Consolidating brokers: Streamlining the sector to improve quality and facilitate growth

The number of brokers and dealers more than doubled between 2009 and 2012, yet trading modernisation looks set to catalyse consolidation. In 2011 the top 10 of the 76 brokers performed daily trades amounting to more than 91% of the market, and the financial viability of most brokerages remains doubtful. As the World Bank and IMF noted in a June 2012 assessment of the financial sector, “Most intermediaries are poorly capitalised, inactive or unable to effectively intermediate between savers and the capital market.”

FRAGMENTATION: While the value of assets managed by brokers remained stable at MNT14bn ($9.8m) from 2008 to 2011, dropping from 0.4% of financial assets to 0.1% according to the IMF, the number of brokers grew from 41 to 76. The distribution of state-owned coal miner Erdenes Tavan Tolgoi (ETT) shares coupled with growing foreign interest prompted a rise in investor accounts. Distribution of shares and rules requiring that at least 10% of any initial public offering (IPO) be sold to Mongolian investors has driven retail account growth. There were over 800,000 accounts at the Securities Clearing House and Central Depository by early 2012, according to the Mongolian Stock Exchange (MSE), which expects the total number of accounts to reach 1.5m with the IPO of ETT. “Many of the recently created brokerages have opened accounts mainly for Mongolians who received ETT shares, but they do not trade much, as ETT shares cannot be sold yet,” Oliver Belfitt-Nash, former head of research at Monet Capital, told OBG. “Roughly 30 brokerages trade on the market, while only at most 10 have a research desk.”

Brokers typically charge 2-3% commission fees and 20 basis points for bonds, while opening balance requirements and fees are very low, ranging from MNT5000 ($3.50) to MNT40,000 ($28). The minimum break-even point of around 2% of daily trades is insufficient for all but the largest brokers that individually account for over 91% of the roughly MNT432m ($300,000) of daily trades in 2011. By mid-2012 only around six brokers were trading “heavily”, and merely 30 brokers traded daily.

Eurasia Capital estimated in early 2012 that a total of $210m had been generated in fees in the previous two years, including listings both onshore and abroad.

Yet revenue remains highly concentrated among a handful of players, with concerns over the technical, human and financial capacity of most. Following the 2010 banking reform, commercial lenders also entered the fray by creating investment banks with clearing and brokerage services. TDB Capital was the first to enter the segment in 2011, followed by UB City Bank (not a clearing bank), Golomt Bank, Khan Bank and XacBank.

While this created newfound competition for the traditionally dominant brokerage, BDS ec, particularly in underwriting, real trading competition will only emerge with the growth in liquidity as expected following the passing of the new securities law (see analysis).

KEY PLAYERS: BDS ec continues to dominate the market with a share that rose from an average of 68% of daily trades over the past two years to 85% in the first half of 2012. In a market dominated by block trades, the broker’s 92% share of such trades in 2012 makes it virtually the only large participant on the MSE. All the other brokers trail at below 4% of daily trades, with the following brokers often changing places in the top five – Eurasia Capital, Frontier Securities, ResCap, Asia Pacific Securities, Monsec, Gauli, Finance Link and Monet Capital. All major brokers are also investment banks, which is necessary given low overall trading levels.

One of two MSE-listed brokerages, BDS ec is majority controlled by US hedge fund Firebird Capital Management, which holds a stake in National Investment Bank (NIB). Firebird’s control has been instrumental in cementing BDS ec’s market dominance since 2005, when Firebird entered Mongolia, particularly as the hedge fund rapidly built up its portfolio in the aftermath of the 2008 economic crisis. Following an MNT1bn ($700,000) IPO in 2006, its shares have remained among the 20 most traded and with the seventh-largest capitalisation on the exchange. By 2008 its share price had grown 30-fold and it sold a secondary issue of 1m shares (10% of its capital). Holding 44% of all foreign accounts, as well as 25% of all local and 30% of institutional and corporate accounts (as of mid-2012), the firm has a definitive market lead. It underwrote 12 of the 17 post-privatisation IPOs in MSE’s history and executed 34% of all government and corporate bond transactions in 2011. Since May 2012 BDS ec has partnered with leading Asian investment group CLSA to offer local cash equity trading to foreign institutional investors. The broker nearly doubled its net profit in 2011-12 to MNT827.1m ($579,000), growing revenue by 31% year-on-year from MNT2.3bn ($1.6m) to MNT3bn ($2.1m).

