies went through the process.
In 2004, nearly all of the receiving companies were asset management companies,
but since 2005 they have primarily been pilot securities firms. There are several
reasons for this, including (1) around 2004, when the consolidation of securities firms
started to pick up, there were virtually no other securities firms strong enough to act
as receiver; (2) in 1999, four asset management companies were established topurchase and dispose of the nonperforming loans owned by state-owned banks, with
their charters set to expire in 10 years, such that each of the companies will have topropose a new business model if they are to survive past 2009; and (3) owing toassistance given to the strongest securities firms, some have become strong enough toact as receiver, and they now are trying to expand their business by acting as receiverto other companies.
Among the financial institutions acting as receiver, the China Securities Investor
Protection Fund has recently been attracting attention. In September 2006, that fundestablished Anxin Securities (capital of 1.51 billion yuan, of which it owns 1.5 billion
yuan). Anxin Securities took over the securities assets of three securities firms thatwent into receivership under the CSIPF: Zhongguancun Securities and China SciTech Securities (in February 2006) and Guangdong Securities (in November 2005).
Anxin is widely expected to be the receptacle for other securities firms when they
become subject to closure.
The firms that are allowed to survive are revived with an injection of capital. Often
this reconstruction is led by the central government for larger firms, and by theregional government for smaller firms that are more regionally oriented. One classic
example of the former is the reorganization of China Galaxy Securities, a state-owned
enterprise at the central government level. China Galaxy Securities, established inAugust 2000 with the merger of the securities divisions of four state-owned banks anda trust company subsidiary of a state-owned life insurer, was at one time one of

The Restructuring of China's Securities Industry 57

China's largest 7 securities firms, with about 200 offices nationwide and 3 million
client accounts. After running up huge losses from illegal activity over the past two
years, however, it became a candidate for reorganization. In June 2005, Central Huijin
and the Ministry of Finance jointly invested in China Galaxy Financial Holding, andestablished three companies under the holding company: China Galaxy Securities,
Galaxy Investments, and Galaxy Asset Management. The new China Galaxy
Securities plans to acquire the securities assets of the existing China Galaxy Securities.
Examples of reorganizations led by regional governments include Southwest
Securities and Kinghing Securities. Located in Chongqing, Southwest Securities'business suffered because of its diversion of client guarantee funds and illegal trades.
Its reorganization plan, which is being managed by the Chongqing State-Owned
Assets Supervision and Administration Commission (SASAC), calls for China
Construction Bank Investment to provide an infusion of capital as well as a working
capital loan. Located in Hangzhou, Zhejiang province, Kinghing Securities posted
huge losses related to the diversion of government bonds owned by its major
shareholder, Kinghing Trust & Investment, and to its provision of large amounts ofcollateral to Kinghing Trust. At end-2005, Kinghing Trust suspended operations, andas it became more difficult to demand repayment from the company, the Zhejiang
government made the decision to rescue Kinghing Securities. In April 2004, a stateowned enterprise owned by Zhejiang province injected capital into Kinghing
Securities through a subsidiary, and on 1 July changed the company's name toZheshang Securities.
As a result of these dispositions, the number of securities firms in China declined
from about 130 in 2004 to 109 by end-June 2006.
The handling of bankruptcies will probably be important moving forward. So far,there have been almost no examples of securities firms going bankrupt, even after
being shut down by administrative order. In January 2006, a mid-level people's courtin Shenzhen ordered the bankruptcy of Dapeng Securities, which had been shut downin January 2005. A bankruptcy law was not adopted until 27 August 2006, however,and became effective from 1 June 2007. It is likely that the number of bankruptcy
cases involving securities firms where the reorganization is not going well will
increase once the bankruptcy law is implemented. This shift from closure byadministrative order to bankruptcy processing should make the entire process ofreorganizing a securities firm more transparent.
3) Securities firms start to list their shares
The leading securities firms are also becoming more interested in listing theirshares. A large number of securities firms have reported plans to list, including
Everbright, Changjiang, Donghai, Haitong, Orient , China Merchants, Huatai,
Guoyuan, and Goldstate.87858The company was ranked No. 1 in registered capital, with 4.5 billion yuan in 2003, intrading volume with A shares in 2004, and in government bond trading volume.
Securities Times, dated 28 July 2006.

Nomura Capital Market Review Vol.9 No.4

One reason that the securities firms have taken to the idea of listing their shares isthat developing the new services and products that are being deregulated requires
large amounts of funds.
Currently, there are only two listed securities firms, Citic Securities and Hongyuan
Securities.9 The success in making acquisitions and expanding market share that Citic
Securities had as a result of its listing and resulting increase in capital has become theenvy of the other securities firms (Figure 1).

