China working on merging its biggest brokers to take on Wall Street

(Bloomberg) – China has started the process of potentially merging its two biggest brokerage firms to create a company that can better compete with the global investment banks as the country opens up its financial markets, according to people familiar with the matter.

Citic Securities Co and CSC Financial Co, along with their government shareholders Citic Group and Central Huijin Investment Ltd, have recently started due diligence and a feasibility study on how to structure the deal, according to the people, who asked not be named discussing private matters.

Regulators, including China Securities Regulatory Commission and the State-owned Asset Supervision and Administration Commission, are briefed in the process, said the people.

A merger between Citic and CSC, both based in Beijing, would create an investment bank valued at US$67 billion, surpassing even Goldman Sachs Group Inc in market capitalisation. The country’s opening of its US$45 trillion financial industry has added urgency for China to build a company that can go head-to-head with the Wall Street giants.

“Compared with global markets, China’s securities industry is still scattered and the big local players are way behind their global peers,” said Wang Jian, an analyst at Guosen Securities Co. “As internal growth is too time consuming, improving the industry’s competitiveness through mergers is necessary amid the influx of foreign capital.”

Still, there’s no guarantee that the current discussions will result in a deal, the people said, adding that Chinese authorities want it to be made on commercial grounds.

Citic’s shares rose as much as 5.7%, while CSC’s stock jumped more than 11% in Hong Kong trading.

China Securities Regulatory Commission said late last year that it wanted to create investment banks of an “aircraft carrier size” to compete, as well as promote an international expansion of its brokerage industry.

Taken together, China’s 131 brokers have assets that are equal to what Goldman Sachs sits on by itself. They are also far from being full-service investment banks, counting on mom and pop traders across the country to contribute much of their revenue. The market is also fragmented, with the top five brokers capturing just about a third of the industry’s revenue, according to Goldman research.

Citic and CSC combined would have about 1 trillion yuan (US$142 billion) in assets and more than 25,000 employees. They rank No 1 and No 2 in terms of underwriting deals, and folding CSC in will add to Citic’s dominance in the brokerage business.

“Citic’s and CSC Financial’s strengths lie in investment banking,” said Luo Zuanhui, a Shanghai-based analyst with Tianfeng Securities. “The two are top 3 players in equity, fixed income underwriting as well as M&A advisory. If the merger goes through it will create a dominate player in this field.”

Citic Securities, CSC Financial, Citic Group, Huijin and the CSRC didn’t immediately respond to requests seeking comment. A press officer at SASAC declined to comment.

Starting this month, Wall Street firms will be allowed to take 100% control over their securities firm unit. Goldman, UBS Group AG and others are looking adding at least 1,000 new bankers, traders and analysts and beefing up office space to expand their footprint in everything from futures and brokerages to asset management.

Driven by further market reforms on derivatives, more institutional reach into debt and equity markets, China’s overall market revenue could triple to US$116 billion by 2026, according to Goldman.