-- On the Critically-ill Securities Industry in China
Many
of you may be curious to know why I am saying “treatment or life
saving” to describe the problems of the Chinese securities industry.
You may ask: who needs treatment and whose life needs saved? In fact,
I am not the one who invented the terms. Chinese scholars invented them
to vividly depict what actually goes on in today’s Chinese securities
industry.
Is the Chinese securities industry really critically ill?
On
October 22, 2004, after the market closed, the People’s Bank of China,
the China Securities Regulatory Commission (CSRS), and the government
of Liaoning Province collectively decided to entrust the China Cinda
Asset Management Company to manage the Liaoning Securities. The
Liaoning Securities reportedly had a black hole of 4 billion yuan
(US$0.48 billion). The People’s Bank of China (also referred to as the
central bank in China) has tentatively agreed to bail out Liaoning
Securities. During the first half year of management in trust, Cinda
will be responsible for cleaning up Liaoning Securities’ debts and
liabilities, and performing an early stage reorganization. Once Cinda
completes the trust period, the Liaoning Securities will be taken over
by another company.
Liaoning Securities is one of the seven
securities firms that have been taken over by the government this year.
The 4 billion Yuan (US$0.48 billion) deficit disclosed was the result
of a recent review of all of Liaoning Securities’ debts. The true
figure of the loss could be as high as 7 billion Yuan (US$0.85
billion), according to people familiar with the matter.
Before
this incident, the stock crisis of Xinjiang Delong Group involved as
much as 50 billion Yuan (US$6.04 billion) of loss. The Chinese
government saved this publicly listed private company with both
governmental guarantees and capital injection, an unprecedented move in
China’s history of the securities market. The recent nose-dive of the
Chinese stock market has created additional crisis for the Chinese
securities industry. Without exceptions, almost every securities firm
is stuck in difficult situations. Technically speaking, the Chinese
securities industry is already bankrupt, with a loss of as much as 100
billion Yuan (US$12.1 billion). This is certainly consistent with the
technically bankrupt Chinese banking system.
Back in 2001, I
had a conversation with a top Chinese official in regard to the
potential crisis in China’s securities industry. Though the issues were
not as serious as those in China’s banking system, the securities
industry had already shown some signs of systemic deficiency.
Unfortunately for some reason, I was not able to obtain accurate data
to fully discuss my concerns with this official.
Lacking
accurate data is still a problem today. Lately, when asked about
detailed figures, some financial experts and government officials told
me very frankly, “We ourselves cannot obtain the true figures. When we
do research, we have to glean data from various government reports and
then analyze them with our own judgment.”
From
many Chinese newspapers and various public channels, I was able to
compile some alarming data and information. In 2003 the Chinese
securities market was entirely in the red. According to the annual
reports from 55 members of the National Inter-Bank Loan Center, the
loss of 55 securities firms totaled 47 million yuan (US$5.68 million).
Some had huge losses, for example, Minsheng Securities lost 467 million
Yuan (US$56.4 million). Five firms reported over 1.1 billion Yuan
(US$0.13 billion) total loss, with each losing at least 100 million
Yuan. The total 2003 annual loss of China’s securities firms, excluding
the loss in the businesses in trust financing, surpassed the record of
100 billion Yuan (US$12.1 billion).
In
August of 2004, the overall deficit of China’s securities industry
surged to another record level, 170 billion Yuan (US$20.5 billion). In
fact, the overall deficit of China’s securities industry in 2003 wiped
out almost all the capitals it raised, which signaled the beginning of
the actual bankruptcy of the entire industry.
In respect to it’s
accomplishment in the securities industry, the Chinese government has
claimed, “China’s securities industry has accomplished in just over a
decade what the western nations accomplished in a hundred years.”
In
my opinion, China’s securities industry did far more than accomplishing
a 100-year endeavor of the western world. As of today the western
securities industries have gone bankrupt, while their Chinese
counterparts have already accomplished what they dare not to
accomplish: total bankruptcy. What an “extraordinary way of surpassing
the west!”
A little hard to believe? In the past few days, I
learned from some official sources that the Chinese government approved
various security firms, including Hainan China Bank, Dalian Securities,
Anshan Securities, Beijing Huayang Loan Corp, Shanxi Huakang Trust,
Jiamusi Securities, and Xinhua Securities, to go through bankruptcy
procedures. The bankruptcy case of Dalian Securities is on trial in the
People’s Intermediate Court of Dalian City. The risk of raising funds
in the capital market became very high recently as a few securities
giants including Southern Securities and Min Fa Securities disclosed
losses of billions of Yuan. According to my calculation based on
incomplete public official reports, the abuse margin in the securities
industry reached over 200 billion Yuan (US$24.2 billion), which
translates to 2.54 trillion Yuan (US$0.31 trillion) for the cost of the
financial reform in China
[1].
