China Sell-Side Research Contracts after Commissions Cut and Soft Dollars Banned

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According to articles from several news agencies, the brokerage industry in China is in the midst of a slowdown, a trend that is prompting many firms to slash both compensation packages and the number of research analysts they have on staff.

Industry Slowdown Under Way

According to industry insiders, many brokerage firms in China have been slashing analyst headcount and/or cutting compensation packages dramatically in recent months.  One Shenzhen-based brokerage laid off 40% of its research analysts during the 1Q24 in response to the industry downturn.  In addition, most brokerage firms are also cutting analyst pay packages, with the 2023 pay cuts among the top 10 brokerage firms in China ranging from 1.2% to 27%.

The recent slowdown is a surprising turnaround from the past decade when the number of sell-side research analysts in the China grew almost 70% to more than 4,800 analysts, according to data from the China Vision Capital.  During this period of explosive analyst growth, securities firms engaged in aggressively competition for talent, bidding up compensation to 10 million yuan (US$1.4 million) per year or more for star analysts.

Some of the reduction in analyst headcount and compensation that is currently taking place is due to a downturn in brokerage firm profits.  The combined profits at Chinese brokerages dropped more than 20% in 2022, snapping a three-year growth streak, according to data from the Securities Association of China. Profits slid 3 per cent further in 2023.  In the 1Q24, the 26 publicly traded brokerages that have released their annual results posted an average 4% drop in profit year-on-year, according to Haitong Securities. 

Another driver of this downturn has been regulation.  In December 2023, the China Securities Regulatory Commission (CSRC) published draft rules aimed at cutting trading commissions for mutual funds and eliminating the use of soft dollar commissions to pay for research from brokerage firms, consultancies, and market data terminals.  Industry experts estimate that these new rules would cut overall commission by one third – an outcome that would put further pressure on brokerage firm profits.

In addition, investors have become increasingly less enthusiastic about pumping money into mainland China’s equity market following its 16% drop over the past three-years, resulting in weaker demand for equity research.

Decreasing Value in Sell-Side Research

Another trend which has been taking place in the past few years has been the decreasing value of sell-side equity research in China.  Traditionally, sell-side research has tended to be overly optimistic as brokerage firms want to maintain strong relationships with corporates who might also be investment banking clients.

However, recently, this unwillingness to criticize covered companies has become even more extreme.  Last summer, a state-owned Chinese newspaper criticized investment bank Goldman Sachs for publishing bearish reports on Chinese banks.  Then, in late 2023 top Chinese investment bank CICC warned its analysts against making bearish calls or negative comments about the Chinese economy or markets in both private and public discussions.

Many money managers have said that these developments have severely diminished the quality of sell-side equity research in China, as most of this research has become homogeneous and provided little unique insight.

Our Take

It is interesting to see that the Chinese brokerage industry and investment research business are starting to experience the same pressure seen in the US and Europe over the past few years since the roll out of MiFID II.

While the overall factors impacting the business in China, including an oversupply of highly paid research analysts, shrinking brokerage firm profits, regulatory pressures, and decreasing value of analysts’ insights are similar to what took place in the US and Europe, the specifics of the developments are unique to each region.

Unfortunately, the challenges now facing the sell-side research business in China are likely to take some time to overcome as the existing oversupply of analysts will need to be reduced and the industry will need to identify new ways to generate insight and value for investors.  If this is anything like what took place in the US and Europe, this right sizing of the Chinese research industry will probably take 4-6 years.

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About Author

Mike Mayhew is one of the leading experts on the investment research industry. In addition to founding Integrity Research, Mike is on the board of directors of Investorside Research Association, the non-profit trade association for the independent research industry, and a frequent speaker on research industry trends and developments. Mike has over thirty years of research industry experience. Email: Michael.Mayhew@integrity-research.com

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