Market needs voice in brokerage consolidation

Govt pressure may thwart efforts to produce world-class financial firms

A-share investors flocked earlier this week to Shenwan Hongyuan Group Co, a company formed by the merger of brokerage sector veteran Shenyin & Wanguo Securities and younger peer Hong Yuan Securities. According to reports, Hong Yuan had accepted a buyout offer of 39.5 billion yuan ($6.31 billion) in stock back in mid-2014.

On its first day of trading, the new company's stock price jumped 32 percent, giving it a total market capitalization of 291.9 billion yuan. This sum conferred Shenwan Hongyuan with the double distinction of being both the Shenzhen Stock Exchange's largest listed company by market value as well as China's second-largest listed securities company (the largest being Citic Securities).

Sentiment turned in Shenwan Hongyuan's second day of trading, when its stock price fell 9.77 percent, shaving some 29.4 billion yuan off its market value.

This radical change from one day to the next illustrates the sway that speculators can still exert in China's A-share market. But putting the company's price fluctuation aside for a moment, let's look at the acquisition deal behind this new company as well as its prospects for the future.

According to its listing documents, the new company's overall strategy is to become a diversified financial services conglomerate with interests in banking, insurance, trusts and leasing. The combined expertise and assets of each partner offer a springboard toward achieving these lofty aims. Indeed, with assets of 105.42 billion yuan, the new company has ample resources to smooth its long-term development plans.

The complementary advantages of the merged company's two partners also provide a leg up - Shenyin & Wanguo's strong suit lies in brokering services and research, while Hong Yuan is seen as a capable investment bank. And with the two institutions operating in different areas of the country - Shenyin & Wanguo mainly concentrated on the Yangtze River Delta region, while Hong Yuan focused on northern China - their merger will allow them to consolidate their geographic coverage.

These and other bright points have given many early investors reason to put their faith in the company's ambitious plans. But can the new behemoth really achieve its growth goals? Maybe not.

One big issue for the new company is that it brings nothing new to the table. State-owned Central Huijin Investment controlled both Shenyin & Wanguo and Hong Yuan before their tie-up, and is now a major stakeholder in the merged company. Many argue that a heavy government presence in protected, monopolized sectors (such as financial services) limits competitiveness and promotes inflexibility. Such criticisms seem founded when one considers Shenyin & Wanguo's history. As an old-school State-owned brokerage, the company developed slowly despite enviable levels of support from authorities. By 2013, the company ranked 10th in its industry in terms of net profits according to the Securities Association of China.

In the international market, world-leading financial institutions - such as Goldman Sachs and Morgan Stanley - all developed through a continuous process of acquisition. For the most part, such deals were made in response to market considerations.

By contrast, it's not hard to see the government's hand behind the merger of Shenyin & Wanguo and Hong Yuan. According to reports, merger discussions between Shenyin & Wanguo and Hong Yuan were prompted by a police investigation into the latter's vice president and vice chairman. Specifically, sources say authorities organized the deal to quell internal disarray caused by alleged irregularities in Hong Yuan's fixed-income division.

If one can safely conclude anything, it's that the Shenyin & Wanguo-Hong Yuan merger likely heralds more such deals within the securities industry. China's fragmented brokerage sector is reportedly filled with over 100 small-time players, many of which lack the resources to compete on a large scale. By spearheading consolidations and mergers, authorities clearly have the best interests of the industry at heart. Yet experience suggests that a market-oriented approach is needed to foster long-term success for individual businesses.