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Categorized | Capital Markets, Financial

Chinese brokerages rush to raise capital

Posted on December 29, 2014

A Citic Securities sign is seen with Skyscrapers, in Guangzhou, China, on Tuesday, June 5, 2007©Bloomberg

Chinese securities brokerages have seen their valuations soar as investors bet the industry is entering a new golden age, fuelled by a booming stock market and financial innovation that is opening up new business areas.

While most have no immediate need for additional funds, brokerages have taken advantage of rising valuations to raise cheap capital.

    “For a long time everyone just remembered that brokerages did well during the 2007 bull market and then badly when the market fell and trading commissions dried up,” said Xu Lirong, fund manager at Franklin Templeton Sealand Fund Management in Shanghai. “Now the market is taking a fresh look and realising that things have changed. Their reliance on commissions has dropped substantially.

    Shares in Guosen Securities, a mid-sized Chinese brokerage, spiked 44 per cent, the maximum allowable rise for new shares, in their Shenzhen debut on Monday. Guosen’s Rmb7bn ($1.1bn) initial public offering this month was the mainland’s biggest since 2011.

    Meanwhile, Citic Securities, China’s largest brokerage by assets, will raise HK$30bn ($3.9bn) in a private placement in Hong Kong, the company said in a filing late on Sunday. Citic’s Hong Kong-listed shares have risen 52 per cent since October.

    Citic’s announcement follows a similar HK$30bn share sale last week by Haitong Securities, the country’s second-largest brokerage. Haitong’s shares have risen 44 per cent in the same period.

    Chinese brokerages have traditionally relied on trading commissions, IPO underwriting and other revenue sources linked to a rising stock market. Investors are now betting that new business areas such as margin lending, corporate loan underwriting and securitisation will create fresh sources of profit.

    But analysts warn that the rally in recent weeks in brokerage shares, which have strongly outperformed the broader Chinese “A-share” market, itself the best performing major market in the world this year, looks overdone.


    The amount Citic Securities will raise in a private placement in Hong Kong

    Richard Xu, China financials analyst at Morgan Stanley, says brokerages are essentially a bet on the broader stock market. He estimates that equity market-linked business account for 56 to 86 per cent of total brokerage revenues.

    “We continue to view Chinese securities firms as cyclical stocks. A-share market performance and trading turnover are their biggest revenue and share-price drivers, despite ongoing new business launches,” Mr Xu wrote in a note.

    Combined equity trading volume in Shanghai and Shenzhen has averaged Rmb799bn per day in December as the market surged, up from only Rmb252bn daily through the first 11 months of 2014. But if the market pulls back or even merely levels off, volumes are likely to fall back, hitting commissions.

    Another concern for brokerages is that income from new business lines may not pan out. Commercial banks are increasingly involved in loan underwriting, in which they act as an intermediary between corporate borrowers and debt investors in exchange for a fee. That puts them in competition with brokerages.

    “Banks may be allowed to enter into underwriting business via consulting subsidiaries, which could marginalise the brokers given the banks’ strong client bases and distribution channels,” Judy Zhang, an analyst at BNP Paribas, wrote on a note.

    Chinese brokerages listed in Hong Kong are trading at 2.3 times book value, compared with only 0.8 for commercial banks, a gap that Ms Zhang says is “hard to justify.”

    Additional reporting by Ma Nan in Shanghai