China's securities houses have taken big chunks out of global banks' Asia capital markets business, both in debt and equity. Back in 2005, for instance, Dealogic's list of the top 10 IPO banks in the region featured seven US names and only one Chinese firm. Ten years later, the same list contains seven Chinese securities houses. And now these firms are turning their attention to the derivatives market. Access to both the onshore and offshore legs of China's equity market has seen them make enviable profits from total return swaps and margin loans, but they are also taking great strides in terms of product and risk management sophistication.
As a result, this year Asia Risk decided to recognise the rapidly increasing importance of securities firms – both in China and the broader north Asia region – by providing a standalone award for this group. Guotai Junan International, the Hong Kong arm of the eponymous Chinese securities house, was the first such unit to be established in Hong Kong, so it is fitting that it wins our inaugural securities house trophy.
Wang Fan, Hong Kong-based director of equity derivatives at Guotai, says the company has had an interesting 12 months, increasing its headcount from six to nine and managing to double revenues compared to the previous year. The key development for Wang and his team was the decision by Chinese authorities to suspend the Renminbi Qualified Domestic Institutional Investor (RQDII) scheme, which was only introduced in 2014.
RQDII allows Chinese firms to make overseas investments using funds raised in China. The programme was seen as a major step forward in Chinese capital market liberalisation as there are no quotas and it doesn't require approval from the State Administration of Foreign Exchange. But as capital outflows spiked following the People's Bank of China's surprise decision in August last year to let the currency depreciate against the dollar, authorities panicked and suspended the scheme.
"Before the suspension of the RQDII programme we were doing a lot of one-way flow business," says Wang. "RQDII investors were moving money out of the mainland after the August rout on China's foreign exchange markets. Investors were looking for offshore dollar assets in the expectation of further renminbi depreciation. They were still familiar names – Chinese companies listed in Hong Kong or the US, for instance.
"After the RQDII programme stopped we shifted our focus to those dollar accounts that are already offshore and ended our cross-border activity. Prior to the August 11 move by the PBoC it was the reverse – investors were leveraging cheap dollars to invest in mainland assets. For example, in 2013–2014, we were doing a lot of dollar leverage on convertible bonds onshore, which is a yield play with a potential upside from RMB appreciation."
Another major change in the past 12 months has been the shift away from using the dollar for the payment, settlement and margining of renminbi-denominated derivatives. In order to meet client demand, Guotai now allows margin payable in renminbi on certain products and has also added the Chinese currency to the list of eligible collateral on all client-facing credit support annexes.
Wang says analysing and pricing counterparty credit risk (XVAs) is standard practice for all credit-sensitive transactions such as interest rate and forex derivatives and is carried out using the firm's own internal models. "The correct quantification of credit risk has a direct impact on capital requirements, CVA charges, the facilitation of credit lines and the pricing of credit-sensitive transactions. It therefore has a direct impact on pricing, quality and the range of services provided to clients."
However, the firm also says that due to its parent's extensive network – Guotai Juan Securities is one of the largest financial firms in China, with just under 500 billion yuan ($75 billion) in assets under management – it also applies an internal ratings approach.
The securities house also has a rapidly expanding ETF (exchange-traded fund) market-making business that provides daily liquidity for 13 ETFs listed on the Hong Kong Exchange. Such ETFs faced real problems when over half of China's listed stocks were suspended in 2015. Guotai resolved the issue by evaluating A-share prices after the suspension to estimate the value of its ETFs. It also used prices from FTSE China A50 and HSCEI index futures as a basis for bilateral negotiations with counterparties.
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