Accelerate the Concentration of Capital for Business Growth and Expansion

Securities firms are nonbanking financial institutions mainly in capital market activities in a knowledge- and capital-intensive industry. When the securities market and the corporation system grow to a certain stage, large securities firms emerge as a key symbol of a well-developed capital market and a mature financial system. The Chinese securities industry's main task for the future is to help Chinese securities firms accelerate the centralization of capital and grow bigger and stronger into large, internationally competitive companies through constant business expansion, innovation, and integration of useful resources inside and outside the industry.

As a priority in the future reform, and the only way to development, mergers and acquisitions should be encouraged and supported in the Chinese securities industry for higher industrial concentration. International experience tells us that the investment banking in developed countries has experienced the evolution from small to large and from fragmentation to conglomeration. The American evolution is the most typical. Although most American independent investment banks shut down or had to undergo restructuring in the 2008 financial crisis, capital remains just as important for securities firms. In fact, capital is always the necessary cushion against risk. From the perspective of industrial development, the competition in a highly fragmented industry is usually chaotic and inefficient. Moderate concentration can bring about the economies of scale in terms of capital.

After several milestone regulatory programs (e.g., the split-share structure reform), as well as the overall improvement initiative for securities brokers and the transparency initiative for public companies, the Chinese securities industry has experienced rapid growth. However, the industry is still in an early stage of development. In particular, there is no substantial change in the brokerage-based profit model of Chinese securities firms. The apparent causes of business difficulties in Chinese securities firms have been the same-old profit model and weak competitiveness for some time. The real causes are narrow-minded institutions and chaotic competition, which led to the generally low profit level in the industry as a whole. Faced with a changing domestic and international economic climate and the high volatility in the Chinese securities market, Chinese securities firms can hardly maintain vitality with a profit model that relies heavily on brokerage and is at the mercy of the market. They have to build their business growth and expansion upon the concentration of capital, whereby they can transform their business model.

Over the past 25 years, global investment banking experienced an unprecedented wave of mergers and acquisitions. A series of M&As in the international securities industry dominated by the United States and Europe helped improve market concentration, shape some global investment banking giants (e.g., Goldman Sachs and Morgan Stanley), and consolidate the crossover business model. Although independent investment banks still exist in the United States, there is no change of tendency toward the concentration of capital. Securities firms have to maintain considerable capital to withstand financial risks and bring about the economies of scale in terms of capital, human resources, and customer bases. The Chinese securities industry should gradually move toward concentration and eventually shape a pyramid-like structure. The structure should have a small number of large investment banks (about five) with super strength that offer a full range of services at the top in an oligopolistic competitive landscape. A medium number (about 30) of securities brokers/dealers of particular innovation skills and a comparative advantage in cost will hold the middle or bottom position, competing with each other in segment markets. In the course of shaping such an industrial structure, a large number of securities firms will go bankrupt or be taken over. Others will go through mergers and acquisitions and become large investment banks with strong innovation skills and capital strength, holding the balance in the Chinese capital market. Of course, the industry will have some short-term pain in the process, but will be more healthy and vibrant overall thereafter.

There are several ways for securities firms to realize the concentration of capital and grow bigger and stronger. Three scenarios are detailed here:

1. The "trusteeship + M&As" model: A securities firm on the brink of bankruptcy or a financial crisis is first placed into trusteeship and becomes subject to restructuring. (In China, such arrangement is a distinctive arrangement for securities firms in trouble. A trustee could be another securities firm, a regulatory agency, or asset management company.) It will then be sold to one or more solid securities firms for further restructuring.

2. Direct M&As model: A capable securities firm grows bigger and stronger by active horizontal and/or vertical mergers and acquisitions, plus integration of resources in a market downturn. Alternatively, two solid securities firms merge with each other and integrate their business and resources in a mutually beneficial cooperation.

3. Flotation: A securities firm can consolidate its capital strength by absorbing public funds in a public offering. It can also place itself under the oversight of public shareholders and introduce strategic investors, an advanced management philosophy, and a business model.

After industrial consolidation, Chinese securities firms could be independent securities entities or securities subsidiaries of financial holding groups. Both kinds of securities firms have their own strengths. An independent securities firm has more independent and flexible decision-making power and makes a quicker response to market changes. It therefore may be more competitive than a securities subsidiary in regard to specialized and innovative skills. A securities firm as a subsidiary of a financial holding group, however, can integrate in an efficient and effective manner all the elements available in the group, develop integrated financial products, and provide a range of financial services on a single platform. In the future, even after industrial consolidation, both types could continue to coexist, providing a wide range of choice for investors.

Restructuring in the securities industry could be an important driving force to help securities firms and the industry improve competitiveness. But other than simple business expansion in size and scale, the goal of such restructuring should be the integration of business philosophy and corporate culture and the improvement of management skills, making the strong stronger and causing strengths to complement each other. Blind business expansion and M&As could offer no help. Or worse, they could lead to the depreciation of brand value. Such industrial consolidation should be a spontaneous market behavior more than anything else. The government should intervene less and allow integration to continue, provided that compliance requirements are satisfied. China has not yet had a case of the bankruptcy of a securities broker in a true sense. All "bankrupt" companies were forced out by government or administrative order. This arrangement will result in the accumulation of risk at the government level and give rise to moral hazard, because it cannot serve as a warning to other securities firms where government-owned assets constitute an overwhelming chunk of the ownership structure. For securities firms, the most important thing in restructuring is to improve, while expanding capital size, business scale, risk awareness, and prevention to a degree that matches the capital size and risk management.

In the new round of restructuring and integration in the securities industry, competent authorities are expected to create a supporting system, give some financial assistance, and enable the securities industry to be entitled to the same degree of attention and policy support as other industries in the financial sector. As a market-oriented mechanism phases in, only the fittest will survive. Improvement of restructuring efficiency will help shape Chinese securities firms into a new force that optimizes the allocation of resources, connects the capital market, facilitates the adjustment of industrial structure and functionality, and promotes the economic growth of China.

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