PricewaterhouseCoopers recently conducted an E-Securities survey in Hong Kong in order to benchmark the industry and analyze the direction of the participants in the coming year. All brokerage houses in Hong Kong were asked to participate. A full copy of the survey highlights can be obtained from PricewaterhouseCoopers’ web site at www.pwchk.com.
As a result of the survey, we believe the key areas that brokerage houses must focus on going forward are investor education and systems security. The survey noted that only 13% of the brokers’ existing clients converted to a brokers’ online offering. While we are not concluding that 87% of the clients are new to the market, as some of the clients are from other brokerage firms who do not have online capabilities, a large number are, and they are attracted by this particular channel of transacting business.
This raises issues not only for the regulator, but also for brokerage firms in terms of how to educate these new market players. The risks of doing business with a less educated investor are far higher, and it is in the interests of the brokerage community to ensure they are operating in a well-informed market.
Security issues
One of the other key issues was the insignificant amount of resources companies were devoting to systems security for their web sites. Only 7% (and this number is higher than it should be due to the amounts being spent by one respondent) of total budgets in the next 12 months have been allocated to systems security. In addition, 28% of brokers have experienced web site failures in the past six months, of these 26% had no facility to notify their clients and half of these have no plans to introduce such a facility.
In a market facing such intense competition, it is understandable that more is being spent on marketing, client acquisition and advertising than on security. However, the marketing costs are only important for initial penetration into the market.
In a brokerage house promoting quick execution, the only selling point is the system in place: not only the speed with which deals can be done, but also the security of that system. As the business becomes more faceless in terms of interaction with account executives, the client portfolio becomes far more mobile and security issues, or failures could result in a significant, if not 100%, loss of clients. It is therefore shortsighted for a brokerage house not to spend significant amounts on security and advertise the fact they have done so.
Online trading is here to stay
The survey confirmed that the majority of brokerage houses were of the opinion that online trading is here to stay and will be the major channel for trading securities in the future. In our survey, we made what some would consider a provocative statement, concluding that 200 registrants would disappear in the next year. More explanation of that statement is probably necessary.
There are thin profits if any to be made in the near future by adopting online trading. The Hong Kong market is far too small with far too many brokers to achieve any significant profits in the short term. For the long term, the only real strategy open to a broker is to attempt to become a niche player, or to make Hong Kong a regional hub.
Given the costs involved in buying or developing systems, consolidation of brokers has started and will continue. In addition, consolidation of the markets/exchanges will also start. The market consolidation will be slow. Unlike Europe, the regional markets in Asia are at very different stages in their development, and given current turnovers on some of the markets, any consolidation in the near future is unlikely. However, consolidation will happen, the only real debate is how soon and to what extent.
Trading via the internet will probably not replace exchanges as some predict. The emergence of Electronic Communication Networks (ECNs) will probably force exchanges to be more competitive rather than disappear. Attempts at trading shares off-exchange has not been particularly successful in the US and companies still prefer to be listed on a country exchange, although many may prefer a regional listing. In the short term, we will witness far more alliances between exchanges and a move by the exchanges to compete with the brokers in the same business.
Competing with the global houses
In terms of which of the brokerage houses will disappear, local dealers should realize they are sitting on a wealth of resources and know-how that will not necessarily result in their elimination to global internet houses. It will be difficult for local dealers to compete with the large internet houses which are now in the market in execution-only business. And even if they did try, there is little money to be made in a market as small as Hong Kong.
Only the big houses will be able to compete on a regional platform and have the courage to invest the sums necessary. What the local houses who wish to survive should focus on is accepting that online trading is here to stay and will become the preferred medium, but at the same time not ignore their real profit earners. The real profits to be made by local players are to be found in the margin financing business, corporate finance (particularly in the Mainland) and research.
Overseas investors (both institutional and retail) have always been willing to pay for good research. However, many local houses have good local research talent which is under utilized. In the near future, we should see an unbundling of the commission rates such that execution-only clients will pay less than those using research as well. There will also be opportunities to outsource research to internet houses which don’t have that capability.
Online trading does not necessarily mean the end to all local brokerage houses. It does, however, require an acceptance of this channel for trading. It also requires brokerage houses to look at the assets (both tangible and intangible) it has to offer and determine how they want to position themselves in order to remain in the market.
Colin Shaftesley, partner, Financial Services, PricewaterhouseCoopers. Email: [email protected].
