Advantage Hong Kong at launch of Stock Connect

Hong Kong-registered brokers may profit more than mainland firms as China eases trading rules.

Hong Kong-registered brokers look set to benefit more from the Hong Kong-Shanghai Stock Connect mutual access programme launching in October than mainland Chinese brokers say analysts.

Foreign investors will have access to about 500 more unique A-shares than they had before, while a large percentage of Hong Kong-listed stocks are also listed in Shanghai. If China continues to open its capital markets as expected and add Shenzhen to the Stock Connect scheme then 855 companies with more than $1 billion of listed market capital will be available.

Goldman Sachs research analysts estimated 1% more average daily turnover for mainland brokers versus 3% more for Hong Kong brokers.

Mainland Chinese brokers such as Citic Securities and Haitong Securities have bet heavily on capturing cross-border flows as China opens up its capital markets by bulking up significantly in Hong Kong in anticipation of reforms as Stock Connect or the Through Train as it has been dubbed. Citic bought Asian broker CLSA, which significantly boosted its staff expenses as part of its efforts to globalise and escape its highly-competitive domestic market.

Mainland Chinese brokers already have extensive research coverage of mid-sized mainland companies but still lack a significant international distribution network and relationships with the largest funds.

Nomura analysts Ben Huang and David Chung played down expectations in an August report: “[We] do not expect a significant impact from the launching of mutual market access (likely in October), given that we’re not sure about the extent to which investors are interested in A-shares and also as there is no clarity yet on the actual fee rate.”

Also mainland Chinese funds have very specific investment mandates and almost all will need to raise new funds to trade overseas, which will take time. 

Local brokers may also struggle to improve market share and attract foreign fund clients given the extra administration and risk incurred by signing up with new brokers. 

In general, when large investors enter new markets they tend to stick with the brokers they use globally but allocate some 5% to 10% of commissions to leading local brokers, say market sources.

As such, some analysts expect China’s two biggest brokers, Citic Securities and Haitong Securities, to enjoy only a modest earnings bump.

“If Citic Securities and Haitong could gain 10% market share of the Through Train quota each, the near-term boost to their bottom line would be 1% to 4%, depending on actual trading volume,” Michael Li, China brokerage analyst at Bank of America Merrill Lynch, said.

To be sure there will be some opportunities for local brokers to get ahead. They may have an edge in the short-term as smaller investors with less complicated fund structures will likely be ready and able to trade first. However, as big global institutional funds get comfortable other large foreign players will also make hay.

“It will evolve, the winners on Day One won’t be the same names a couple of years from now,” said Ali Naqvi, head of equities Asia Pacific at Credit Suisse.

The battle for business won’t prevent some banks making money from supporting competitors; global banks will also service Chinese brokers as they expand in Hong Kong.

“For us this builds our custodian business in China, our foreign exchange business and builds connections with clients,” Michael Vrontamitis, head of trade and product management at Standard Chartered told FinanceAsia. “We’re also servicing brokers in Hong Kong such as segregated accounts and cash management in renminbi,” he added. 

Head start
Foreign brokers with securities joint ventures on the Chinese mainland have a head start, including Goldman and UBS. Goldman Sachs alone has 30 analysts based mostly in China covering close to 200 A-share companies.

Brokers that can offer funds a package of services in mainland China and offshore in Hong Kong will have an edge against competitors. Some are touting custody services bundled with execution will ameliorate differences in settlement date of security transactions between Hong Kong and the mainland.

“From a macro and a business perspective it’s a fantastic opportunity so we have to be ready,” Rakesh Patel, HSBC’s co-head of equities for the Asia Pacific region told FinanceAsia. Patel said he is meeting clients alongside other HSBC bankers to offer execution, offshore renminbi and custody services in one package.

Brokers with access to renminbi may also have an advantage. Funds have to swap foreign currency for renminbi to invest in mainland China. Northbound trading has to be settled in offshore renminbi, or CNH.

“One cannot ignore access to CNH; Stock Connect is just the latest representation of this fact,” said Ian Cohen, chief operating officer in equities for HSBC.

Rising tide
Of course the Stock Connect programme will be a benefit for all brokers in the long term as China continues to open its capital markets.

Brokers are already feeling some benefit as hedge funds and retail investors pile into Shanghai shares to arbitrage price differences between the two exchanges ahead of the launch, narrowing the spread between mainland Chinese A-shares and those of Chinese companies listed in Hong Kong — H-shares.

“Quotas are in heavy heavy demand as investors arbitrage A and H-shares; which will last until Stock Connect starts and beyond,” HSBC’s Patel said.

Brokers also see opportunity helping investors manage their various trading quotas after the Through Train launches. For example, many investors will trade cash equities via the Through Train as it is cheaper but may use their QFII quota for convertible bonds which are not accessible via the Through Train.

A stock market rally ahead of launch is also making it easier for several Chinese brokerages to raise much-needed capital. GF Securities, and Guotai Junan Securities, for example, have hired banks to help with their planned initial public offerings in Hong Kong later this year.

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