As we enter 2021, one of the main factors for global securities firms' credit quality is the economic and market fallout from the COVID-19 pandemic; how officials, markets, and firms respond to it; and, hopefully, the recovery from it. That said, market development, investor participation, competitive dynamics, and revenue drivers for securities industries vary significantly by country. As a result, our outlooks and ratings on securities firms are typically driven more by local themes and conditions rather than global issues.

Sectorwide Assumptions

Economic and market conditions

Our base case is for a global economic recovery in 2021, albeit with substantial risks to the forecast and geographic variation. In the absence of a clear economic turnaround, we see global markets at risk to the potential expiration or faltering of government stimulus and market support programs, elevated defaults, and the overhang from high debt leverage. Positive factors include low rates and the potential for economic rebound, particularly if COVID-19 vaccines can be widely distributed rapidly and prove effective.

As vaccine rollouts in several countries continue, S&P Global Ratings believes there remains a high degree of uncertainty about the evolution of the coronavirus pandemic and its economic effects. Widespread immunization, which certain countries might achieve by midyear, will help pave the way for a return to more normal levels of social and economic activity. We use this assumption about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly

Interest rates

Governments' responses to COVID-19 are likely to prolong accommodative central bank policies and low rates globally. That said, while this may lower borrowing costs, the impact of low rates varies considerably given different business models across the globe. For instance, it, will weigh on retail brokers' revenue earned on spread and on client cash balances, which in the U.S. is typically a big portion of revenue, but it is much less so in China. The persistence of close to zero interest rates for a considerable period of time could also dampen fixed-income sales and trading revenues for institutional brokers.

Market volatility

We generally expect market volatility to normalize, after the very high levels in 2020 (especially in the first two quarters). That said, prolonged low rates, particularly if economies rebound, could fuel bubbles in asset prices, especially given the recent run-up in equity markets in many countries. This could cause market volatility to spike in some markets, particularly if markets become sensitive to the potential withdrawal of government support programs. Higher market volatility increases risk and potential for losses, as well as reduces investors' participation.

Debt issuance

While the amount of debt issued in 2020 greatly exceeded expectations, we expect it to decline in 2021, reducing total underwriting opportunities and fees, albeit with considerable variation from country to country.

Regionalization

We believe that increased focus on governance and transparency as well as defensive efforts to delist some foreign companies from key capital markets, including a well-publicized effort to delist some Chinese companies from U.S. equities markets, could inhibit the flow of capital. At the same time, we expect the continued opening of China's markets to spur their development.

Retail investor participation

The increase in retail investors' participation is another recent trend across much of the globe that we expect to play out in 2021. In the U.S, retail investors represented as much as 25% of total equity transactions in 2020, versus 15% the year before. While some of this may be attributable to people being locked down at home, and therefore could reverse in 2021, we think it is more fundamentally driven and has more important ramifications in the U.S. and Russia. To some extent, the surge in retail participation is benefiting securities firms more than exchanges in the U.S. since most of the trades are internalized by market-makers/wholesale brokers (who acquire the orders from retail brokers) or executed on dark pools and do not reach exchanges.

Conversely, retail investor participation has always been high in Asia, and it has been the development of the institutional investor base, particularly in China, that is the bigger story there.

Regulation

We expect regulatory reform to continue across the globe, with the U.S. regulatory rollback likely over with the new administration, Russia implementing new capital and liquidity requirements on firms, and the EU and U.K. implementing new regulations.

Economic and industry risks

Currently, the securities firms in France, the U.K., and Chile face elevated economic risk (as well as industry risk in France). If this increases, we could lower the anchors--or starting point for the ratings--for securities firms in those countries (see "An Update On Securities Firm Anchors By Country (December 2020)," Dec. 17, 2020).

Individual firms

Individual firms' business mix, recurring revenue, exposure to market and economic conditions, risk-adjusted capitalization, liquidity, and appetite for acquisitions will continue to be the primary drivers of ratings and rating changes.

U.S. Retail Securities Firms: Fundamentals Are Good On Market Rebound, But Lower Rates And Potential Market Volatility Could Weigh On Earnings

Key expectations

Ratings should be largely stable.  We expect that any rating changes will be driven by firm-specific, more than sectorwide, issues.