Figure 1 Amount of capital at Citic Securities (compared with other pilot
securities firms)[Net Capital][Shareholders' Equity](100mn yuan)
100

120

80

100

GF Securities

80

Huatai Securities

60

Orient Securities

40

Haitong Securities

60
40
20

20

0

0

2002

Source:

2003

2004

2005 20061H(100mn yuan)

2002

Citic Securities

China Merchants Securities
Donghai Securities

2003

2004

2005

20061H

Nomura Institute of Capital Markets Research, based on data from Wind
Information

Those securities firms that want to list their share are considering do so through abackdoor ("hermit crab") listing ("jieke" in Chinese) rather than through a direct IPO.
Under a backdoor listing, an unlisted company injects assets into a listed company
and changes the name of the listed company to that of the unlisted company, thereby
achieving its listing through the back door. This borrowing of the listed company's
listing qualifications, or shell, has been likened to the way a hermit crab borrows ashell.
The steps required for an IPO are time consuming, and the listing review done by
the CSRC looks closely at whether the applicant has posted a profit for the past three
years consecutively.10 Because many securities firms posted losses in 2002-05, even if
they turn profitable in 2006, the earliest they could achieve three straight years of
profits would be 2008. A backdoor listing offers a way around this issue.
There are also restrictions on backdoor listings, however. Because government
regulations prohibit a financial institution from also operating a non-financial business,
910

Company name and code are Citic Securities (600030.SH) and Hong Yuan Securities(000562.SZ).
The Securities Law includes a provision (in Article 13) stating that one of the requirements
for an IPO is that the firm have no false record in its financial statements over the latest 3
years and have no other major irregularity, but one of the key factors to be consideredaccording to the rules of the CSRC's Public Offering and Listing Review Committee is
whether the company has posted a profit for the past three years consecutively.

The Restructuring of China's Securities Industry 59there is a need for a clean shell ("jingke" in Chinese) that does not own any nonfinancial assets. Since the listed company's non-financial business assets must be soldto create a clean shell, those assets have to be fairly easy to sell. The asset sale must
be agreed to by the listed company's shareholders and, in the case of a company that is
critical to a regional economy, agreement by the regional government is also essential.
In choosing a shell, there are some securities firms that have established criteria thatthe shell must meet: (1) asset disposition must not be difficult, (2) the listedcompany's major shareholders have an intention of selling their shares, and (3) theshell's capital must be of suitable size.11
There were rumors of a number of backdoor listings planned for 2006, but almost
none came to fruition, owing to opposition from either the listed company itself or aregional government that did not want to let the companies go. GF Securities hasreceived approval from the authorities for its planned backdoor listing throughYanbian Highway Construction, however. In September 2006, Yanbian Highway
announced that it had exchanged shares with GF Securities at a ratio of 1:0.83, andthen changed its names to GF Securities. If GF Securities succeeds with its backdoor
listing it will be the first to do so, and its success will likely lead to an increase in thenumber of backdoor listings in the future.

3. Implementation of new supervisory system and looming deadline forcompleting consolidation
1) Implementation of new supervisory system
In step with the reorganization and restructuring of securities firms, the system forsupervising and administering securities firms is also in the process of changing.
The authorities view the current period of consolidation as a "special period for
disposing of risks" and the period after that as a "period of normal supervision andadministration." CSRC Chairman Shang Fulin, speaking at a roundtable discussion on
consolidation of securities firms in September 2006, noted changes in the supervisory
and administrative system between the two periods included (1) a shift in the
supervisory approach from eliminating existing risks and ex-post surveys andpenalties to preventing risk and instilling discipline; (2) a shift in supervisory methods
from empirical-based judgment and qualitative analysis to indicator-based
administration and quantitative supervision and administration; (3) a shift in the
supervisory structure from governmental supervision and administration to an
integrated, triangular system relying on governmental supervision, industry selfregulation, and each company's internal controls.
The authorities have already begun to gradually implement new methods prior to
the normal supervisory period to make their supervision and administration of

11

Securities Markets Weekly, dated 6 August 2006, from a conversation with the Vice
President of Changjiang Securities, who is also the vice chairman of a working group on
listing activities.

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securities firms more effective. During this process, the focus has been on
implementing risk control indicators for each type of business.
In July 2006, the CSRC formally announced Administrative Measures for
Securities Companies Risk Control Indicators (Risk Control Law) and new rules forcalculating net capital for securities firms (Net Capital Rules). Both were
implemented effective 1 November 2006.12
Although rules on risk control indicators for securities firms were already in place,they were scattered across various regulations and circulars, only a few indicators
were covered, and certain aspects of the method for calculating the indicators were
not rigorous. The law sets down more detailed and scientific rules for the risk
indicators.
The new law quantifies indicators of risk control at securities firms and establishes
net capital requirements for each business. For example, for the securities company
overall, the ratio of net capital to net assets cannot fall below 40%, the ratio of net
capital to debt cannot fall below 8%, the ratio of net assets to debt cannot fall below
20%, and the ratio of current assets to current liabilities cannot fall below 100%. For
the proprietary trading business, total proprietary trading in stocks cannot exceed 1x
net capital and the proprietary trading business overall cannot exceed 2x net capital. A
further requirement is that a securities firms' securities borrowing and lending (SBL)
to a single client cannot exceed 5% of net capital.

