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Undermotivated Innovation and Underdeveloped Competitiveness of Securities Companies

Despite considerable growth of Chinese securities companies in terms of capital strength and business range over more than 20 years, there has not been substantial change in the profit-generation model. This is characterized as "leaving the result to the fortune," and is considered a major problem to the Chinese capital market, hindering its growth and participation in global competition. There are three main reasons for this lack of success:

1. Capital power is weak with low risk tolerance.

2. Corporate governance structure needs improvement.

3. The profit model is old fashioned.

Capital Power Is Weak with Low Risk Tolerance Capital strength is an integral part of the competitiveness of a securities company. According to the statistics of the Securities Industry and Financial Markets Association (SIFMA), the aggregate capital of the U.S. securities industry was USD 3161.34 billion and rose to USD 4638.142 by 2010. That same figure for China in the first half of 2011 was only CNY 1670 billion. The total business income of the American securities industry for 2010 was USD 254.752 billion, while the same figure for China in the same year was CNY 191.1 billion. The net profit of the American securities industry was USD 24.8 billion, while the same figure for China in the same year was CNY 77.557.

The gap between Chinese securities firms and their U.S. counterparts is still wide with respect to net capital (risk provisions deducted). See Table 1.14 for a net capital comparison of 10 leading American investment banks (2001) and Chinese securities firms (2011).

TABLE 1.14 A Comparison of Net Assets of 10 Leading American Investment Banks (2002) and Chinese Securities Firms (2011)

Globally Leading Investment Banks (2001)

Leading Chinese Securities Firms (2011)

Name

Net Assets (USD in billions)

Name

Net Assets (CNY in billions)

Schwab

5.0

Guoyuan Securities

11.771

Deutsche Bank Alex. Brown

8.283

GF Securities

11.963

Paine Webber

21.147

Shenyin and Wanguo Securities

12.084

Salomon Brothers

21.369

Guoxin Securities

12.490

Bear Stearns

26.252

China Merchants Securities

14.063

Lehman Brothers

43.874

Guotai Jun'an Securities

17.347

First Boston

46.553

Everbright Securities

17.647

Goldman Sachs

47.925

Huatai Securities

21.658

Morgan Stanley

49.637

Haitong Securities

32.460

Merrill Lynch

72.569

CITIC Securities

41.050

Source: Feng (2005); globally leading investment banks; Wind Information Co.; Chinese securities firms.

The situation is even worse in regard to the capital strength of a securities firm. See Table 1.15 for a simple analysis of listed Chinese securities firms.

Corporate Governance Structure Needs Improvement Tables 1.16 and 1.17 illustrate a simple comparison of the ownership structure of American investment banks and Chinese securities firms.

We can learn from this information that even in listed Chinese securities firms, the ownership concentration is still generally higher than that of U.S. investment banks. The level of concentration is much higher if we include many more unlisted Chinese securities firms in the picture. Of course, Chinese securities firms have made efforts to optimize their ownership structure and improve corporate governance.

Still, relatively high levels of concentration in ownership structure and low liquidity of equity (mostly in nonlisted securities firms) automatically lead to one main boss in control of insiders, which goes against the improvement of corporate governance and decision-making efficiency.

TABLE 1.15 Capital and Profitability of Listed Chinese Securities Firms

Total Share Capital (shares in billions)

Gross Asset Value (CNY in billions)

Net Profit (CNY in billions)

Northeast Securities

0.639

19.576

0.528

Guoyuan Securities

1.964

24.901

0.926

GF Securities

2.960

95.947

4.198

Changjiang Securities

2.371

35.773

1.283

CITIC Securities

11.017

153.178

12.136

Guojin Securities

1.000

11.030

0.438

Southwest Securities

2.323

22.778

0.805

Haitong Securities

8.228

115.413

3.868

China Merchants Securities

4.661

95.359

3.229

Pacific Securities

1.503

5.856

0.204

Huatai Securities

5.600

113.463

3.480

Source: Wind Information Co.

TABLE 1.16 Ownership Concentration in Listed Chinese Securities Firms

Ownership by the Controlling Shareholder

(%)

Ownership by Top 10 Shareholders

(%)

Pacific Securities

12.01

82.32

Northeast Securities

30.71

70.89

Guojin Securities

27.35

75.02

Changjiang Securities

14.72

60.85

Guoyuan Securities

23.55

68.71

Haitong Securities

5.87

38.93

GF Securities

21.12

88.65

Southwest Securities

40.45

71.78

China Merchants Securities

28.78

80.63

Huatai Securities

24.423

70.9556

CITIC Securities

20.3

37.23

Source: Wind Information Co.

TABLE 1.17 A Statistical Analysis of Ownership Structure in Major American Investment Banks

A Statistical Analysis of Ownership Structure in Major American Investment Banks

The Profit Model Is Old Fashioned According to modern financial theory and practice, securities firms are supposed to be the most active and innovative financial institutions in the modern financial system. However, the problem with the status quo in China is that Chinese securities firms are still engaged in few business activities and are still dependent on supporting government policy at the mercy of the market for business growth.

Since the explosion of the American subprime mortgage crisis in 2008, due to a huge impact on the conventional profit model, investment banks have suffered sharp fluctuations in revenue and earnings. Many pioneer brokers/dealers have failed to maintain their profitability with innovative activities. In the United States, where the subprime mortgage crisis started, the overall level of profitability of American investment banks fell sharply and the earnings were cut by nearly half, down from USD 474.2 billion in 2007 to USD 254.8 billion in 2010.

However, an analysis of revenue structure of American investment banks and Chinese securities firms shows that the former have maintained, on a reasonable basis, relatively stable revenue from each of their main activities. Investment banking remains the main source of revenue, brokerage revenue remains at a relatively low level, and revenue from asset management and other activities (e.g., research and consulting) grows steadily (see Figures 1.11 and 1.12).

It is a critical moment for change in the profit models of the Chinese securities industry. Many brokers have already begun planning for a realistic approach to adapt to future growth and constantly enhance the core competencies. Their ideas include:

- Curb the decline in commission rates, keep customers and maintain stable brokerage revenue by shaping new business offices, and promote paid investment advisory services, among others

- Develop innovative activities and find new profit-generating activities

- Stimulate interaction between conventional business activities and bring about synergy

In its 2011 interim report, CITIC Securities Co. suggested more practical development ideas, such as investing more, promoting buyer-oriented business activities, building a sound mechanism, inspiring innovation, consolidating domestic business, increasing international presence, and encouraging customer-oriented business.

Chinese securities firms can successfully transform their business model and go on to a broader road to growth, as long as they can keep up with the pace of development trends, focus on customer needs, and constantly promote innovation.

Shift in Revenue Structure in the American Securities Industry (1980-2010)

FIGURE 1.11 Shift in Revenue Structure in the American Securities Industry (1980-2010)

Notes:

1. Commissions and revenue from sale of funds refers to brokerage commission revenue and revenue from sale of funds.

2. Trading revenue refers to revenue generated by the bid-ask spread when an investment bank is making a market.

3. Revenue from investment banking refers to revenue from securities underwriting and other securities-related investment banking activities.

4. Other revenue refers to revenue from research and development, settlement of spot commodities and futures, and other income.

Source: Securities Industry and Financial Markets Association (SIFMA).

 
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