BEIJING - The China Securities Regulatory Commission (CSRC) on Friday issued guidelines that will enable securities companies to incorporate the pilot program for private equity (PE) investments into their regular businesses.

The move will allow more brokerages to launch PE funds, which will broaden their revenue streams and the fund-raising channels of the country's cash-strapped small and medium-sized enterprises, said Yang Zhihua, deputy director of the department of securities firms at the CSRC, at a news briefing.

The regulator required that domestic brokerages can use no more than 15 percent of their own capital for PE investments, but it did not set limits on the funds they raise from the market. It also ruled that the number of investors in a PE fund set up by brokerages cannot exceed 50.

The pilot program for PE investment by securities companies was launched in 2007. So far, 34 have gained a license for PE investment with a registered capital of 21.6 billion yuan ($3.34 billion) and the total value of investments has reached 10.2 billion yuan, according to the regulator.

China International Capital Corp has been approved by the regulator to set up a PE fund of 5 billion yuan. It is the country's first PE fund to be managed by a securities broker.

"The move by the regulator is a positive one for domestic brokerages as it will help boost their asset-management business which is considered an important revenue source by international investment banks," said Dong Dengxin, a finance professor at Wuhan University of Science and Technology.

Global investment banks such as Goldman Sachs and Morgan Stanley on average derive 20 to 30 percent of their revenues from asset management, which includes PE investment. But the number is less than 5 percent for Chinese securities firms.

The regulator has been reluctant to make a major move to expand the PE business of securities companies over the past few years because of widespread concerns about a potential conflict of interest between their IPO underwriting businesses and PE investments.

Regulators and customers are concerned that brokerages may be tempted to lower IPO standards or whitewash the financial reports of their clients to push IPO prices higher so that they can profit from PE investments as pre-float investors.

In order to address the conflict of interest issue, the regulator requires that employees of securities firms cannot work for their subsidiary investment companies at the same time. Brokerages must set up a "firewall" to prevent communication between the investment banking team and PE investment team.

Subsidiary investment companies owned by brokerages are required to have an independent decision-making process and they are banned from investing in an unlisted company after its parent securities firm becomes the company's underwriter of the company, according to the CSRC's Yang.

"The key is to manage the potential risks involved in PE investments and to strengthen the internal governance of securities brokerages to prevent a conflict of interests," he said.

China Daily

(China Daily 07/09/2011 page9)