Case

Analysis of China Asset Management Sector

Consultative Report on Samsung Project Phase 4

China 's securities market has witnessed substantial development since its founding, with the equities market capitalization soaring all the way from RMB 104.8 billion yuan in 1992 to RMB 4,163 billion yuan as at the end of June, 2003. The total equities market capitalization increased from 4% in 1992 to 40% in 2002 as a percentage of Gross Domestic Products (GDP). From 1991 to the end of June 2003, the Chinese domestic equities market successfully financed a total amount of RMB 739.5 billion yuan for its listed companies. By the end of June 2003, there have been a total of 1250 listed companies including both A shares and B shares. The underwriting scales of the listed companies have also been on the rise. A total sum of RMB 753.1 billion yuan in both Treasury bond and financial bond were underwritten in 2002, as compared with RMB 34.4 billion yuan in 1997. China's securities market has demonstrated its importance in the national economy.

Chinese securities market possesses its distinctive Chinese characteristics. The establishment and existence of Chinese equities market were initially intended to finance state owned enterprises, which rationale may also pose a potential problem for the long term development of Chinese equities market. To balance the interests of different parties, a quota system has been adopted to provide financing for state owned enterprises. As a result, numerous small capitalization firms are listed. These listed firms, while geographically dispersed, belong to various sectors. Consequently, the regulation of securities underwriting and of listed companies is merely confined to formalities rather than material content and listed companies have displayed their born defects in terms of quality. On the other hand, since the governance structure of listed companies has not been substantially improved, a low level of both operational competence and capital utilization has eventually led to worsened company performance as time goes by. Secondary stock market exists as a byproduct of equities market, but, from the capital supply viewpoint, mainstream capital is still restricted from investing into the secondary market.

Another Chinese characteristic of the equities market is associated with state owned shares. State owned shares, accounting for majority of the total shares, can not be traded in the market. Consequently, governance structure and governance mechanism of listed companies can not be materially improved. It is, therefore, difficult for the investing public to implement supervision. Such characteristic has determined that the trading volume at the stock exchange is quite limited for each single stock. This nurtures speculations and makes it more difficult to engage in effective asset restructuring. Therefore, the trading of state owned shares will be one of the most important factors to shape future Chinese equities market.

Viewed either from the systematic factors that limit the stock market demand and supply or from the history of stock market development, China 's stock market is nothing more than a policy market. In the stock market, the government has been playing five different roles as social public product and service provider, major policy maker, market supervisor, market organizer and market investor respectively, among which the latter two are the main roles of the government. Meanwhile, Chinese mainstream securities firms are also protected in the form of state monopoly.

Stock market supply is the most basic factor and any improvement thereof is critically determined by the reform of state owned enterprises and state economy which will be a long term process. Whenever there is an intensified contradiction in the stock market, the government tends to seek emergent solutions from the stock market demand factor and any improvement thereof is critically determined by the reform of state owned banking system and financial system. Since both enterprise reform and financial reform involve interests from many aspects, the contradictions and corresponding solutions in stock market development may prove to be a process that can not be solved by a simple policy, but rather, a process that involves gradual agreements and compromises by all aspects.

Given the rapid development in Chinese economy, we believe China 's securities market will also follow a fast track development pattern. Meanwhile, Chinese securities market will also become more standardized and market-oriented.

According to our estimation, the current market size of China 's asset management sector involves an amount of RMB 330 - 390 billion yuan. The clientele of asset management are mainly composed of institutional investors. The current mode of asset management can be classified into four categories including public placement fund, financial advisory, capital trust and bank-securities cooperation among which public placement fund is the mainstream mode of asset management.

The situations in Chinese asset management sector reflect the positioning and contradictory development logic of Chinese securities market. Not a development target for the government, the asset management sector experienced non-standard operations in its initial development stage. Practices such as price manipulations and insider trading were followed by individuals and some institutions to facilitate their interest transfers. Some listed companies even speculated on their own stocks. The publication of stock market information still needs to be improved.

Regulators view asset management as a practice of speculations in stocks with amassed funds. Mindful of its potential social risks, regulators tend to impose tight controls. Particularly, regulators take tough measures to control the mode of private placement funds. Meanwhile, asset management's business innovation targets more people in the general public, and the greater risks regulators believe in the asset management sector, and the more strict approval procedures regulators will impose. The development of asset management sector is generally sustained by the supporting measures taken by regulators whose purpose is to save the market. Currently, the asset management sector still finds its difficulty in attracting mainstream capital. Regulators mainly support the development of public listed funds.

There are no existing uniform laws governing the asset management sector. However, relevant legal regulations can be separately found in various laws, decrees and governmental stipulations. China Securities Regulatory Commission (CSRC) is the chief regulator of asset management sector. China Banking Regulatory Commission and China Insurance Regulatory Commission will also take charge of relevant supervisory responsibilities as banking capital and insurance capital are allowed to enter the equities market.

In light of China 's economic growth and expansion in securities market, we believe the qualities of listed companies will be improved and investment scope will be further broadened. Both residential savings and investment intent have greatly increased. Given the establishment of social security system and increase in corporate capital, Chinese asset management sector has a promising future development prospect.

Participants in the asset management sector include fund management companies, securities firms, trust investment firms and other institutions. Furthermore, insurance companies and commercial banks are also potential new comers. A SWOT analysis demonstrates that investment fund management firms are presently and will be the main players in China 's asset management sector.

The mainstream asset management institutions in China are primarily state owned enterprises. Because of the lack of ownership supervision and confusion in shareholders' rights in state owned enterprises, most asset management firms fail to integrate shareholders' interests into the company strategic development resulting in less perfect corporate governance structure. The dual role of both shareholders and employees has pushed management into a dilemma. Many asset management firms are often controlled by insiders mainly from management. Consequently, state interests may be neglected and management tends to focus in short-term interests.

As a reflection of the above characteristics, specific practices by the mainstream asset management institutions include rat trading, solicited acceptance of individual or institutional stocks, high funding cost, imperfect risk control system and ineffective executions.

Generally, foreign investors are encouraged to enter the asset management sector by investing in those fund management firms that have a track record of standardized and transparent management. In the short run, foreign investors are not encouraged to inject capital into those asset management firms that still need to improve their management standard. Existing laws have no specific stipulations on foreign investors who wish to invest in trust investment firms. For those foreign investors who wish to enter China 's asset management sector in the short run, it is advised, taking risks and time cost into consideration, that foreigners would better inject equity capital into existing investment fund management firms.

Although currently there are problems such as conflict of interests, cultural confrontation, management break-in, and compensation among shareholders in some of the investment fund management joint ventures, from an overall point of view, more investment management firms are still in need of assistances from foreign partners in many aspects ranging from strategic planning to specific product development. Therefore, there exists considerable room for further cooperation between Chinese side and its foreign partners.