Golding the Tiger Lilly

"China's 130 securities houses lost 15 billion yuan (A$2.5 billion) in 2004 and probably more in 2005. All but a handfull are technically bankrupt.

Embezzlement and criminal activity is so widespread in the securities market that the regulator is moving to take all cash settlements out of the business and hand it over to the banks under a complex custodial arrangement.

It is a bankrupt industry, riddles with scandal and commonly considered to be rotten from top to bottom.

'There is effectively no institutional investor class here in China. There is 1.6 trillion yuan (A$267.5 billion) in people's savings accounts but no one wants to put it into the mainland stockmarket. The corporate governance sucks; the intersts of management are not aligned with those of shareholders. It is rotten from tope to bottom. And there are no real reform measures -- it is like putting scaffolding around a crumbling building.'

The brokerage industry in China is only 15 years old. When the stockmarket was set up in the mid-1990's, the provincial and city governments moved in to set up the brokerage houses. The industry fell into the same trap as the state-owned banks -- a politically driven process with poor corporate governance and a lack of supervision. Now it is a financial basket case.

[And yet] the new fight [for Western brokerage houses] is to land a spot in the Chinese broking and investment banking industry.

The Goldman Sachs solution has been [to] set up a brand new securities house... effectively held in trust for it by a Chinese associate. First Goldman made a donation of $US62.5 million (A$83.7 million) to authorities in Hainan province. This money was to be used to pay out depositors whose money had been embezzled in the failed Hainan Securities Company. Shortly afterward, Beijing's securities regulator, in a State Council approved decision, issued a new broking license -- completely separate from Hainan Securities.

[Goldman's Chinese associate, Fang Fenglei] set up Beijing Gao Hua Securities Company using Goldman funding. Goldman Sachs then took a 33 percent stake in a separate company, Goldman Sachs Gao Hua Securities, with Fang's brokerage company holding the remaining equity.

I t cost Goldman an estimated $US200 million all up and was completed in mid-2005. [But it got a leg up on its competitors.] 'Goldmans have got 50-plus [employees]. The amount of people they can see, play golf with etc. -- without having to fly in and out from Hong Kong -- means their ability to source deals is immense.'

UBS has taken a different tack to Goldman Sachs. The UBS deal received State Council approval last September, just before the securities regulator pulled up the drawbridge and said no more deals for now. UBS will pay $US212 million for 20 percent of the troubled Beijing Securities, which had losses of 160 million yuan in 2004. This makes it the first foreign firm to buy directly into one of the ailing mainland brokerages. It allows UBS to have control of management of the group. And previous obligations and losses have been carved out. UBS will not be liable for them.

UBS' co-shareholders include the local Beijing government, three state-owned companies and the [ubiquitous] World Bank's private-sector investment arm, IFC. Exact details of the ownership structure have still to be released.

Critics claim that UBS paid $US200 million to go down the same rocky path as Morgan Stanley did in the 1990s -- the CICC road. This was a new joint venture investment bank, a one-off deal allowed by Beijing. Almost from day one Morgan Stanley became embroiled in huge arguments with its joint venture partners and has finished up treating its equity in the group as a protfolio investment, surrenduring all management input.

CICC has been a profitable investment for Morgan Stanley but it is a totally separate operation and actually competes with Morgan Stanley for deals. CICC is now run by Levin Zhu, the eccentric son of former Chinese premier Zhu Rongji.

ON the positive side, the potential for the Chinese market far outwieghs that of other emerging markets such as Russia. The Chinese are among the highest savers in the world [and the banks and brokerages are plumped up to get their hands on that savings]. Once the local population has confidence in the stockmarket, the growth potential [and ability of the brokers to skim off the savings] is enormous.

For the world's biggest brokers and investment banking houses, the opportunity is too big to ignore."

I apologize to Colleen Ryan who wrote most of the material above in the Australian Financial Review's headline story "High stakes: brokers battle for foothold in China" yesterday, 26 April 2006; I cut and rearranged her piece and added a couple of snide comments in brackets.