2) Looming deadline for completing consolidation
The end of this round of securities firm reorganization and restructuring thatentered high gear in 2004 is finally approaching.
CSRC Chairman Shang reemphasized at the roundtable that all of thereorganization and restructuring of securities firms currently taking place had to becompleted by August 2007. He also emphasized that there were earlier deadlines forphased-in targets: (1) by end-October 2006, all problems, including diversion of client
trade settlement funds and client bonds, illegal discretionary accounts, and thediversion of funds by shareholders in securities, must be eliminated, and the ratio
standards prescribed in the Risk Control Law had to be met; and (2) by end-December
2006, the government bond repo problem must be resolved and securities companies
must disclose basic information.
The October 2006 deadline in the Risk Control Law requires that securities firms
have net capital of at least 200 million yuan in order to engage in securities
underwriting and recommendation, proprietary trading in securities, or the businessadministration of securities assets. This is also the minimum capital requirement forbeing qualified as a standard securities firm. There are currently about 60 securities
firms that have neither the pilot nor standard qualification. Because those firms that
12

The comment-seeking drafts underlying the two were announced in January 2006, andafter making revisions based on a request for comments from the industry, they wereformally announced in July.

The Restructuring of China's Securities Industry 61

do not meet the net capital requirement by end-October would theoretically be subject
to closure, we expect the companies to restructure and enhance their capital on an
accelerated basis. We expect this to result in a further consolidation in the number of
securities firms, currently at 109, from 2007.

4. New pecking order in the securities industry
1) Affiliates of the asset management companies, of Central Huijin, CCB
Investment, or the CSIPF, and of the pilot securities firms are emerging as majordomestic players
The power relationships within the securities industry are being redrawn throughthis process of securities firm consolidation and reorganization (Figure 2).
In the early stages of this program of receivership for problem securities firms, areceiving asset management company would take over the securities business of the
problem company, which has to some extent provided a basis for the asset
management company itself being transformed into a securities firm.
Since then, Central Huijin and CCB Investment have become shareholders of alarge number of securities firms through capital infusions. Central Huijin is now ashareholder in a number of leading securities firms, including China Galaxy Securities,
Guotai Junan Securities, and Shenyin Wanguo Securities, while CCB Investment
owns stock in Southwest Securities, Citic Construction Securities, CCB Securities,
and Qilu Securities. Additionally, CSIPF established Anxin Securities, as noted above.
There is a strong possibility that Anxin Securities will become a receiver for shutteredsecurities firms, and if it does it would give birth to a powerful CSIPF-Anxin
Securities group.
The pilot securities firms that both take problem securities firms under receivershipand also acquire other companies are also increasing their influence in the sector.
Among the 18 pilot securities firms, there has been a notable increase in the trading
share of Citic Securities, GF Securities, Everbright Securities, and Huatai Securities.
Data on shares of trading in securities (stocks, mutual funds, bonds, and warrants)
shows that although Citic Securities has only a 2.9% share on its own, that share rises
to 7.7% when including the three companies that it has acquired ownership of: Citic
Construction Investment Securities, Jintong Securities, and Citic Wantong Securities.
Likewise, GF Securities by itself has a 3.5% share, but counting the five companies
that it acquired it has a 5.4% share (Figure 3).

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Figure 2 Three major domestic categories and foreign firms in the securities
industry[Central Huijin, CCB Investments and CSIPF affiliates]

CentralHuijinCCB
Investment

Galaxy Securities

Fund
infusion

Shenyin Wanguo
Securities
Guotai Junan
Securities

Equitystake

CCB Securities
Citic Construction
Securities
China Science
Securities

Receivership

Zhongguancun
Securities

CSIPF[Asset Management Company (AMC) affiliates]
D'Hong Securities
China
Huarong
AMC

China
Cinda AMC

China
Orient AMC

Receivership

China Fortune
Securities
Hengxin Securities

Receivership

Hantang Securities
Liaoning Securities

Receivership

Minfa Securities*There are a total of four AMC, but China Great Wall AMC
has not served as a receiver of securities firms.

Guangdong
Securities[Pilot Securities firm affiliates]
Equity stake

Citic
Securities

Equity stake[Foreign-capitalized firm affiliates]

Citic Construction
Securities
Citic Wantong
Securities

Equity stake

Jintong Securities

Equity stake

GF Northern
Securities

MorganStanley
BOC
International

Credit
Lyonnaise

Equity stake

GF Huafu Securities
GF
Securities

Receivership
Receivership
Receivership

Haitong
Securities

Receivership

Wuhan Securities
Hebei Securities

Goldman
Sachs
BNP
ParibasFirst Flushing
Securities

Daiwa
SMBC

Gansu Securities

UBS

Equity stake

China International
CapitalEquity stake

BOC International(China)Equity stake

China Euro
Securities

Equity stake

Equity stake

Equity stake

Equity stake

GS Gaohua
Securities
Changjiang BNP PP
Securities
Daiwa SMB-SSC
Securities
Beijing Securities

