The discussion of setting up a securities investors' protection fund was forced into the limelight again recently with the unveiling of a new rule to pool interest generated from subscriptions to bond and share issues as one source of the fund.

The fund, initiated by the China Securities Regulatory Commission (CSRC) and the Ministry of Finance, is mainly intended to give investors some compensation when they suffer from losses brought by misbehaviour or bankruptcy of securities companies.

While regarded as an innovation in the financial market, the proposed fund also aroused concerns on the inadequacy of the fund's sources, its protection scope and function in the stock market.

The annual interest of the subscription fee is estimated to be some 300 million yuan (US$36.2 million). "Although this is a big amount of money, it is far from being adequate compared with China's 70 million securities investors," said Sun Qing, an analyst at China Securities Co.

Before the introduction of the new rule, the subscription interest goes to the listed firms. The shifting of the interest from the listed companies to the fund then aroused concerns among some insiders that it is detrimental to investors because the listed firms can use the money to make more profits and then pay more dividends to them.

Moreover, when a problematic securities firm is closed down or goes bankrupt, it needs much more money to pay the bill, experts said.

For example, when the former market leader, Southern Securities, fell into financial trouble and was taken over by the government at the start of 2004, the central bank had to re-lend it 8 billion yuan (US$967.4 million), in case its investors rushed to withdraw their guarantee funds.

And in the case of Xinhua Securities, which was closed down in December 2003, the central bank re-lent it 1.5 billion yuan (US$181.4 million).

Sources need to be broadened

Such a protection fund may give investors some help to recover their losses, but the existing funding source is very limited, falls far short of the need and should be broadened, said Li Yongsen, a professor at the Financial and Securities Institute of Renmin University of China. His idea has been echoed by many experts.

Their mostly suggested model of the fund is in the troika structure, with money from the finance ministry, the central bank and the brokers as its main source.

The securities regulator is drafting a rule to regulate securities firms, the 21st Century Business Herald reported. The drafted rule is expected to lay the framework for the investor's protection fund and it proposes five sources of the fund: membership fees from the securities companies, allocation from the Ministry of Finance, re-lending from the central bank, interest generated from subscription of stock and bond issues, and donations.

Many analysts think the framework is reasonable.

The government, brokers and listed firms should contribute to the investors' protection fund because some of their income actually comes from investors, in the form of either stamp taxes, service fees or proceeds. Moreover, compared with them, the investors, especially mid-sized and small investors, are more fragile when faced with market risks, according to Sun Qing with China Securities Co.

Small investors do not have solid financial strength and have little say in corporate policy-making, he said.

However, others, especially brokers, have their reservations.

Given the present dim market performance, it would be hard for all securities companies to pay certain deposits to form a pool of compensation funds, said Xu Gang, general manager of the research department of CITIC Securities.

"I do not think it is fair for the well-operating brokers to pay the bills of the underperformers," he said.

Xu also suggested that reinsurance to clients' guarantee fund at the brokers would be a better method than compensation funds.

Li is against the idea that each securities company pay a membership fee as one source of the fund.

The stock market has been in prolonged doldrums and most of the brokers are in the red. To pump any more money from them means to push the clients' guarantee funds to a more dangerous position, explained the professor.

Embezzlement of clients' guarantee funds is not a rare thing in the industry in China. And when the securities firms fall into financial troubles brought by overridden-debts or investment failure, investors often find it hard to get their money back.

"It is negotiable for them to pay the deposits in the future when the market is healthier. But at present it is not practical," Li said.

In addition to the sources proposed by the regulators, some experts suggested absorbing the penalty money from the deceitful listed firms and misbehaving securities companies into the protection fund.

Compensation scope needs to be widened

Even when the funding sources are solved, another concern is the scope of compensation. Who should be protected? And under what circumstances can they get the compensation?

Investors' losses come not only from misbehaving brokers, but also from the fraud of listed companies, the malfunction of the trading system and some other uncontrollable forces, experts said.

Only when the protection scope is big enough, investors can enjoy the fund in a real sense, said Jiang Wen, an experienced stock trader in Beijing.

Jiang said the biggest point of the fund to him is that the government is trying to make investors come to understand that they should take part of the responsibility for their investing.

"The government will gradually fade out as a rescuer and the investors have to learn to choose credible brokers in the future," he said.

China's stock market performed poorly last year, with the benchmark Shanghai composite index falling 15 percent, hit by economic cooling measures, corporate scandals and a spate of share issues.

A recent online survey made by Xinhuanet.com about the hot topics during the annual meetings of National People's Congress and Chinese People's Political Consultative Conference shows that the topic that draws most attention is how the capital market can be pulled out of the lingering swamp.

The topic received 72 percent of the votes, far more than the No 2 topic with 36 percent about anti-corruption and the No 3 with 30 percent about the increasing gap between the rich and the poor.

Legal loopholes and unsolved structural problems

The launch of the compensation fund may offer investors some relief, but many securities companies, investors and scholars all agree that the fund is only a bail-out programme, because it fails to offer an automatic solution to the existing problems in the securities industry.

The limited source of the fund is a smaller problem compared with the twisted market system.

Even if the fund itself was large enough, it still could not cover the endlessly emerging losses caused by the structural problems and legal loopholes, said Zhao Xijun, also a professor at Renmin University of China.

He suggested that some technological and legal improvements be introduced.

The cost of breaking the law is far less than the illegal gains and it is urgent to speed up disposal of poor-performers in the industry to build up its competitiveness, Zhao said.

On the other hand, it is vital to introduce a trading system to strictly separate the money of the investors and the brokers, because the root cause of embezzlement of clients' guarantee funds by the brokers is their shared securities accounts or trading seats, according to Jiang, the veteran Beijing trader.

Giving the securities companies more financing channels is also vital for the protection of the investors' guarantee money, Xu Gang of CITIC Securities commented.

Moreover, the fund should be operated independently, said Yi Xianrong, a senior researcher in finance at the Chinese Academy of Social Sciences.

Yi also said that a strict securities investors' protection law is integral to form a healthy market environment and to protect investors.

(China Daily March 7, 2005)