Merrill Lynch's recently announced joint venture with China's Huaan Securities again raises the question of why global banks are rushing into an opaque, poorly regulated market with declining valuations and a severe corporate governance problem. A market so lousy that China's best companies prefer to list offshore. And why are these giants cutting joint venture deals when the pool of potential partners is so shallow?
The same questions were asked when earlier entrants including Goldman Sachs and Daiwa moved in, and the basic answer is the same: the huge potential of the China equity markets just cannot be ignored.
China's markets, like its state enterprises, are in rough shape – both Shanghai and Shenzhen hit six-year lows in February.
But there is a growing universe of private sector Chinese companies needing capital, and the state banks are gradually cleaning themselves up and getting serious about managing risk (underscored by China's recent endorsement of Basel II). The China Securities Regulatory Commission (CSRC) is also showing signs of being more proactive on market regulation.
Underwriting to do
With this in the background it is easy to see there could be lots of underwriting down the road. But even in the shorter term, there is still hay to be made – precisely because the markets and so many companies are on the floor. There are opportunities in M&A, opportunities in helping companies list offshore, opportunities across the whole restructuring spectrum. China, after all, adds up to the world's biggest restructuring project.
Asked for his explanation, Barry Livett, a director at the EU-China Financial Services Cooperation Project in Beijing, said: "They're betting on a growing private sector going to list."
International institutions, he added, are also looking to snare business as Chinese firms accelerate overseas buying activity. And like everyone else for the last two years, global banks have been waiting for the kickoff of Beijing's Qualified Domestic Institutional Investor (QDII) program, which should see a flood of cash go offshore – all of which will require advisory and other services.
The only firm thing to say about China's partner pool is that it is getting smaller and poorer, thanks to closures and mergers on the back of continuing. One estimate suggests 800-odd firms lost US$1.2bn last year – as against US$120m in 2003.
None of this deterred Goldman Sachs, which spent US$190m acquiring 33% of a joint venture with Gaohua Securities last year, that stake being the maximum allowed.
In 2002, Japan's Daiwa Securities hooked up with Shanghai International Group to establish Shanghai Daiwa SMBC-SIG Investment Consulting. BNP Paribas joined up with Wuhan-based Changjiang Securities Corp and appliance-maker Haier group.
But the prize for taking the long-term view has to go to Morgan Stanley. It did not wait for China's entry into the World Trade Organization to get moving. Back in 1995, it formed China International Capital Corp (CICC) with the Construction Bank of China, and business rolled in. Among its bigger claims to fame was China Telecom's US$1. 52m IPO for which it was lead manager.
Buying stakes in Chinese securities companies shows global firms are ready to wait out the market's difficulties, said a mainland executive with a European joint venture. "Merrill and the others will look for returns through restructuring and consolidation of this market. The Chinese financial market is very attractive now for global investors – we saw the same maturing process in Japan and in other emerging Asian countries."
Gloom and zoom
The gloom and doom can be overplayed. Euro Project's Livett says corporate governance with China listed companies is improving, which will eventually help revive Mainland investor interest.
"There's been sterling work by regulators to raise the bar. Regulations have made it easier for securities firms to raise money from the market," he said, citing the China Securities Regulatory Commission's (CSRC) decision last year to reduce restrictions on securities firms issuing bonds.
The greater involvement of foreign investment banks also helps to raise the bar. "Global investment bankers like Goldman Sachs and Merrill Lynch are strong in management and risk control compared to domestic peers," said another banker.
And although Chinese players have a long way to go to catch up with the savvier foreigners, Livett said consolidations could yet produce some serious competition.
"China has a tendency to create national champions and that's what it may do here," he said. Among possible contenders he cites are the asset management firms set up to absorb bad debts from the state banks.
But they had better get a move on. Lehman Brothers, Credit Suisse First Boston and others are reportedly seeking local partners too.