By the most conservative estimates, an additional 1.2 trillion Yuan
(US$0.14 trillion) injection is needed for the Chinese financial
industry. Adding both items together, to pull the financial industry
out of non-performing loans, the Chinese government has to set aside
3.7 trillion Yuan (US$0.45 trillion)--equivalent to 2,850 Yuan
(US$344.2) per capita in China.
How
did Chinese stockholders end up with such misfortune? Their misfortune
actually began on the very first day the securities market was
established in China. From that first day to October of 2004, China
raised 900 billion Yuan (US$108.7 billion) by issuing new stocks and
collected 300 billion Yuan (US$36.2 billion) of stock-related taxes,
and the securities firms charged around 250 billion Yuan (US$30.2
billion) of commissions. In other words, Chinese shareholders invested
a total of about 1.5 trillion Yuan (US$0.18 trillion) in the stock
market. Yet their returns have totaled a miserable 70 billion Yuan
(US$8.45 billion) from the stock yields, with the gulf of difference
totaling 1.4 trillion Yuan (US$0.17 trillion), most of which is born by
average Chinese shareholders.
From another perspective, the
market capitalization of China’s entire securities market is worth 1.5
trillion Yuan (US$0.18 trillion), two thirds of which are in terms of
the restricted shares controlled in the Chinese government’s hands.
Almost each of the 60 million shareholders has incurred significant
losses.
The foundation of the Chinese securities industry has
almost vanished entirely. In today’s Chinese securities market, there
is no trace of rule or law, only deceit, excessive speculation and
gambling. It’s no secret that nowadays illegal trading and deceit are
the only rules. In June 2003, CSRS asked all stock exchanges to conduct
a survey among major securities firms. It discovered that the illegal
buyback of government bonds totaled 20 billion Yuan (US$2.42 billion).
Six months later, the authorities ordered Southern Securities to stop
any bond trading and officially take over control of the company.
Having discovered that Southern Securities owed 5 billion Yuan (US$0.60
billion), CSRS decided on February 25, 2004, that China Securities
Registration Corporation should conduct another survey on illegal
buybacks of government bonds. The survey this time showed that the
amount of illegal buybacks surged five times within only six months,
reaching 100 billion Yuan (US$12.1 billion).
The
financial reports for the first half of this year revealed that the
large account deficit of the securities firms was mainly attributed to
a high percentage of their own portfolio existing in their portfolio
configurations. Among the 40 securities firms that issued financial
reports for the first half year, securities worth 29.3 billion Yuan
(US$3.54 billion) were owned directly by the firms themselves--a
position which had changed little from the beginning of the year. These
firms all suffered tremendous loss in the second quarter as both the
equity and bond markets went south. In particular, Haitong Securities
lost 317 million Yuan (US$38.3 million) in its own portfolio. Shenyin
Wanguo saw their portfolio value drop 175 million Yuan (US$21.1
million). Guotai JunAn and Guangdong Securities lost 133 million Yuan
(US$16.1 million) and 100 million Yuan (US$12.1 million), respectively.
It
is estimated that the loss in these securities firms’ own portfolios
outpaced their overall revenues in the first six month, with the median
loss being 129 percent of their revenue. Actually the depreciation of
their portfolios became the major culprit for their deficit. On the
other hand, the newly promoted business of financial trust securities
accounts was another area of disaster. The overall business manages 100
billion Yuan (US$12.1 billion). Normally the securities firms guarantee
their customers for a minimum return of 6 percent. Some even promise a
15 percent return. This means that even if the securities firms would
withdraw the capital from the equity market right after the market drop
in the second quarter, their loss would have reached 20 billion yuan
(US$2.4 billion). Based on some publicly available data, I estimate
that the actual loss in that business, totals 40 billion yuan (US$4.83
billion). The securities firms in China are really on the verge of
collapse. After the subsequent nose-dive of the Chinese stock market in
September, that loss is likely to exceed 50 billion yuan (US$6.04
billion).
In addition, savvy investors must be asking, “So, now
you tell me that China’s securities market lacks regulations and laws
and that securities firms are illegally diverting their customers’
funds. There’s something else missing in this picture. It seems that
the source for a large amount of securities firms’ funds is a still
mystery. Where is all the money coming from?”
The answer is
actually very simple. With a series of Chinese government policies and
laws, experts outside of China were misled to believe that everything
in China was legalized and the financial system in China was consistent
with the western system.
