Structure of the Brokerage Industry Mr. Andrew Sheng Chairman - PowerPoint PPT Presentation

Hong Kong Institute of Bankers Structure of the Brokerage Industry Mr. Andrew Sheng Chairman Securities and Futures Commission 13 November 2002

The Brokerage Industry Worldwide trend – consolidation  Two-tier structure – world class international  brokers as well as small local brokers Well capitalized industry  Business model challenged by banks and e-  brokers Strategies taken for the industry and the need  to gear up 2

Consolidation is happening – Europe Profits for brokerage industries in UK, France, Germany and Italy (Euro bn) 7.0 5.7 Wholesale brokers 6.0 -54% Retail brokers 5.0 3.3 4.0 2.6 3.0 -51% 2.0 1.6 2.4 1.0 -58% 1.0 0.0 2000 2001 3 Source: Estimates of McKinsey and JP Morgan

Consolidation is happening – Worldwide and Local Number of NYSE Members Number of NYSE Members Number of SEHK Participants Number of SEHK Participants 700 700 900 900 650 650 850 850 600 600 800 800 550 550 750 750 500 500 700 700 450 450 650 650 400 400 600 600 350 350 550 550 300 300 500 500 1960 1960 1970 1970 1980 1980 1990 1990 1993 1993 2000 2000 1930 1930 1940 1940 1950 1950 1991 1991 1992 1992 1994 1994 1995 1995 1996 1996 1997 1997 1998 1998 1999 1999 2001 2001 1986 1986 1987 1987 1988 1988 1989 1989 1990 1990 1991 1991 1992 1992 1993 1993 1994 1994 1995 1995 1996 1996 1997 1997 1998 1998 1999 1999 2000 2000 2001 2001 2002 Sep 2002 Sep Source: NYSE Source: NYSE Source: HKEx Source: HKEx 4

Number of brokers in major markets (US$ bn, end 2001) No. of exchange Market Avg market turnover participants turnover per exchange participant HKEx 495 241 0.5 NYSE 365 10,489 29 LSE 258 4,551 18 TSE 114 1,661 15 ASX 93 244 2.6 SGX 34 72 2.1 Remark: The number of exchange participants in Hong Kong here only includes those who report to the FRR, and does not include those who have ceased (or indicated to cease) business or those who have not commenced business. 5 Sources: Websites of various exchanges and broker associations

HK’s Brokerage industry is a two-tier structure (end Aug 2002) large international brokers (mainly Cat A + some Cat B brokers)  and local small retail brokers (mainly Cat C brokers) Cat A Cat B Cat C Total Number of Exchange Participants 14 51 418 483 Market Share in Turnover (Aug 2002, %) 53% 30% 17% 100% Average Turnover (12 months ending Aug 2002, HK$ bn) 120 21 1.7 7.2 Average Number of Clients 779 4,437 583 996 Shareholders’ funds / total assets (%) 31% 33% 63% 43% Remark: The number of exchange participants here only includes those who report the FRR, and does not include those who have ceased (or indicated to cease) business or those who have not commenced business. 6 Source: SFC, FRR Returns

Shareholders’ Funds Remain Stable Shareholders’ Funds to Total Assets ratio  maintained largely at 40+% for the industry Shareholders’ funds / total assets (period end, %) Cat A Cat B Cat C Total Aug 2002 31% 33% 63% 43% Jun 2002 28% 29% 59% 39% Mar 2002 28% 32% 60% 41% Dec 2001 35% 36% 63% 47% Remark: The number of exchange participants here only includes those who report to the FRR, and does not include those who have ceased (or indicated to cease) business or those who have not commenced business. 7 Source: SFC, FRR Returns

Market Turnover – HK$6-8 bn daily except during peak periods Average Daily Turnover (HK$ bn) 15.5 16.0 15.0 14.0 13.0 12.3 12.0 11.0 10.0 9.0 8.0 7.8 8.0 7.0 6.9 7.0 6.0 5.7 5.0 1996 1997 1998 1999 2000 2001 2002 (1-9) 8 Source: HKEx

Turnover of HSI constituent stocks – very stable in volume terms Average Daily Turnover at constant prices (HK$ bn) HSI constituent stocks Mainland enterprise stocks Other stocks 3.5 3.3 3.1 3.0 2.9 3.0 2.9 2.9 2.8 2.7 2.7 2.7 2.7 2.4 2.5 2.4 2.2 2.2 2.2 2.1 1.9 1.9 2.0 1.8 1.8 1.6 1.3 1.5 1.4 1.4 1.3 1.0 1.2 1.1 1.0 0.8 0.8 0.8 0.7 0.5 2000 Q1 2000 Q2 2000 Q3 2000 Q4 2001 Q1 2001 Q2 2001 Q3 2001 Q4 2002 Q1 2002 Q2 2002 Q3 Remark: HSI constituent stocks do not include those which are also Mainland enterprise stocks. 9 Source: SFC Research Paper No. 1, “Turnover Behaviour of the Hong Kong Stock Market”, SFC website

