When the great and the good gathered earlier this year in Beijing to celebrate the 10th anniversary of CICC (China International Capital Corporation), the atmosphere was a mixture of satisfaction and apprehension. The satisfaction came from the company's rapid growth over the past 10 years, and the apprehension is rooted in the challenges that CICC is facing as China's investment banking and capital markets landscape changes ever more drastically.

CICC was created to ensure a Chinese investment banking presence in the first round of partial government privatizations. The company first made its mark on the 1997 China Telecom deal and has since raised over $47 billion in equity financing and just under $9 billion in debt financing in the role of lead underwriter, as well as advising on $62 billion of mergers and acquisitions.

Alongside smaller stakes held by Singapore's GIC (7.35%), the Mingly Corporation (7.35%) and the China National Investment and Guarantee Corporation (7.65%), the two biggest shareholders used to be China Construction Bank (43.4%) and Morgan Stanley (34.3%). However, this year the CCB stake was transferred to a new company, Jianyin Investment. Only by thus obtaining an arm's length relationship between listco and underwriter was it possible to meet Hong Kong Stock Exchange regulations keeping the underwriter independent from the listing candidate. Jianyin Investment owns 10% of CCB and holds all of CCB's non-banking assets.

It's no secret that relations between CICC and Morgan Stanley have been through ups and downs. In the early days, the balance of power was firmly with Morgan Stanley. That was logical, given the US bank had the technological and financial expertise CICC needed to get started. As a result, there was no Chinese CEO until the current one, Levin Zhu, appointed in October 2002. The first five all came from Morgan Stanley, starting with former World Bank consultant Edward Lim appointed in 1993; Harrison Young in 1995; Austin Koenen in 1997; Elaine La Roche in 1999; and Peter Clark in 2001. However, the chairman was chosen by CCB. Today that position is combined with the position of CEO in the person of Levin Zhu.

For Morgan, the current relationship with CICC falls short of the original goal. This was to secure the services of a loyal foot-soldier to help secure the big Chinese deals for the delectation of the US bank. Although Morgan Stanley's track record clearly shows it still wins an impressive number of international China mandates, the bank has been reduced to that of a mere financial investor within CICC itself. "Morgan is now a financial investor - not a strategic investor as it hoped to be," as one CICC insider emphatically puts it.

The power struggle about the future of CICC - whether as an appendage to Morgan Stanley or an independent Chinese entity - was settled the day that Goldman Sachs was picked ahead of Morgan Stanley for the global coordinator spot on the $2.9 billion PetroChina IPO. It was a deliberate snub, according to current CICC staff.

"That showed that CICC had power - and that it could use its government connections for its own sake, and not just for the benefit of Morgan Stanley," recalls one employee.

These days, no Morgan Stanley executive has a senior executive role within CICC, although John Mack, chairman and CEO of Morgan Stanley, has a seat as a non-executive director on the four-man board, alongside one representative each from the other minority investors. The board is balanced by a management committee that has day-to-day management control, and consists of Levin Zhu and two managing directors, Bi Mingjian and Huang Xiaoheng. Bi, who holds an MBA from the George Mason University in the US and who was a consultant for the World Bank until he joined CICC in 1995, is considered the unofficial number 2. Huang heads up all CICC's back office operations.

CICC is organized along lines familiar to any Western investment banker, comprising IBD (investment banking department), capital markets, sales and trading, fixed income and research. Around 70% of the company's revenues come from primary market activities - historically equity rather than debt underwriting. Salaries are similar to those paid to mainland staff at the likes of UBS and CLSA, although a little less than at the pure investment banks such as Morgan and Goldman. But the structure of how monies are paid is along American lines in terms of the bonus and yearly assessment. The latter can be two to three times the base salary. It's paid based both on the performance of the bank as a whole and on that of the individual. The individual is subjected to a '360 degree assessment' by his superiors, subordinates and peers in the classic US manner.

