Chinese banks barred from sponsoring IPOs; Securities brokerages at centre of China regulator’s crackdown

May 23, 2013 3:29 pm

Securities brokerages at centre of China regulator’s crackdown; Chinese banks barred from sponsoring IPOs

By Simon Rabinovitch

On the first anniversary of its stock market listing last month, Xi’an Longi Silicon Materials Corp served its factory workers steaming plates of simmered fish, an unusual delicacy for the staff canteen. It was to “ensure that all employees would share in the happy occasion”, the company says.

Just over three weeks later, on May 3, Xi’an Longi received a visit from the stock market regulator. The China Securities Regulatory Commission was launching an investigation, on suspicion that the company had violated the nation’s securities law by failing to disclose a steep fall in profits in the run-up to its listing.

The questions surrounding Xi’an Longi, a producer of silicon wafers and semiconductor ingots, are just one front in a much bigger battle being fought over how China polices its financial industry. At the centre of this battle are the securities brokerages that bring companies to the stock market in initial public offerings.In the past 10 days, the Chinese securities regulator has suspended three brokerages – Ping An Securities, Minsheng Securities and Nanjing Securities – from handling any IPO business. Another two, including Guosen, the company that underwrote Xi’an Longi’s listing, have been placed under investigation. Xi’an Longi said it would co-operate with the investigation.

It is a show of strength from the Chinese regulator, representing the first time brokerages have been barred from sponsoring IPOs since 2006, when the government introduced a new securities law.

“Whoever profits from illegal acts must bear the corresponding responsibility,” the CSRC says.

Investors have turned increasingly optimistic about China’s brokerages, partly on the belief that tougher regulatory standards could lead to some consolidation in the industry. China has 114 securities brokerages, according to official figures.

The regulator’s overarching target is to restore faith in the Chinese stock market, with investors put off by weak corporate governance and regular insider trading scandals. Last October the regulator froze all IPOs, vowing to clean up the market before resuming approvals. The key plank in its campaign is to make brokers more responsible for the stocks they sell to clients.

Its harshest punishment so far was directed at Ping An. The CSRC fined the brokerage Rmb76.65m ($12.5m) for sponsoring the IPO of Wanfu Biotechnology, a company the regulator found had manipulated earningsbefore and after its 2009 listing. It was the biggest fine ever levied against an underwriter in China, and observers were surprised when Wanfu itself was given a much lighter fine of just Rmb300,000.

“Brokerages need to be responsible for making sure financial statements are accurate. In the past they focused on getting underwriting fees without doing any hard work on the financials,” says Steven Sun of HSBC. “These punishments are a good beginning.”

But changing the way that China’s investment banks operate is no easy task.

One analyst, speaking on condition of anonymity, says the regulator’s bark has so far been fiercer than its bite.

“The brokers being punished are mostly the mid to small-sized names who were all known as rapid and aggressive in their expansion in the IPO market in the last several years, but not really the big players,” he says.

The timing of the underwriting suspensions is also likely to let most brokers off the hook. With IPO approvals widely expected to be frozen until July, if not later, there is no work for sponsors to do now, so being forced to sit on the sidelines costs them nothing at the moment.

CSRC has too much power over how the market runs . . . In the end, banker competitiveness doesn’t really come from offering the best credibility in the market. Banker competitiveness eventually becomes kissing the asses of the regulators. That is how companies pick their bankers

– Brokerage chief

A senior executive in a brokerage jointly owned by a Chinese securities company and a foreign investment bank says the regulator was itself the root of the problem.

“CSRC has too much power over how the market runs, who should have what licence, who should do what business, what companies should get IPOs,” he says. “In the end, banker competitiveness doesn’t really come from offering the best credibility in the market. Banker competitiveness eventually becomes kissing the asses of the regulators. That is how companies pick their bankers.”

Foreign investment banks have seen their market share in China badly eroded over the past five years. The top three investment banks by revenue last year in China, including Hong Kong, were Citic Securities, Bank of China and Guosen Securities, according to Dealogic. Only three international banks cracked the top 10.

The silver lining of their poor performance in China is that foreign banks have so far avoided the regulator’s crosshairs – they have yet to be implicated in any of the underwriting investigations.

One possibility is that international companies, unscathed by the crackdown, may benefit from the reputational damage to their Chinese rivals. However, the executive in the Sino-foreign brokerage joint venture is not optimistic.

“We want there to be systematic changes in China rather than campaigns,” he says. “I don’t believe that underwriters were created bad or evil. The market mechanism is sick, and it is the regulator that creates this market.”