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Securities firms see rays of hope in new reforms

2014-06-16 10:07 Shanghai Daily Web Editor: Qin Dexing
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China's financial reforms look set to usher in a new wave of opportunity for securities companies just when their traditional lines of business are losing momentum.

In a sweeping plan outlined last month, the State Council, China's cabinet, set forth nine initiatives to open up the country's capital market further and boost competitiveness.

The China Securities Regulatory Commission, as a follow-up to the policy announcement, issued guidelines on May 29 that it said will nurture modern investment banking, support business and product innovation and promote a regulatory transition.

The commission said it will encourage securities companies to expand asset management, participate in fixed-income, currency and commodities markets, and develop derivatives and private products.

All these changes will come as welcome relief for securities firms, whose brokerage and underwriting businesses — once their primary source of revenue — have fallen on bad times.

Industrial woes

"It's the worst of times for securities companies that have experienced a decline in commission income," said Shao Ziqin, an analyst of CITIC Securities, "It's also the best of times because securities companies will enjoy more freedom to innovate and diversify their businesses."

Brokerage used to contribute more than 50 percent of the revenue for the securities industry. However, a persistent rate war has eaten into commission income.

The average commission rate of Chinese securities companies was 0.068 percent in the first quarter of this year, a drop from around 0.08 percent in 2013, according to a research report by China International Capital Corporation.

The decline sent the proportion of brokerage income in first-quarter revenue to 29 percent from 37 percent in 2013, and no end is in sight. Some brokers are promoting online brokerage services with a record low rate of 0.02 percent.

CITIC Securities said it expects commission rates and income at China's 115 securities firms to drop 25 percent this year.

Meanwhile, a moratorium on initial public offerings has added to the woes of the industry.

The combined revenue from investment banking services at China's securities houses plunged 27 percent in 2013 because of a regulatory freeze on initial public offerings, data from the Securities Association of China showed.

The new industry buzzword is innovation.

"To transform themselves from traditional brokers into modern investment bankers is the only way for securities companies to survive," said Shui Pi, an independent business commentator.

Zhao Shasha, an analyst with Huarong Securities, said the next three to five years will be critical in the transition to develop new products and services.

Recent history suggests that broadened business activities are a shot in the arm for the industry. Margin-trading and short-selling, reforms launched in 2010, posted a dramatic rise last year after the securities regulator expanded the businesses by allowing brokerages to borrow cash and stocks.

Income from both activities surged 251 percent last year to 18.5 billion yuan (US$3 billion), becoming the third-biggest source of earnings and accounting for 11.6 percent of total revenue, according to a calculation based on data from the Securities Association of China.

After regulators allowed brokerages to set up and manage mutual funds in late 2012, income from that activity jumped 162 percent in a year.

The door to opportunity is opening wider.

"Based on the policy announcements, we expect more financial derivatives to be launched, including index futures, options futures, stock options and other derivatives from the over-the-counter market," said Pan Hongwen, an analyst at UBS Securities.

The regulator is also likely to deregulate the asset securitization business and unveil details for a real estate investment trust (REIT) pilot program, Pan said.

OTC market

China's booming over-the-counter market is also becoming a new growth point for securities companies.

The OTC market, also known as the New Third Board, gained new momentum last year after it was expanded nationwide, with qualified companies across the country allowed to buy and sell equities.

As of May, 740 enterprises were listed on the OTC board. PricewaterhouseCoopers estimates that more than 5,000 companies will be trading on the board in the next five years.

In August, a new system that will be implemented in the OTC market to allow brokerages to act as market makers and make profits on bid-offer spreads.

"The introduction of the market-making system will greatly boost trading activity on the OTC market and help diversify the income structure of securities firms," said China Securities in a report.

Businesses related to the OTC market could contribute up to 10 percent to the revenue of the securities industry in the long term, China Securities estimated. Despite all the new products and businesses in the pipeline, analysts said the most urgent need is to raise the leverage ratio for brokerages, enabling them to borrow more money to fund new businesses.

"Easing restraints on financing is a prerequisite for securities firms to fully play their role in the capital market," said Shao of CITIC.

The leverage ratio of China's securities industry was 2.21 in the first quarter, according to a CITIC Securities report. By comparison, the ratio is more than 10 among US investment banks.

In the statement released last month, the securities regulator said it would support equity and debt financing of securities institutions and encourage the exploration of new financing channels and instruments.

Pan of UBS said improving the leverage ratio would be a positive step, but the future of China's securities industry lies in self-innovation rather than regulatory-promoted innovation.

New businesses promoted by regulators may lead to homogenous competition and dilute profitability, Pan said.

"We believe only differentiation can cultivate the real core competitiveness of securities companies," said Pan.

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