Management of Risks Associated with the Direct Investment Business of Securities Companies
The direct investment business of securities companies refers to a practice by securities companies to search for and identify high-quality investment projects or companies using its own expertise. The company then makes equity investments with its own raised capital or funds in order to gain a return on equity.
In March 2008, the CSRC started allowing qualified securities companies to apply for direct investment pilot projects. In July 2011, it subjected the direct investment business of securities companies to routine regulation, widening the space for the growth of the direct investment business. By the first half of 2011,18 direct investment projects of securities traders had gone public successfully. Three direct investment projects were cleared by the issuance examination committee. The book return of direct investment projects stood at CNY 2.591 billion, with an average return rate of 432.68 percent. By that time, 34 securities traders had been qualified for direct investment, and almost all set up their direct investment subsidiaries. The total registered capital was CNY 23.5 billion, an average of CNY 712 million for each company. Based on the 15 percent net capital upper limit, the amount of directly investable capital was expected to reach up to CNY 46.9 billion.
Risks Associated with the Direct Investment Business
Liquidity Risks The direct investment business of securities companies usually has a long investment cycle. The operation term is typically 3 to 5 years, or even 7 to 10 years. It is very difficult to transfer the investment within the operation term. Poor liquidity is a sign of long risk cycles. If the important final exit step is not carried out smoothly, there will be high liquidity risks. The financial structure of a securities trader is highly leveraged. The sources of capital include not only capital owned by the securities trader itself, but also debts. If those sources are to be used as long-term capital, the liquidity risks of the capital must be constantly controlled. Otherwise, financial crises will become extremely likely, leading to the spread of risks.
Profit Fluctuation Risks Risks facing the direct investment business of securities traders are a combination of technical risks, market risks, and financial risks. They are characterized by the possibility of a highly risky scenario in which a small risk eventually leads to the failure of the entire project. Without an existing market for the equity assignor to reach a transaction agreement directly with the investor, it is impossible to avoid the risks of profit uncertainties.
Information Disparity Risks Information is limited in the direct equity investment market. Typically, the direct investment business seldom involves public market operations and is not required to disclose transaction details. The target enterprise being invested may exploit the disparity of information to prevent the securities trader from making decisions in an efficient and correct way.
The Spread of Risks While engaging in direct investment, the role of a securities company changes from a financial intermediary to an equity investor and manager. The securities intermediary services of the securities trader cover the primary and secondary market, investment and financing, and financial strategy consultation. The securities trader is thus able to provide its clients with all-around one-stop integrated intermediary services. These advantages meet the needs of clients of the securities direct investment business. The securities trader is willing to accept synergic development between various business lines, thus playing the dual role of both service provider and service recipient. In this way, different business risks interact, take cover, mutate, and amplify. The whole operation process of the direct investment business—from financing, project decision making, management, to the final exit—is closely connected to other business divisions of the securities company. The financing process is not viable without the customer base of the company. Assistance from the sales division and retail division is needed. Sometimes even the product innovation division needs to transform equity capital from a certain concept to an innovative product for sale. The original retail business then becomes a type of capital market business participating in high-risk activities. Support from various divisions of the company is indispensable in the project decision making and management processes. Multidivisional cooperation increases compound risks, causing originally concentrated risks to spread from one division to another. The interconnection of different business lines will finally amplify the risk impact of a single business line, magnifying the overall risk for the company.