Walter Hutchens’ Blog

The Financial Times reports that PRC officials have approved the establishment of a PRC-based investment bank between Goldman Sachs and Fang Fenglei, a prominent PRC banker. The FT report has been repeated by others, here for example by Reuters. The South China Morning Post reports here that this will be accomplished by converting Hainan Securities into the Fang-Goldman JV.

I have previously expressed an opinion that this cannot happen under PRC law because the PRC rules on foreign investment in the PRC’s investment banking sector do not contemplate that an individual can be the dominant Chinese party to such a venture.

This new FT report has prompted me to review the regulations in detail. On review, it looks to me like Fang could be a shareholder in such a venture. The main rules are the Establishment of Securities Companies with Foreign Capital Participation Regulations (外资参股证券公司设立规则 or Waizi can gu zhengquan gongsi guize) promulgated by the CSRC June 1, 2002 and effective July 1, 2002.

Under these rules there are two ways to create a foreign-invested securities company (FISC) in the PRC mainland. One is to take an existing securities company and convert it into an FISC. When you do this, at least one PRC shareholder must after the conversion hold at least 1/3 of the FISC, and the foreign shareholder(s) are capped at 1/3.

Thus, shareholders of Hainan Securities could sell up to 1/3 of the firm’s shares to Goldman and theoretically sell up to 2/3 of the firm to Fang Fenglei. In any case, some single Chinese shareholder would have to hold 1/3 of the shares of the converted entity.

Alternatively, an FISC could be established afresh. Under that approach, a PRC securities company must hold at least one third of the shares of the venture.

Since Fang is an individual and not a PRC securities company, if a Fang-Goldman FISC venture were created by establishment of a fresh FISC (rather than conversion of an existing securities company into an FISC as the SCMP article suggests), Fang could hold at most 1/3 of the venture because there would have to be a securities company shareholder in the mix. (Fang could hold more than 1/3 under this approach if Goldman was willing to take less than the 1/3 maximum it is permitted, but that seems unlikely since they eventually want control and are reportedly looking for a way to option Fang’s shares).

Before I wasn’t sure Fang as an individual could hold any shares in such a Chinese-foreign investment bank venture, but that doesn’t appear to be a problem. Article 8 of the Establishment Regs cited above requires only that PRC shareholders to a Chinese-foreign investment bank meet the general CSRC-established qualifications for Chinese investors in securities companies.

Those qualifications in turn are spelled out in the CSRC’s Procedures for Security Company Administration (证券公司管理办法, or Zhengquan gongsi guanli banfa) promulgated December 28, 2001 and effective March 1, 2002. Article 9 of that regulation simply requires that shareholders in PRC securities companies not have a record of serious violations of PRC laws and be solvent. The CSRC must confirm (rending) Chinese shareholders if they hold more than 5% of a securities company, but there is no explicit bar against an individual holding such shares.

The FT story that this long-rumored deal is moving forward makes no mention of creating this venture through conversion of an existing PRC securities company into an FISC. That made it seem to me like the JV would be established afresh and hence that Goldman and Fang were getting around the requirement that a PRC securities company hold 1/3 of the venture. Thinking that, I was ready to launch a rant about how despicable it is that Goldman sought a special dispensation that flouts promulgated PRC law. But it obviates my concern if the carcass of Hainan Securities is the vehicle for establsihing this venture as the SCMP reported.

Some PRC shareholder will have to hold 1/3, and Goldman will be capped at 1/3, but Fang Fenglei could hold up to 2/3.

The FT article suggests the CSRC must still approve the deal. Because the CSRC is part of–indeed under–the State Council that has reportedly granted this special approval, it is hard to imagine that approvals from the “financial regulator” will be a problem if the FT facts about a State Council approval are accurate.