Fast trades and rock-bottom prices will energize Hong Kong’s retail investment community. But many of the city’s brokerages won,t survive the excitement.
By Kazuhiko Shimizu
February 2001
Institutional Investor Magazine
No one can say the online revolution arrived in Hong Kong unannounced.
For months the city’s 50 or so online brokerages have been relentlessly promoting their e-prowess. 2cube Securities, the joint venture of J.P. Morgan Chase & Co. and Internet entrepreneur Richard Li Tzar-kai’s Pacific Century CyberWorks, plastered its name on Hong Kong’s subway walls in December and treats prospective customers to the song “Money, Money, Money” at trading demonstrations. In TV ads that began airing at year-end, Hong Kong and Shanghai Banking Corp. featured ordinary people trading online, with “We do things my way” as the tag line. Such local firms as Celestial Asia Securities Holdings, Cash on-line and Tai Fook Securities Group tout their abilities in cybercafés and on billboards and buses, while newly arrived U.S. powerhouses are making their own kind of noise. Charles Schwab & Co. unveiled its online operations by opening a swank new office in the expensive downtown Admiralty District in October. And E*Trade Group is launching its Hong Kong service within the next few months.
High-profile partnerships abound. Credit Suisse First Boston’s CSFBdirect has joined Hutchison Whampoa, the flagship of Hong Kong billionaire Li Ka-shing (father of Richard Li) to form Hutchison CSFBdirect, an online brokerage. And two of the region’s retail banking powers, Australia & New Zealand Banking Group and Oversea-Chinese Banking Corp. of Singapore, plunked down $22 million in October to help Hong Kong,s inaugural online service, Boom.com, to expand.
The fanfare is a rousing prelude to two developments that are likely to radically reshape the competitive landscape for brokerage firms in Hong Kong. By June the Stock Exchange of Hong Kong will complete its implementation of straight-through automated trade processing, cutting online transaction times from 15 minutes to two seconds. And next year the bourse will deregulate commissions. Many of the world’s exchanges have abandoned minimum transaction fees and embraced online trading, but Hong Kong is rare in that it is taking on both challenges so close together. Optimistic market participants predict a coming boon for the city’s notoriously jumpy investors that will help to expand the retail investment market.
But there’s bad news, too. Many analysts agree that this combination of deregulation and technological advance will produce cutthroat competition among the city’s roughly 500 brokerages. “I am ready for battle,” says Peter Wong, executive director of Tai Fook Online Service, a subsidiary of Tai Fook. “I am ready for a lot of blood and dead bodies.”
Indeed, the bloodletting among members of the 60-year-old bourse is expected to be severe, with many firms unlikely to survive. Predicts Anthony Yung, head of KGI Asia’s Hong Kong,based online brokerage operation, owned by Koo Group of Taiwan, “The number of brokerages that are members of the Hong Kong Stock Exchange will be cut in half within two or three years.”
Firms with relatively small capital bases will be hit the hardest, as they struggle to cope with the combination of expensive technology, higher maintenance costs and lower fee income. The fallout will strike both traditional firms and the online upstarts, whose numbers have surged from two in 1998 to the current 50.
“In the longer term, Hong Kong does not need more than ten to 15 online firms,” says Karen Buck, who runs Hong Kong operations for New York,based TD Waterhouse Group, a Hong Kong Stock Exchange member since late 1999 that is expanding its existing online operation.
Competitive pressures are already increasing. The exchange’s nonmembers, which include many of the new online partnerships, have begun slashing commissions , in some cases, eliminating them, albeit temporarily. In April of next year, when the exchange eliminates the 0.25 percent per-trade minimum for its 490 members, the price warfare will intensify.
The blood will be spilled in the quest for future riches rather than immediate spoils. There are an estimated 1 million active retail investors among Hong Kong’s 6.8 million residents. Although the city’s stock market investors have a notoriously active and short-term profile, individuals currently account for only 45 percent of total exchange activity. That compares with about 80 percent in such places as South Korea and Taiwan. And just 13 percent of Hong Kong stock market activity takes place online, which pales in comparison with South Korea’s roughly 60 percent. There is no day-trading community to speak of in Hong Kong.
Still, though coming relatively late to the cybertrading craze, Hong Kong has embraced electronic trading with a vengeance. According to Hong Kong,s Securities and Futures Commission, that 13 percent online penetration, reported in November, was ten times what it had been just seven months before. Once the stock exchange completes its technological makeover (32 exchange members began a phased introduction of the new system in November), the number of online investors is expected to double. Most projections put online trading at about 40 percent of total market activity within three or four years.
Known as AMS/3, the Hong Kong bourse’s new system will for the first time allow orders to be placed over the Internet or by mobile phone. It will transfer the orders electronically through a brokerage firm to the trading floor, back to the brokerage, then to the customer , all in about two seconds. The current system can take as long as 15 minutes to process the same information. With AMS/3 in place, Hong Kong’s retail investors will finally get to experience the full power of the Internet, something investors in many other major financial centers already enjoy.