Potential COVID-19 market hangover.  The withdrawal of the Fed's COVID-19 measures to support markets could spark market volatility, particularly given the tightening of credit spreads and big run-up in U.S. stocks since March 2020. However, if the Fed remains too accommodative for too long in the face of recovery, it risks feeding another round of asset price bubbles further down the line. Higher volatility increases the potential for market losses, the amount of margin that firms post to the clearinghouses, and the amount of capital required to support a trading book.

Regulation.  The new administration is likely to increase regulatory scrutiny of the sector and, over time, push regulatory reforms that could increase costs and limit some revenue sources. While there has been some effort to initiate a financial transaction tax in New Jersey, we do not expect the new administration to push a federal one. However, if one is eventually enacted without an exemption for market-makers, it could hurt the technology-driven trading firms.

Low short-term interest rates.  We expect low rates will continue to depress all retail firms' profitability to varying degrees. We expect brokers that own banks to have less incentive to sweep brokerage clients' uninvested cash to their own banks, unless they invest in riskier assets. The exception is Schwab, which is much more reliant on interest spread income.

Transformed discount brokerage sector.  Consolidation has concentrated the subsector and brought in Morgan Stanley, a wild card with its ownership of E*Trade. We expect retail participation to remain elevated, even if the COVID-19 vaccine returns most people to work, because they can trade without commissions. However, because of zero commissions, this will be less profitable for the brokers. Payment for clients' order flow may be a source of revenue, but it is likely to attract more regulatory scrutiny with the new administration.

Key risks

Market correction.  While not anticipated, we see some chance of a market correction given the stock market run-up since March 2020 and the pandemic. This would decrease asset-based fee revenue for all retail firms, further depressing profitability already hurt by low interest rates. This could again put pressure on the highly leveraged private equity-owned independent brokers (Kestra, Advisor Group, and Aretec), particularly those with debt to EBITDA-based covenants.

Cyber risks.  Cyber remains a potential financial and reputational risk for all U.S. financial institutions.

Profitability and competitive pressures.  We think discount and independent brokers and smaller unrated firms could face profitability challenges and competition, increasing pressures to grow, including through acquisitions. Conversely, this represents opportunities for some of the higher-rated firms to be consolidators.

Discount brokers

Charles Schwab Corp., IBG LLC

Independent brokers

Advisor Group Holdings Inc., Aretec Group Inc., Kestra Advisor Services, LPL Holdings Inc.

Other predominantly retail firms

Oppenheimer Holdings Inc. and Raymond James Financial Inc.

U.S. Institutional Securities Firms: Capitalization And Liquidity Buffers Should Support Ratings

Key expectations

Market rebound.  A continued rebound in markets would be favorable for traditional institutional firms like Jefferies Financial, Cantor Fitzgerald, Stifel, and, to a lesser extent, Raymond James. But, it would likely reduce the trading revenue of the technology-driven trading firms (Jane Street, Hudson River Trading, DRW Holdings, VFH Parent, and Citadel Securities), which benefited greatly from the pickup in volatility in 2020. Increased market volatility has the opposite effect and would hurt risk-adjusted capitalization for all institutional firms.

Underwriting volumes.  While underwriting volumes in some areas like municipal debt and lower-rated credits may increase, they're likely to be down overall as issuance levels normalize after a record year in 2020, affecting Jefferies Financial, Cantor Fitzgerald, Stifel, and Raymond James.

Credit losses.  We expect credit losses to increase as firms work through the fallout from the COVID-19 economic recession, which could affect Jefferies, Stifel, Raymond James, and, to a lesser extent, Cantor Fitzgerald.

Capital and liquidity.  Capitalization and liquidity buffers should support ratings. As credit and market risks play out, capital and liquidity will remain key rating drivers.

Key risks

Operational risk.  If market volumes and volatility swell again in 2021, operational risk--particularly potential "low-probability, high-impact" failure of risk management systems at technology-driven trading firms--could increase. Cyber risk continues to be an important risk to monitor.

