CICC attracts stock market ire

China International Capital Corp accused of dumping the shares it underwrites.

It is perhaps a sign of the tough times China's stock market is going through that even the country's best connected and most successful investment bank has not been able to stop coming under attack for dumping the stock of companies it underwrites, often at the most inopportune moment.

A leading mainland paper, the Economic Observer, recently accused CICC of dumping the stock of telecoms player China Unicom and electronics maker TCL Group and thereby dragging down their share prices.

The paper says that as a result, A-share listed China Unicom's stock price dropped under the hitherto un-breached resistance level of Rmb 3 per share on November 1, and hit its lowest level since March 2003.

The next day, TCL dropped through its issue price of Rmb 4.26, ending up down 10% at Rmb 3.86.

CICC managed both issues, with TCL listing on the Shenzhen market in January this year, and China Unicom carrying out its 1.5 billion share rights issue at the end of July.

According to A-share regulations, hard underwriting is the norm for investment banks, and CICC was left holding 17% of China Unicom's 1.5 billion rights issue at the end of July and an unspecified amount of TCL's share issue, making the company a major shareholder in both companies.

The paper also accuses the underwriting group of 'churning' the shares it held from the China Unicom placement, and describes several huge transactions in the days following. It says that these transactions took place between different brokerage branches of the same investment banks which were members of the underwriting syndicate: Galaxy, CICC, Guotai Junan and Citic.

It is obvious to Western investors that CICC, in undertaking the role of underwriter, is not intending to become an investor in the stock. The bank's function is to sell the stock as quickly as possible, taking into account its duty to ensure smooth aftermarket trading.

Naturally, CICC wanted to sell this stake off as soon as possible, although market sources told FinanceAsia the bank made a gentleman's agreement with China Unicom not to sell off the shares for several months. Indeed, six months have gone past since the rights issue and almost one year since the TCL IPO.

What might appear normal commercial behaviour in developed markets is complicated by several factors in China.

As the investment bank singled out by the government for maximum support in order to develop it into an international player, CICC almost always gets senior positions on both international and domestic share issues - for example, the bank has participated in the IPOs of Sinopec, China Unicom, China Merchants Bank, Bao Steel and many other Chinese blue chips.

Many market participants resent what is perceived as the easy money CICC earns through its underwriting.

For the China Unicom deal, for example, CICC is estimated to have pocketed Rmb 135 million on the deal, or 3% of the offer size.

The primary market, in particular, is seen as overly generous to investment banks by market critics.

Despite some moves towards a book-building process, the price/earnings ratio is decreed to have a ceiling of 20 times by the China Securities Regulatory Commission, well below the prevailing secondary market of around 30 times.

This ensures the stock flies on its debut and is apparently a way of ensuring retail investors are guaranteed a satisfactory result. Such a structure also makes selling the stock a no-brainer.

The investment bank makes its money in two ways: from the officially mandated 1.5%-3% fee on the size of the deal and thanks to the difference between the IPO prices and the secondary market.

Not surprisingly, one local investment banking source estimates that 90% of CICC's revenue comes almost exclusively from underwriting work. CICC also has a brokerage license, but is not permitted to trade shares on its own account, although it is in the process of applying.

However, bankers protest that fees are extremely competitive in the wake of the abolition of the 'channel system' earlier this year. Under that system the CSRC only permitted a certain number of IPOs per year, and fees were at the upper end of the band.

Now any company can apply for an IPO, leading to a rush by investment bankers to win the deal, which is often achieved by discounting the IPO fee.

Fund managers are especially annoyed, because, says one, when CICC dumps all its stock at once it has a disastrous effect on the secondary market.

Thus, by the time the China Unicom share-price broke the Rmb 3 barrier, a fund was the biggest shareholder of the counter's tradable shares, and CICC, the previous biggest shareholder, was long gone.

One rival banker told FinanceAsia that the upset caused by CICC is linked to its status as the favourite official bank.

"There's a problem of perception. CICC wants to operate commercially, but some observers, especially those that took a hit in the secondary market when the share price dropped, see the bank as a government player with special privileges, and which should act responsibly in return," he says.

CICC's major shareholder is government-owned China Construction Bank, while its foreign joint venture partner is Morgan Stanley.

Some observers have consequently argued in favour of lock-up clause of at least six months to prevent early offloading - a somewhat bizarre requirement for China's investment banks, who are already have onerous obligations to ensure the quality of the listing candidates.

The bank's head, Levin Zhu, must be missing the relative tranquility the bank enjoyed when his father premier Zhu Rongji, was in charge. But Zhu resigned two years ago.

Many believe the stock market is not the focus of the existing leadership of Hu Jintao and Wen Jiabao, who are more preoccupied with the less glamorous but important job of trying to ensure the reform of the country's banking system through the international listing next year of China Construction Bank, Industrial and Commercial Bank and Bank of Communications too.

Many conclude that a lack of government focus, in conjunction with feeble efforts by the CSRC to impose stricter controls, is the main reason why the domestic A-share market has tanked, recently reaching five-year lows.