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 31st 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.
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