Yet CICC is no Chinese clone of its US counterparts. Levin Zhu, son of the China's former premier, for example, does not adhere to the clothing standards of Wall Street, and often prefers a T-shirt and jacket to a three-piece suit.

"He's very smart, but he's not exactly what you would call flamboyant," muses one staffer, who estimates he sees him just two to three times a month.

Levin is reportedly low-key with his staff, and generally pleasant, probably due to his status as the son of a top official.

"He has to tread a bit carefully. People don't like it if a 'Red Prince' [relative of a top official] throws his weight around too much," says the staffer.

Zhu's management style is reportedly hands-off rather than hard-driving He is content to stay in his private office rather than to prowl around the company's cubicles checking up on what his colleagues and subordinates are doing.

And some CICC veterans are reluctant to credit Zhu with all of CICC's success, claiming he joined CICC only after the bank had already made its mark. His first major position was COO, to which he was appointed in February 2001, four years after the company carried out its first major deal.

Still, CICC - under Zhu - has become the leading investment bank in China, a fact even acknowledged by its rivals. In 2000, the company's record year, the company made almost $200 million in revenue, way in excess of anything its domestic competitors made. Last year, the company's revenues came in at around $125 million. Issuance thus far this year is strong, but the freeze on IPOs since May imposed by the regulator will likely hit the bank's numbers.

The majority of CICC's bankers are candid about the tremendous advantage of having such a prominent member of China's bureaucracy heading up their ship. But they are also anxious to rebutt the charge CICC's success is only based on high-level guanxi. They also point out that thanks to their relationship with Morgan Stanley they are by the far most professional of China's investment banks.

Thus far, the combination of bureaucratic clout and professional competence has helped keep them in the lead. But two domestic securities firms, Guotai Junan and CITIC Securities, are making aggressive moves to close the gap. From the outside, Gaohua Securities, the joint venture between Goldman Sachs and the vehicle of China's most experienced investment banker, Fang Fenglei, is also gradually making an imprint after being founded in 2004. ChinaEuro Securities, the JV between CLSA and a small Chinese securities firm is also a well-established competitor. A new partnership between UBS and Beijing Securities is adding to the pressure.

It's not surprising therefore that CICC is trying to find a way of dealing with the future challenges of the securities market.

"We have always relied on the primary market for the bulk of our income. Our brokerage business only brings about 30% of our revenue. But the jumbo state privatizations are coming to an end. So the secondary market is an area where we need to expand our capability," notes one staffer.

China IPO fees are very low, even by Hong Kong standards, where fees are half those banks can charge on the Nasdaq market. IPO fees in China are just 1.5%, compared to 3% in Hong Kong and over twice that in the US. Partly the fees are low because the deals are so large that the SOEs who flock to CICC for their domestic and overseas listings feel they deserve a discount.

CICC's great strength is its unique ability among Chinese investment banks to service both the H-share market and the A-share market. Thus, while the domestic market has suffered badly since 2002, the H-share and red-chip (two classes of shares which represent mainland companies) indices have been surging in Hong Kong. CICC has been involved in the overseas listings of China Life ($3.5 billion) and PICC in 2003 ($1.8 billion), Air China ($1.2 billion), China Netcom ($1.3 billion) and China Telecom ($1.7 billion) in 2004 and Shenhua Coal in 2005.

But with the supply of giant IPOs drying up, the company is aggressively lobbying for a license to conduct proprietary trading and looking at other measures to boost its income.

So far the bank has been stymied by the fact that the Chinese government does not permit foreign-invested securities houses to trade Chinese assets on their own account and because its capital base, currently registered at $125 million, is too small to offset the risk of prop trading.

However, CICC has obtained China's first foreign currency asset management license. CICC will now be able to provide advisory and asset management service targeting the proprietary foreign currency assets of domestic institutional clients.

And debt, especially, is looking up.

