China's leading brokerages set for new dawn in Hong Kong

HONG KONG, June 3 Mon Jun 2, 2014 5:00pm EDT

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HONG KONG, June 3 (Reuters) - As brokers in Hong Kong and Shanghai prepare for the introduction in October of mutual trading of securities between their cities' bourses, the big Chinese players stand to benefit more, posing a threat to smaller Hong Kong-based brokerages.

Under the so-called Shanghai-Hong Kong stock connect scheme foreign investors will place buy or sell orders on Shanghai's A-share market through brokers located in Hong Kong, while Chinese who want to invest in Hong Kong's H-share market will be able to use brokers in the mainland.

Currently, foreigners only have very limited access to the A-share market under pilot programmes, that allocate quotas, such as QFII (Qualified Foreign Institutional Investor) and renminbi QFII as China is only gradually loosening controls over its capital account.

The new scheme will also involve quotas, but opens doors for retail investors.

The upcoming change provides a golden opportunity for Chinese names that have long had a presence in the former British colony without becoming big hitters there.

The rise of the Chinese brokers, thanks to lower operating costs, more extensive research coverage, a full suite of capital market services and cheaper brokerage costs will result in a wave of consolidation among Hong Kong's mom and pop brokers, and lower tier foreign investment banks.

"The through train scheme may lead to some industry consolidation among the smaller players in Hong Kong," said Chris Lai, Hong Kong and China banks analyst at Bank of America Merrill Lynch in Hong Kong, referring to the the stock connect scheme.

Only bigger brokers will be able to easily afford the investment needed to build trading systems for the stock scheme, and adapt to the different trading hours and settlement dates in Hong Kong and Shanghai.

By industry standards Hong Kong is a fragmented market with many small brokers, some of which operate out of single-room offices and employ only a few workers. More than 500 brokerages compete for business in the city's open market, with the top 14 accounting for more than half of turnover, according to data from the Hong Kong Stock Exchange.

In comparison, mainland China has 114 brokers with none of the top tier brokerage firms having a market share of more than 10 percent.

The stock connect scheme will be a boon to brokers who have seen turnover and equity offerings shrink on the world's 6th and 7th biggest stock markets due to a dimmer economic outlook.

While turnover on the Hong Kong market has steadily declined in recent years, its army of brokers have fought over a shrinking pie, leaving them vulnerable to the onslaught from Chinese brokers.

Average daily average turnover on the main bourse has steadily declined to 56 billion Hong Kong dollars in the first quarter of 2014 from 72 billion Hong Kong dollars in the whole of 2008, according to the Hong Kong stock exchange.

ENTER THE DRAGON

Compared to their Hong Kong counterparts, Chinese brokers have far greater A-share research coverage, years of operating experience in the onshore markets and a lower fee structure.

Leading the charge will be Haitong Securities, Citic Securities and Galaxy Securities.

Having previously had little more than a toehold in Hong Kong's brokerage market, they have deepened their presence in recent years by acquiring competitors and raising funds.

In 2009, Haitong Securities bought a majority stake in Taifook, in the first-ever acquisition of a Hong Kong broker by a mainland securities company. And last year, China's biggest securities company Citic Securities bought an 80 percent stake in CLSA, formerly owned by French bank Credit Agricole.

Wilson Hui, group executive director of Haitong International Securities Group says Chinese players with a presence in both markets will benefit the most, and "will enjoy a competitive edge over local brokers".

"The advantage of Chinese brokerages lies in their research ability on China's A-share market and full coverage of over 1,000 listed-companies, while foreign investment banks only have a selection of about 100 companies," said Rex Chan at Chinese broker Industrial Securities' International Department.

Some global investment banks and regional brokerages are strengthening their A-share research ability, either by expanding stock coverage or seeking cooperation with Chinese brokers.

In recent months, Citigroup, Credit Suisse and others have asked their research analysts to bolster coverage of China's A-share market - a class of share that has restricted ownership for foreigners.

In grabbing market share from the local and international players, the Chinese brokerages will follow a path taken by Chinese banks in equity and debt capital markets, where they have steadily climbed league tables for debt and equity offerings.

(Editing by Simon Cameron-Moore)

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