A competition storm is brewing in China's fund management sector which could mean the end of the road for some unqualified players, as the country's commercial banks are queuing up for approval to establish fund management companies.

This host of new players will also threaten securities brokerages, some of whom are already on the verge of bankruptcy.

Rules governing commercial banks' establishment of fund management companies are currently being worked out by the central People's Bank of China, the China Banking Regulatory Commission (CBRC) and the China Securities Regulatory Commission (CSRC).

A draft regulation to this effect was released last November. Market analysts say that a final decision is expected within a few weeks, after consultation with the nation's commercial banks and fund management companies is completed.

According to the draft, joint ventures with foreign fund management institutions, domestic insurers and social security fund are especially encouraged. A commercial bank can establish a maximum of two fund management firms.

China's commercial banks were given the opportunity to manage funds only after last June's implementation of a law governing securities brokerages' investment in fund management companies, and the amendment to the country's law on commercial banks, which came into force in February 2004.

Prior to that, Chinese commercial banks were prohibited from investing in non-banking financial sectors, with their revenues consequently rely too heavily on deposits and loans.

Allowing commercial banks, with their combined saving deposits of 11 trillion yuan (US$1.33 trillion), to operate the fund management business offers authorities an opportunity to deal with the country's low direct financing ratio.

The nation's high level of indirect financing poses great risks to the country's banking system, according to the central bank's third-quarter monetary report in 2004.

People's Bank of China Governor Zhou Xiaochuan, told the central bank's annual conference, held earlier this month, that it will work to improve the ratio between direct and indirect financing in China this year and encourage the development of the stock market, bonds and some acceptable risk investment.

"The entrance of commercial banks will intensify competition in the fund management sector," said Yi Xianrong, director of finance development division of the Chinese Academy of Social Sciences' Institute of Finance and Banking.

There are currently only two types of player in this sector -- domestic fund management firms and joint ventures in which foreign investors have been able to hold a stake of up to 49 per cent since last November.

Compared with them, commercial banks generally have the great advantage of a massive customer base across the country, allowing them to provide better access to potential investors.

"They also enjoy better credibility, which the mass of individual investors views as the most important quality," Yi said.

China's 6-year-old, US$40 billion fund management industry has experienced various ups and downs. Although it developed very fast at its launch, it encountered tough times between August 1999 and May 2000, when news about irregular trading involving 10 fund management companies dampened investors' confidence. Since then, the sector has been fighting to re-establish its reputation.

The entry of new players to this sector will accelerate product innovations, and the improvement of both the service and reputation of the existing fund management firms, Yi said. "Inevitably, some weak players will be cleared out. "And increased competition in terms of sales and trading from commercial banks running fund management companies means that some poor-performing securities brokerages could also go to the wall.

"That will force securities brokerages to promote their sales capabilities and launch more channels catering to customers' special needs," said Zuo Xiaolei, chief analyst at Galaxy Securities. "It is good to have such strong competitors, as it will drive the whole sector forwards."

She said the impact on well-established securities brokerages will be minor as they have their long-term institutional customers.

However, commercial banks face their own challenges.

"As newcomers, they should relish the opportunity and establish a good reputation among investors from the very beginning," Yi said. "The most important thing is to give the investors handsome returns."

But that is no easy task in China's current investment market.

Following rapid expansion in the first half of last year -- especially in February, which witnessed the issue of eight funds, a historic high -- growth tailed off in the second half of last year.

That is partly due to the poor performance of China's stock market, a major investment destination. The benchmark Shanghai composite index has been hovering between 1,200 and 1,300 points, with some analysts even predicting it will dip below 1,200 points.

Under such circumstances, most fund managers are receiving worse-than-expected results, including Merrill Lynch's disappointing maiden mutual fund in China.

The top US broker had planned to earn over US$300 million, but in fact only raised US$130 million from November 18 to December 28. However, the company remains confident its fortunes will improve over the next couple of months.

"For fund managers, scale is not everything," said Zuo. "The key is investment return."

Get approval first

Whatever the current situation means, China's commercial banks seem confident about the future.

Banks including the Industrial and Commercial Bank of China (ICBC) -- the country's biggest lender -- and the China Merchants Bank are queuing up to be among the first batch to be approved.

But they will have to wait until the regulation is formally announced.

The ICBC is remaining tightlipped on media reports claiming that it is planning to set up a joint venture fund management firm with China Huarong Asset Management Corp and Commercial East Asia Finance Holding Ltd, a Hong Kong-registered investment bank in which ICBC hold a 60 per cent stake - with proposed registered capital of up to 500 million yuan (US$60.39 million).

The bank recently reported its operating profit had increased 20 per cent year-on-year, to 74.7 billion yuan (US$9 billion) in 2004, a year-on-year growth of 20 per cent. And its ratio of non-performing loans fell two percentage point to 19.1 per cent last year.

Like its two peers -- the Bank of China (BOC) and China Construction Bank (CCB), ICBC may also start a joint-stock reform, with final regulatory approval expected next month, according to analysts. They said the Chinese Government may inject more capital than it did -- a combined US$45 billion -- into BOC and CCB at the end of 2003.

Liu Jun, an official at the China Merchants Bank, said: "We have applied but have yet to receive approval." She said in an interview with China Daily that the opening of the fund management sector to commercial banks last year means that no bank is going to miss this golden opportunity. "Many commercial banks are preparing and applying for the business."

But for a commercial bank to start up in this business, it first has to get qualification approval from the CBRC and then the CSRC's nod on its operational scale and range of fund products. The central bank will approve and monitor the new ventures trading in bond market.

(China Daily January 17, 2005)