Finance

Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

Almost 12 months after they were forced to buy up stocks to put a floor under the market, China's brokerages are in a bad place again.

The anticipated trading rush after a link between the Hong Kong and Shenzhen stock exchanges opened Dec. 5 hasn't eventuated and investors are punishing firms including Guotai Junan International Holdings Ltd. and Haitong Securities Co., whose shares had rallied in the lead up to the connect. Brokerage houses are also dealing with a bond rout, showing how precarious a bet on the sector can be.

Short-Lived
Investors had bid up Chinese brokerage stocks listed in Hong Kong in the hope there would be a business boom from the Shenzhen trading link. That didn't happen
Source: Bloomberg

Shenzhen's slew of new-economy stocks and a wide variety of mid-caps in Hong Kong had many predicting a lot more cross-border action than when the Hong Kong and Shanghai exchanges opened a similar channel in November 2014. Yet volumes on both sides have disappointed. Only a small portion of the daily quota has been used both ways.

Distinctly Disappointing
Daily trading volumes on the northbound, or China side, of the Shenzhen-Hong Kong Connect have fallen since its start earlier this month
Source: Bloomberg

It's hard to see a pick up anytime soon.

Northbound, or Hong Kong trades into China, are hobbled by foreign-investor concerns that any money pumped in will lose value as the yuan continues to depreciate. China's lack of inclusion in the MSCI Emerging Markets Index didn't help either. On the flip side, Chinese appetite for stocks in Hong Kong has been muted by an increase in interest rates in the U.S. Rising borrowing costs hurt the many real-estate firms listed in the former British colony, as well as companies that took on a lot of debt when funding expenses were low.

On top of that, China's brokerages are grappling with surging note yields as people dump bonds. According to Credit Suisse Group AG, between 40 and 60 percent of a brokerage's proprietary book is typically in fixed income, and as Sealand Securities Co.'s recent travails show, if counterparties are involved, exposure levels may not be very transparent.

Not Many Happy Returns
GF Securities has the highest exposure in its proprietary-trading portfolio to bonds but most top brokerages are right up there
Source: Credit Suisse

Brokerages in Asia's biggest economy also have to contend with the long arm of the state. Beijing is prone to closing off initial public offerings, a key earnings source, at will, and can also dictate how much brokers lend on margin. In September, regulators put a lid on M&A revenue by blocking backdoor listings and banning equity raisings after reverse mergers.

The one edge Chinese securities firms do have -- equities underwriting and trading -- could even be at risk, with moves afoot to let local lenders and foreign-investment banks in on the action. At present, banks only dominate the underwriting and trading of bonds and commodities, while international players have to partner with mainland ones to operate in China's securities industry.

Until China's stock connects start bearing fruit, investors might be wise to give its brokerages a wide berth.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Nisha Gopalan in Hong Kong at ngopalan3@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net