Repurchase agreement funding costs.  Cost of this funding could increase if the Fed is unable to maintain liquidity in this market, potentially eroding availability of funding for firms' securities positions.

Wholesaling of U.S. retail investors' equity and options orders.  This has become more attractive with the growth in retail investor trade volume (Virtu and Citadel Securities). However, we believe this activity is likely to draw additional regulatory scrutiny, particularly as discount brokers may look to increase their revenue from wholesale market makers payments for order flow.

Rated institutional securities firms

Wholesale institutional.  Jefferies Financial Group Inc., Cantor Fitzgerald L.P., StoneX Group Inc., Stifel Financial Corp.

Trading firms.  Citadel Securities L.P., VFH Parent LLC (Virtu), DRW Holdings LLC, Jane Street Group LLC, Hudson River Trading LLC

Table 1

U.S. Securities Firms Ratings And Rating Component Scores
Company	Anchor	Business position	Capital, leverage, and earnings	Risk position	Funding	Liquidity	Comparable ratings adjustment	Group SACP	External influence*	Issuer credit rating	Outlook
Advisor Group Holdings Inc.	bbb-	Adequate	Very weak	Strong	Adequate	Adequate-High	0	b+	-2	B-	Stable
Aretec Group Inc.	bbb-	Adequate	Very weak	Strong	Adequate	Adequate-High	0	b+	-2	B-	Stable
Cantor Fitzgerald L.P.	bbb-	Adequate	Adequate	Adequate	Adequate	Adequate-High	1	bbb	-1	BBB-	Stable
Citadel Securities L.P.	bbb-	Adequate	Strong	Adequate	Adequate	Adequate-Low	1	bbb	-1	BBB-	Stable
Charles Schwab Corp.	bbb-	Very strong	Strong	Strong	Very Strong	Strong	-1	a+	-1	A	Stable
DRW Holdings, LLC	bbb-	Moderate	Adequate	Moderate	Adequate	Adequate-Low	1	bb	-1	BB-	Stable
Hudson River Trading LLC	bbb-	Moderate	Adequate	Adequate	Adequate	Adequate-High	0	bb+	-2	BB-	Stable
IBG LLC	bbb-	Adequate	Very strong	Adequate	Adequate	Adequate-High	0	bbb+	-1	BBB	Stable
INTL FCStone Inc.	bbb-	Adequate	Adequate	Moderate	Adequate	Adequate-High	0	bb+	-2	BB-	Stable
Jane Street Group, LLC	bbb-	Moderate	Strong	Moderate	Adequate	Adequate-Low	1	bb+	-2	BB-	Stable
Jefferies Financial Group Inc.	bbb-	Adequate	Strong	Adequate	Adequate	Adequate-High	1	bbb+	-1	BBB	Stable
Kestra Advisor Services	bbb-	Adequate	Very weak	Strong	Adequate	Adequate-High	0	bb-	-2	B	Stable
LPL Holdings Inc.	bbb-	Strong	Weak	Strong	Adequate	Adequate-High	0	bbb-	-1	BB+	Negative
Oppenheimer Holdings Inc.	bbb-	Adequate	Adequate	Adequate	Adequate	Adequate-Low	-1	bb	-2	B+	Stable
Raymond James Financial Inc.	bbb-	Strong	Strong	Adequate	Strong	Strong	0	a-	-1	BBB+	Stable
Stifel Financial Corp.	bbb-	Adequate	Adequate	Adequate	Strong	Strong	0	bbb	-1	BBB-	Stable
VFH Parent LLC	bbb-	Adequate	Weak	Adequate	Adequate	Adequate-Low	1	bb	-2	B+	Stable
*External influence reflects holding company structural subordination.

China: Matthew Effect Continues Amid Rising Market Opportunities

Key expectations

The securities firms with leading market positions and strong balance sheets will stand out amid the rising competition due to their established client bases and ability to provide comprehensive services by coordinating business lines. Leading brokers have stronger balance sheets to support their expansion of capital-intensive business. They also have more financial resources to innovate, such as in fintech, to improve services quality and enrich product offerings.