This is certainly not the case. In
spite of the government ruling in the past few years that bank funds
are prohibited from entering the securities market, due to the problems
of the system, securities firms and the banking industry have been
closely tied together, and a lot of funds freely flow from banks to the
securities firms. From the central government to local governments,
from corporations to government agencies, everyone, out of one’s own
interest, has been broadly violating laws in the name of, “developing
the economy and maintaining the stability.”
The major avenue
through which securities firms obtain the funds from banks is through
the practice of short-term loans within the industry. Data shows that
as of March 31, 2004, securities firms raised 222.2 billion Yuan
(US$26.84 billion) via the short-term loans from various banks, which
covered over 80 percent of the total bank loans. The second avenue
through which securities firms obtain funds from banks is re-loaning
from the People’s Bank of China. In dealing with the issue of closedown
and takeover of securities firms, the People’s Bank of China has been
playing the role of the last “life-saver” for an extended period of
time. Since 2002, the People’s Bank of China has refinanced many
troubling securities firms and helped them escape from the disaster.
The Chinese government has been tapping into government credit and
public funds to rescue law-breaking securities firms, and through
various means it is robbing the wealth of millions of ordinary Chinese.
The impact of such a practice is often negative. Not only does it
encourage illegal practice within securities firms and magnify the cost
of China’s financial reform, but also it ultimately forces all Chinese
people to share the loss. For example, the 1.5 (US$0.18 billion) and
1.45 billion Yuan (US$0.175 billion) of loans that the People’s Bank of
China issued respectively to the troubled Anshan Securities and Xinhua
Securities now vanished entirely with the bankruptcy of these firms. In
addition, the 10 billion Yuan (US$1.21 billion) of refinancing for
Southern Securities and other securities firms will almost certainly
not return. The reserve fund that the Chinese government allocated to
take over Southern Securities alone totaled as much as 8 billion Yuan.
It looks like another 10 billion Yuan (US$1.21 billion) of new,
non-performing loans will surely be added.
Today’s securities
firms in China are absolutely lawless, and so are the publicly listed
companies and the government administration organs. Recently, Mr. Zhang
Weixin, a financial expert in China, filed a lawsuit against the
State-owned Assets Supervision and Administration Committee of State
Council (SASAC). The Chinese government purposely encouraged publicly
listed companies to illegally swallow smaller companies. The incident
involved reported that TV & Broadcast Intermediary Co. that used
its stocks to pay down its debts, and this clearly reveals how the
Chinese government violated the law and deceived ordinary Chinese
investors of the company. After Mr. Zhang filed his lawsuit, a Chinese
court rejected his case, with the excuse that “state-owned shares” have
already been written off.
According to Section 186 of the
current Corporate Law, when a company needs to write off registered
capital, it must compile the balance sheet and a list of resources. It
must inform debtors within ten days after its decision to write off
registered capital, and within thirty days it must publish a notice at
least three times in newspapers. Within 30 days after receiving the
official notice or 90 days after the first public notice, debtors are
eligible to demand the company to pay back the debt or provide
appropriate guarantees. The registered capital after the write-off
cannot be lower than the legal minimum. Based on this section, at least
the following processes have to be followed to write off assets: the
notice should be published after the board meeting is held and the
write-off decision is approved, and, 90 days after the public notice,
the write-off can proceed if there is no dispute from debtors. In stark
contrast, in Zhang’s lawsuit, it is clear that China’s legal entity,
SASAC, and the publicly listed company, openly ignored the law without
even covering up their crimes. And, all for the sake of their own
interests. How shameless and corrupt!
When a country openly
tramples its own laws and ignores the interest of its own citizens, in
what way can it have any credit or dignity? By the same token, when a
one-trillion-Yuan industry took only a dozen years to accomplish the
“mission” from a “flourishing” system to a bankrupt one, isn’t the root
cause clear enough?
In face of the trauma of China’s securities
industry, some people once questioned if the challenges the Chinese
government faces are to treat the patient or to save his life? Some
people in China once criticized the western securities theories and
practices in the excuse of China’s specific situations.
Is China
really so different from the rest of the world? Shall we really toss
out the existing theories and practices completely and reinvent the
wheel only because of “China’s special situations”? “China does not
have to reinvent the wheel,” as one Chinese official concluded. In some
sense, I agree with his viewpoint very much. What China needs, is to
renovate itself, not to ignore the experiences of other countries in
the name of “special situations.” It is not that western economic
theories are inapplicable, but the lack of self-renovation, and
appropriate political and legal systems that plague China.
