Opportunities for Foreign Investment in PRC Securities Companies

The implementation of The Rules on the Establishment of Securities Companies with Foreign Equity Participation (the Old Securities JV Rules), which became effective on July 1 2002, was the last major step prior to the most recent changes. It is worth noting that when the Old Securities JV Rules came into effect, the PRC stock markets at that time were in the doldrums, with liquidity stagnant and losses and compliance issues commonplace.

Under the Old Securities JV Rules, foreign shareholders were not permitted to hold more than one third of the total equity interest of a Sino-foreign securities joint venture (a Securities JV) regardless of whether such interest was to be held directly or indirectly. Securities JVs were also not permitted to have as broad a business scope as that enjoyed by fully-licensed PRC securities companies. In view of these limitations on equity holding and business scope, coupled with past losses, business uncertainty and other developing market concerns, foreign investors have been generally reluctant to invest in Securities JVs over the past few years. There have been a handful of exceptions. A few foreign investment banks had struck deals to access the PRC domestic securities industry (including the creative landmark deals pursued by UBS and Goldman Sachs), prior to the suspension by CSRC of all approvals for the establishment of, and investment in, PRC securities companies in 2006.

The PRC financial services and capital markets landscape has changed significantly since then. Fuelling the bullish stock markets have been a myriad of developments including the unprecedented volume of new domestic A-share issuances, the policy shift towards A/H share dual listings, the emerging market opportunities in bonds and futures and the liberalisation of foreign strategic investment in A-share listed companies. The growth of the fund management industry, the expansion of inbound investment with the qualified foreign institutional investor (QFII) scheme and now the outbound investment under the qualified domestic institutional investor (QDII) scheme have contributed to an increasingly more complex and diverse market. With the emergence of, and subsequent boom in, the PRC stock markets in recent years, the argument for further liberalization and market access to the securities sector through a Securities JV platform, notwithstanding its limitations, has increased in attractiveness.

Following the third round of Sino-US Strategic Economic Dialogues (SED III) held on December 10 2007, the CSRC announced a lifting of its moratorium on foreign investment in PRC securities companies, thereby re-opening the opportunity for overseas players to set up Securities JVs. The long-awaited amended Rules on the Establishment of Securities Companies with Foreign Equity Participation (the Amended Rules), which contain some significant changes to the Old Securities JV Rules, came into effect on January 1 2008.

Concurrent with the Amended Rules, the CSRC also issued the Trial Measures on Establishment of Subsidiaries by Securities Companies (the Trial Measures), effective from 1 January 2008, to address the legislative vacuum in this area. The concession towards renewed foreign investment in the PRC securities companies made by China at SED III and the implementation of the Amended Rules represent the commencement of the latest chapter of prospective investment opportunities by foreign investors in the PRC securities industry.

ESTABLISHMENT OF SUBSIDIARIES

The Trial Measures are applicable to Securities JVs, either as parent companies or as subsidiaries. There are restrictions. The Trial Measures impose certain criteria on the parent company, including a minimum net asset requirement of Rmb1.2 billion or a market share of no lower than the industrial average if the proposed subsidiary seeks to undertake securities brokerage, underwriting, sponsorship or securities asset management. It is also notable that a parent company is prohibited from engaging in any business that competes with its subsidiaries, which would mean that, for example, if a subsidiary underwrites A-shares, the parent company will no longer be able to do the same.

FOREIGN INVESTMENT IN LISTED SECURITIES COMPANIES

Previously, a Securities JV could only take the form of a limited liability company under the Old Securities JV Rules, which in effect meant that it could not be a listed company. However, the Amended Rules provide that a foreign investor may, pursuant to applicable securities regulations, invest in domestic listed securities companies by either acquiring a shareholding listed on a local stock exchange or by establishing a strategic cooperative relationship with such a listed securities company.

There are a number of other interesting developments under the Amended Rules.

Firstly, in addition to the general restriction on foreign shareholdings in a Securities JV being limited to one third of the total equity interest of the Securities JV, the shareholding of a single foreign investor in a listed Securities JV is capped at 20% and the total foreign ownership cannot exceed 25%.

Secondly, provided that the controlling shareholder is a domestic shareholder, the listed Securities JV is not subject to the requirement that at least one domestic shareholder must hold no less than one third of the total shares.

Thirdly, in the past, foreign investment in a domestic securities company would normally result in the post-investment entity being restricted to a more limited business scope, which was a significant disincentive to foreign investors. However, it is noteworthy that, following direct foreign investment in a domestic listed securities company, the existing (and usually a fully-licensed) business scope of such a listed securities company will now be maintained. What this means is that the listed Securities JV would be permitted to continue its lucrative A-share brokerage and trading business.

SHAREHOLDING RESTRICTIONS AND REQUIREMENTS

In comparison with the caps on foreign equity investment in domestic listed securities companies, the maximum foreign investment in a non-listed Securities JV still remains at one third of the total equity interest in that securities company. It remains unclear if and when CSRC will further liberalize foreign investment in non-listed securities companies and in particular whether it will increase the existing foreign equity cap to 49%, although various media sources have speculated that one of the critical achievements of SED III was that the CSRC would subsequently consider raising the ownership cap on foreign investment.

In respect of Chinese partners in a non-listed Securities JV, at least one Chinese securities company (in the case of greenfield Securities JVs) or at least one Chinese shareholder (in the case of existing Securities JVs) must hold no less than one third of total equity interests in that securities company.

LIMITATIONS ON BUSINESS SCOPE

Another feature is that a Securities JV may now not only underwrite but also sponsor share (including A-share) and bond offerings under the Amended Rules.

A listed Securities JV may, following foreign investment, maintain its original business scope. However, a non-listed Securities JV is still not permitted to engage in these broader business activities, i.e., it may not engage in A-share brokerage and trading.

For ease of reference, the table above sets out a comparison between the permitted business scope of fully-licensed securities companies and that of non-listed Securities JVs.

OTHER DEVELOPMENTS

One of the significant changes under the Amended Rules is that the standards for foreign investors in securities companies have been lowered. Under the Old Securities JV Rules, a foreign investor was required to have a track record of having conducted securities business in its home country for at least ten years. The Amended Rules only require that one of the foreign investors in a consortium be authorised to conduct financial services in its home county. That foreign investor is required only to have been in operation for at least five years. This offers the interesting prospect of new opportunities for private equity firms to be involved in financial institution investments, something which until now has been difficult.

Lock-up provisions are also formally stipulated in the Amended Rules, providing that foreign investors may not transfer shares in a Securities JV within three years of the date of investment. The Amended Rules have also lowered the minimum number of licensed securities personnel employed by a Securities JV from 50 to 30.

CONCLUSION

The recent changes represent a further important step in permitting foreign investment into the securities industry. The developments are incremental and in fact, still represent limited opportunity. The SED III Joint Fact Sheet suggests a possible future expansion in the business scope of qualified Securities JVs by allowing them to engage in “securities brokerage, proprietary trading and asset management in the future”. This means that there is still further high-level negotiation that will be done as pressure will remain for the PRC government to adopt policies to reflect the concessions made at SED III. More importantly, for now, these changes signal an end to the moratorium of investment in securities companies and set the stage for what is likely to be a multitude of transactions in this area as foreign financial institutions look to establish their platform investments in this area.

*About the authors:

Victor Ho is a Partner, Lynn Yang is of Counsel and Jane Jiang is a Senior Associate at Allen & Overy LLP, in China and Hong Kong.