Talking Point

Bigger is better

The recent rally in China’s A-shares anticipates a landmark regulatory shift

Stock-Market-w

Remember, when it’s red in China that means the stocks are going up

In 1933 Franklin Roosevelt signed an emergency act – commonly known as Glass-Steagall – to restore confidence in an American financial system that had been battered by the Great Depression.

One important outcome was the separation of investment banks from mainstream commercial lenders. The legislation largely stayed in place until 1999, when Glass-Steagall was repealed. The removal of the restrictions separating banking and broking sparked a golden decade in the US financial markets. Yet some blame that same deregulation for sowing the seeds of the 2008 global financial crisis.

Fast forward to contemporary China where there is speculation that regulators are preparing to tear down the firewall that separates their commercial lenders and investment banks as well.

The prospect of the policy change has been a key reason for a major bull run in the A-share market.

Conversely, the sudden exuberance has more cautious observers worried that share prices are getting overheated and that the market could be heading for another meltdown akin to the “Great Fall of China” in the summer of 2015 (see WiC293).

Why is China breaking the ‘Glass-Steagall’ wall?

Retail and wholesale lenders have largely been kept apart from the investment banks for years. In the early 1990s the Chinese dipped their toes into the mixed-operation model, allowing state lenders to operate as brokerage businesses. That soon led to a market crash, with the Shenzhen stock exchange getting particularly overheated.

Regulators then changed tack and implemented regulations styled on Glass-Steagall principles, which prevented the commercial banks from underwriting stocks and offering brokerage services. But more recently, some of the more influential think-tanks have been studying the European model of “universal banks”.

The setting up of the China Banking and Insurance Regulatory Commission (CBIRC) in 2018 – effectively a combination of the banking and insurance regulators – was another sign of a policy shift. The securities industry is still governed separately by the China Securities Regulatory Commission (CSRC). Yet talk is rife that Beijing is planning to create a more powerful ‘super regulator’ that covers the entire financial system.

In late June Caixin Weekly also reported that the securities watchdog was close to awarding securities licences to the commercial banks. At least two of the major commercial lenders are likely to join a pilot scheme, although the trial will begin with investment banking, rather than testing the fuller array of financial activities such as market making and margin financing.

The idea is to create “aircraft carrier-sized” investment banks in a move to bolster the domestic sector in the lead-up to the opening-up of the Chinese financial markets to foreign competitors, which Beijing has promised before the end of this year.

The aircraft carrier metaphor has been making the rounds in the Chinese media since December last year. While China boasts some of the world’s largest banks and insurers by assets and market value, its brokerages are minnows on the global scene. Even if you combined the 131 local brokers doing business last year, their assets would barely match those of Goldman Sachs, China Securities Journal has noted.

Which firms have the potential to become China’s new champions?

Until relatively recently private-sector financial firms had been pushing for more of a place at the table. But most of them have turned out to be pretenders. Anbang is the best example. It amassed most of the financial industry licences required in China. Following a crackdown on capital flight and overseas acquisitions (see WiC371), the disgraced insurer was then nationalised (see WiC399).

Also taken over by the state: Baoshang Bank (see WiC454), a lender controlled by Tomorrow Group, whose founder Xiao Jianhua is said to have been spirited out of Hong Kong’s Four Seasons hotel and back into mainland China (see WiC354).

Some commentators blamed companies like Anbang and Tomorrow for contributing to the A-share exuberance of early 2015 and the subsequent stock market collapse in the summer of that year. But what’s clearer is that the central government has always been cautious about giving private sector financial firms too much freedom. Ping An, an insurer that has deftly navigated the greyer areas between state and private sector ownership for decades, does hold its own banking and brokerage units. But its brokerage firm Ping An Securities is a minnow on the domestic scene and it was given a hefty fine in 2013 for sponsoring a fraudulent IPO (see WiC194).

That makes the state-owned financial enterprises the more obvious candidates for the latest experiment. ICBC (the Industrial and Commercial Bank of China) is said to have submitted a proposal to the CSRC to allow it to set up a wholly-owned investment bank as far back as 2018. As the biggest bank in China by assets, ICBC must be one of the main contenders for a licence under the pilot scheme. “The plan was reviewed by several ministries and received positive feedback from top regulators, though they urged caution,” Caixin reports.

Other contenders for licences?

Aside from the big state lenders, two special SOEs stand out as potential winners should the financial market enter a new phase of deregulation.

Citic Group and Everbright Group were both designated to help usher in Deng Xiaoping’s market reforms in the 1980s. Both were given mandates to pioneer new businesses (see WiC232) in an era when the capital markets were deemed as deeply undesirable by leftist hardliners (see WiC249)

Today both SOEs, at parent level, do not seem entirely bound by Glass-Steagall-like restrictions. Citic Group already controls the biggest and arguably most international of the Chinese securities firms (thanks to its acquisition of Hong Kong-based broker CLSA in 2012). It is also the biggest shareholder in Citic Bank, which had a market value of Rmb242 billion ($31.21 billion) as of Thursday.

Citic Securities is already expected to get a bigger role in the next round of M&A deals shaping the sector. It did a $2 billion deal to take control of Guangzhou Securities last year. And in late June Bloomberg reported that Citic Group was planning to buy a stake in CSC Financial, the second largest local broker by market share, from Central Huijin Investment (also the main shareholder in many banking SOEs such as ICBC).

A potential merger between the two brokers would create a powerhouse worth $82 billion, Bloomberg believes. The report sent the share prices of Citic Securities and CSC Financial upwards and the market value of the duo has since surged to more than $100 billion.