Treatment
is certainly essential to the Chinese securities industry. Yet to truly
cure the industry, one must first cure the Chinese political system and
strengthen and perfect its legal system. It requires the Chinese
government to follow its own laws, rather than to trample them. Only
through such changes, can the Chinese securities industry really get
out of the current critical condition. Unfortunately, this is not what
the Chinese government is willing to do.
Life-saving is apparently
the choice of the Chinese government. First of all, with the nose-dive
of China’s stock market, the present government has applied desperate
measures by introducing the policy of allowing bank funds and social
security funds to enter the stock market. It is obvious that the
government has given up the plan for China’s long-term interest. As is
well known, even in the United States and many European countries where
the legal systems have better integrity and the regulations are
tougher, that allowing bank funds to enter stock markets is strictly
regulated. In the United States, social security and benefit funds are
extremely restricted and regulated against entering the equity market.
Ordinary people choose to deposit their funds into banks only because
of the low risk of the banking system as compared to the high risks of
the equity market. In contrast, once the boundary between commercial
banks and investment banks is blurred in China, how can Chinese people
have any sense of financial security any more? In exchange for today’s
stability and for the interest of its communist party and a few groups,
the present Chinese government is willing to sacrifice the future of
the country and of its citizens. Ironically, this is what the Chinese
government calls, “the innovative economic reform” and “maintaining
social stability.”
As a matter of fact, ever since China
opened its first stock market, it has been aiming at the huge private
savings of its citizens. The functions of China’s equity market can be
roughly categorized as follows: the first step is to let some local
powerful entities issue stocks to shift the tremendous risks and
potential crisis of the state-owned enterprises to the ordinary
citizens; the monopolized capitals are used to steal the wealth of the
society via the stock market; once the central government realized the
tremendous gains in this avenue, they started to offer slices of the
pie to their local governments; and then many government entities began
to be actively involved in the equity market, and become the market
makers who openly deceive and rob the Chinese people. Meanwhile, the
participation of the small to medium investors in the market
practically covers up the two functions above, and in fact, they become
the symbolic decoration to validate the legality of the equity market.
When
the state-owned banks and the central government are in trouble, the
Chinese securities market becomes the best resource in slowing down the
crisis of the state-owned enterprises. As is seen, large state-owned
enterprises now become the dominant force in the raising capital game
of the stock market. From Sinopec to Baosteel Group, to investment
banks, the big killer whales are busy butchering the innocent
shareholders in Chinese stock markets. In spite of their shrewd slogans
of “perfecting the corporate administration structures,” their intent
to use the equity market to relieve their financial troubles is very
obvious. Today raising capital in the equity market becomes a single
most important goal of most Chinese enterprises. The critically ill
Chinese state-owned banks are also fighting to climb onto the already
shaky boat of the Chinese equity market. It is very likely that these
enterprises are too heavy to stay afloat. The result could be that the
equity market will not only fail to save the humongous state-owned
banks, but it too, will capsize.
In China, the only functionality of the securities market is to create a deficit in China’s future, without any restriction.
Xinhua
News Agency reported on October 17, “The authorities explained the
reason to purchase individual debts and customers’ securities exchange
settlement funds. During the take-over process, individual debts will
be purchased at discount and the debtors can use this to participate in
the asset allotment.” (Author’s note: Debt up to 100,000 Yuan
(UD$12077.3) will be purchased entirely, while the amount in excess of
this limit will be purchased at a 90 percent discount.)
Although
the report did not elaborate the cause of the practice, one can
understand that under the threat of take-over, resolving the issue of
individual debts for the highly risky securities firms is just part of
a series of strategies from the central bank to treat the firms that
have long been in the red. The Chinese securities industry is truly in
a bloody phase. Despite the life saving remedy from the central
government by using the public funds of the country, I am still
doubtful of the future of China’s securities industry. The drastic move
by the central government to use public funds to save the Chinese
banking system has only, based on my years of observations, piled up
the mountain of bad loans without improving the fundamentals of China’s
banking system at all. So, how can this life-saving action for China’s
securities industry lead to any different results? I recall a Chinese
economist’s argument, “the conflicts in China’s economic reform are
accumulating upwards (towards the central government).”
Can
ordinary Chinese avoid the disaster that streams upward? I have no
answer for such a serious question, as I don’t know how the Chinese
government handles these issues. Let us all keep watch.
So, again, I ask, do we need treatment or life-saving for the critically ill Chinese financial and securities industries?
[1]
The 2.54 trillion Yuan comes from 1) 1.68 trillion Yuan of NPLs in four
big state banks; 2) .86 trillion Yuan of NPLs transferred to asset
management companies. They add up to 2.54 trillion Yuan.
