The revision of the risk control index system is expected to moderately relax the capital constraints on leading securities firms to a certain extent, further enhancing their leverage levels. Against the backdrop of regulatory policies guiding the capital-intensive development of securities firms, encouraging them to grow stronger through mergers and acquisitions, and the increasing profitability divergence in the industry, the potential leverage ratio and Return on Equity (ROE) of the securities industry are anticipated to increase.

On September 20th, the China Securities Regulatory Commission (CSRC) issued the "Regulations on the Calculation Standards of Risk Control Indicators for Securities Companies" (hereinafter referred to as the "Regulations"). This revision of risk control indicators is an important measure for the regulatory authorities to implement the central financial work conference's requirements for comprehensively strengthening financial regulation and enhancing the service capabilities of investment banks. It reflects the regulatory orientation of four aspects: highlighting comprehensive coverage, emphasizing prudence and strictness, strengthening risk management, and promoting the function of the industry.

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The calculation standards for risk control indicators have been further adjusted and optimized. Compared with the draft for comments released by the CSRC in November 2023, the "Regulations" have made further adjustments in the calculation standards for risk control indicators, mainly in the numerator and denominator sub-items and calculation standards of the four core risk control indicators (risk coverage ratio, capital leverage ratio, liquidity coverage ratio, and net stable funding ratio), with local adjustments made according to the needs of industry development.

In the risk capital preparation calculation table, there are the following five adjustments: 1. The risk capital preparation calculation standard for securities firms' equity assets has been reduced (the calculation standard for Shanghai 180, Shenzhen 100, CSI 300, and CSI 500 constituent stocks has been reduced from 10% to 8%, and for general listed stocks from 30% to 25%), which may be more conducive to securities firms increasing their investment in A-shares and other equity assets. 2. New calculation standards have been added for cash management financial products in collective and trust products, non-full margin equity swaps, private custody, and gold lending business, which are 5%, 5%, 0.2%, and 2% respectively; 3. The calculation standard for investment in other non-standard assets in single and collective asset management plans has been increased from 0.8% and 3% to 3% and 5%; 4. The market risk capital preparation for financial assets and derivatives in market-making business has been reduced, which may be more conducive to securities firms playing an active role in the capital market through market-making business; 5. The market risk capital preparation for yield swap business with a margin ratio lower than 100% of the nominal principal and domestic individual stocks as the subject has been increased.

In the calculation table for the total amount of on- and off-balance sheet assets, the conversion coefficient for asset management business has been increased from 0.3% to 0.5%, and the balance at the end of the period for yield swaps with a margin ratio lower than 100% of the nominal principal and domestic individual stocks as the subject has been added, calculated at 20% of the total nominal value of the contract.

In the liquidity coverage ratio calculation table, the liquidity discount rate for equity and ETF assets has been increased. The liquidity discount rate for Shanghai 180, Shenzhen 100, CSI 300, CSI 500 constituent stocks, and broad-based index ETFs, minus the frozen or pledged part, has been increased from 40% to 50%.

In the net stable funding ratio calculation table, the continuous three years of Class A AA级以上 (including) and Class A available stable funds have been relaxed. The discount rate for subordinated debt, long-term loans, and应付 bonds for securities firms with a continuous three years of Class A AA级以上 (including) is 20%, and for those with a continuous three years of Class A is 10%.

Compared with the current rules, the "Regulations" highlight supporting the excellent and limiting the inferior in the calculation of risk coverage ratio and capital leverage ratio, supporting businesses such as asset management and market-making. Compared with the draft for comments, the "Regulations" have not changed much overall, with the differential addition of part of the liquidity liabilities over 6 months as available stable funds, and continue to optimize some calculation standards.

1. Risk coverage ratio (= net capital / sum of various risk capital preparations, regulatory standard ≥ 100%, warning standard ≥ 120%): The risk capital preparation coefficient for securities firms rated Class A and above for three consecutive years has been reduced; the calculation coefficients for market-making business and asset management business have been reduced; compared with the draft for comments, new calculation standards such as gold lending business have been added. The "Regulations" continue the requirements of the draft for comments, reducing the adjustment coefficient for risk capital preparation for securities firms rated Class A AA级以上 (including) for three consecutive years from the current 0.5 to 0.4, and for those rated Class A from 0.7 to 0.6, while the rest of Class A, B, C, D remain unchanged at 0.8, 0.9, 1, 2 respectively; securities firms on the "white list" rated Class A AA级以上 for three consecutive years can pilot the use of internal model methods and other advanced risk measurement methods to calculate risk capital preparation after recognition by the CSRC.At the same time, the "Regulations" also continue the support for businesses such as asset management and market making as outlined in the draft for comments. In the calculation rules for risk capital reserves, the calculation standards for single asset management plans and collective asset management plans investing in standardized assets are reduced from the current 0.3% and 0.5% to 0.1% and 0.1%, respectively. The calculation standards for other non-standard assets in the above two types of asset management are increased from the current 0.8% and 3% to 3% and 5%, respectively (the draft for comments did not adjust the calculation standards for other non-standard assets). The market risk capital reserve for financial assets and derivatives held in the market-making accounts of securities firms is calculated at 90% of the respective calculation standards. The "Regulations" continue the draft for comments' provision to increase the calculation standard for stock index futures, equity swaps, and sold options from 20% to 30%, and also add calculation standards for gold lending business, cash management type financial products, and equity swaps without full margin.

