China’s Investment Banking Shakeout Resembles the Swiss Model
The biggest brokerage merger in years looks more like a bailout, masking billion-dollar losses from bond underwriting.
Is combining Guotai Junan with Haitong Securities a reluctant bailout?
Photographer: Qilai Shen/BloombergA shotgun marriage might avert an immediate catastrophe, but is not enough to bury all the conflicts. As regulators in Switzerland are finding out, forcing UBS Group AG to take over embattled Credit Suisse Group AG in 2023 has resulted in resentments that sometimes bubble up in the form of creditor lawsuits, disputes over executive pay, and what constitutes a healthy balance sheet.
China is combining Guotai Junan Securities Co. and Haitong Securities Co., two of the biggest brokerages and both partly owned by the Shanghai government, in a share swap deal. The new entity will be the largest broker by asset size, topping Citic Securities Co. in areas such as stock trading and margin finance.
Synergies?
After the merger, the new entity will still be weak in equity underwriting
Source: JP Morgan
Note: Data refers to market share
While the merger was touted as a big step in Beijing’s yearslong ambition to create an “aircraft carrier-sized” investment bank, the reality may be closer to a scenario in which Haitong needed to be rescued.
Not unlike Credit Suisse, Haitong’s overseas arm dabbled in risky margin loans and sold funds that contained illiquid assets. The meltdown of New York-based family office Archegos Capital Management, as well as the collapse of supply chain funds linked to Greensill Capital, were major contributing factors to Credit Suisse’s demise in 2023.
In all likelihood, Haitong International, the overseas unit, is edging toward negative equity, if not there already, thereby making a strong case for a bailout now. As of June, the subsidiary reported net assets of only HK$1.4 billion ($180 million), against HK$113 billion in total assets. As a major underwriter for Chinese firms that raised offshore debt in Hong Kong and a trader in those instruments, the subsidiary has incurred huge losses since real estate developers’ bonds started to default in 2021.
Despite posting three consecutive years of losses, a sizable chunk of its holdings may not be properly written down yet, strongly suggesting more red ink to come. As of June 2023, Haitong International held HK$31.8 billion in financial assets, with HK$23.1 billion, or over 70% of the total, counted as level 3 fair value measures, which often rely on unobservable inputs to value hard-to-sell assets. Most were in the form of unlisted investment funds. In other words, they were not yet mark-to-market. By comparison, Guotai Junan’s overseas arm is in much better shape, with level 3 financial assets amounting to only 15% of the total.
More Red Ink?
Most of Haitong International's financial assets were booked as level 3
Source: Company filings
Note: Data as of June 2023, the latest available
Haitong International was delisted and taken private by its parent in January. As a result, we do not have more detailed information on the valuation of its financial holdings since June 2023. Haitong Securities and Guotai Junan didn't reply to an emailed request for comments on the merger’s rationale.
More than a year after their merger, UBS was still dealing with Credit Suisse’s unsound business associations. It has offered to repay investors 90% on Credit Suisse’s supply chain funds, which had exposure to loans made by Greensill that were marketed as safe investments. Similarly, Guotai Junan will have to figure out what to do with Haitong International’s investment funds.
Liquidating Haitong International is not an option, however. It’s a prominent book runner in Hong Kong’s debt capital markets, taking orders for new issues and having established trading lines with most houses. This year, it’s an active underwriter in offshore bond issues by indebted local government financing vehicles in China. In other words, it still serves a purpose, and could possibly therefore make a comeback.
There’s a lot of resentment in the aftermath of the Credit Suisse takeover. Senior executives at UBS felt that they were being punished for its smaller rival’s reckless behavior. While China has a long history of keeping the lid on dissatisfaction, make no mistake, discontent is there. After all, just like the arranged marriage in Switzerland, Shanghai-based Guotai Junan and Haitong are practically two sides of the same coin, strong in stock trading and weak in equity underwriting. Their merger has little synergy. The most plausible rationale may be a reluctant bailout.
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