Ambitious and affluent , per capita GDP reached HK$182,500 ($23,400) in 1999 , Hong Kong residents also seem to have a natural affinity for technology, which is one reason experts predict that legions of new investors will jump into the market. “There will be some conversion of traditional trading to online trading, but at the same time, there will be new investors who are 20 to 35 years old , younger investors who are Internet-savvy,” says Jasmine Soo, a senior analyst in Hong Kong for International Data Corp., a technology research firm.
A recent Nielsen/NetRatings survey found that Hong Kong’s Internet subscribers spend ten hours and 13 minutes per month online, more than their peers elsewhere in Asia. IDC forecasts that the number of Hong Kong Internet users will jump to 3.4 million by 2004, from 1.4 million now. Three out of four residents already carry mobile phones, though less than 1 percent use them to connect to the Internet. IDC predicts that 56 percent of the population will have a mobile Internet connection by 2004, when the number of mobile phone users could reach 6.9 million, or about 92 percent of the projected population. The convergence of Internet and mobile phone technologies, coupled with the speculative nature of much Hong Kong investment, could make the city a “hotbed for wireless mobile trading,” says Soo.
The advent of the new technology will upset the status quo in Hong Kong’s brokerage community. The exchange, Asia’s second most active after Tokyo,s, is divided into three member categories. The first consists of the 14 largest international firms, those with a mostly institutional clientele, such as Morgan Stanley Dean Witter and Citigroup’s Salomon Smith Barney. These firms account for about 40 percent of trading locally and offer access to all of the world,s exchanges. A second tier of 41 midsize firms, including Cash on-line, KGI, Hong Kong,based South China Holdings, South China Online and Tai Fook, together account for about 35 percent of market activity and cater to a mix of retail and institutional clients that focus largely on Hong Kong’s 736 publicly traded companies. Most offer some connection to the U.S. or to other Asian markets. And last, there are 435 small brokerages, exclusively retail and local, that are vying with one another for slivers of the remaining 25 percent of the market. Outside the exchange’s immediate control are the roughly 50 partnerships or other new online entities.
Because the largest firms are so well capitalized, experienced in online trading and able to offer so many other financial services, they are expected to weather any price competition and capture market share over the next year or two. Certainly, the executives at these diversified and deep-pocketed firms are confident that their smaller rivals will not be able to offer the products needed to retain customers or win new ones. Moreover, online trading requires a huge investment in computer systems that are robust enough to meet the full range of investors, needs. “You can connect to the stock exchange with one PC [and very limited online services], or you can connect with a bank’s 300 services. Which is the customer going to sign up with?” asks Richard Kimber, head of personal e-business for the Asia-Pacific at HSBC.
Not surprisingly, smaller competitors don,t think it’s quite that simple. Chun-Leung Chan, who heads 2cube, and Tai Fook Online’s Wong, among others, contend that small and midsize local firms understand the intricacies of the market , both investors and companies , better than newer arrivals. Hong Kong,s first organized stock exchange was established in 1891, and reports of informal securities trading go back several decades before that. Vast new global product lines, instantaneous pricing and multimillion-dollar advertising expenditures are unlikely to unravel overnight customs and relationships developed over more than a century.
Based on 2cube’s own research, Chan notes that “95 percent of Hong Kong investors are interested only in trading Hong Kong stocks, because they know Hong Kong companies.” The smaller firms have their own networks of contacts, and their traders understand the markets best, according to Chan and Wong.
With branches throughout the city, the locals also have name recognition and the trust of clients. Despite Hong Kong’s cosmopolitan image, residents usually prefer to deal with a firm that they, or even their parents, have known for decades. Wresting such clients, particularly the older ones, away from the smaller firms in the next few years will be difficult.
Still, even those who don,t foresee a massive shakeout, like Richard Ho, dean of the business faculty at City University of Hong Kong and a specialist in Asia-Pacific financial markets, do expect a significant number of firms to disappear. Ho estimates that about 20 percent of the smaller firms will be forced to shut down or merge with competitors.
One view shared by nearly all the parties, however, is that it will not suffice to offer online services exclusively. Indeed, only Boom.com operates without a traditional firm as a backup. The high-net-worth customers targeted by many of the largest firms tend to prefer to pick up the phone and call their special account executives at their favorite brokerages. “The rich people in Hong Kong have already established relationships with their own brokers. They would not go to global online traders,” says Wong.
Those championing the Internet, whether local or foreign, may also be underestimating the social aspect of investing in Hong Kong, say some observers. “Hong Kong is not like the U.S. or South Korea,” says Christina Cheung, head of South China Online. “People live in a small area and prefer to go to a brokerage house. It is a social gathering. Retired people or housewives can chitchat and talk to other investors and spend their leisure time there.” Like most firms, South China is hedging its bets: It changed its name in 1999 from South China Brokerage Co. to South China Online, though it plans to continue offering traditional services.
