Overview of the Chinese Securities Market and Industry in 2002 -- Deep Distress Needing Urgent Remedial Action

In 2002, the structural and psychological weight of the roughly two-thirds of shares of the 1224 companies listed on the Shanghai and Shenzhen exchanges that are non-tradable and mostly state-owned¡ªa situation resulting from a view of the market as a way to bail-out the state-owned sector, not as means of privatization--as well as the poor performance of these companies, drove China¡¯s stock market to a three year low. The index of shares on the Shanghai exchange dropped to 1,359, some 35 percent below level in 2000. 

In the absence of short selling or other risk hedges, the market index provides a good indication of gains or losses in investors¡¯ equity portfolios. Clearly, investors have been losing big. They have also been exiting the market, such that the buy side is increasingly looking narrow and hollowed out. 

A survey conducted by the China Securities Registration and Settlement Company at the end of November 2002 found that of 34.5 million investor accounts for trading domestic A shares officially opened with the exchange, only 14.7 million, or 43 percent, had any share balance, and that 4 million account holders had liquidated their positions in the previous 12 months. Further over 90 percent of ¡°active¡± accounts had positions with a market value of less than RMB 100,000 (USD12,000). Only some 53,300 accounts held positions over RMB 1 million (USD 121,000) in value. Figures for the Shenzhen exchange would show a similar but no doubt stronger pattern of abandonment of the market by disillusioned investors.

But more serious is the condition of the securities firms. At the end of 2002 there were are 126 securities companies in China, with over 2900 sales offices. Thirty-three were offering full services, including underwriting as well as brokerage. 

In 2002, for the second year running, Chinese securities firms racked up losses so massive that many companies, and perhaps the industry as a whole, has been decapitalized. Such is the systematic extent of the crisis that officials and media are treating the subject with extremely caution. 

In 2001 a main source was losses from discretionary asset management stemming from the firms¡¯ illegal commitments to corporations of ¡°guaranteed¡± returns. This practice was observed industry-wide. In 2002 industry-wide losses in brokerage and underwriting--the other two main businesses of the securities firms in addition to asset management--had cumulatively reached RMB 22 billion (USD 2.7 billion). And, in the continuously falling market, 2002 losses from asset management were certainly massive as well. The combined loss figure for the industry has been estimated at some RMB 40 billion (USD 4.8 billion). 

This loss would have largely consumed the net capital of the industry, calculated in May 2002 by CSRC at 48 billion (RMB 5.8 billion), using strict regulatory formulas which discounted illiquid, largely non-performing assets. Against this background, the dramatic increase observed in 2002 in borrowing by securities firms in the interbank money market, is further testimony to an industry in distress and to rising systematic risk. 

Under pressure from the CSRC, the industry was forced to raise capital by 50 percent in 2002. By November total registered capital had reached RMB 104 billion (USD 12.6 billion), two and one half times the level in 2000. Still, according to CRSC, average registered capital of Chinese securities firms is RMB 840 million (USD 102 million), and 64 percent of firms by number have registered capital of RMB 1 billion (USD 121 million). The most highly capitalized is Haitong Securities with RMB 8.7 billion (USD 1.1 billion), which is about 5 percent of the capital of Morgan Stanley.

Objective market conditions also put pressure on securities firms¡¯ revenues in 2002. Brokerage revenues, which typically make up some 85 percent of earnings, plummeted from the combined impact of lower trading volumes and deregulation of commission. Trading turnover of stocks and funds on both exchanges in 2002 was RMB 2,916 billion (USD 353 billion), down 29 percent from 2001. It is estimated that total brokerage commission generated in the industry was some RMB 7.3 billion (USD 881 million), or an average of RMB 2.5 million for every securities sales office.

In 2002 there were 70 IPOs in the domestic market, down from 74 in 2001, which produced underwriting volume of RMB 77.8 billion (USD 9.4 billion). China International Capital Corporation captured RMB 23.3 billion of this in four giant IPOs, including China Mobile, leaving the rest of the industry with only RMB 54.5 billion (USD 6.7 billion). Excluding the four largest IPOs, the average deal raised RMB 410 million (USD 50 million). On this meager volume underwriters could hardly recoup expenses. 

At root of the securities industry¡¯s problems is that the securities companies are all competing in a regulatory regime-mandated, highly limited range of products and services, which has tended to allow for little differentiation or specialization. Compounding this situation are the features of SOE management¡ªlack of strategy, diffused responsibility, over-investment in people and facilities, weak or absent cost controls, undisciplined sales practices. 

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