China conference leads to better financial regulatory environment

Financial conglomerates will be regulated in segments by the relevant regulator, but much remains to be done.

At a recent conference in Beijing, some progress seems to have been made on the issue of coordinated supervision of financial conglomerates. However, observers say the issue is far from exhausted.

The rise in China of financial conglomerates such as Ping An Insurance, China International Trust and Investment Corporation and China Everbright has posed a challenge to the regulatory framework.

CITIC, owns or has controlling stakes in CITIC Industrial Bank, CITIC Securities, CITIC Prudential Life Insurance and other finance related groups. China Everbright also owns a bank, a securities house, an asset management company and an insurance agency.

The difficulties arise because the existing regulators only cover one area each: The China Securities Regulatory Commission covers stocks and increasingly bonds, the China Insurance Regulatory Commission covers insurance, and the China Banking Regulatory Commission covers banking. But there is no super regulator, which combines all supervisory tasks. That means that regulators have needed to find ways of cooperating efficiently together – no mean feat where China's bureaucracies are concerned.

Industry players are putting pressure on the government to allow pure holding companies, but so far no law has been passed. The authorities are not confident about the existing state of most Chinese banks.

However, the aforementioned three companies, and especially CITIC have been permitted to invest in a range of industries as parent companies with their own core businesses rather than holding company merely owning shares in subsidiaries.

"The authorities are looking at these companies as a feasibility study. If they do increase their profits and stability, a gradual relaxation could be allowed," estimates Wei Yen, senior banking analyst at Moody's.

That process will require a functioning regulatory environment and progress seems to have been made a conference last week. This brought together the different regulators, but notably did not include the People's Bank of China.

This, say observers, implies that the PBOC is bowing out of regulatory functions completely. That indeed is reflected by the creation of CBRC this year, which has taken over the function of regulating the banking sector, while the central bank concerns itself with currency conversion and interest issues.

But confirming that the PBOC is still not completely out of the picture, the CEO of one of the CITIC companies, Wang Jun, mentioned in a press conference that when the group was permitted to become a financial conglomerate by the State Council, it was made clear that the PBOC would be the supervisor, rather than State Council. The same condition applied to China Everbright when it received permission.

Those comments make the absence of the PBOC at the conference especially perplexing, since it is not clear who, if any, is the new regulator of these companies.

To add to the opacity, other organs are also involved, since CITIC's and Everbright's personnel affairs are regulated by the Organization Department of the Communist party. This important function is normally taken over by the industry regulator, which is concerned with conflicts of interest and maintaining Chinese walls, rather than a purely political organ like the Organization Department.

While it is not clear who takes over the ongoing regulation of financial conglomerates, principles hammered out at the regulators' conference suggest that financial subsidiaries will be regulated by the regulator which has most in common with that particular subsidiary. The same principle will apply to the parent companies.

When it comes to the parent companies and their subsidiaries, the permutations are numerous; but it is reported that eventually a distinction will have to be made between true holding companies, which merely manage their assets and parent companies which themselves have an active line of business. If the latter, the regulators will have to distinguish between parent companies which have a financial line of business, and parent companies which are engaged in a completely different pursuit.

The latter is an important challenge, since companies such as electronics goods maker Haier, with no previous experience in finance, are pushing to move into creating conglomerates that incorporates financial businesses.

"The attraction of a holding company is that it permits companies to acquire other companies without going through the pain of a merger right away," points out Moodys Wei Yen.

That is because the holding company sits at the top of the structure with its subsidiaries operating in an independent function below it. It is an ideal vehicle for mergers and acquisition, and in the banking world, for cross selling products.

However, Wei Yen also points out that the authorities are concerned about the current health of the banks, and hence the risk of contagion if one part of the conglomerate should run into trouble. Indeed, it was only in the late 1990s that some mainland banks were permitted to invest in other financial institutions.

"Ideally, the banks should clean up their core businesses before branching out into other areas. But it's human nature to see easy profits on the other side of the fence," he says.

Regulations on how to regulate these different entities need to be formulated. The conference reported that the simplest permutaiton would be for the parent company to answer to the regulator depending on its core business, and the subsidiaries with their own core businesses, responding to their relevant regulators.

It does however, leave many of the possible permutations unaddressed, especially the issue of pure holding companies, should they be eventually allowed, and parent companies engaged in non-finance related activities.

However, a start has been made on this important topic, and the participants also informed journalists that methods for coordinating regulatory activities had been introduced, as well as measures for information sharing.