Wong believes the big players will end up beating a hasty retreat once they confront the entrenched relationships and limited size of the Hong Kong market. “International online stock brokers will spend too much money to pay for a small piece of the cake and then pull out,” he says. “There is not enough bread to go after for them. They are not well known in Hong Kong. You have to spend a lot of money even to build a brand name.”
Most firms are scrambling to find a position somewhere between the virtually unlimited product menus of the global behemoths and the narrow selections offered by local firms. At the same time, they want to balance traditional and online activities. They,re seeking a niche they can exploit without expending all their capital trying to be all things to all investors. They are also trying to avoid rampant price-cutting. “If you get involved in discount games, it is going in one direction only: You are eliminating each other,” says Boom.com CEO Mark Duff. “Do you want to attack international online traders? They are 800-pound gorillas, and they have more marketing muscle than anyone. Do you want to take that head-on?”
Duff’s answer is to distinguish his online service by means other than just pricing. Boom.com focuses on upper-middle-class professionals with incomes of between $50,000 and $150,000, offering them trading in U.S. securities as well as in those that trade on seven Asian stock markets, including Hong Kong,s, plus insurance products and mutual funds.
Even the largest firms seem to be trying to sidestep the slugfest over existing customers. As present, Morgan Stanley and SSB are confining their online business to institutional clients in Hong Kong (though Salomon’s Citigroup sibling, Citibank, is expected to offer an online trading system for retail customers), while Merrill Lynch & Co. says it has no plans to launch a big local retail attack on its own this year. Instead, Merrill will focus on its global joint venture with HSBC, Merrill Lynch HSBC. The pair introduced their global Internet banking and brokerage service (unrelated to HSBC’s Hong Kong,based online trading system) late last year in Canada and Australia, and they plan to be operating in 20 countries (including Hong Kong this year) by 2005.
Charles Schwab is looking to set itself apart from the crowd by targeting young professionals who have not yet established strong ties to a particular brokerage. Following the clicks-and-mortar approach it pioneered in the U.S., Schwab opened its highly visible street-level office facing the main commuting route into the city center in the Admiralty District in October. (Though Schwab offers a full range of products online, the branch is meant to present a tangible face to the investing public.) Shortly afterward the firm opened a call center, Asia’s first, in Causeway Bay, to handle investor inquiries and allow clients to feel comfortable interacting with the firm.
“I don,t think we can come here and take over the market. We will be a good complement to the market,” says Larry Yu, who oversees Schwab’s Asia-Pacific services. “We are not targeting existing retail investors, who account for about 18 percent of the population, but an additional 12 percent who are potential investors.”
For those seeking to poach existing investors, an acquisition is another route into the marketplace. E*Trade last year purchased TIR Securities, a local institutional discount brokerage that came with a Hong Kong Stock Exchange seat. The firm has also set up E*Trade Securities (HK) for its retail business. The head of the firm’s online business for the region, Mathias Helleu, understands that Hong Kong is a tightly knit marketplace. Thus to start E*Trade will offer only local equities for retail customers. “If you look at the number of investors, Hong Kong is a small market, but it is one of the major financial markets. Our goal would be to make Hong Kong a hub from which to expand into other parts of Asia,” Helleu says.
Even as the the city’s firms scramble to find a profitable niche, there are encouraging signs that the increase in business will live up to expectations, though that growth won,t come cheap. Advertised transaction rates continue to fall. KGI undercut everyone last May with a special promotion: no commission for six months. More recently, it featured a 0.15 percent rate for customers signing up at its cybercafé. Other firms followed suit. In November, 2cube featured a 0.18 percent rate, and Hutchison CSFBdirect, which went live in January, is offering a 0.2 percent rate through April.
Most online brokerages say they are encouraged by the response. After more than a year of offering online brokerage services, TD Waterhouse officials say online trading now accounts for slightly less than 20 percent of its total volume. KGI insists that online trading (in which it also includes touch-tone phone transactions) made up about 15 percent of trading revenue in November. And KGI’s online clientele increased fivefold last year, from 2,000 in January to about 10,000 in December.
Signs of a growing market hearten competitors like HSBC’s Kimber. He likens Hong Kong’s brokerage environment today to that of Australia two years ago. “If you look at Australia in the past two years,” he says, “they doubled trading volume and the number of retail investors who owned shares after they introduced the straight-through process in November 1998.”
In Australia HSBC now does 90 percent of its stock trading volume online and ranks as the country,s third-largest retail brokerage. Two years ago it was 15th. Kimber attributes HSBC’s rapid rise to its early and aggressive shift to cybertrading. He has similar aspirations in Hong Kong.
Of course, so do dozens of other fierce competitors.
