A Universe Apart: China Galaxy Securities

The Sleeping Giant Panda Awakes: China's Securities Industry

The fact that the world’s second biggest economy is two-fifths the size of the biggest economy but has a securities industry a fifth the size relative to its economy, the easiest conclusion to draw is that brokerage opportunities abound in China. With the US$1.4 billion IPO of China Galaxy Securities, China’s largest securities broker by sales, comes the conclusion that this is the company to invest in. Despite being one of the largest securities broker in mainland China, it has just 5% of the market, which suggests there is lots of potential in the industry. Citic and Haitong Securities are other top ten brokers in China. There are 114 brokers in total in mainland China.

China Galaxy Securities HQ

Headquartered in Beijing and founded in 2000, China Galaxy Securities is a nationwide comprehensive securities company. China Galaxy Securities is majority owned by one of China’s sovereign wealth funds, suggesting an ability to curry favour with the Chinese government – an important determinant in the success of mainland Chinese companies. It founded a Hong Kong subsidiary in 2011, China Galaxy International Financial Holdings, which aims to offer investment banking, asset management, and securities brokerage services overseas. Stock broking, part of its securities brokerage business, is Galaxy’s main business. It plans to develop other parts of the securities brokerage business, such as margin lending, using proceeds from its recent IPO, as these areas’ sales have grown 100% in 2012 due to eased regulation. Other businesses include investment banking, asset management, wealth management and proprietary trading. China Galaxy Securities hold a leading position in the country’s securities industry in terms of debt underwriting, ranking first from 2009 to 2011 and second in 2012. Their business will be helped by becoming one of the ten qualified companies to act as lead underwriters for financial debt instruments of non-financial corporations in 2012. Their other businesses are also quite established with financial advisory clients including major corporations such as China Southern Airlines, China Petroleum & Chemical Corporation, Shanxi Coal Import & Export Group, and Mittal Steel Company. Moreover as at 31^st December 2012, China Galaxy Securities had served roughly 29,000 asset management clients, invested RMB 442 million in 8 private companies with the aim of restructuring the businesses and seeking to exit through an IPO a few years down the line, and counted 190,000 High Net Worth Individuals as clients.

Millions of Yuan

However there are pressures due to the heavy competition. Average commission per trade dropped by 20% from 2010 to 2012. The make-up of the securities brokerage industry has also induced heavy competition resulting in the top 10 brokerages claiming only 40% of the market share. One consequence of this is that there is a big difference between the IPO fees pocketed by investment banks in Europe and the USA (around 7% of deal volume) compared to investment banks in Asia (just 2.5%). This points to the need for fewer players in Asia, not more. Yet there may be a danger of more players entering investment banking once regulation allows the state-owned banks (Bank of China, ICBC, Agricultural Bank of China, etc) into the securities brokerage industry, which may further reduce commission and cut into the market share of the current top 10 brokerages. Furthermore, China Galaxy Securities’ business is closely tied to the performance of China’s capital markets, which have foundered in recent years. This is evident when one compares the S&P 500’s 13% increase in 2012 with the Shanghai-Shenzhen 300 index which only rose 8%. Further difficulties are perceived in the backlog created by China’s markets regulator of over 800 companies waiting to IPO in China.

Prop Trading on the Up in China

Despite the pressures, there are many potential opportunities that China Galaxy Securities are at the forefront of being able to capitalize on. Just as Western investment banks cut back from riskier activities as a result of the financial crisis, top Chinese brokers are filling this gap. These areas such as proprietary trading, private equity, lending money on margin to investors buying securities and other alternative investments accounted for around 21% of the Chinese securities brokerage industry’s profits in 2012. These were all areas where Goldman Sachs was or is the world market leader, for example they run the world’s second largest private equity funds under management and the second largest business servicing hedge funds. Yet as the world’s regulators make these riskier activities more costly for banks such as Goldman Sachs to pursue and outright ban proprietary trading, this is an opportunity for upcoming Chinese brokers to break onto the international stage. For instance China Galaxy Securities got almost 7% of revenues and more than 12.5% of profits (US$38.5 million) from prop trading in 2012. They are also making a concerted effort to expand its prop trading assets, which have grown 30% over the past two years.

A long-term Chinese investor

Additionally, since April 2012, the Chinese Securities Regulatory Commission have liberalised rules allowing Chinese brokerages to invest in a wider variety of markets, to lower their capital requirements against these activities and to start issuing their own bonds. In the year following the liberalisation, just over US$13 billion of bonds were issued by Chinese brokers. The aim is to introduce more liquidity into China’s stock and bond markets. Yet the real problem is the lack of a long-term investing culture and the dearth of established institutional investors such as pension schemes, insurers and mutual funds. The moves are part of efforts to broaden and deepen China’s capital markets, and brokerages are already taking the opportunity to boost borrowings and juice up returns. The added advantage is that this is all happening with Chinese brokers having quite low leverage, with the industry’s total net assets just 1.4 times net capital currently.

China Galaxy Securities IPO’d on the Hong Kong stock exchange in May 2013, with its shares rising 11% to settle at HKD 5.62 at the end of its first day. They are currently trading at HKD 5.26 per share. So invest in a company a financial universe apart, invest in China Galaxy Securities. You may be investing in the Chinese Goldman Sachs, which will boost your profits to a universe apart too.