2. Capital leverage ratio (= Core net capital / Total on- and off-balance sheet assets, regulatory standard ≥ 8%, warning standard ≥ 9.6%): New classification regulation for total on- and off-balance sheet assets; compared to the draft for comments, the asset total conversion coefficient for asset management business is increased. For those with an A-class AA level (inclusive) for three consecutive years, the coefficient for total on- and off-balance sheet assets is 0.7, for those with an A-class for three consecutive years it is 0.9, and for the rest, it is 1. The "Regulations" increase the conversion coefficient for asset management business in the calculation of total off-balance sheet project assets from 0.3% to 0.5%.

3. Liquidity coverage ratio (= High-quality liquid assets / Net cash outflow within the next 30 days, regulatory standard ≥ 100%, warning standard ≥ 120%): High-quality liquid assets newly include the constituents of the CSI 500 Index, and the discount rate is increased compared to the draft for comments. In high-quality liquid assets, the constituents of the CSI 500 Index are newly added, with the discount rate increased from 40% in the draft for comments to 50%. At the same time, the discount rate for the frozen pledged part in the deduction items is increased from 40% to 50%. In the net cash outflow within the next 30 days, the discount rate for commodity derivatives is adjusted from 12% to 8%, which is the same as in the draft for comments.

4. Net stable funding ratio (= Available stable funding / Required stable funding, regulatory standard ≥ 100%, warning standard ≥ 120%): Available stable funding newly includes loans and liabilities with a remaining maturity of 6 months to 1 year, with the discount rate linked to the rating of securities firms. Compared to the draft for comments, the "Regulations" newly include loans and liabilities with a remaining maturity of 6 months to 1 year in available stable funding, and differentiate the discount rate according to the rating results: for those with an A-class AA level (inclusive) for three consecutive years, it is 20%, for those with an A-class for three consecutive years, it is 10%, and for the rest, it is 0%, further highlighting the support for high-quality securities firms to moderately expand their capital space.

Compared to the current regulations, the "Regulations" reduce the discount rate for the constituents of the CSI 500 Index in the calculation details of required stable funding from 50% to 30%; for all other assets, a new discount rate setting for different maturities is added, with discount rates of 50%, 75%, and 100% for maturities within 6 months (inclusive), within 6 months to 1 year (inclusive), and over 1 year (exclusive), respectively (in the 2020 version, the discount rate for all other assets was 100%). The discount rate for cash management type financial products is reduced to 0% (it was 20% in the 2023 draft for comments).

Expected to increase the potential leverage ratio and ROE of the securities industry

This revision further refines the calculation methods for risk control indicators, especially clarifying that the risk control indicators for high-quality securities companies are appropriately optimized to support compliant and stable high-quality securities companies to moderately expand their capital space. According to the "Securities Company Classification Supervision Regulations," securities companies are divided into 5 major categories and 11 levels from A to E. Looking at the classification list from 2017 to 2021, most of the top securities firms with larger asset scales have a high classification ranking, and the number of AAA-level classified securities firms has increased during the period from 2019 to 2021, with the overall compliance management and risk control management level of the industry continuously improving.

In recent years, the number of securities companies of all categories has generally remained stable, with the proportion of A, B, and C class companies in the 2024 classification results being 50%, 40%, and 10%, respectively, with the number of AA-level companies remaining around 14. The capital constraints on top securities firms with sound risk control mechanisms are further relaxed, and the improvement of incentive mechanisms is expected to drive the continuous improvement of the industry's risk control capabilities, better providing comprehensive financial services for the real economy. From the perspective of the industry pattern, the implementation of the "Regulations" may be more beneficial to top securities firms, and is expected to increase the potential leverage ratio and ROE of the securities industry.

The risk management system of securities firms is continuously improving, and the new risk control indicators are expected to guide the rational allocation of funds in the securities industry, better serving the real economy. At the same time, against the background of supply-side reform, business transformation and mergers and acquisitions may continue to advance, and the trend of building first-class investment banks and investment institutions through mergers and reorganizations, and organizational innovation is expected to accelerate.

The new risk control regulations are expected to help some high-rated securities firms further improve the efficiency of fund use and guide securities firms to return to their functional positioning. In the first half of 2024, the risk coverage ratio and net stable funding ratio in the risk control indicators of listed securities firms were relatively tight, such as Tianfeng Securities with a risk coverage ratio of 120.13% and a net stable funding ratio of 107.80%, and CITIC Securities, Guotai Junan, and China Galaxy with net stable funding ratios of 129.76%, 135.13%, and 137.35%, respectively. The new risk control regulations use a differentiated calculation method for some parameters in the risk coverage ratio, capital leverage ratio, and net stable funding ratio indicators, and high-rated securities firms are expected to benefit from the optimization of these regulatory indicators.In addition, the "Regulations" continue the support for asset management and market-making business as outlined in the draft for comments, and also adjust the calculation standards for risk capital reserves required for derivative businesses such as options futures, and equity swaps, once again reflecting the regulatory emphasis on the functional positioning of securities firms, guiding them to play a role in long-term value investment, serving the financing needs of the real economy, and managing residents' wealth. The "Regulations" also timely update and optimize some indicator calculation details according to business changes, bringing all business activities under the control of risk control indicators, and further enhancing the effectiveness of regulation.

According to the analysis by Guolian Securities, overall, the revision of the risk control indicator system is expected to moderately relax the capital constraints on leading securities firms to a certain extent, and further improve the level of capital utilization by leading securities firms. Against the backdrop of regulatory policies guiding securities firms towards capital-intensive development, encouraging securities firms to grow stronger through mergers and acquisitions, and increasing industry profit differentiation, the potential leverage ratio and ROE of the securities industry are expected to increase.