This month's founding of BOC International (China) gave the mainland its first Sino-foreign securities firm after accession to the World Trade Organisation and likely the first such joint venture to trade A shares. The event may hasten talks about the promises of freeing up the US$500-billion Chinese stock market - Asia's second-largest after Japan - and pressure for other foreign investment banks to catch up. However, latecomers may find in the near term that most of the enormous potential is beyond their reach. Foreign investors are allowed a small stake and there is limited business scope granted to such joint ventures under China's WTO commitments. Shanghai-based BOC International (China) and China International Capital Corp (CICC), China's first Sino-foreign investment bank, are enviable exceptions. CICC has approval to trade A shares, but the start up may come later than BOC International (China), which expects to be up and running soon. That may partly explain why most of the joint-venture talks in the investment banking field are shrouded in secrecy and few are ready to tie the knot. To start with, Bank of China International (BOCI), the Hong Kong-based investment banking arm of Bank of China, has taken 49 per cent in BOC International (China). Morgan Stanley and other foreign partners have a similar shareholding in CICC. In both cases it is more than China's WTO commitment of allowing foreign investors up to 33 per cent in joint-venture securities companies at some time during the three years after its December accession, and 49 per cent after three years. The two existing joint ventures' strong mainland backing is credited for the special treatment. CICC, founded in 1995 with the State Council's blessing, has China Construction Bank - one of the Big Four state banks - as its largest shareholder. Foreign investors not lucky enough to find partners which have the stature of China Construction Bank or Bank of China may fear limited management control in joint ventures and so not be able to defend against the risks of China's volatile, and at times, anything-goes markets. A Shanghai-based partner in United States law firm O'Melveny & Myers, Howard Chao, said: 'I would think foreign investment banks are less interested in a minority stake where they don't have control, but still have the investment risks of China. 'Given the regulatory problems many domestic firms have experienced, the foreign firms are worried about their reputations if they cannot control [the joint ventures].' Domestic securities brokerages have been chastised for a range of transgressions, including collaborating with fund management companies to profit from price-rigging. One of the country's top brokerages - Shanghai-based Shenyin & Wanguo Securities has been named a defendant in what is likely the largest shareholder lawsuit against a locally listed mainland company. The basic problem stems from the infancy of this sector of the mainland economy, with its lax regulations and improper market practices. For a while CICC and BOC International (China) may be the only joint-venture securities firms in China licensed to trade A shares for clients and on their own accounts. The privilege is much coveted by other potential foreign investors due to the sheer size of the A-share market - accounting for much of the markets capitalisation - and the fat profit margins. CLSA chief executive Rodney Smyth said: 'We would obviously prefer to have an opportunity to establish a complete joint venture, with a full range of capabilities.' In September last year, CLSA announced an agreement with Shanghai-based Xiangcai Securities to form a joint venture. WTO commitments oblige the mainland to allow joint-venture securities firms to underwrite domestic securities, including A shares and foreign currency-denominated B shares as well as government and corporate bond issues. However, brokerage and proprietary trading of A shares will stay off-limits. In January, Beijing's China Securities Journal quoted a China Securities Regulatory Commission official as describing China International Capital Corp and BOC International (China) as exceptions. The restrictions for others not only narrow any joint ventures' business scope, but also complicates negotiations. The draft rules allow foreign investors to either buy into existing brokerages or to set up new joint ventures with domestic partners. However, most domestic brokerages would cringe at the first option, which would mean having to spin off their lucrative A-share brokerage and proprietary trading business, a domestic brokerage executive said. Brokerage and proprietary trading of A shares account for about 80 per cent of domestic brokerage revenues. That partly explains why most foreign investment banks known to harbour plans for a joint venture in China have chosen to start from scratch. Earlier this month, BNP Paribas Peregrine announced a tie-up with Wuhan's Changjiang Securities, the eighth-most profitable domestic brokerage last year. Guillaume Dry, deputy group chief executive of BNP Paribas Peregrine, said the two this year hoped to set up a Shanghai-based securities joint venture. HSBC and Goldman Sachs are also holding preliminary talks with domestic brokerages about possible joint ventures. HSBC is the only one known so far to lean towards buying into an existing operation. In such cases, valuation could become a central negotiation problem. The potential of China's investment banking sector may also be seen as limited and less certain than fund management. Fund management, particularly of open-ended funds, is still in its early years on the mainland. Andrew Godwin, a Shanghai-based partner in law firm Linklaters, said: 'This is one area in which foreign fund managers see huge potential because it's such a new area.' They are also tempted by the possibility of managing part of China's huge pension pool. By contrast, 'the stock market is more established, perhaps the requirement for foreign expertise is lower', Mr Godwin said. Graphic: fin28gbz
