A recent report from Citi Research’s Judy Zhang looks at how China’s brokers are in the grip of transformation, with much more to come.
Citi research analysts reckon an M&A wave could be about to sweep through the Chinese brokerage business. Here’s why:
The regulatory push for high-quality financial development and financial sector supply-side reform, per the Government’s Central Financial Work Conference (CFWC) guidance to
To boost capital markets and investor confidence, regulators have launched a three-stage fee rate cut program, including:
The analysts note that China brokers are generally facing higher barriers to replenish capital. With the traditional route for recapitalization restricted, brokers are likely to see M&A as viable alternatives to pursue growth and scale.
How Are Brokers Likely to Transform?
#1 Transform wealth mgmt. biz to be AUM driven
The full Citi Research report notes that brokers used to earn a decent institutional trading commission by focusing on boosting mutual fund sales in exchange for allocation of trading volume from mutual fund companies. But this has now been banned under the new fee rate regime. The analysts say this could put pressure on brokers to transform their mutual fund business from a sales-driven model to an AUM-driven one.
The report also draws a comparison with the US wealth mgmt. industry, which had historically undergone similar fee model transformation from charging sales loads (based on fund sales volume), then to 12b-1 fees (based on funds’ outstanding volume) by brokers/mutual fund companies, and eventually to charging investment advisory fees (based on assets in investors’ accounts) by investment advisors. That transformation was mainly driven by:
Reading across from the US experience, the report says China brokers’ mutual fund business to undergo following biz transformation including:
#2 Transform capital-based biz to boost leverage & ROE
Compared with global peers, China brokers’ ROEs are much lower mainly due to:
-lower fee income contribution in revenue mix; and
-lower leverage ratios as China brokers lack stable returns in their capital-based businesses to enable leverage build-up and suffer from higher funding costs.
Over the long term, the report points to opportunities for China brokers to gradually build up leverage thanks to:
- lower funding cost for brokers amid the falling interest rate environment.
- launch of new capital-based biz (incl. market making, derivatives biz etc.,) which could help generate stable revenue/ return for brokers to allow them gradually to build up leverage.
- the new capital rule relaxation could also pave the way for brokers to further develop capital-based businesses (incl. market making, derivatives biz) which were encouraged under the New Capital Rule.
For more information on this subject, if you are a Velocity subscriber, please see China Brokers - Broker Supply-side Reform a Key Theme; Large Brokers w/ Diversified Biz to Standout (9 Jan 2024)
Citi Global Insights (CGI) is Citi’s premier non-independent thought leadership curation. It is not investment research; however, it may contain thematic content previously expressed in an Independent Research report. For the full CGI disclosure, click here.