On the face of it, the proposed pilot scheme allowing certain Chinese securities firms to invest their own capital is a good move.
Rather than live or die according to market fluctuations, they could, for example, make a sensible investment in a meat processing plant, thereby opening another, more sustainable source of income.
The problem is that, historically, letting a broker invest his firm’s own money has been akin to issuing checkbooks to toddlers and releasing them into the nearest toy store.
China’s 100-plus brokerages are said to have made combined profits of US$3.3 billion in 2006 on the back of a 130% rise in the domestic stock markets. Set against the US$2.6 billion net loss of 2004, which came as the Shanghai Composite Index was on its way to a six-year low, it shows the extent to which brokerages are beholden to market movements.
However, it’s worth pointing out that the single biggest source of losses was proprietary trading – trading on one’s own behalf – as brokers created webs of false accounts to hide their losses.
This behavior led to a government crackdown, with all proprietary trading accounts separated from standard accounts and all trades using own funds reported to regional head offices.
Diversifying income streams is exactly what needs to happen in China’s securities industry – indeed, stock index futures are expected to do just this as they give brokers a chance to profit on a downturn.
However, such measures will only be successful if they are backed up by tighter risk control. Brokers may be on a roll now but it remains to be seen whether they can stop treating the market as a casino.