China’s securities regulator will allow Citic International Capital Corp. and Citic Securities Co. to make direct investments, like foreign private equity companies have been doing, in domestic Chinese companies. This lifts a previous ban imposed on domestic brokerage companies. This may represent, in part, recognition of the value that can be created by financial intermediaries, such as private equity companies. It may also be a reaction to complaints from China’s own citizens that China has allowed foreign companies to benefit excessively from the privatization of China’s largest firms. Furthermore, China’s recent investment in the Blackstone private equity group has also come under fire as Blackstone shares have performed poorly since their IPO.

Foreign investment banks which have made pre-IPO investments in key Chinese companies reaped windfall profits when those companies later listed on the stock market. Witness UBS’ 2.6X return on its US$492 million investment in Bank of China. Also, Goldman Sachs’ US$4 billion gain on a US$2.6 billion investment in Industrial & Commercial Bank of China. One sign that capturing pre-IPO profits for Chinese firms may be a factor is the fact that Citic Securities’ direct investment unit will specialize in pre-IPO stakes.

Over time, as Chinese companies and individuals begin to grow even bigger chests of capital, China is likely to want to further develop and deepen a domestic financial industry able to efficiently invest the capital which has been built up. Over time, this should produce a more competitive economy and balance out the current high reliance on businesses that generate returns based on cheap labor.