China's long-practised segregated regulatory scheme for the banking, securities and insurance sectors is being shaken by the expected launch of fund management companies by a few pilot commercial banks.

The country's financial regulators jointly announced earlier this month that three domestic banks had been chosen as pilots to launch fund management firms, ushering in a new era of banks that can also take part in capital market investments.

The three pioneers are the State-owned Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB) and Shanghai-based joint-stock lender, Bank of Communications.

Regulators have promised to speed up the reviewing of applications to invest in fund management companies and complete the reviews by September and then issue the relevant licenses.

If the experiment works well, more banks are expected to join the business later on and launch their own fund companies.

Previously, Chinese banks were not allowed to take part in securities investments or insurance, focusing mainly on the traditional lending and deposit services.

They could only sell mutual funds or insurance policies as the sales agent and provide fund custody, but not issue their own funds.

If they can also initiate mutual funds and take part in the core investment business, it will divert part of the country's 13 trillion yuan (US$1.6 trillion) savings pool into the capital market.

The reform marks an important step taken by the domestic financial institutions towards cross-industry operations, said Yi Xianrong, a financial researcher at the Chinese Academy of Social Sciences.

Previously, China only had a few financial conglomerates that had a number of subsidiaries of banking, insurance and securities, like CITIC Group and China Everbright Group. But these subsidiaries are operating independently and are not allowed to invest in each other.

The ice-breaking move of allowing banks to invest in the fund management business will be a major stimulus to the financial markets, said Yi.

It enables the banks to expand their business sphere and improvise a profit model, meanwhile offering the savings fund wider investment channels. It also infuses fresh energy into the capital market, he said.

Their entry will also put existing fund managers under more pressure to compete and urge them to do a better job.

China's fund industry has witnessed rapid expansion over the past two years, with a boom of mutual fund initial public offerings in spite of the correction of the stock market.

About 50 funds were issued last year, raising more than 170 billion yuan (US$20.5 billion), according to statistics from the China Securities Regulatory Commission (CSRC).

The scale exceeded that of all mutual funds issued in China over the past five years.

The rosy prospect of China's asset management business has also attracted many foreign investors and made domestic banks fidgety. Domestic bankers have been actively lobbying regulators for fund management licences so they too can get a slice of the action.

Pilot scheme

Now with the green light from the regulators, it is crucial for the pilot banks to kick off with a good start. This is not easy, given the immaturity of China's financial markets and investment tools as well as no solid regulatory scheme.

According to a regulation on the launch of fund management companies by domestic commercial banks released in February, interested banks must first apply to the China Banking Regulatory Commission (CBRC) and report to People's Bank of China.

Then they must undergo an examination by the CSRC for the relevant fund management firm licences.

It is preferred that these bank-invested fund companies have a diversified equity structure, which means the banks have to find strategic partners to jointly develop the new business.

Zhang Yuan, director of the Policy and Regulation Department of the CBRC, said that such strategic partners should include one foreign institution that is familiar with the fund management business, hoping its participation can bring advanced expertise.

Sources within the ICBC, one of the three pilot banks, said the bank has picked Credit Suisse First Boston and China Ocean Shipping (Group) Company (COSCO) as its partners to jointly initiate a fund management firm.

CCB is also actively preparing for the new fund business.

Li Chunxin, deputy general manager of the fund custody department of CCB, said last week the bank would work together with one domestic company and a foreign asset management company to initiate a fund management joint venture. But he did not reveal the names of the partners.

Banks have their advantages, such as client sources, distribution networks, as well as their familiarity with monetary market investment tools, experts said.

The vitality of the fund managers, no matter who their shareholders are, exists in their marketing ability and whether their operation can be market-oriented, said Li with CCB, adding that the bank is already very familiar with the fund management business and has a number of qualified professionals.

Brand construction and reputation are also essential for these banks' survival.

Li said the bank's potential partners in the mutual fund business are generally optimistic about the market potential in China.

The bearish performance of the bourses will not dent their enthusiasm.

As for Bank of Communications, which is also preparing for a public listing in both the A share market and Hong Kong, it has remained rather low-profile since being picked as one of the pioneer banks to invest in asset management. Market sources say Schroder Investment Management and China International Marine Containers (Group) Co Ltd are likely potential partners.

A number of other Chinese banks, including Bank of China, China Merchants Bank (CMB) and Shanghai Pudong Development Bank, have also filed applications to build their own fund management companies.

Ma Weihua, president of CMB, said in March that the bank had prepared two plans - either to launch a new fund company with its strategic partners or buy into an existing fund company.

Risk concerns

In spite of the banks' enthusiasm, a major concern about the their entry into the securities investment business is the risk control scheme.

To minimize the risks, regulators have required that a bank can not provide custody for funds issued by its own fund management company.

In addition, a fire wall must be set up to separate the asset management entity from the commercial banking business.

But experts said the authorities should come up with detailed rules to clearly define the obligations for relevant participants and relevant punishment for lawbreakers. Also, the banking and securities watchdogs should enhance co-ordination on these aspects.

Qin Chijiang, deputy secretary- general of the China Society of Finance, said banks should build up a solid risk control system and enhance their management to protect the interests of their investors, especially the depositors.

They should explore the fund management market steadily in a prudent way and train more professionals instead of simply seeking business expansion, he said.

Given the immature financial markets in China, banks interested in the fund management business are also facing other challenges, like risk culture cultivation and customer and brand differentiation, experts said.

It has been suggested that the bank-invested fund companies should start with the development of bond funds and monetary market funds that banks are more familiar with rather than equity funds.

That could also help ward off some of the competition pressure from existing fund companies.

(China Daily April 18, 2005)