Investors are on alert in regard to Everbright Group as well. For many years the parent company had both Everbright Securities and Everbright Bank under its wing, although the latter was so poorly run that its controlling stake was transferred to Central Huijin in 2007 following a Rmb20 billion bailout.

Everbright’s brokerage was also mired in financial scandals and costly trading errors (see WiC205)

Everbright Bank announced in late June that Central Huijin had sold a 19.5% stake in the lender back to Everbright Group. Following the share deal, Everbright Group will effectively own a 48.5% stake in Everbright Bank (and Central Huijin becomes the biggest shareholder in the unlisted Everbright Group with a 55.7% stake). The restructuring, according to 21CN Business Herald, means that Everbright Group has emerged as another of the favourite candidates to trial a “mixed business model” of commercial and investment banking.

Everbright Securities has been an unloved stock, spending most of the previous 12 months hovering at the Rmb10 level in Shanghai. But in the past two weeks its share price has nearly tripled, taking the broker’s market value to more than Rmb120 billion.

How bullish has the A-share market been?

The share price spikes in Citic and Everbright’s brokerage units have triggered part of the A-share market’s recent bull run, especially at the Shanghai bourse which is dominated by banking and financial heavyweights. Speculation about the shake-up in the financial sector is fuelling the view that the new ‘aircraft carrier’ banks will compete robustly with the international securities houses, channelling a flood of new funds into the market and driving up share prices.

Earlier this month we also reported how the Shanghai Composite (SHCOMP) was set to tweak its compilation methodology to boost its sluggish performance. Everbright Securities was one of the local brokers forecasting that the key index was on the verge of a major bull run (see WiC502). By July 9, the SHCOMP had surged upwards for eight consecutive trading sessions. The 16% rally saw the index briefly close above 3,450 and touch levels not reached since the market meltdown in 2015.

That rally is dwarfed by the gains on the Shenzhen bourse. ChiNext, the city’s tech board, has rebounded nearly 50% since March 23 (when stocks were at their lowest point during China’s Covid-19 outbreak).

According to Bloomberg, the total value of China’s domestic equities has climbed to $9.7 trillion, or a whisker away from topping the $10 trillion record set in June 2015. That seems to show that retail investors aren’t deterred by the carnage of the sudden sell-off five years ago. On social media, stocks have become one of the most discussed topics and another telling indicator is that the apps of many of the domestic brokerages were jammed earlier this month by people trying to open or reactivate their trading accounts.

So far, the government has been sending mixed signals about the stock market run. The state-run broadcaster CCTV spent more than a minute of its evening news on July 6 on the A-share market, concluding that the rally has underlined the country’s confidence in the government’s ability to contain the Covid-19 outbreak and reboot the economy.

But other media outlets have offered words of warning. “The tragic lesson of the abnormal stock market volatility in 2015 remains vivid, cautioning us that we must promote a healthy and prosperous stock market in a correct posture,” the Xinhua-run China Securities Journal said in an editorial last week.

Financial regulators are also stepping in to counter some of the more speculative practices. Last week the CSRC said it had cracked down on unlawful fundraising and it published a list of 258 margin lenders that were said to be behaving illegally. A couple of state-owned funds also said they would be cashing in part of their A-share portfolios in another move to calm the market.

Is the rally running out of steam?

Most financial commentators agree that the Chinese government is happy to embrace a ‘moderate’ bull market. That’s hard to calibrate. Stocks in Shanghai jumped 5.7% on the day when a front-page editorial in a state-owned newspaper celebrated the “wealth effect of the capital markets” and the prospect for a “healthy bull market”.

“Be it a ‘slow bull’ or a ‘healthy bull’ we just don’t want to see another ‘crazy bull’,” 21CN Business Herald, another newspaper, noted.

The rally has also been fuelled by ample liquidity, thanks to monetary easing by central banks globally. Investors are clearly hopeful that the Chinese economy is poised for a stronger rebound in the second half of the year and that the pandemic isn’t going to shut down the world’s second biggest economy for another extended period.

Tech stocks have shone brightest on expectations that more traditional business models will move more of their operations online as a result of Covid-19. Internet giants Alibaba and Tencent have both surged more than 40% since late March to record highs.

Many of the more popular tech plays are listed in Shenzhen or else in Hong Kong or New York.

But Shanghai’s own tech bourse could drive market sentiment further. The STAR Market will celebrate its one-year anniversary next week on July 22. Data from Refinitiv shows that it has raised $14 billion in capital so far this year with 66 deals, just behind Nasdaq’s $18 billion.

The largest deal yet for STAR is for the chipmaker SMIC, one of the most high-profile returnees to the Shanghai bourse after delisting in the US. Its shares debuted Thursday closing 202% higher than its offer price. In a reality check, the foundry’s Hong Kong-listed shares then took a 25% plunge the same day (following a 500% rally this year). Its A-shares are trading at a 192% premium, which some will view as unsustainable.

There was also a substantial correction to the bull run yesterday with the SHCOMP plunging 4.5%, its steepest percentage fall since February. The drop will have sobered investors who’d got accustomed to near continuous gains. Overriding some of the earlier themes that had driven the speculative excitement was the economic data. While news that second quarter GDP grew 3.2% was better than expected, there was concern that retail sales fell 1.8% in June from a year earlier when economists had predicted growth of 0.3%. Car sales also shrank by 8.2% last month.

Some analysts also believe the Shanghai market was rattled by an article in the overseas edition of the People’s Daily that questioned the lofty valuation of Kweichow Moutai, one of the bourse’s star performers. It sank 8% yesterday – though the distiller was still worth Rmb2.2 trillion after the sell-off versus Rmb592 billion for SMIC.


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