The China Securities Regulatory Commission (CSRC), the industry watchdog, has suggested that a special company be established to operate a compensation fund for investors who fall victim to misuse of funds after placing their money in brokerages for securities trading. Each securities company would be expected to contribute its share to the fund, and the government would also infuse some money.

The fund could then invest in government bonds or obtain loans from banks.

Often, misused funds simply vanish with investment failures of the brokerages, or, in a few cases, the brokerages themselves get crushed by heavy debt and are forced to close their business or go bankrupt. Individuals employed by the brokerage may also embezzle funds. A compensation fund would provide relief to investors.

Experts, however, argue that the creation of such a fund, despite similar examples in developed markets, is not a cure-all.

"China's situation is different from mature markets," said Hu Ruyin, director of the research center of the Shanghai Stock Exchange.

First, it is still unclear who should shoulder civil or criminal liabilities for the securities companies' illegal actions and the consequent losses to investors.

"If no individual or institution has to be liable, then nobody has to pay the bill and it will be hard to discipline the industry as a whole," said Hu.

He explained that even if the compensation fund system were established, it would lack solid institutional and legal support and would be very fragile.

Client fund misappropriation has been a major source of risk for securities businesses.

Since 2002, seven mismanaged domestic securities houses have been closed down by authorities or taken over.

In January, the government seized control of Southern Securities, once a heavyweight in the business but plagued with embezzlement scandals and heavy debt.

Another dozen firms were put on the CSRC's "high-risk monitoring" list last year, which means they will be closely watched, insiders said.

To reduce irregularities in securities trading, experts say, legal amendments, stronger enforcement and a market competition mechanism are needed.

The launch of a compensation fund is a passive solution to make up for the loss to investors, said Ba Shusong, deputy director of the Financial Research Institute of the State Council's Development and Research Center.

The industry needs more proactive efforts to curb irregularities and promote competition, he said.

He added that regulators, already aware of the importance of market forces, have been moving in this direction recently, but the pace should pick up.

In the past, securities companies could stay in business even if they misbehaved, but the situation is changing gradually.

Experts forecast that China will see mergers and acquisitions among securities houses in the next five to 10 years.

Instead of following administrative orders, the restructuring should be conducted by the market mechanism, Ba said.

The securities firms are also working on product innovation and developing new profit sources to remain in the game.

"The competition is already intense," said Dong Chen, an analyst with China Securities, "and only the strongest will survive. In the future, those with better performance records, asset quality and growth potential will obtain more preferential policies."

The next step, he said, would be to make firms that break the law or under-perform pay the price or gradually withdraw from the market.

(China Daily May 10, 2004)