Xing'An Securities*There are other pilot securities firms;see Figure 6

Source:Nomura Institute of Capital Markets Research

The Restructuring of China's Securities Industry 63

Figure 3 Share of securities trading volume for pilot securities firms and theiraffiliates
Securities trading
volume(100mn yuan)
1 GF Securities
3,740
GF Northern Securities
211
GF Huafu Securities
627
First Flushing Securities
308
Wuhan Securities
213
Hebei Securities
644
2 Citic Securities
3,050
Citic Construction Securities
3,403
Jintong Securities
1,099
Citic Wantong Securities
594
3 Haitong Securities
4,500
Xing'An Securities
281
Gansu Securities
87
4 Everbright Securities
2,862
Tianyi Securities
1,270
Kunlun Securities
188
5 Huatai Securities
1,860
Asia Securities
902
United Securities
1,505
7 China Merchants Securities
3,333
Beijing Securities
914
6 Guosen Securities
3,883
Min'An Securities
217
8 Orient Securities
1,909
Northern Securities
309
9 Changjiang Securities
1,186
Dapeng Securities
197
10 Donghai Securities
429
Wuzhou Securities
114
12 Guotai Junan Securities
7,379
11 Shenyin Wanguo Securities
5,390
1,455
13 BOC International (China)
14 China International Capital
1,504
15 Ping An Securities
1,141
16 Guoyuan Securities
911
699
17 Shanghai Securities
18 Guodu Securities
431

Share
3.5%
0.2%
0.6%
5.4%
0.3%
0.2%
0.6%
2.9%
3.2%
7.7%
1.0%
0.6%
4.2%
0.3% 4.6%
0.1%
2.7%
1.2% 4.1%
0.2%
1.8%
0.8% 4.0%
1.4%
3.1%
4.0%
0.9%
3.7%
3.9%
0.2%
1.8%
2.1%
0.3%
1.1%
1.3%
0.2%
0.4%
0.5%
0.1%
6.9%
5.1%
1.4%
1.4%
1.1%
0.9%
0.7%
0.4%

Note:

1. Names in bold are pilot securities firms and indented names are securities firmsthat the pilot firms have a stake in.
2. Securities trading volume is for stocks, bonds, mutual funds, and warrants, etc.,from January to June, 2006. Shares are percentages of total, including trades by
non-pilot securities firms.
Source: Nomura Institute of Capital Markets Research, based on data from Wind
Information

2) Trends among foreign-capitalized firms
Prior to China's accession to the WTO, two foreign-capitalized securities firms had
already been established in China. One of those, established in 1995, is China
International Capital, with the foreign partners including US-based Morgan Stanley
and a non-financial company based in Hong Kong. The other company, established in
2001, is BOC International (China), with the foreign partner Hong Kong-based BOC

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Nomura Capital Market Review Vol.9 No.4

International Holdings. After China jointed the WTO, and then implemented its Ruleson the Establishment of Foreign-shared Securities Companies on 1 July 200213, thefirst foreign-capitalized securities firm to be established was China Euro Securities,
on 19 December 2002.
China currently has six foreign-capitalized securities firms. In September 2005,
UBS Securities announced that it was taking a stake in Beijing Securities, anacquisition that was apparently approved in June 2006. Although UBS has only a 20%
stake, it has effective management control, and has also de facto obtained a fulllicense (the company is scheduled to change its name to Ruiyin Securities ).
Meanwhile, on 15 December 2005, the CSRC announced a freeze on all
applications for equity participation in foreign-capitalized securities firms. 14 The
likely reasons for the freeze were (1) growing criticism within China that its securities
firms were selling out too cheaply to foreign capital and (2) criticism, pointing to theapproval of a full license for UBS, that the rules were not being consistently applied.15
Because there are still advantages from obtaining the business and governanceexpertise that comes with foreign capital, once the targets for the reorganization andrestructuring of securities firms are met, the freeze on foreign capital participation is
likely to be lifted.

5. Problems left by this restructuring and more restructuring to comeThis round of consolidation has expelled problem securities firms from the market
and improved the situation of the leading securities firms, thereby producing
numerous benefits, including a reduction in security market risk and a restoration of
investor confidence in securities markets.
There are still problems and issues remaining, however. First is that although manyof the securities firm shareholders have been replaced following the current round of
consolidation, there has yet to be any fundamental change in China's shareholder
structure, which remains dominated by state ownership. The new shareholders addedfrom the recent capital increase are also state-owned enterprises, and in some cases
management at these securities firms is either appointed by the government orcomprises former government officials. This explains why there is still doubt overwhether corporate governance is functioning effectively at securities firms following
the consolidation.
Second, the securities firms are trying to enhance their capital through such means
as capital increases and listing of shares in order to develop new services and expand
market share. In this regard, not only a larger capital base but also qualitative
improvements aimed at making better use of this capital have become increasingly
important. Enhancement of risk management capabilities is probably critical to
improving quality when capital is growing.
13
14
15

Article 10 stipulates that foreign ownership cannot exceed one third.
China Securities Journal, dated 15 December 2005.
WTO rules state that securities house joint ventures cannot offer brokerage of A shares.

