In September 2021, Fitch Ratings revised upward the assessment for China’s securities companies’ operating environment, from ‘bb’/Stable to ‘bbb-’/Stable. Jonathan Lee, managing director and head of Asia Pacific for non-bank financial institutions at Fitch Ratings, discusses the implication on Chinese securities companies’ standalone credit profile assessment.
1. How does Fitch analyse the operating environment of China’s securities companies?
Fitch scores China’s securities industry operating environment (OE) at ‘bbb-‘. It is an outcome of the positive and negative adjustments to the base implied OE score at ‘bb’ category that is derived from the latest GDP per capita ($10,235 as of 1Q21) and the World Bank’s Ease of Doing Business percentile ranking (83.6, January 2021).
We made positive adjustments to reflect China’s ‘A+’/Stable sovereign rating and the resilience of its economy. Nevertheless, high system leverage and inefficient credit distribution continue to pose risks to the broader financial system, albeit diminishing. These, together with structural issues around financial transparency, continue to contribute to the five-notch gap between the OE score and sovereign rating.
2. What drove Fitch’s revision in the assessment of the operating environment of China’s securities companies?
The upward revision captures China’s extended period of relative strength in macroeconomic stability among the largest economies, evident during the pandemic in the past year. It also reflects, importantly, progressive regulatory strengthening that addresses financial system risks, driving improvement of the risk profiles of securities firms. The regulatory clampdown of shadow-financing activities has helped contain the build-up of systemic risks within the financial system.
Securities companies’ contingent risks that originate from serving as credit conduits to channel funds provided by banks to avoid regulatory supervision have been substantially reduced from the levels in 2017. The removal of implicit guarantees also strengthens the operating environment.
3. What is Fitch’s view of the regulatory strength for the securities industry?
Fitch has a positive view of the regulatory development around the securities industry that addresses potential systemic risk and promotes risk culture. The China Securities Regulatory Commission (CSRC) has imposed risk metrics to control the absolute level of securities companies’ trading and lending exposures as part of its active monitoring of their risk exposures. These, together with the minimum loan-to-value requirement for the riskier stock-pledged reverse repo business, will help contain concentration risk and ultimately credit and market risks, if these measures are well executed.
CSRC’s annual grading of securities firms also reflects regulatory emphasis on risk control. The evaluation is based primarily on securities companies’ performance in risk management and compliance, in addition to other metrics on business and financial performance. Nonetheless, the lack of detailed disclosure about the grading methodology has limited its visibility to and applicability by external parties.
4. How will regulatory developments and financial reforms affect the business prospect for securities companies?
The Chinese government’s 14th five-year plan for 2021-2025 that outlines its objectives for economic and social development through 2035 states that increasing the proportion of direct financing is key to China’s financial reform. Direct financing could reduce the financial system’s over-reliance on bank borrowings, prevent financial risks from credit-fuelled economic growth, curtail moral hazard, and improve capital market transparency. Fitch believes the promotion of direct financing will help improve the efficiency of capital allocation in the system, instill market discipline and rein in implicit government support.
Fitch expects the policy drive to benefit securities firms’ investment-banking revenue as market demand increases. This, together with the updated securities law to change the approval systems for initial public offerings (IPOs) and corporate bonds to registration-based systems, will drive further franchise differentiation in the investment-banking sector, as market participants place greater emphasis on lead underwriters’ capability and reputation.
5. What is the prospect for the Chinese securities industry in terms of competition and market consolidation?
Changes in the regulatory environment will encourage the development of more substantial franchises and intensify industry consolidation. The sheer size of the Chinese capital markets will be supportive in accommodating a number of large securities companies with strong balance sheets.
The strengthening of the regulatory environment and deeper markets will likely benefit securities firms with robust investment banking and asset management franchises, as well as those with strong information technology capability. The latest regulatory developments, which focus on risk management and compliance performance, will probably help larger securities companies improve risk infrastructure, enhance self-regulation and temper risk cultures.
6. How will the higher assessment of the operating environment affect securities companies’ credit profile?
The stability of the macroeconomic environment and the regulatory progress are credit positive for securities firms’ standalone credit strength. Fitch regards a Chinese securities firm’s company profile as an increasingly important differentiating factor as changes in the regulatory environment will encourage the development of more substantial franchises and intensify industry consolidation.
The improved OE score will benefit the assessment of the financial profile of Chinese securities companies, based on Fitch’s OE-tiered financial benchmarking ratios. Chinese securities firms with a leading franchise and strong financial benchmarks will increasingly have standalone credit profiles assessed in the ‘bbb’ range under an improving OE, reflecting their more seasoned risk control framework, franchise strength and ability to capture the growing business opportunities across multiple business lines, including securities broking, investment banking and asset management.
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