Stock Markets in China Among Best in World: Merrill

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Last updated at: (Beijing Time) Tuesday, July 02, 2002

Stock Markets in China Among Best in World: Merrill

Despite many reported corporate scandals, the stock markets in China have among the best infrastructures in the world, said Richard Margolis, a senior consultant with Merrill Lynch Asia Pacific.

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Despite many reported corporate scandals, the stock markets in China have among the best infrastructures in the world, said Richard Margolis, a senior consultant with Merrill Lynch Asia Pacific.

"The defects in China's security markets get a lot of publicity. What gets less publicity is the fact that the infrastructure is actually first class," he said in an exclusive interview. "The market infrastructure is among the most advanced in the world and in some ways surpasses London's."

China's system is totally computerized and has a completely automated trading and settlement system.

"It is a remarkable achievement to put into place something that good in such a short time," he said.

The infrastructure copes with a staggering volume of transactions.

But the high-quality infrastructure means that trading, simply executing someone's transactions, as is the case in many markets that are automated, is a very low value added function. Automation means that mainland firms are facing the same challenges as brokerage houses all over the world - how to deal with falling revenues.

Securities

The company, which is one of the world's leading investment banks, is interested in China's financial industry, ranging from bonds to home loans, although it has little intention to form a joint venture.

The global financial services giant is no stranger to China. Over the past decade, Merrill has served as credit-rating adviser to the Ministry of Finance and has assisted the central government and enterprises in raising approximately US$17 billion in the international capital markets.

Merrill was the first US investment bank to lead-manage a B-share offering in China on behalf of Shanghai Erfangji. Foreign joint ventures are allowed to underwrite and trade foreign currency-denominated B shares.

China is relaxing rules following entry to WTO, but the securities industry market is opening up much less than other financial services, such as insurance and commercial banking, Margolis noted.

July 1 is the effective date for new rules put forth by the China Securities Regulatory Commission (CSRC), which allows qualified foreign investors to take up to a 33 per cent stake in a securities company or a fund management company.

In three years the percentage of foreign ownership could increase to 49 per cent in fund management companies. But these joint ventures can only underwrite but not trade yuan-denominated A shares.

The restriction on trading A shares is a problem for international securities firms. "In combination with other things, and as a general principle, we don't like to underwrite issues that we cannot also trade," said Margolis.

Therefore, Merrill Lynch does not think one of these new joint ventures was the right thing for the company at this time.

"We are looking at collaborating on various securities and investment banking activities, but in a framework that is looser and less formal than a joint venture," he explained.

The cap on foreign stakes also means that Merrill would have very little control, he said.

Bond market

It is the bond market which Margolis sees as having enormous potential.

"The capital market, which is underdeveloped, has the most need of development," Margolis said. It will be beneficial for the Chinese government to make use of foreign firms' experience in the bond market..

Currently there is a shortage of renminbi funding instruments for sound projects and bonds are usually a more accurate pricer of risk.

Still there is very limited opportunity for international firms in the bond market due to government regulations, explained Margolis. He believes that the Chinese government is being wisely prudent, especially after the spectacular 1995 bankruptcy of a large Shanghai securities company speculating on the government bond futures market.

But he added that those fears of speculation may be slightly misplaced at the moment because the control systems now work a lot better than they did in 1995. And in addition, there is a strong demand for people to undertake genuine funding operations.

"Still we (Merrill Lynch) would very much like to be involved in a bond market to create new products, but we would also like to be able to gain a reasonable commercial reward for doing that and being able to underwrite and trade these products as we help develop them," said Margolis.

Insurance

Margolis also sees opportunities for Merrill in other areas.

With WTO deregulating parts of the insurance sector and a rising middle class wanting to protect the gains they have made, the life insurance industry is growing very rapidly in China. But the new industry is very short of good-quality long-term investments to buy to underwrite the long-term obligations that life insurance companies are taking on.

"A well-developed bond market with a good range of long-term debt instruments, is an important part of the jigsaw puzzle for a well run life insurance industry," said Margolis.

With China's economic boom, the home loan market is another area that is growing very rapidly. Banks lend to customers over 20 years, but they can't borrow from customers for over 20 years, he explained.

This is a problem called maturity mis-match risk and is the mirror image of the problems that the insurance companies are facing. "Creating some kind of body that could sell long-dated securities that will be used to fund mortgages, like Fannie Mae, is another development that would probably be beneficial," he said.

"These are all areas in which firms like Merrill Lynch can help by developing these new businesses in return for being able to conduct business." Fannie Mae is the US largest source of financing for home mortgages.

Currently Merrill Lynch has an office in Shanghai, which it opened in 1993 and an office in Beijing, which it opened in 1994. In addition, the company has 800 staff in Hong Kong, many of whom are engaged in supporting mainland activities.

"We have plans to add research capability on the ground in China. Our investor clients increasingly want us to make sense of the A share markets for them, even though they cannot yet buy and sell in them," said Margolis.

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