Setting Sights on China

When the Depository Trust & Clearing Corp. was looking for a place to set up a round-the-clock corporate-actions center in South Asia, it undertook an exhaustive evaluation of possible sites, according to James Femia, managing director and head of the DTCC's global corporate-actions business. It looked at everything from labor pools and education to language, cost structures and even quality of life before settling on Shanghai, a port city of 13 million located in the eastern-central region of China.

"It's a major financial center that has a very large skilled workforce," Femia explains. "We believe the economy is vibrant as well as fast growing; Shanghai is becoming a major metropolis in the Asian marketplace."

That includes a modern infrastructure, he says - one that will allow the DTCC's new corporate-actions center to handle more than 100 different types of events, including rights offerings, elective dividends, tender offers and stock splits. The goal is to have more than 30 corporate-actions specialists working out of the Shanghai center.

"What we found is that we needed to have an Asian presence," says Femia. "Corporate actions that take place in Asia are generally considered to be the most complicated. It's very important in this line of business that we have folks who are able to deal with the local markets operating in the local time zone." While moving into a foreign land can be a challenge, Femia says, "We found the authorities were generally welcoming and easy to deal with. It only took a few months to get the office up and running - a very painless process."

DTCC has built an Internet-based system to handle the corporate actions and worked with the local telecom providers to install high-speed lines.

Golden Shores

The depository's move into China is reflective of the growing shift under way in global capital markets. As Femia notes, firms such as the DTCC need to align themselves with their clients and market opportunities. And right now, the capital markets see opportunities in China.

That's because the country of one billion people is undergoing an economic revolution. China's gross domestic product has been growing at nearly a 10 percent clip for the past decade as it unwinds its centrally controlled economy and adopts a more free-market approach to business. It's privatizing large government-controlled corporations, opening up stock markets and generally loosening restrictions on doing business in the world's most populous country. That's creating opportunities for Western-based firms.

Pretty much every major financial institution now has some type of presence in China, including JPMorgan Chase, Citibank, UBS, Morgan Stanley, Goldman Sachs, Lehman Brothers, Merrill Lynch, CFSB and BNP Paribas. "Everybody is already here in different ways," says Bob Kwauk, a securities lawyer in the Beijing office of Blake Cassels & Graydon. But that doesn't mean it's a free-for-all. "Securities companies are still very limited in what they can do."

Most of the work involves acting in advisory services for businesses and helping underwrite Chinese IPOs in the various different share structures and exchanges that service the Chinese market. "They still cannot trade shares on their own behalf or on behalf of clients. They cannot do brokerage work here," explains Kwauk. That's reserved for the approximately 120 licensed domestic broker-dealers.

Still, Western firms are not shut out; rather, they must rely on joint ventures (JVs) and are limited to a 33 percent ownership stake in the JV, explains Ron Otsuki, senior vice president and managing director, international investment, for Manulife Financial in Hong Kong. "The market is evolving quickly," says Otsuki, whose firm was allowed by insurance regulators to set up an asset management company last year.

The latest Wall Street business coup, however, was scored by Goldman Sachs in December, when it received approval from the China Securities Regulatory Commission (CSRC) to establish a JV investment banking firm: Goldman Sachs Gao Hua Securities Co. The deal is notable because it now allows Goldman to offer a wide range of investment banking services to domestic mainland Chinese clients. Goldman will invest a reported $190 million in the complex transaction and will hold 33 percent of the venture.

The joint venture is expected to underwrite locally listed firms and Chinese-denominated bonds and convertible bonds. It also allows Goldman to catch up to Morgan Stanley, which has had a joint venture investment bank, China International Capital Corp., in China since 1995. China International Capital Corp. is one of the leading underwriting firms in the region and has been involved in more than $40 billion of equity financings since 1997.

Other investment banks are knocking on the door. Merrill Lynch Investment Managers has been given the go-ahead to establish a joint venture fund management company with the Bank of China. Other firms with joint ventures include BNP Paribas, which has a JV partnership with Changjiang Securities, and Credit Lyonnais Securities Asia, which has a JV with Xiangcai Securities.

Wild, Wild West

Pauline Dan, a portfolio manager for greater China at Manulife, says the major attraction for investment management firms is "the huge amount of assets that are likely to be privatized" as China moves from a communist to capitalist system. "It's the wild, wild West."

