The risk to investors is less a matter of broker solvency and the custody of retailers' assets than the fact that small investors are largely forced to deal with market complexities on their own. One result is that large numbers of small, risk-averse investors often rely on their own rules of thumb. Since independent entities trading on their own behalf is part of the definition of chaos, it is little wonder that China's A-share markets have seen bouts of irrational exuberance in between sometimes long periods of bearish sentiment.
The current plight of China's brokerages results in large part from the balkanized structure of broking in the early 1990s, when provinces – and many secondary cities as well – set up their very own local brokerages. Brokers earned investment banking fees from underwriting state-owned enterprises, and then earned broking commissions as China's common folk – the long-suffering masses, or laobaixing – tried to outsmart the big money in the secondary market. Small brokerages could not support the skills in research or trading to serve anything beyond the basic needs of managing what was in effect a large casino.
As problems developed, brokerages were merged rather than closed. Shanghai's Guotai Securities takeover of Shenzhen's failing J&A Securities resulted in Guotai Junan, and Shanghai's conservative Shenyin took over rival Wanguo to form Shenyin Wanguo Securities. Both mergers occurred in the 1990s and required long periods to integrate vastly different corporate cultures. Rather than effect change in the business models of local brokerages, the mergers merely masked the problems.
Enter the big boys
The recent arrival of international brokers offers the prospect of change but much will depend on the attitude of the regulator. Both Mainland and Taiwan regulators behave as though it is their job to support markets rather than to police them to ensure fair play. One element of this is the notion that outsiders are bent on crashing local markets and therefore must be watched closely. This, in the short-term at least, may limit the ability of international brokerages to do business and therefore to improve professionalism in China's markets.
To date, however, the regulator has been flexible, allowing international brokers to take managerial control but not to acquire majority stakes in local brokers. This permits technology transfer but could be used to stop international firms from rocking the boat if changes became too far-reaching.
If the experience of joint venture banks, insurance companies, and fund management firms is any guide, the regulator will not have to worry too much: putting together Mainland and international financial firms soaks up at least a year of management time before anything concrete begins to happen.
But in the meantime …
So the A-shares roil along, heedless of structural changes which may bring an end to this amazing chapter of China's financial history. In the nearer term, however, we will be called to account for all the 1-fen (or a penny) and 1-jiao (ten pennies) coins we've been filching from our ayi's, or maid's, piggybank so we'd better decide how to invest these funds wisely.
Sorry about Baosteel 600019 CH, which has plummeted since we opened our portfolio. Although Baosteel is a world-class steel outfit, we forgot the troubling detail that in cyclical industries like steel, even good companies are prone to having a bad year or two in every cycle. Baosteel is there now, and the buying point is still somewhere ahead of us. Look again at this one in the first quarter next year. So this time, let's do a sure thing and put half our funds into Shanghai Pearl Tower 600832 CH, the operator of the architectural masterpiece by the same name. The share price has already withstood the rigors of unlocking the government shares and is now rising to its 200-day moving average. Holiday spending should buoy the stock through first quarter next year, and if this one crashes, ayi will at least realise that it was for a good cause. By the way, that's her calling supper now, better run…