ON THE RISE: Lagging far behind, the second-largest brokerage in 2011 with 3.53% of trades was Frontier Securities, founded in 2007 and held as a subsidiary of Hong Kong-based IRIS Asia, a fund manager dedicated to equities, bonds and property in Asia. While the brokerage remains a small player, Frontier stands to benefit from growing appetite on the part of Asian institutional investors. Eurasia Capital, founded in 2008 and with a mere 3.28% of trades in 2011, is also positioned to rise. Part of Silk Road Management, a Mongolia-focused group investing in public and private equity and property, the group has majority stake in MSE-listed property investment group Mongolia Development Resources and runs the $30m private equity Mongolia Human Capital fund. It also advises Hong Kong’s Quam Asset Management on its Silk Road Mongolia Fund, the first investment fund focused on Mongolian stocks listed offshore. The broker teamed up with Doran Capital Partners, a South Korean private equity and property investment firm, in June 2011 to raise some $100m in Korean investment for Mongolia.

Over the past decade, Hong Kong’s Asia Pacific Investment Partners (APIP) has run a Mongolian brokerage, Asia Pacific Securities, which accounted for 1.3% of trades in 2011. With commanding stakes in 10 leading Mongolian conglomerates that reflect its clear focus on the property market, APIP expects to stage an IPO in Hong Kong in 2013. Established in 1997 as Bats Invest and one of the first full-fledged brokerages, Monet Capital was less active in 2011 as it restructured its business into investment banking.

Resource Investment Capital (ResCap) was founded in early 2010 by private equity firm Origo Partners, listed on London’s Alternative Investment Market and based in Beijing, in partnership with Mongolian conglomerate Monnis International in a 35:65 split. A boutique investment bank focusing on natural resource deals, ResCap has ramped up its trading, particularly in block trades. In October 2011 it launched the MSE Liquidity Fund, investing 30-70% of its assets in locally listed equities and the balance in high-interest bank deposits. ResCap was the third-largest trader on the MSE by June 2012. While not a key player on the local market, the oldest full-fledged Mongolian investment bank, Mongolia International Capital Corporation (MICC), established in 2005, has managed a majority of Mongolian IPOs on international exchanges, mainly in Australia and Hong Kong. Looking to establish an initial $50m fund, MICC is expected to move into the local brokerage business as MSE liquidity rises. While Firebird remains the largest and most successful foreign investor among Mongolian brokers, the experience of other foreign brokerages has thus far been marginal.

RAISING THE STAKES: Migration to a new trading platform in July 2012 raised the stakes for brokers. While most participants expect the market to consolidate to around 20 brokers over the next five years, regulatory reforms are under way as competition heats up in what most expect to be a rapidly growing market. Under the new T+3 settlement procedures, brokers are required to hold 30% of the value of the trade, which should not be less than MNT10m ($7000), in a settlement account with one of the four clearing banks, pending settlement by the client within three days of trade. Opening an account with a clearing bank took most brokers over a month, with complaints over high charges and the requirement that individual investors also open a clearing account with the same bank as their brokerage. The number of brokers dropped to 24 in August 2012 before rebounding. By late September some 45 brokers had opened accounts, while a mere 1100 individual investors had done the same and were able to trade – far fewer than the 800,000 accounts at the clearing house.

While the new settlement mechanism has squeezed less-capitalised brokers, more regulatory action is needed. In mid-2012 brokers were only required to hold a minimum of MNT50m ($35,000) in shareholder equity, but this is expected to rise in the coming years. While foreign brokerages are required to form a joint venture with a local firm, this restriction is likely to be eased. “Many of the newly established brokerages were placeholders, hoping to partner with foreign brokers and banks once market reform is implemented,” Nick Cousyn, chief operating officer at BDS ec, told OBG. Meanwhile tighter enforcement of education and training requirements, and possibly for brokerages’ research output, would further professionalise the market. The development of local brokerages is key to attracting foreign investors that are concerned about counter-party risk.