Commission downgrades 60% of brokerages

More than half of China's 95 brokerages have been downgraded by the China Securities Regulatory Commission in its annual classification.

The main reasons for the downgrades are brokerages' noncompliance with regulations, flouting of rules and below-par risk management capacity, according to Dong Dengxin, a researcher at the Wuhan University of Science and Technology and a financial analyst.

Researchers say the downgrades will help make the market more transparent and cleaner.

The downgrades are also expected to further squeeze brokerages' already shrinking net profit due to market fluctuations.

The commission's classification system accords ranks or ratings to brokerages based on their record or performance.

A set of criteria determines a brokerage's rank. Key factors are risk management capacity, profitability and compliance.

Eleven ranks are distributed over five classes. The top-rated A class has three ranks: AAA, AA and A. Ditto for the B class and the C class, followed by the D class (D) and the bottom-of-the-pile E class (E).

Currently, no brokerage has the highest AAA rating. Only eight brokerages are rated AA.

According to the commission's regulations, a downgraded brokerage is required to increase its allocation to its investor-protection fund.

Otherwise, it would attract fresh restrictions that would stop it from starting a new line of business as well as expanding current businesses, analysts say.

Founder Securities Ltd, which was classified as A last year, was downgraded to C this year for several instances of flouting commission rules.

According to Founder Securities, it has been investigated and punished for breaking disclosure rules and for not meeting the "know your customer" norms in some transactions.

Following the downgrade, Founder Securities now needs to augment its investor protection fund from 1 percent of revenue to 3 percent.

Shenwan Hongyuan Securities says in a note that brokerages can compete fairly only when they all operate based on the rules and law. The downgrades, it says, suggest the market regulator is strengthening compliance and risk management - and cracking down on misbehavior and dishonest and illegal practices.

A downgrade may affect a brokerage's business activities such as investment banking. Bond issuers generally do not prefer to hire low-ranked brokerages as underwriters, particularly when other higher-rated ones bid for the same role, says Yin Jianjun, a researcher with Shanghai-based Shenda Asset Management.

Stricter compliance requirements and fluctuating market conditions will likely hurt the profitability of brokerages in the second half of 2016, according to a research note from China Merchant Securities.

"The equity market is going to be more active in the second half of 2016 with more channels anticipated to open to investors, such as the Shenzhen-Hong Kong stock connection, and more initial public offerings to be seen. New issuance of stocks and bond issuance will certainly benefit larger players in the sector," China Merchant says in the note.

(China Daily Africa Weekly 08/26/2016 page29)