China Seeking a Role Model for Markets?

China, we all know, is the great investment market of the future. The danger is that it always will be thus--a place of immense promise (like Brazil) but a black hole for investors’ capital.

How can foreigners be confident of a long-term payoff in Chinese stocks and other investments? By definition, an emerging market is inherently risky, of course. But it would help a great deal if the Chinese were to build a financial system--and stock markets--with integrity, honesty and full disclosure.

Happily, the Securities Assn. of China seems on the right track. Formed in 1991, the group is patterned after the National Assn. of Securities Dealers in the United States--a self-regulatory organization whose goal is to advance the cause of capital formation while protecting the rights of investors.

On Thursday, a 30-member delegation from SAC visited First Interstate Bank in Los Angeles, officially for advice on how to structure stock offerings of Chinese firms for sale in America. But most of the questions directed to First Interstate executives Alan R. Adelman and Ken Ackbarali were of broader scope: how the U.S. commercial banking and brokerage businesses work, who performs which tasks and how risk is allocated.

Adelman, for example, had a rapt audience when he explained how the 1929 stock market crash led to the separation of powers between American banks (as deposit takers and lenders) and brokerages (as stock underwriters and market makers). Though the lines have blurred since, the basic safeguard remains: U.S. banks can’t speculate in stocks with depositors’ funds.

There’s a good reason why that distinction is of interest to the Chinese. In China now, the burgeoning ranks of specialized banks and securities firms all are offshoots of the People’s Bank of China. Many members of SAC are former commercial bankers who have left the relative calm of that business for the wilds of investment banking. The financial system is one massive entity, extraordinarily interlinked and evolving rapidly--as is regulation of the system.

“China has only started its capital markets in the last two or three years, while your system was started 100 years ago or more,” said Liu Dawei, leader of the SAC delegation and an executive with the People’s Construction Bank of China. “So it’s necessary for us to learn,” he added, speaking through a translator.

Does Liu believe that China’s banking and brokerage systems should be separated, for investor safety? “I think this is a very complicated question,” he replied. “We have quite a bit of work to do.”

But Yu Zhi Qiu, a manager in the asset management area of J&A; Securities in Shenzhen, appeared swayed by the lessons of 1929 America. “It’s very important,” he said of the separation issue.

Adelman, First Interstate’s chief investment officer, said the bank’s relationship with SAC, cultivated since 1991, is mutually beneficial. First Interstate builds important contacts within the fledgling Chinese securities industry, which may later lead to investment opportunities in China for the bank’s trust fund clients.

The capital-needy Chinese, meanwhile, get the bank’s help in understanding what foreigners want to see before they’ll funnel money into Chinese equities.

So far, Adelman noted, only a handful of Chinese stocks trade outside China. In the United States, they are Brilliance China, a minivan maker, and China Tire. Both are on the New York Stock Exchange.

Beyond those names, Americans who want to buy Chinese equities directly can trade in Hong Kong-listed stocks, or they can buy the limited number of stocks available to foreigners on the Shanghai and Shenzhen exchanges. But the latter are such illiquid markets that First Interstate, and many other U.S. institutions, have been reluctant to step in.

Liu, clearly conscious of the challenge China faces in attracting--and keeping--capital, told Adelman at the end of his visit Thursday, “We have a lot of questions, a lot of problems--but (also) a lot of business to do.”