The Restructuring of China's Securities Industry 65

With these problems and issues still around, we expect to see a further redrawingof the power relationships within the securities industry that is being formed from thisconsolidation, consisting of affiliates of pilot securities firms, of asset managementcompanies, of Central Huijin, CCB, and CSIPF, and of the foreign-capitalized
securities firms.
To start with, the intervention of Central Huijin, CCB, and CSIPF in the
restructuring of the industry and their ownership of shares in securities firms is aimed
at eliminating financial risk and improving the health of the securities market. Thissuggests that once these objectives are met, there is a high probability that the threecompanies will sell their holdings, either through a transfer or listing.
Second, acquisition and restructuring is generally an effective way for a company
to get access to external funding, personnel, and markets. In the case of China's
securities firms, however, services and earnings structures have so far been similar
and thus offer little in the way of complementarity on the business side. Consequently,
the advantages of acquisition have been minimal outside of obtaining storefronts,
clients, and personnel related to the brokerage business. Nevertheless, as explained
below, new products and services are now being implemented. The companies areeach changing their business models in step with the development of these new
products and services, and this should lead to new restructuring opportunities.

V. Diversification of products and services
1. Establishing the legal framework for diversification
The diversification of products and services plays a major role in restructuring andstrengthening the securities industry. Looking at recent developments concerning
financial innovation, the master plan for capital markets reform announced in January
2004, entitled Several Opinions on Promoting the Reform, Opening Up, and Stable
Development of Capital Markets (so called "nine opinions"), proposed thediversification of products for securities investment (futures markets and derivatives).
In response, the Circular on Issues Concerning the Boosting of Securities Industry
Innovation was issued in August 2004, which proposed that (1) security firms
innovate businesses, business methods, and organizations, raise the level of service,
and improve profit models to become stronger and (2) after improving the relevant
regulations following an initial trial phase, gradually develop financial innovations.
Also in August 2004, the CSRC, which had been inspecting securities firms,
solidified its policies of "supervision/administration by category" and "feed-the-strong,
starve-the-weak" and announced its model for pilot securities firms and standard
securities firms. Specifically, new products and services would initially be introduced
on a trial basis by pilot securities firms, which in fact are trying to implement all of
the new products and services outlined below based on these principles.

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The new Securities Law went into force on 1 January 2006. The new law moves
away from the old approach of regulations and is a revolutionary law that has changed
course toward deregulation. First, in regards to new products and services, the turmoil
in financial markets in the 1990s prompted the People's Bank of China (the centralbank) to prohibit financial institutions from participating in futures markets, and in1998 the old Securities Law also limited securities transactions to cash trades only.
The new Securities Law opened the door to futures, options, and margin trades(Articles 42 and 142 of the new Securities Law) in order to advance the functioning of
capital markets and enable their future development.
Second, there were also substantial revisions made to security firm businesses, andthe system of administration by category in which securities firms were categorized aseither general securities firms or brokerage securities firms, was abolished. Thisadministration by category was effective in the initial development of securities firms,
but as time passed it became a barrier to business innovation in the industry, and also
resulted in some serious problems in which the inability of securities firms todifferentiate their businesses produced some excessive competition. Under the newlaw, the administration of securities firms was revised to separate administration bytype of business, such as securities brokerage, investment advisory, underwriting,recommendation, and asset management, and capital requirements were also revised
to fit each business.

2. New products and services attracting interest
In response to these changes, pilot securities firms have been allowed to move into
new businesses since 2005. Collective trust accounts, warrants, and ABS (assetbacked securities) have already been introduced, and preparations are under way for
margin trading and stock index futures, which are expected to be introduced before
the end of 2006.

1) Collective trust accounts (collective asset management schemes)
Under collective trust accounts, a securities firm collects funds from wealthy
investors privately and then manages those funds under a client agreement in a
product also called a collective asset management scheme. The basic laws governing
this are the Provisional Rules on the Business of Clients' Asset Management Businessby Securities Companies and the Circular on Issues Regarding Conducting Businessof Collective Asset Management by Securities Companies,16 and a comment seeking
16

The discretionary accounts noted earlier that did so much damage to the businesses of
securities firms are primarily in the form of two-party contracts between the securities firm
and the client, and the problem was the guaranteed yield. The collective trust accounts ofrecent interest are based on one-to-many contracts. The Provisional Rules on theBusiness of Clients' Asset Management by Securities Companies (implemented in 2004)
classifies discretionary accounts as the "predirected" asset management business andcollective trust accounts as the "collective" asset management business; the guarantee of
either principal or yield is prohibited for both.

