March 07, 2024 (MLN): The Chinese securities regulator’s ramped-up efforts to contain downside volatility in the country’s stock market could affect local securities companies by reducing fee income and increasing uncertainties in proprietary trading activities, says Fitch Ratings.
The unwinding of derivatives and structured products in the current market environment with heightened volatility could also expose securities firms to higher counterparty and operational risks as the selling could trigger a knock-on effect on the market.
In this environment, Fitch believes the strength of securities firms’ risk management frameworks and their capability to execute risk policies are increasingly differentiating their financial performance.
The largest securities firms we rate, with their adequate capital positions and more sophisticated risk management capabilities, are better equipped to navigate through the market volatilities without impairing their credit profiles.
Press reports suggest that China’s securities regulator in recent weeks imposed a ban on net selling by certain large firms in the first and last 30 minutes of stock market trading and disallowed some quantitative hedge funds from unwinding long equity positions.
This builds on a tightening of oversight of quantitative trading that started in September 2023 and underlines the government’s increased focus on stemming downside volatility in the stock market, especially amid dampened investor sentiment.
However, we believe relief from these measures may be temporary, with the market’s long-term performance still relying heavily on the economy’s performance and incremental policies to stimulate the underlying economy.
Weak sentiment in capital markets has dampened demand for brokerage services and is likely to result in mark-to-market losses on proprietary trading portfolios.
The entity further believes such risks are particularly high for equities (which accounted for 20% of top-10 securities firms’ aggregate investment assets at end-1H23), less transparent and potentially more illiquid funds, and wealth-management products.
These together account for 34% of investment assets. Meanwhile, increased regulatory restrictions and frequency of window-guidance on trading strategies, such as a temporary ban on net-selling and short-selling, also raise operational risks at securities firms.
That said, hedging and active portfolio management, guided by risk limits, could help securities firms adjust their positions even with the net-selling ban and, in turn, contain the negative impact.
A continued decline in interest rates could also boost the value of securities firms’ bond portfolios.
The top-10 Chinese securities companies held 44% of their investment portfolios in fixed-income securities, based on our calculations at end-1H23.
A hypothetical severe stress scenario with a 15% decline in the value of securities firms’ holding of bonds and margin loans and a 30% decline for other financial investments based on their 1H23 positions could lead to materially weak capital positions for the top-10 securities firms.
Still, our analysis suggests the more comprehensive risk infrastructure at leading firms will allow them to prevent large losses, as firms would have adjusted their positions in advance to avoid breaching internal risk limits.
This was evident during recent episodes of market volatility, such as China’s 2015 stock market collapse.
Securities firms also face the risk of being asked by the regulator to inject more capital into the stock market to support market stability.
The regulator recently urged certain institutional market participants to support the stock market’s development and reiterated the plan to guide more medium-to-long-term investment vehicles into the stock market.
Fitch believes these requirements to commit additional capital, if any, are likely to be commensurate with a securities firm’s financial capacity, and not result in a significant capital strain on rated issuers.
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Posted on: 2024-03-07T12:36:24+05:00