Source: SFC, FRR Returns Source: SFC, FRR Returns Net Commission Income (HK$ mn) Net Commission Income (HK$ mn) 130 130 180 180 230 230 280 280 330 330 380 380 430 430 480 480 80 80 Jun-00 Jun-00 Jul-00 Jul-00 Commission Income – relatively Aug-00 Aug-00 stable for Category A Brokers Sep-00 Sep-00 Oct-00 Oct-00 Nov-00 Nov-00 Dec-00 Dec-00 Category A Category A Jan-01 Jan-01 Feb-01 Feb-01 Mar-01 Mar-01 Apr-01 Apr-01 May-01 May-01 Jun-01 Jun-01 Jul-01 Jul-01 Aug-01 Aug-01 Category B Category B Sep-01 Sep-01 Oct-01 Oct-01 Nov-01 Nov-01 Dec-01 Dec-01 Jan-02 Jan-02 Feb-02 Feb-02 Mar-02 Mar-02 Apr-02 Apr-02 Category C Category C May-02 May-02 Jun-02 Jun-02 Jul-02 Jul-02 Aug-02 Aug-02 10

Source: SFC, FRR Returns Source: SFC, FRR Returns Recurring Overheads (HK$ mn) Recurring Overheads (HK$ mn) 100 100 150 150 200 200 250 250 300 300 350 350 400 400 450 450 500 500 50 50 0 0 Operating Costs are on the Downtrend, but Jun-00 Jun-00 Jul-00 Jul-00 Aug-00 Aug-00 slower than commission income Sep-00 Sep-00 Oct-00 Oct-00 Category A Category A Nov-00 Nov-00 Dec-00 Dec-00 Jan-01 Jan-01 Feb-01 Feb-01 Mar-01 Mar-01 Apr-01 Apr-01 May-01 May-01 Jun-01 Jun-01 Category B Category B Jul-01 Jul-01 Aug-01 Aug-01 Sep-01 Sep-01 Oct-01 Oct-01 Nov-01 Nov-01 Dec-01 Dec-01 Jan-02 Jan-02 Feb-02 Feb-02 Category C Category C Mar-02 Mar-02 Apr-02 Apr-02 May-02 May-02 Jun-02 Jun-02 Jul-02 Jul-02 Aug-02 Aug-02 11

Changing market share Average Daily Turnover at constant prices (HK$ bn) 60% 53% Category A Category B Category C 50% 47% 42% 40% 39% 40% 36% 35% 33% 32% 32% 32% 32% 32% 31% 30% 30% 30% 30% 28% 27% 23% 20% 17% 10% 1996 1997 1998 1999 2000 2001 Aug-02 12 Source: HKEx

Institutional trading’s share is rising  Local individual trading: 49% in 1999/2000 fell to 36% in 2000/2001 Market Share in Turnover by Investor Type (%) Overseas institutional trading 38% (28%) Local institutional trading Overseas individual 19% trading (18%) 3% (2%) Local individual trading 36% (49%) Principal trading 4% (3%) Remark: Figures in parentheses are 1999/2000 13 Source: HKEX, Cash Market Transaction Survey 2000/2001

Retail market share changing Brokers only Banks only Both brokers and banks Others 1% 1% 2% 4% 100% 3% 5% 10% 10% 90% 27% 80% 39% 30% 70% 49% 60% 50% 40% 69% 30% 56% 54% 20% 40% 10% 0% 1992 1994 1997 2001 Remark: Others refer mainly to stock trading through family members or friends 14 Source: HKEX, Retail Investor Survey 2001

e-Brokers’ market share In 2001 : Brokers only Banks only Both brokers and banks Others 1% 0% 2% 100% 2% 10% 90% 21% 80% 70% 49% 72% 60% 50% 58% 40% 30% 20% 40% 25% 21% 10% 0% Existing stock investors New stock investors Online traders Remark: Others refer mainly to stock trading through family members or friends 15 Source: HKEX, Retail Investor Survey 2001

Risks in the Brokerage Industry Financial risks arising from margin financing – pooling  and accepting less liquid stocks At end Aug 2002, 255 brokers (including securities  dealers and margin financiers) engaged in margin financing with total margin loans amounting to $13.1 bn and collateral accepted totaling $44.6 bn. Of these, $10.9 bn worth of margin clients’ collateral was re- pledged to obtain bank loans of $1.8 bn Because of pooling, margin clients may have difficulty  to recover their securities from the banks in event of broker failure [non-borrowing and low-borrowing margin clients are more exposed] Some brokers may accept less liquid stocks as collateral  Lack of widespread use of IP accounts → structural  exposure to broker risks 16

SFC Strategies for the Industry Operational strategies – Risk-based regulatory framework  Legislative strategies – FRR changes (effective 1 Oct 2002)  to address the illiquid stock problem  to avoid excessive borrowing by re-pledging margin clients’  stock collateral Establishing a Working Group (comprising the industry,  academics and professional bodies) to rationalize the capital and financial requirements Imposing licensing conditions on risky brokers  Proposing to extend the broker fidelity insurance to all  securities dealers and margin financiers under the SFO Investor and broker education  Through media, outreach programs and other channels like  District Council Offices and the Consumer Council Alert investors and brokers to the risks in margin financing and  pooling Maintaining Dialogue with the Industry  17