Opinion: Better Corporate Governance Is the Path to Strengthening China’s Brokerages

The creation of a significant brokerage agency is imminent, as Guotai Junan Securities Co. Ltd. and Haitong Securities Co. Ltd. have announced plans to merge. This move represents the first major merger since the introduction of the new Nine Guidelines for the securities industry and is poised to be the largest "A+H" dual-market acquisition in China’s capital markets [para. 1]. It is anticipated that the new entity will become the largest brokerage in China by assets, but doubts remain about whether the merger will improve profitability or create enterprise value greater than the sum of its parts. Corporate governance will be a crucial factor to focus on for measuring the merger’s success, alongside metrics like assets and profits [para. 1].

China’s securities industry has seen many mergers over the past three decades. Guotai Junan itself was formed by merging Guotai Securities and Junan Securities 25 years ago [para. 2]. There are currently 141 brokerages in China, but many are "big but not strong," with similar business models and a reliance on market conditions. The leading Chinese brokerages struggle to compete with top global investment banks, while smaller brokerages are more vulnerable. Historically, the industry has lacked motivation for self-improvement, relying on making "easy money." Therefore, while mergers aim to enhance profitability and competitiveness, they must also deal with corporate governance and risk control issues [para. 2].

Brokerage mergers align with current policy directives, including the Central Financial Work Conference and the Nine Guidelines by the State Council, which advocate for industry consolidation [para. 3]. The China Securities Regulatory Commission (CSRC) has set goals to foster 10 leading firms within five years and cultivate globally competitive investment banks by 2035 [para. 3].

Corporate governance is a pivotal aspect of sustainable development for brokerages, impacting shareholder interests, insider abuses prevention, and decision-making mechanisms [para. 4]. Effective governance is interconnected with compliance, risk control, and the company’s culture. Without proper governance, brokerages cannot maintain strategic capabilities, professional expertise, or attract top talent [para. 4].

The recent Haitong Securities merger highlights governance issues. Haitong’s aggressive international expansion led to significant losses due to involvement in the Chinese real estate sector’s U.S. dollar-denominated debt crisis, exposing governance flaws and a breakdown in risk control [para. 5]. The departure of a key executive, amid exorbitant salary scandals, further revealed weaknesses in Haitong’s management oversight. Such governance issues are not uncommon in China's securities industry [para. 5].

Many brokerage mergers do not involve equally strong firms but rather stronger firms aiding weaker ones or weaker firms banding together, resulting in challenges like asset consolidation, team integration, network restructuring, and governance harmonization [para. 6]. The Guotai Junan and Haitong Securities merger, both managed by Shanghai’s state-owned asset administrator, might face fewer integration challenges than cross-regional mergers, but corporate governance improvements will still be challenging [para. 6].

Corporate governance has been a longstanding issue. Twenty-five years ago, during the Guotai and Junan merger, governance topics like board fiduciary responsibility and stock ownership were already critical challenges [para. 7]. Following China's WTO accession, corporate governance gained increased focus but remains incomplete. Modern financial enterprises with robust governance structures are now emphasized by policymakers [para. 7].

With the stock market in a prolonged slump and securities firms under operational pressure, governance reform has become urgent. The first-half financial reports for 2024 show that listed securities firms’ net profits declined by about 20% year-over-year [para. 8]. While external factors contribute to this decline, internal weaknesses within the sector are also exposed. The securities industry must address these internal governance issues to improve operations and restore credibility [para. 8].