Business model modernization is key to improving sector's health, says McKinsey

Comprehensive transformation is imperative for Chinese securities firms, as their performance slumped significantly last year due to following outdated business models, according to a report from global consulting firm McKinsey and Co.

The combined income of the 131 securities firms in the report dropped 11.9 percent year-on-year, totaling 126.6 billion yuan ($18.7 billion) during the first half of 2018. During the same period, their combined registered net profit margin contracted to 26 percent from 36 percent in 2017.

The decline continued into the subsequent months.

The combined net profit of the 131 securities firms dropped 42 percent year-on-year during the first three quarters of 2018, according to statistics from the Shanghai-based market information provider Wind Info. By November, among the 35 securities firms providing comparative figures from 2017, 29 of them reported losses.

Industry competition was characterized by the top firms improving and weaker firms falling further behind last year, according to McKinsey. The top 10 securities firms contributed the majority, 70 percent, of industry profit in the first half of last year. The combined profit of the weakest 81 firms was negative during the first six months of 2018.

Richard Huang, partner at McKinsey and Co, said that the leading securities firms are stronger in the institutional and asset-heavy businesses. They also started their digital transformation earlier.

More importantly, Huang said, they have given up their former internal structures based on smaller teams, adopting a talent pool structure that is more widely seen in mature markets.

The decline in initial public offerings last year resulted in contracting business for securities firms, industry insiders said.

According to financial market tracker Eastmoney Choice, 60 securities firms providing IPO sponsor and underwriting services reported a total combined income of 5.31 billion yuan in 2018, a sharp drop from the 14.99 billion yuan reported in 2017.

This sluggish performance has forced securities firms to downsize their headcounts.

According to McKinsey, about 18 securities firms shut their institutions in the northeastern and western regions of China.

Eastmoney Choice estimated that there were at least three securities companies laying off 1,000 people each by October. Beijing-based JZ Securities saw the most job cuts, with 2,503.

Huang from McKinsey said that the job-cutting trend in the industry has continued for at least two years, as it is one of the most frequently adopted methods to reduce costs in the short term.

Small and medium-sized securities firms were the most significantly affected, and some of them also lowered employees' salaries.

Against this backdrop, Huang said, industry integration can be expected in 2019, with smaller firms merging with larger players.

Similar to the development path taken by securities companies in mature markets like the United States, the Chinese securities industry may comprise large comprehensive service providers and boutique firms, he noted.

"Although the industry is facing some difficulties, we still see huge room for development. The reform of the capital market is playing a significant role. The system will be completed more rapidly, signaled by the introduction of a science and technology innovation board and the accelerated delisting process," said Huang.

Meanwhile, China's securities industry promises huge potential in terms of the diversity of products and services, he added.

"As the industry has become more international, overseas institutions will bring in innovative services, products and systems, which will help to improve the entire industry," he added.