The Restructuring of China's Securities Industry 67

draft entitled Implementing Rules for Collective Asset Management Business of
Securities Companies was announced in July 2006. This comment-seeking draft
includes a bankruptcy remoteness provision to separate out collective trust accounts
from a securities firm's property when that firm goes bankrupt. Collective trust
accounts are currently handled by pilot securities firms, but the plan calls for standard
securities firms to eventually be able to handle them as well.
Since the first of these products was sold in March 2005, 17 12 pilot securities
firms18 have sold 19 such products, with a total of 28.252 billion yuan in assets undermanagement (an average of about 1.5 billion yuan per product).
Collective trust accounts, unlike funds collected through public subscription(mutual funds), are funded through private offering, and thus cannot be advertised inmass media (it is possible, however, for the company to sell them itself or contract thesale to other securities firms or commercial banks). The assumption is that thecustomer is already a customer of that firm or of the bank, etc. that is selling the
product, and thus has investment experience and the ability to tolerate risk. Minimum
investment amounts are fairly high, 50,000 yuan for restricted products and 100,000
yuan for unrestricted products, and thus the product is aimed at high-income earners.
The restricted products are primarily invested in government bonds, bond mutual
funds and other products with strong credit ratings and high liquidity, and stocks ofcompanies with strong earnings and equity mutual funds are restricted to no morethan 20% of the portfolio. The unrestricted products are invested based on anagreement without these restrictions. 19 These products have the features of money
market funds, bond funds, or stock funds, depending on the investment guidelines.
Securities firms can earn management fees and can also put their own funds in the
product. In other words, they can earn income based on results. Management fees
seem to be in the area of around 0.5% of total assets, and the firms' own funds usuallyaccount for about 3-5% of the product's net assets. The rate of growth in net assets ofcollective trust accounts was reported to be over 7% for April-June 2006.20

2) Warrants
Although warrants were traded in China during the 1990s, trading was suspended
following the financial turmoil in the mid-1990s and the authorities' shift to a morecautious stance, just as was the case for futures trades as explained below. The
exchanges later began to reconsider their reintroduction, and the reform of
nontradable shares became the direct catalyst to resume the listing and trading of
warrants in August 2005, nine years after the suspension began. Legislatively, theProvisional Measures on Administration of Warrant Related Business by Shanghai

17
18
19
20

68

Everbright Securities' Sunshine Plan.
Securities Times, dated 24 July 2006.
Use of bond holdings for repo transactions is prohibited.
Shanghai Securities News, dated 27 July 2006.

Nomura Capital Market Review Vol.9 No.4

Stock Exchange came out in July 2005 (as did a similar law for the Shenzhen
Exchange), followed by a number of circulars.
According to the provisional measures, both the issuer of the stocks subject to thewarrant and third parties are able to issue warrants. The warrants currently being
traded in China, however, were issued in the context of the reform of nontradable
shares, and effectively, the issuers of existing shares (or their parent companies) are
issuing call and put options.
One key feature of the nontradable share reforms is that the holder of nontradable
shares must pay consideration to the holder of tradable shares in order to acquire theright to trade the nontradable shares. Warrants were included as one of the methods ofpaying this consideration. As of mid-September 2006, there were 26 warrant issues,and the issuers are primarily the collective entities comprising the parent companiesof the listed companies. The combined total amount of trades in the Shanghai and
Shenzhen markets was 1.87704 trillion yuan in H1 200621, and the pilot securities
firms have noted that their income from warrant trading commissions has been
growing since 2005.
The introduction of warrants has led to speculation, which has had a negative
impact by distorting market prices, and consideration is being given in some areas toimplementing a market-maker system. Also, as the reform of nontradable shares
gradually moves toward closure, there will not be any more warrants issued inconnection with nontradable shares, and minus any other changes we expect the sizeof the warrant market to shrink moving forward. Partly as a way to build a serious
derivatives market, we expect to see efforts made to introduce warrants issued by
securities firms and other third parties.

3) ABSABS are securitized products based on cash flow-generating assets owned bycorporations. The first ABS were introduced in August 2005 (securities backed by therevenue streams generated by United Telecommunications' CDMA mobile network
leases and handled by China International Capital), based on the Provisional Rules on
the Business of Clients’ Asset Management Business by Securities Companies, butsince those measures did not contain any provisions expressly related to ABS, in
March 2006 the Circular on Measures for Specialized Asset Management bySecurities Firms was announced. After that, in June 2006 an initial draft of the
Circular on Problems Related to the Trial Development of the Asset Securitization
Business by Securities Firms was published, along with a request for comments fromthe securities industry and others.
As with other new products, the CSRC is following the principle of experimentfirst and expand later, and at the present stage it is the pilot securities firms that arehandling ABS. Nine securitized products have already been issued, at a total issuance
21

China Securities Journal, dated 12 July 2006.

