June 18,2008

CSRC Ups Regulations Across Whole Securities Industry

By Ma Wenluo
In the grind and clash of the Chinese securities market, the China Securities Regulatory Commission (CSRC) has not always handled its charge with the surest of hands.  But it is relatively new at the business, the stock market here being less than 20 years old, and it is gradually taking greater charge and improving the lot of investors.
  To that end, this last weekend CSRC and the Ministry of Finance issued regulatory guidelines for Asset Evaluation Agencies (AEAs) on undertaking the business of securities and futures.
China's stock market started up in the early 1990s, and its regulatory structure was based on foreign experience. In the early stages, Chinese regulatory authorities focused on IPO companies and lead underwriters, but neglected intermediary service agencies. Ten years ago, after the outbreak of the Asian financial crisis in 1997, the Chinese government promulgated its first Securities Law, but at that time the regulation of intermediary service organizations was limited to securities investment consulting organizations and credit rating agencies (CRAs). The rash of corporate scandals in the US at the beginning of this century showed Chinese authorities the importance of securities service organizations for the stability of the market. A new Securities Law, enacted on January 1, 2006, extended their scope to securities investment consulting organizations, financial advisers, CRAs, asset evaluation agencies, accounting firms and so on.
For 10 years, regulation of intermediary organizations, starting from scratch, has gradually deepened. AEAs are now supervised by State-owned Assets Supervision and Administration Commission and CSRC. Due to a lack of an effective exit mechanism, the operation of "selecting the superior and eliminating the inferior" can not be carried out and standards of assessment are chaotic. Hidden trouble in securities assessment is seriously damaging the interests of investors. Therefore, CSRC has set out more stringent regulatory requirements for AEAs.  Aspiring AEAs must follow seven conditions, such as undertaking asset evaluation for at least 3 years, installing a strong quality control system and other internal management systems, before they can be eligible to practice asset evaluation in the securities market. At the end of 2007, CSRC also put forward specific requirements for financial advisers, who play the watchdog role in listed company M&A.  Since the issue of stock and bonds requires legal opinions issued by lawyers, CSRC also set corresponding regulations for law firms engaged in securities business law. A bit later, CSRC set regulations for CRAs for the first time.
China's supervision of intermediary agencies developed with the government’s understanding of them and with the opening out of the stock market. In the early stages, because domestic accounting firms played a crooked role in listed company financial scandals, authorities invited Ernst & Young, Deloitte Touche Tohmatsu, KPMG, Price Waterhouse Coopers and Arthur Andersen to undertake mandatory audits of foreign companies listed in China’s B-share market, as well as listed banking, securities and insurance companies. Chinese companies with overseas financing also needed audit reports from these companies. Despite charges 2 to 5 times higher than those of domestic firms, they rapidly dominated the audit market, and ranked the top five in income, and their total income in China was higher than that of all domestic accounting firms combined. The super-national treatment the "big five" accounting companies enjoyed aroused widespread challenge. And the 2001 disintegration of Arthur Andersen due to the Enron fraud scandal had people question the ethics and audit quality of the foreign behemoths. Meanwhile, domestic accounting standards have gradually converged with international standards, and from September, 2007, CSRC has no longer required B-share companies to undertake domestic and foreign double audit at the same time.
Government regulation of the credit ratings industry has also followed the line from worshipping foreign rating agencies to restricting their business. The first Securities Law prescribed the conditions for establishment of CRAs, but their examination and approval nuts and bolts and their business rules were to be formulated by the CSRC. With one problem following another in the development of China's securities market, a specific regulatory approach to CRAs was not forthcoming. In 2005, the Chinese government allowed foreign banks such as the International Finance Corporation (IFC) and the Asian Development Bank (ADB) to issue RMB-denominated bonds, rated by Standard & Poor's, Moody's and other foreign institutions. But then WorldCom, Enron and last year’s outbreak of the subprime crisis centered a load of doubt on the three major global rating agencies. In the US, Congress asked the SEC to strengthen its own regulation of rating agencies. Against this background, the government here began to restrict foreign investment rating agencies.  Recent regulations now require CRAs to be organizations registered in China with non foreign capital shares.
China’s restriction on foreign securities service organizations does not mean a narrowing of the opening out of China's securities market. Indeed, the opening of China's securities markets has been the US government's asking price in the Sino-US Strategic Economic Dialogues (SED) for the past three years. The Chinese willingness to allow the establishment of joint venture investment banks, joint venture fund management companies, the issue of stock and bonds by foreign enterprises, and QFII scale is expanding. For example, UBS Securities Company, of which Swiss-based UBS AG owns 20 percent, and Goldman Sachs Gao Hua Securities have become, respectively, lead underwriters and co-lead underwriters of the issue of subordinate bonds by Shenzhen Development Bank, the Bank of Ningbo and Ping An of China.  And CSRC has just approved a new joint venture between Credit Suisse and the Chinese company Founder Securities. 
On June 15, a CSRC spokesman said that the opening of China's securities market had reached a high level, corresponding to the development of the securities industry and the maturity of the capital market. He worried that in the turmoil of international financial markets, excessively rapid opening would invite financial risk and negatively impinge on the capital market. He stressed the need to sum up the experience of reform and opening up of China's capital market with a comprehensive analysis of the opening out policies and their implementation in order to lay a solid foundation for perfecting the securities industry and capital market.


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