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Chapter 2. Analysis of Functions of Chinese Securities Companies

As the most important financial intermediaries in capital markets, securities companies play an important role in the economic and financial system by providing financial services for the following four unique core functions:

1. Securities issuing and underwriting

2. Asset securitization

3. Merger and acquisition of stock of resources

4. Wealth management

In the first two sections of this chapter we will discuss, from the perspectives of both theory and reality, the theoretical fundamentals of these four core functions and the performances of international investment banks and Chinese securities companies. The third section of this chapter will describe the effects of reforming the fund custody regime on Chinese securities companies' functions. Embezzlement of customers' margin funds, before the reform, led to veiled increases in leverage ratio and speculative activities of securities companies, resulting in the systemic crisis that has swept the sector. However, the establishment of the third-party custody system has institutionally assisted securities companies to control the investment leverage and standardize financial services, which has made for a well-functioning system on the basis of the institution. We reinforce the important implications the reform of capital custody regime had in staving off systemic crises and assisting securities companies to play their core functions. We do this by comparing and analyzing the fact that investment banks embezzled customers' margin funds, which led to high leverage in the global financial crisis.

The fourth section investigates from an empirical perspective whether various institutional reforms such as listing, classification management, and ameliorating governance structure by securities companies were beneficial to help them fulfill their core functions. The results indicate that there was significant improvement of underwriters' reputation for securities companies. Specifically, the function of reputation in the underwriting activities has become visible in the Growth Enterprise Market (GEM).

Securities firms are known as investment banks in Europe and the United States, but are called securities firms in China and Japan. Under either name, they have a long history. They came along in the early days of capitalism as merchants' banks that accepted bills, helping to facilitate trade and commerce. They then developed into modern investment banks in an early form, handling government bonds, corporate debentures, and securities underwriting. They have grown further into financial giants, with considerable interests in every corner of the financial market. A review of such evolution would unveil economic development, technological advances, and social change right through today.

Securities firms are no longer limited to conventional business activities such as securities underwriting and financial advisory services for M&A and divestitures. Having completed organizational transformations from partnerships to corporations and solved capital problems that constrained business growth, securities firms have made new breakthroughs in proprietary trading and asset management to become great creative minds for financial derivatives and structured products, showing great strength in all aspects of the financial market. The 2008 subprime crisis ended with the collapse of Bear Stearns and Lehman Brothers and the conversion of Morgan Stanley and Goldman Sachs. However, the disappearance of the investment banking model that features large independent investment banks does not mean the end of mission and investment banks, which continue to exist in another form. Securities firms still play a pivotal role in global capital markets in terms of finance and information dissemination.

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