China Securities Sector:“Support fund”reality check

What’s new: Our tracking of the “support fund” created by CSFC (funded by 20% net capital of 50 securities firms) suggests a second weekly net sell for the week of 23 Nov. Due to this, coupled with the resumption of IPO on 30 Nov, we believe regulators now see a normalised A-share market and their next step will be further deregulation and formulating an exit plan for the “support fund”.

    What’s the impact: “Support fund” becomes a net seller. Given the “support fund” was created as an emergency measure, we believe CSFC is trying to lighten the position as the A-share market is picking up. Shanghai composite index has recovered from the August bottom by 27% by 23 Nov. CSFC will likely provide some details of its exit plan soon, improving visibility.

    “Support fund” should have recorded a 9% unrealised gain by 23 Nov based on our analysis of market activity data of four branches that CSFC uses to trade stocks.

    Registration-based stock issuance system is top of CSRC’s wish list for 2016. CSRC’s chairman mentioned that the regulator is trying to facilitate the revision of the Securities Law so that the launch of a registration-based stock-issuing system will have concreate results next March. In the proposed system, issuers and relevant intermediaries bear larger legal liability as more flexibility in terms of timing and pricing is given to issuers and underwriters. Hence, there will be more emphasis on the expertise and track record of underwriters. Investors will also rely more on securities firms when making their investment decisions rather than relying on the CSRC listing committee.

    What we recommend: We share investors’ concerns on the opaque nature of the “support fund”, especially when and how the contributions of securities firms can be redeemed is uncertain now. However, when we use our sum-of-the-parts method to value the “support fund” contribution and other organic business of securities firms separately, we find their current valuations appear fundamentally attractive. Hence, we maintain our Neutral rating on the sector and recommend companies with solid fundamentals, such as Haitong Securities (6837 HK, HKD14.36, Buy[1]) (for its good track record in underwriting business and non-cyclical growth in financial leasing and margin lending) and Huatai Securities (6886 HK, HKD19.96, Buy[1]) (for structurally gaining market share in margin lending and low valuation). The key sector risk is uncommercial regulatory intervention in the A-share market.

    How we differ: We believe credit risks on margin loans offered by securities firms have been overplayed. With sound LTV control and eligible collateral standards, we think the asset quality of brokers’ formal margin lending is solid.