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Internal Logic for Organizational and Management Evolution in Chinese Securities Firms

To a considerable extent, the change of organization and management in Chinese securities firms is subject to the general policy for the Chinese financial system reform, and is therefore politically sensitive. Such change is also closely related to competition in a changing internal and external environment and the underlying demand in the market. From the perspective of historical evolution, the emergence of Chinese securities firms (as an outcome of the change of the Chinese financial system) and the choice of

TABLE 3.3 Chinese Securities Firms Affiliated to Financial Holding Companies

Chinese Securities Firms Affiliated to Financial Holding Companies

Source: Websites or annual reports of the companies listed.

organizational and management models are closely related to the functional orientation of the Chinese financial market (the stock market in particular). They both relate to an inherent call of the great change in Chinese economic and financial environment over the past 30 years.

In the early 1990s the ideological dispute about the choice of "planned economy" or "market economy" remained a highly sensitive topic. From a macroscopic point of view on market positioning and functional orientation, the Shanghai and Shenzhen stock exchanges were created such that they did not entirely apply proven economic theory to practice for market-based optimization of resource allocation. To a considerable extent, this was part of the exploration of a new system in an attempt to find a way to make a strategic change of financial support strategies (i.e., a shift from monetary financial support to monetary and securities-based support). This was a period of economic transition, when the monetary revenue was drying up and the state-owned banking system was carrying a huge economic burden. It was exposed to increasing risk as a result of massive bad debts accumulated over the years. The government allowed diversification of promoters of a securities firm. For example, special purpose banks, insurance companies, or other financial institutions at the central level could be accepted as charter members. Local financial institutions and even departments of finance could subscribe to capital contributions or shares. National or local trust and investment companies, which were quite new in the market, could also be allowed to set up a securities firm.

Therefore, even though the government was not very strict with the restrictions on market access, it was clearly a reasonable outcome that promoters chose a wholly government-owned company as the only organizational model either for institutional controllability or for exclusive ownership of returns. The market was in its infancy, securities firms were engaged in extremely simple and simplified activities, and financial institutions had much crossover in their activities due to the lack of regulatory constraints and sound institutional settings. Promoters did not define particular institutional positioning and functional orientation for securities firms. As a result, the management in securities firms was usually a natural extension of that of parent companies, which inherited the characteristics of a planned economy. There was little difference between securities firms and other financial institutions in China, in terms of management.

However, things changed after 1993. Landmark events in the reform included the stripping of nonperforming assets and the establishment of three policy-oriented banks. Along with the reform in state-owned special purpose banks, the Chinese government seemed more clear and determined about the commercialization and market-oriented reform in financial institutions. In that context, another proposal came to the attention of policymakers. This was for a market-oriented reform in securities firms that were inferior to special-purpose banks in terms of assets, capital, and influence. The moment came along with the enactment of the Companies Act of 1994 and Financial Institutions Regulations. Financial institutions in securities-related activities were brought to compliance. During the process, limited liability companies became the preferred organizational model for securities firms and most of them completed conversion within two to three years.

Along with the rapid development of the financial market, there was an increasing demand for diversified securities services. There was also increasing competition between financial institutions. For the purpose of enhancing core competencies and expanding market share, securities firms began to review their management models. They replaced the one-dimensional model, building on business offices in multiple activities with single-level or multilevel management systems that built on the classification of activities, embraced diversity, and relied on multidepartmental collaboration.

New legislation, including the People's Bank Act, the Commercial Banking Act, and the Insurance Act of 1995, established legislatively the financial model based on separation of activities. The institutional independence of Chinese securities firms was thus confirmed. Satisfying the increasing need of money for a new technology-enhanced makeover, this went beyond the capital restrictions in companies of limited liability, where there was only a single type of shareholder and most equity was in the hands of the controlling shareholders. After 1997, some Chinese securities firms further converted from companies of limited liability to corporations. This was in compliance with relevant regulations to separate from banks and other controlling shareholder, and it consolidated institutional independence and improved corporate governance. By the end of 1998, 29 of the 90 Chinese securities firms had completed such conversions.

While working on the organizational transformation, many large Chinese securities firms started to focus on business risks. Generally, they established internal control mechanisms that included audit committees, risk control committees, and oversight departments. They also took back autonomy in business offices. Individuation and diversification started to appear in organizational structure and business mix. The Securities Act of 1999 legally differentiated the securities firms that offered brokerage services from the ones that offered general services. This improved or brought a change to the market operation system. Such changes included administrative approval to regulatory endorsement for IPOs and the launch of a sponsorship system.

At the beginning of the new century, there was another major change of climate for the Chinese financial system reform. China's accession to the WTO in 2001 required the Chinese financial system to be integrated into the global system as soon as possible. Opening up, accompanied by marketization and internationalization, became a driving force pushing forward the financial system reform and the change of organization and management in Chinese securities firms. After China's accession to the WTO, Chinese financial institutions would be faced with increasing competitive pressure from foreign competitors. To help Chinese securities firms prepare for possible competition against foreign competitors in regard to capital, business, human resources, and others, the CSRC released in July 2006 the Risk Control Indicators-Based Regulatory Measures for Securities Firms and the Circular on Release of Net Capital Calculation Standards for Securities Firms. These regulations defined risk control indicators and determining net capital as the core indicator. The Provisional Assessment Measures for Securities Firms in Creative Activities, which had been amended twice, also made the size of net assets one of the qualifying criteria for securities firms to carry out creative activities. Net assets became a prerequisite factor for the operation and expansion of brokers. They also determined their market standing in the years to come. Many Chinese securities firms that had already diversified their investors by conversion into corporations now dreamt of becoming public companies. Within a few years, dozens of securities firms had their IPO plans. There was a tendency of organizational transformation across the industry between 2006 and 2007 just before the financial crisis. By that time, 17 securities firms became public companies through IPOs or backdoor listing (Zhanyu 2009).

While Chinese securities firms were lining up to become corporations and then public companies, other financial institutions (e.g., commercial banks) brought major changes to their business activities. Chinese financial reform went further, with the development of the financial market, improvement of regulatory practice, change of regulatory philosophy, and changeover of the competitive landscape due to the advancement of technology and innovation. A considerable number of banks or other economic entities then started to target an "integration" model, whereby a financial institution could use a financial holding company to segregate some activities and cause different activities to complement each other. This resulted in some securities firms becoming a part of conglomerates, subject to conglomeration management. However, despite the group-like organizational framework and management structure, Chinese financial holding companies have not yet brought noticeable synergies between different business divisions/subsidiaries (e.g., banking, securities, insurance, and trust). Those synergies would be far less significant than the practical effect of synergies found in full-service banks in the Continental Europe or even in American bank/financial holding companies.3 The lack of synergies is due to the existing regulatory system as well as the realities of financial development.

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