That's also part of the problem. Blake Cassels & Graydon's Kwauk says that China's capital markets have a nefarious reputation with widespread instances of collusion and market manipulation. "There are all kinds of problems with the quality of the listed companies" and what he calls "corporate governance transparency issues."

Kwauk says that despite the concern about the capital markets there still is opportunity for North American-based firms that can bring good governance to the table. "They really need foreign companies to come in - not so much for the capital as for the discipline in management and to set the industry straight," he says. "There's no question about it, there are some great opportunities for securities companies to come in. Unfortunately, I think it is going to be the exclusive playground of the so-called Big Boys. The process is going to be fairly slow and very cautious."

As well, observers warn that the Chinese market is saturated and not all that healthy, with domestic securities firms reporting losses of $411 million in 2003 and $447 million in 2002. Three out of four are losing money, and Manulife's Otsuki notes that "profits from commissions are pretty low compared to Wall Street firms."

Neil Katkov, an analyst at Celent Research in Japan, says that domestic Chinese brokers also are not well capitalized and most have less than $5 billion in assets under management. "Considering its size, the market still has too many players," he says. Nonetheless, observers say there is much opportunity. The country's total stock-market capitalization has grown from less than $1 billion in the '90s to more than $600 billion in 2001 with more than 1,000 listed companies.

Exchange Opportunities

One of the areas of opportunity lies in servicing the various players, from broker-dealers to the exchanges themselves, all of which need trading technologies. And there's no lack of exchanges in China, which boasts six. China also has the STAQ, the securities trading automated quotations system (which is based on the Nasdaq and the National Electronic Trading System [NET]) that trades Treasury Bonds and shares owned by state-owned enterprises.

It's at the exchanges where firms are finding opportunities, says Katkov. For example, Citibank is the U.S.-dollar clearing bank for the Shanghai Securities Central Clearing & Registration Co. It provides securities services for clearing and custodial services.

Global technology firm Accenture is also finding opportunities. Accenture was recently selected along with its partner, the Deutsche Borse, to help the Shanghai Stock Exchange build a new electronic trading system. The exchange licensed the Deutsche Borse's Xetra trading system, which will be adapted for the Chinese market.

Robert Gach, who heads up Accenture's financial services for the Asia Pacific region, says, "What we are looking to do first and foremost is help the exchange meet its vision and build a robust, scalable trading platform for future innovations and new products." Accenture beat out two other bidding consortiums, IBM and OM, and Hewlett-Packard and AtosEuronext, for the contract.

Accenture has been in discussions with some of the other exchanges about their technology needs and the future development of their markets. However, Gach adds, it's "going to take time."

Manulife's Dan notes that opportunity abounds for technology firms to bring in the latest and greatest in trading solutions. "When China first started to develop trading platforms, it was on a proprietary basis. They developed it entirely on their own." Each broker has to provide its own link to fund mangers and the exchanges, she says.

Another area of opportunity is foreign exchange, which is tightly controlled. In October, The China Foreign Exchange Trade System (CFETS) selected Reuters to help it build a global foreign exchange trading system for CFETS and its member banks. Bob Ray, senior vice president of business development at the Chicago Board of Trade (CBOT), is also looking to build closer relations with his Chinese counterparts at the Dalian Commodity Exchange (DCE). The CBOT has hosted a Chinese delegation from the DCE and recently signed a memorandum of understanding. "It's really key that we have a relationship with them and work with them to help build the market," Ray says.

Under the agreement, the exchanges will share information on market and product development and work towards developing new derivative products. It's an information exchange, Ray notes, involving things like market oversight and discussion about technology and risk management. One area of weakness, he says, is telecommunications. "I don't believe they have the telecom infrastructure in place that would make everyone sleep well at night."

Ray says that it's important to strive for consistent standards and understand each other's market structure. "China is a very, very significant marketplace in the global economic community." The closer that "we can align ourselves," he explains, the greater the confidence investors will have in the overall markets and the more efficient they will become.

The changes to China's capital markets won't happen overnight, but they are progressing. "The only thing I can say for certain is that the markets are going to be volatile," says Manulife Financial's Otsuki. But he notes that just five years ago there were 10 fund management companies in China and a handful of fund managers. Now, he says, there's probably 40 fund companies "and a huge number of managers - the whole market is really expanding, which is what you would expect for a developing market. The one thing the Chinese government does really, really well is absorb information and expertise from other regulators and other markets. They are all ears in terms of trying to figure it out."