The Restructuring of China's Securities Industry 69

amount of 26.35 billion yuan.22 The cash flows of the underlying assets of most ofthese issues are relatively stable, including highway tolls and utility fees for water andelectricity. In addition to these securitized products based on corporate assets, there
are also securitized bank loans, including MBS issued by the CCB in December 2005
and ABS issued by the China Development Bank.
Investors include mutual funds, the social security fund, financial firms, trustee
investments and other institutional investors, and insurance companies are likely tostart investing in the future. The minimum purchase amount for beneficial securities is
100,000 yuan, and it appears that the draft circular published in June raise that to 1
million yuan. It appears that the authorities, taking account of risk tolerance, want toeffectively limit purchasers to institutional investors.
Income for the securities firms include underwriting and financial advisory fees,
and they are also able to invest their own funds, provided their investment does notexceed 10% of the number of beneficiary certificates issued.
The June draft circular is reportedly clear on the bankruptcy remoteness of theassets.23

4) Margin trading
The CSRC announced in June 2006 its Measures for the Administration of Margin
Financing and Securities Lending Business of Securities Companies on a Trial Basisand the Guidelines for the Internal Control of Margin Financing and Securities
Lending Business of Securities Companies on a Trial Basis. These laws lifted theprohibition on margin trading.
Specifically, the small number of pilot securities firms will be approved to conduct
the margin trading business initially, and the approved securities firms are able to lend
stocks and funds in their portfolio to customers. The securities that clients are able totrade are limited to listed securities announced on a securities exchange. After the
relevant regulations are improved following an initial trial phase, other securities
firms will also be allowed to conduct the margin trading business, and this will lead to
growth in the number of sources of funds and securities for the SBL business. To
engage in the margin trading business, a securities firm must meet the sevenconditions outlined below. (1) Over three years experience in the securities brokeragebusiness, and approval as a pilot securities firm; (2) Sound corporate governance; (3)No legal violations over the past two years; (4) Favorable financial condition; (5)Separate management of client assets; (6) Centralized management of trades,
settlement, client accounts, and risk control; (7) The people, systems, and funds
required to develop the trial margin trading business.
This business is expected to be limited to only the leading pilot securities firms.
22
23

70

China Securities Journal, dated 15 September 2006.
When the company that owns the underlying asset of an ABS, the securities firms or thetrust institution goes bankrupt, said assets have never been attached.

Nomura Capital Market Review Vol.9 No.4

On 1 August 2006, the CSRC began receiving applications for the SBL businesses.
Eight pilot securities firms have turned in applications: GF, Everbright, Guotai Junan,
Citic Investment, Orient, Guosen, China Merchants, and China International Capital.24
Four of them have net assets of less than 1.2 billion yuan and therefore are probably
planning a future capital increase.
Also in August 2006, both exchanges announced their Rules for Implementation of
Pilot Margin Trading and Securities Lending. The underlying securities for margin
trading must meet several conditions, including (1) being listed on the Shanghai Stock
Exchange for at least three months, (2) in the case of margin buying, a float of at least
100 million shares and a secondary market cap of at least 500 million yuan, and (3) inthe case of margin selling, a float of at least 200 million shares, a secondary market
cap of at least 800 million yuan, and at least 4000 shareholders. Other rules include aloan period of six months, guarantee funds of at least 50%, a collateralization of atleast 130%, and a collateral value for the underlying security of 70%.
In regards the earnings generated by the securities firms from margin trades, we
expect interest rates, which are higher than those on bank loans and vary by company,
to be around 8% for most of the companies. Citic Securities had 1.2 billion yuan infunds that it could lend to clients when it launched this business, and using an annualinterest rate of 8%, we estimate revenues in the first fiscal year of 96 million yuan.25
During the trial period of margin trading, securities firms will do the business with
their own funds. As the trial scope widens and the level of margin trades increases,
however, the sector will not be able to keep up with the margin trading business using
only its own funds. For this reason, securities firms will probably have to introduce
new financing ways in the future, either directly from the money market or indirectly
through securities financing corporations.

5) Financial futures trading
Stock index futures are expected to be introduced before end-2006. For a long time
now, both securities companies and institutional investors have had strong interest in
hedging tools, and recent moves to introduce China stock index futures in overseas
markets (Singapore) should also provide further impetus for their introduction in
China. Futures on the Shanghai & Shenzhen 300 Index are to be introduced first, withan increasing variety of products after that.
Recently, the China Financial Futures Exchange (CFFE) was established on 8
September 2006. Additionally, the Regulations on Administering Futures Trades are
currently limited to commodity futures, but there are plans to amend the Regulations
to include financial futures.
On 18 September, the CFFE announced a provisional Shanghai & Shenzhen 300
Index futures contract. The contract terms include (1) the contract month of the index
24
25

Securities Times, dated 2 August 2006.
The Economic Observer, dated 6 August 2006.