This year to July in the role of lead underwriter, CICC has carried out Rmb498 million in total financing, and is on target to match last year's Rmb849 million for the full 12 months. The main reason for the spectacular growth in 2004 is the rocketing growth of debt financing (including convertible bonds) which jumped to just under Rmb500 million in 2004 compared to almost nothing in 2003. With fees of around 1%, debt financing is even less well-paid than equity underwriting, but they nevertheless helped push CICC's revenue growth up 26% in 2004 compared to 18% in 2003, according to CICC's own figures.

The background to this transformation is the government's determination to reduce the role of bank financing in China. The numerous cases of politically-inspired and corrupt lending has caused a mountain of non-performing loans, the size of which could overwhelm China's financial system.

Despite CICC's superiority over local bankers, its own bankers are the first to admit that the gap with the international banks still exists. For example, according to one staff member, 10 members of the investment banking department have joined foreign rivals so far this year.

This source says that the IBD has an over-manning problem, with more vice-presidents and other senior staff than associates.

"Clearly, that's frustrating for the younger guys. In that sense, the IBD has behaved a little bit like a state-owned enterprise, with people never being fired," he says, laying the blame for the exodus at the door of the dim promotion prospects in such an environment.

Another experienced staffer says that CICC suffers from two problems. Firstly and most importantly, although CICC has great relationships with companies (especially government SOEs) the bank has a weak position with institutional investors in both Hong Kong and the mainland.

"We don't have long relationships with institutional investors. Thus we lag behind Goldman and Morgan Stanley. An institutional investor might buy an unpopular IPO from these firms because they think it will lead to juicy IPO allocations later," he says. He adds that weak relationships with the major players in Hong Kong mean that CICC misses out on many profitable secondary trades. That's because doing the deals is technically easy - it's the relationship with the investor which determines which bank gets the nod.

"Nor are we especially good with our mainland institutional investors. But that's because Chinese domestic institutional investors are rather undeveloped, and the market is dominated by retail investors," he adds.

Indeed, the scarcity of Chinese institutional investors means that investment banks find it hard to provide lucrative added-value services such as block trades. And distribution, for example, is largely done automatically by lottery to retail investors by the stock exchange. Ironically, the stock exchange is considered a big competitor to securities houses because of its very sophisticated technology.

One solution could be for CICC's to become a major institutional broker, and later, perhaps, a retail broker.

"We need to improve our brokerage and secondary market operations. Perhaps we should buy a brokerage like Morgan Stanley did. However, its acquisition of Dean Witter didn't turn out as well as expected. That's a dilemma for CICC too," he says.

Secondly, the company doesn't have much of a track record with China's private sector. CICC is viewed as an establishment bank for establishment players, mainly giant SOEs.

This year and the next promise to be important ones for the bank. CICC has, of course, already come an impressive distance. You only need to compare it to the other fledgling Chinese investment banks set up by ICBC and Bank of China respectively, namely ICEA (Industrial and Commercial East Asia Finance) founded in 1998 and BOCI (Bank of China International) founded the same year. Neither of the banks' track record with the government's privatization programme comes close to CICC's, and they both focus on the smaller deals, often on the Growth Enterprise Market of Hong Kong.

"Originally we were worried about these competitors. But they have no track record. We are not at all worried about them," says a CICC employee dismissively.

Still, the competition is getting sharper with the advent of more foreign JVs or foreign-invested brokerages, as in the case of UBS' recent 20% investment in Beijing Securities. The days of relatively easy profits could be fading. In a new and increasingly open environment, CICC must adapt and show that it can compete with the likes of its erstwhile partner Morgan Stanley. Otherwise achieving independence from that domineering presence will represent only a hollow victory.

For its part Morgan Stanley is making up for its diminishing influence at CICC by looking elsewhere. Indeed, Morgan Stanley may become the only foreign investment bank to be allowed to buy directly into a second brokerage. The broker's name has not been released and approval by the regulator is pending but some sources are confident the deal will be done.