Guotai Junan: Differentiated release of capital space, recommend increasing holdings of high-quality leading securities firms benefiting from the expansion of capital space.

Guotai Junan issued a research report suggesting investors to increase holdings of high-quality top-tier brokerage firms benefiting from the widening capital space. It is anticipated that the optimization of risk control indicators will benefit brokerage firms in stock investments and market-making businesses, helping top-tier brokerage firms with stable operations to boost leverage levels and enhance ROE. Event: On September 20, the China Securities Regulatory Commission revised and issued the "Regulations on the Calculation Standards for Risk Control Indicators of Securities Companies" (hereinafter referred to as the "Calculation Standards"), which will officially take effect from January 1, 2025. Key points from Guotai Junan: The purpose of the CSRC's revision of the "Calculation Standards" is to further enhance the role of risk control indicators as a "baton", implement the requirements for comprehensive strengthening of financial regulation, and promote high-quality development of industry institutions. 1) Since the revision and issuance of the current "Calculation Standards" in 2020, the four core risk control indicators of brokerage firms - risk coverage ratio, capital leverage ratio, liquidity coverage ratio, and net stable funding ratio - have been maintained at a level 1.5-2.5 times the regulatory standards, with no major risk events occurring. 2) The purpose of this revision is to implement the requirements for comprehensive strengthening of financial regulation and promoting high-quality development of industry institutions since the Central Financial Work Conference, further enhancing the role of risk control indicators in guiding the allocation of resources by securities companies, and improving the proactive and effective nature of comprehensive risk management to provide strong support for their own high-quality development and for economic and social development. The "Calculation Standards" relax the calculation standards for risk control indicators for brokerages' stock investments, market-making activities, and other businesses, expanding the capital space for high-quality brokerage firms and strengthening risk prevention in off-exchange derivative businesses. 1) Targeted relaxation of certain business calculation standards to guide functional play. The calculation standards for stock investments and market-making activities have been relaxed, with market risk capital reserves for Shanghai 180, Shenzhen 100, SSE 300, and CSI 500 index constituent stocks reduced from 10% to 8%, and other listed stocks reduced from 30% to 25%, with an increase in the conversion rate of high-quality liquid assets of the aforementioned index constituent stocks. Market risk capital reserves for financial assets and derivatives in market-making accounts are calculated at a 90% standard. 2) Further optimization of classification measurement, highlighting classification supervision. The risk coverage ratio has relaxed the adjustment coefficient for high-quality brokerage risk capital reserves, from 0.5 to 0.4 for consecutive three years of Class A and above AA-rated (inclusive), and from 0.7 to 0.6 for consecutive three years of Class A. The capital leverage ratio has relaxed the conversion coefficient for total on and off-balance sheet assets, to 0.7 for consecutive three years of Class A and above AA-rated (inclusive), and 0.9 for consecutive three years of Class A; Differentiated augmentation of available stable funding allows for the inclusion of residual borrowings and liabilities with a remaining tenure of 6-12 months, with 20% for consecutive three years of Class A and above AA-rated (inclusive) and 10% for consecutive three years of Class A, 0% for others. The above coefficients or standards are adjusted each year on January 1 based on the previous year's classification evaluation results. It is expected that the optimization of risk control indicators will benefit brokerage firms in stock investments and market-making businesses, helping top-tier brokerage firms with stable operations to improve leverage levels and enhance ROE. 1) Targeted optimization and relaxation of the calculation standards for stock investments and market-making activities will help brokerage firms to play a role in long-term value investing and providing financial services to the real economy. 2) Further optimization of classification measurement will help high-quality brokerage firms with top classification ratings to overcome bottlenecks in indicators such as net stable funding ratio and capital leverage ratio, improving leverage levels, boosting ROE, and striving for excellence. As of the first half of 2024, CITIC SEC, China Galaxy had net stable funding ratios at or below 140%, close to the warning line of 120%; Shenwan Hongyuan Group, China Galaxy, GF SEC had capital leverage ratios at or below 13%, close to the warning line of 9.6%. Risk Warning: Significant fluctuations in the capital markets.