The Restructuring of China's Securities Industry 71

future would be the current month, the following month, and the final month of thenext two quarters (for a contract in July 2007, the contract months would be July,
August, September, and December), (2) guarantee funds of 8%, and (3) a one-day
stop high (low) of +-10% of the previous days settlement price. The contract details
will be adjusted, if necessary, following simulated trades, after which the futures will
be listed.
According to new reports, futures companies will handle the dealing of futures, andsecurities companies will not be allowed to directly engage in the financial futures
dealing business. On the other hand, pilot securities firms will engage in the businessof introducing futures transactions, which means introducing their investors to the
futures companies. This business is expected to eventually be extended to standard
securities firms.
The authorities will prohibit the establishment of new futures companies moving
forward, while encouraging securities firms to acquire existing futures companies.
Seven of the pilot securities firms already own a futures company, and the others havealready begun making moves to acquire their own. Some of the securities firms aim toeither have 100% control or at least 70-80% control, and about half of theapproximately 180 futures companies that currently exist are said to be considering
selling their shares.

VI. Conclusion -- Issues and outlook for China's securities
industry
There have always been doubts over the business viability of the securities firmsthat were established by regional governments as a way to compete with other regions.
Particularly during the four-year period of declining share prices that began in 2001,
huge losses were generated in discretionary accounts, and this became a problem forthe securities industry overall. Among some securities firms, the problem became so
serious that delaying a solution was not an option, and this motivated the authorities
to launch a reorganization and restructuring of the securities industry from 2004.
Failed securities firms were weeded out through a variety of means, while thesecurities firms with strong financial positions were turned into organizations capableof pursuing new business opportunities. This arrangement was basically meant tomake the strong companies even stronger, and in the future, we expect the direction
taken will be to distinguish the major securities firms from the second-tier niche firms
as a way to stabilize the industry.
At the same time that the securities industry is classified in this way, it is also
important that China's financial industry gradually moves toward a universal banking
model. First, the increase in savings from economic development and the emergenceof a high-income class will create demand for diversification of financial products andservices. The impact from other financial reforms, such as when interest rates andexchange rates become more volatile owing to the increasing liberalization of interest

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Nomura Capital Market Review Vol.9 No.4

rates and capital account, should create demand for hedging tools and other new
services. This will create more room for each of the different subsectors within thefinancial industry to encroach on the others in the new products and services arena.
Second, China's transition period following WTO entry reaches a major milestone
at end-2006, five years after entry, when its financial institutions will be subject tointernational competition. Some observers believe that with financial institutions fromthe industrialized world increasingly moving toward universal banking, if China does
not do the same it will become uncompetitive.
In fact, the proposed 11th five-year plan, passed by the Central Committee of the
CPC on 11 October 2005, recommended the steadfast promotion of trial integrated
financial businesses (Section 25), and the integrated financial model appears to be aforgone conclusion. The same is suggested on the legislative and supervisory fronts,
including the Provisional Regulations on Intermediary Business of Commercial Banks(2001, adoption of registration system and inspection and ratification based on type ofintermediary business), the Commercial Banking Law (December 2003, potential toenter non-banking businesses through stock investments and other methods), and theState Council's Several Opinions Concerning the Reform and Development of the
Insurance Industry (June 2006, known as the "Ten Articles;" it covers trial integrated
management in the insurance industry and equity participation in commercial banking
using insurance funds), and the new Securities Law (revision of Article 6: exceptions
for industry divisions separately prescribed by the state).
There are already examples of mutual encroachment among the subsectors,
including (1) banks establishing mutual fund companies, (2) insurance companies
investing directly in the stock market and establishing mutual fund companies, and (3)insurance companies taking equity stakes in banks and securities firms. Additionally,
as noted above between the securities firms' collective trust accounts and the asset
management products of banks, the products of different sectors are becoming similar
enough to compete with each other.
For the time being, we look for a gradual move toward integrated management,with each financial institution preparing its internal controls and the authorities setting
up their supervisory mechanisms, and we expect this will later lead to the formationof financial holding companies.
When that happens, it will become important for the supervisory andadministrative function to respond to risks from the overall financial system. Financial
authorities already acknowledge that the current vertical division of sectors forsupervision and administration is becoming anachronous to actual conditions in thefinancial industry.
In fact, the People's Bank of China, the China Banking Regulatory Commission(CBRC), the CSRC, and the China Insurance Regulatory Commission (CIRC) are
now looking at establishing a cooperative regulatory body for the overall financial
system to prepare for the emergence of financial conglomerates. It appears that thiswould be a permanent institution within the State Council with a slightly higher status
than these other regulatory bodies, and that it would be tasked with formulating a state

The Restructuring of China's Securities Industry 73

financial strategy, formulating a development strategy for each financial sector, andsupervising and administering financial conglomerates. We expect the specifics of thisbody to emerge at the Central Financial Work Conference26, slated to convene at the
beginning of 2007.

26

Held jointly by the China Communist Party and the State Council, this important
commission, decides China's financial policies, and is not the same as the Financial Work
Conference that is held annually. It has only been held twice in the past, in both cases
when the financial situation had become critical. The first time it was held was
immediately after the Asia financial crisis began, on 17-19 November 1997, and thesecond time it was held on 5-7 February 2002, right after China joined the WTO.

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