China Galaxy Securities, the mainland's sixth largest brokerage firm by revenue, is pitching its initial public offering to investors by offering to expand its money-making margin financing business at a time when domestic stock markets are showing signs of recovery.
However, Galaxy's larger rivals Citic Securities and Haitong Securities are struggling to make meaningful headway in the margin financing and securities lending business, and some analysts say the lack of relevant derivative instruments to hedge against risk associated with underlying securities is one of the main restraints prohibiting healthy development.
"The absence of credit default swaps, a financial swap agreement that functions as an insurance to hedge against default risk, is a classic example of the underdevelopment of the domestic corporate bond market," a senior banker at a US investment bank said. "A market-driven mechanism needs comprehensive services to support a sustainable development."
Galaxy, based in Beijing and controlled by Central Huijin Investment, a subsidiary of the sovereign wealth fund China Investment Corp, is poised to unveil bold plans to capture the country's nascent short selling and securities borrowing industry.
Securities firms believe policymakers in Beijing will spur the development of the country's capital markets, especially in the areas of equity trading, bond issuance and greater openness to foreign investors, who are keen to invest in the closely guarded securities markets.
China introduced the pilot trading scheme allowing margin financing and stock lending for brokerages firms to stock exchanges in August. That was seen as an attempt to boost lacklustre operating conditions after the benchmark Shanghai Composite Index fell below the psychologically important 2,000-point level, the lowest since February 2009.
Meanwhile, there is widespread speculation that a number of large state-owned commercial banks, including China Construction Bank and Industrial and Commercial Bank of China, have applied for securities brokerage licences. That poses a risk to Galaxy's expansion plans, as a majority of its customers are retail investors.
In its prospectus the company said: "Commercial banks … present a greater challenge to securities firms' business in areas such as bond underwriting, financial advisory and sales of wealth management products, by leveraging their branch network, client base and capital base."
Margin financing business at Galaxy represented about 22 per cent of overall assets last year, up from just 3 per cent in 2010, while securities lending rose to 3 per cent from scratch.
China's brokerage industry is highly scattered, with the top 10 securities firms representing only 45 per cent of the overall market.
Apart from domestic players, foreign investment banks are also struggling, after the virtual shutdown of the listing market since mid-October amid concerns over listing procedures and the quality of IPO hopefuls.
Chen Youan, chairman of Galaxy Securities, said the unprecedented open regulatory environment at home was one of the key investment incentives for investors, suggesting that executives are convinced that industry regulators will offer more favourable treatment.
The company planned to use about 60 per cent of the US$1.37 billion proceeds from its initial share sale to develop the lucrative but tricky broking business, which allows investors to buy and sell listed securities with money borrowed from a brokerage firm.
According to bankers familiar with the transaction, the order book for the state-owned firm's new shares has been well covered but it is too early to tell about their pricing as the company still has to meet investors in New York, Boston and London.
It captured a big order for US$360 million worth of shares from seven cornerstone investors, including AIA and the Malaysian sovereign wealth fund Khazanah Nasional, even with a six-month lock-up.
It is understood that the management at Galaxy has expressed a strong desire to price the stock high as the share prices of rivals such as Haitong and Citic Securities have risen since the middle of last month.