Feeling the Squeeze in Hong Kong's Equity Sector

People in glass houses shouldn't throw stones. Equity analysts in Hong Kong spill oceans of ink warning about the danger of overcapacity in mainland China's industrial sector. They should pay more attention to overcapacity in the Hong Kong equity-brokerage industry.

It's been a heady few years. In 2009, when London, New York and other Western financial hubs fell into despair, slashing jobs and closing business lines, Hong Kong became something of a safety valve for the industry. Major investment banks expanded their presence in the city. Midsize firms like Barclays Capital and boutique outfits like Jefferies began jostling for market share. Korean, Japanese and Taiwanese competitors have moved in or expanded their presence, too.
In New York City alone, 22,000 securities industry jobs have been lost since January 2008, and the state's comptroller expects another 10,000 to go by the end of 2012. Yet in Hong Kong, recruiters report frenetic hiring through 2010 with new firms paying top dollar to snatch talent away from existing players.

The appeal is easy to see. The strongest prospects for growth are in Asia. In the initial-public-offering market, for instance, Ernst & Young says that 138 IPOs in the third quarter in Asia raised $13.5 billion, more than the total for North America and Europe combined.

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Residential and commerical buildings stand in the mid-levels district, bottom, with Victoria Harbour and the Kowloon Peninsula beyond in Hong Kong, China, on Friday, July 8, 2011.

Sensibly, the bankers are following the money. But as the equity-broker market becomes more crowded, the danger is that there won't be enough fees to go around. Andy Maynard, head of trading and execution at CLSA, says buy-side firms typically allocate 80% of their commissions to just their top 10 brokers. Anyone wanting an outlook on Hong Kong-listed Industrial & Commercial Bank of China has researchers from 48 different firms to choose from. That might suggest someone is going to go hungry.

A prolonged bear market will mean even less to go around. In the year following the eruption of the financial crisis in September 2008, trading volume on the Hong Kong exchange fell 36% year-to-year and IPO fund-raising dropped 66%. Growth prospects in Hong Kong still look better than they do in the U.S. or Europe—that is why everyone has headed east. But no one expects 2012 to be a bumper year.

John Feng, an expert on the equity sector at financial-services consultancy Greenwich Associates, says that when the commission wallet shrinks, major players typically command a bigger share. Full-service firms with a global presence are better placed than most to ride out the storm. Chinese firms like Bank of China International have a niche catering to mainland customers. It's the second- and third-tier players from the U.S. and elsewhere in Asia that will have the toughest time.

Some are already feeling the heat. Knight Capital, which entered the Hong Kong market in January 2009, announced in August this year that it will exit. If the bear market extends into 2012, that won't be the only firm squeezed out.