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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 firms still confront a host of challenges, ranging from the need for fundamental transition of the profitability model to heated, cruel market competition. Acquisitions, mergers, and transition of models will reign as the basic rules of survival for the securities industry in the future. In order to take a dominant position in future competition, securities firms must grasp the future development of Chinese economic and market transformation of the country's financial structure, on one hand, and understand their positions and improve general competitiveness, 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 first-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 number of securities firms 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 fierce market competition, as opposed to the financial crisis that may result from the defects in institutional design. This is because institutional loopholes for major financial risks in securities firms 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 first 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, and brokerages 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 firms with strong overall competitiveness will champion the future M&A in the securities industry. Nonlisted brokerages will obviously stay at a comparatively disadvantaged position, although those with controlling shareholders or 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, as expansions of all business dealings are interlocked with the scales of capital.

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

Hard-to-Replicate Core Competitiveness

Few securities brokerages would be able to attain competitiveness in all elements. The agenda for the majority of securities traders will not pursue scale and comprehensiveness, but rather core competitiveness with unique advantages. This is also necessary for the few giant firms with all-element competitiveness. In China's current services portfolio of securities companies, specific advantages could be developed from all elements, including brokering, wealth management, M&A, financing and refinancing, assets securitization, and derivatives trading. For example, in order to become competitive in the brokering business, brokerages must have powerful marketing capability; a smooth, effective trading network; and superb service capabilities. To stand out in wealth management, a securities firm must be able to grasp the bigger picture of the market, have first-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 financial support system. The isomorphism era of the profitability model in the Chinese securities industry is about to end. Proprietary competitive strengths established on a "big" foundation represent the future development direction of Chinese securities firms.

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

Stringent Risk-Management

Mechanism, Swift and Effective Risk Disposal Capacity Managing risk is key to all financial institutions, and securities firms are no exception. One reason for the eventual demise of some powerful prime investment banks that even boosted reforms in financial structure was indifference to crisis. Self-destroying risks crept onto those firms just as they were amassing huge profits. While in pursuit of their own ultimate interests, their risk-management regimes were either ineffective or too vulnerable. When serious financial storms arrived, they found themselves powerless.

Mounting experience and lessons have unveiled the following fact: Liquidity risks affect the lifeline of all financial institutions. Managing risk is key to survival. Only by surviving, can the firm hope to grow.

To establish an effective risk-management program, securities firms must develop their internal systems, including corporate governance structure, information transparency, front- and back-office risk-separation mechanisms, capital liquidity, and risk response capabilities.

Broad International Perspective, First-Rate International Abilities

The strategic goal of the reforms and development of China's financial system is as follows: Turn the Shanghai-Shenzhen-anchored Chinese financial market into a financial market growth pivot with global implications by 2020, and make

Shanghai (and Shenzhen) the new international financial center to facilitate the market, international, and modern appeals of the Chinese financial system across the spectrum.5

In order to become an international financial center, China needs to have a substantial number of blue-chip companies and growth-oriented enterprises with investment values, complete corporate governance structure, and international influences. In addition, the financial services in the Chinese capital market also need to achieve international caliber. Therefore, China must develop a number of securities firms (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 firms to develop their international horizons, priorities are as follows: Understand and master the rules of the international money market, grasp the operating laws and transitional trends of the international financial market, maneuver the complex financial vehicles in the international market, and know the operating characteristics and changing directions 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 firms must improve their international capabilities, in terms of financial services, by both developing a strong ability for market expansion and by exploring and meeting the diverse financial 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 financial structure. A seamless combination of these four elements will generate powerful vitality and unparalleled competitiveness.

 
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