Opening of the Securities Industry

The China Securities Regulatory Commission (CSRC), the watchdog of the Chinese securities market, hopes to improve the quality of Chinese investment banks by introducing international investment bankers to the domestic market. Many Chinese investment banks have a poor history of complying with securities laws, despite the frequent sanctions of the CSRC. The CSRC hopes that international investment banks will provide positive models for domestic firms, and will force the domestic investment banks to improve their performances in a more competitive environment.

On December 12 2001, CSRC published the Draft Rules of Approval of Sino-foreign Joint Venture Securities Companies (the Draft Rules). Though it will likely be some time before promulgation of the final version of these rules, it will be much sooner than the deadline of three years after accession as committed by the Chinese government in the WTO Protocol of Accession. Zhou Xiao Chuan, the Chairman of the CSRC, said in a recent speech that the CSRC welcomed experienced international financial institutions to enter the China securities market and that he believed the competition would benefit both local and international market participants.

The Sectors To Be Opened

The sectors to be opened to Sino-foreign Joint Venture Securities Companies (JVSCs) consist of: i) the underwriting of A, B and overseas listed shares issued by Chinese companies (Overseas Listed Shares), and debentures (including government debentures and corporate debentures); ii) the brokering of B and Overseas Listed Shares, and debentures (including government debentures and corporate debentures); iii) the dealing for their own account of B shares and Overseas Listed Shares, and debentures (including government debentures and corporate debentures); and iv) other businesses approved by the CSRC.

The Draft Rules don't address some important sectors that are traditionally core business areas for investment bankers globally, including consulting (for example, advising the acquirers and the target companies in merger and acquisitions), and investment advising (for example, advising a client to buy or sell securities and publishing analytical reports). The CSRC left itself a discretionary space to allow the JVSCs to work in sectors that are not explicitly addressed by the Draft Rules; it is however unclear now to what extent the CSRC will draw a boundary in this respect.

Methods of Formation

There are two alternative ways to establish a JVSC: by registering a new joint venture company with Chinese partners; or by purchasing the equity held by the shareholders of the domestic securities companies or the new equity issued to the foreign investors.

There are problems with both of these methods. When establishing a new company, the foreign investors must find Chinese partners that have enough cash or non-cash assets (contribution in kind is allowed by the Draft Rules if the non-cash assets are necessary for the operation of a JVSC) to make their capital contribution. Another problem a foreign investor may need to consider is how to resolve the competitive relationship between the Chinese partners and a JVSC. If purchasing the equity of a Chinese securities company, most of the difficulty lies in the creation of a new company via a "spin off". There are two main reasons to spin off certain businesses or assets out of the target company. One is the creation of a new target company without unprofitable businesses or businesses conflicting with the new strategies of the JVSC, and the other reason is that it is necessary given that the target companies have a broader business scope than the business scope of the JVSC approved by the CSRC. Under the latter circumstance, the target companies are required by the Draft Rules to spin off the businesses and assets falling beyond the initially approved business scope of the JVSC.