Foreigners drawn in as fear and loathing grip China's finance industry

DEC 4, 20156:46 PM

[SHANGHAI/HONG KONG] A widening regulatory probe into some of China's biggest brokerages has set nerves jangling in a financial industry still recovering from a summer of turmoil, with fear of becoming entangled in investigations spreading among foreign investors.

People working at domestic securities firms report an ugly mood after news in the past week of increased scrutiny of the sector by authorities. A nervous inertia is slowing new business as staff are encouraged to report their bosses or colleagues for corruption.

"It's creating a very dog-eat-dog environment," said a partner at a Chinese mutual fund. "People collect evidence on their bosses, because if they get rid of their boss, it means that they can get promoted faster."

Foreigners operating in China or investing in the mainland through Hong Kong are also worried about becoming entangled in the widening regulatory net. "Everyone is absolutely terrified of China," said a director at an international brokerage in Hong Kong, echoing the sentiment of many in the industry contacted by Reuters. Most did not want to be identified due to the sensitivity of the issue.

The crackdown on the securities industry - from hedge funds and institutional fund managers to brokers and banks - began after the mid-year equity market crash wiped around 40 percent off mainland share prices, which Beijing blamed partly on"malicious" short-selling and insider trading.

Even though domestic stock markets have rebounded steadily by about 25 per cent since the pit of the crash in August, market executives say the regulatory atmosphere has not relaxed.

Authorities have revealed little about the specific reasons for the probes, but three sources told Reuters they believed some of the investigations involved suspicions of insider trading relating to trades by China's "national team" - the big brokerages and fund managers dragooned into buying stocks as part of unprecedented measures to prop up the market.

"PUPPET CEO"?

Chinese shares tumbled more than 5 per cent last Friday, the biggest one-day drop since the nadir of the summer rout, after Reuters reported the country's fourth-biggest brokerage was under investigation.

The launch of a probe into China Haitong Securities added to investigations by the China Securities Regulatory Commission (CSRC) into bigger rivals CITIC securities and Guosen Securities .

Haitong, along with Guotai Junan Securities, is also being probed by anti-corruption investigators, state-run news agency Xinhua said. Bloomberg reported on Friday that a former Beijing police chief who put away one of China's top Communist Party officials has been put in charge of the corruption campaign of the securities industry. "They put a notice on all the floors with the number that you can call anonymously to encourage people to dial in. They say they just want people to report corruption," said a source at Guotai Junan.

Guotai Junan, CITIC and Guosen did not respond to requests for comment and a Haitong spokesman referred Reuters to the company's public statements. CSRC and anti-corruption authorities did not respond to requests for comment.

Brokers, consultants and lawyers said foreign investors operating in China were becoming increasingly reluctant to speak publicly on market issues in case they attract adverse attention from regulators.

While they welcome the need to investigate and prosecute rule breakers, they say a lack of legal recourse in China creates the fear about being caught up in the net. When authorities call executives in, they say they are never sure if they are being asked to help with enquiries or are under suspicion and when they might be released.

A lawyer who has assisted foreign firms caught up in the probes said some were introducing new onshore compliance programmes, although that did not guarantee keeping out of trouble. "You can't 'comply' because there is no rule of law," he said. "The best thing you can do is establish processes for who is likely to be taken away, and how to make sure they aren't disappeared forever."

Chinese corruption investigators typically cast a wide net, often dragging in dozens of the primary target's business associates. That unnerves many investors. "Until very recently, if you wanted to advance your business on the mainland you had to have certain key relationships, but yesterday's super-asset can quickly become today's liability,"said Steve Vickers, CEO of Steve Vickers and Associates, a political and corporate risk consultancy based in Hong Kong.

Another consultant said he had even been asked by foreign investors about the feasibility of hiring a mainland "puppet CEO" who would take instructions from offshore but be on the hook for any investigation. "But no-one is stupid enough to agree to that," he added.

THERE WILL BE BLOOD

On Sunday, CITIC, Haitong and Guosen all confirmed they were being investigated by the CSRC over suspected rule breaches. Haitong's chairman was quoted by the official Shanghai Securities News saying it will tighten risk controls and make strict checks on clients.

The brokerages have said they are operating normally, but several industry sources said the investigations were having a chilling effect. "At the moment, if you don't do what the CSRC asks you to do, there will be blood," said a source at a large US hedge fund operating in China.

Shen Weizheng, an asset manager at Shanghai-based Ivy Capital, said he had planned to launch an overseas investment fund in co-operation with CITIC Securities, using the brokerage's cross-border swap business. But regulators suspended the over-the-counter swap business out of the blue.

"I signed the business agreement last week and submitted it to CITIC for approval. Now, the business is suspended," he said."I'm very disappointed."

More complicated structured products or innovative financing have been most impacted, said a source at top-five bank leasing company, as firms seek to avoid scrutiny while regulators pore through records. "We want to remain low-key right now, don't want to bring trouble on ourselves," said the source. "Everything will start up again, though, as soon as they leave."

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