Capital markets reforms and cross-border fund flows should support markets and underwriting volume.  We expect registration-based IPO procedure, the government's stance to make direct financing a top priority, and a healthy IPO pipeline will help support the revenue stability and profitability for securities firms. Cross-border trading, asset allocation, and other related products and services should add to revenue sources and provide a competitive edge for those securities firms with integrated onshore-offshore operations and relevant licenses.

With the scraping of foreign ownership limit on securities firms, global players look to increase their presence in China and further stifle competition, especially in areas such as wealth management, asset management, financial advisory, and derivative products.

Registration-based IPO procedure, as opposed to a regulatory approval framework, could increase procedural efficiencies and underwriting volumes, though it also imposes a higher standard for due diligence efforts.

We expect securities firms to strengthen internal controls and risk-management capabilities.  In our view, the revised regulatory rules on risk management assessment is credit positive, strengthening securities firms' internal controls, including governance and enhanced risk monitoring over subsidiaries. We also expect securities firms to focus more on operational risk controls and compliance issues due to the higher scrutiny and penalty under the registration-based system for securities origination.

Capitalization buffer could wane with the expectation that leverage will likely rise.   Chinese securities firms have accelerated their asset expansion in recent years, supported mainly by capital placements. Thus, the industry's leverage ratio picked up by only 0.5x to about 3.8x in third-quarter 2020 from 2017 and is still low compared with the developed markets. For our rated companies, their leverage increased faster and is about 1.5x higher than the industry average because they are mostly strong players and are given more accommodative regulatory capital requirements. And we expect their leverage to continue to rise.

On a risk-adjusted basis, we view directional equity exposures to be of higher risk, and fast growth in this segment could put pressure on our capital and earning assessments. The allocation to equity exposure may relate to the co-investment rule on some IPO deals and private equity investment to secure investment banking deals under the registration-based system.

Key risks

Ongoing high market volatility.  Challenges rising from economic recovery due to COVID-19 and the pace of reform could add market volatility in the short term. We expect capital market reform to be ongoing, which could bring temporary shocks as the market digests those changes. Curbs on real estate investment and the advancing of banks' wealth management product clean-up could whet domestic investors' appetite for equity investment, not to mention the inflow of foreign money into China's markets. While market sentiment and trading activities are high, a quick increase in valuation could catalyze an asset bubble and underpin high volatility. This is particularly true for the high-tech sectors.

How new product risk is managed.   New businesses could add complexity to securities firms' risk profile. For example, over-the-counter derivatives have undergone fast growth since the licenses were regranted to a few leading brokers in 2018. Very few brokers dominate the market, while the risk management for this type of new business is not an easy task with the lack of critical market depth and other unique features of the A-share market.

Accumulating credit risk.  The total volume of margin financing is piling up, approaching the historical high level, especially while some brokers are still resolving some of their legacy stock-pledged lending exposures. The default rate in the domestic bond market is likely to increase, though it's still low. We expect to see more defaults of state-owned enterprises (SOEs) with more market-based debt restructuring. The government willingness to support is likely to differ among SOEs and remain stronger for public policy-focused ones. This will put pressure on the proprietary bond investment and trading book and heighten risk for brokers with investment concentration.

Table 2

Chinese Securities Firms Ratings And Rating Component Scores
Company	Anchor	Business position	Capital, leverage, and earnings	Risk position	Funding	Liquidity	Comparable ratings adjustment	Group SACP	External influence*	Issuer credit rating	Outlook
China International Capital Corp. Ltd.	bb	Strong	Strong	Adequate	Adequate	Adequate-High	0	bbb-	1	BBB	Stable
CITIC Securities Co. Ltd.	bb	Strong	Strong	Strong	Adequate	Adequate-High	0	bbb	1	BBB+	Stable
Dongxing Securities Co., Ltd.	bb	Moderate	Strong	Adequate	Strong	Adequate-High	0	bb	3	BBB	Stable
Guotai Junan Securities Co. Ltd.	bb	Strong	Very Strong	Adequate	Strong	Adequate-High	0	bbb	1	BBB+	Stable
Haitong Securities Co. Ltd.	bb	Strong	Strong	Adequate	Adequate	Adequate-High	0	bbb-	1	BBB	Stable
Huatai Securities Co. Ltd.	bb	Strong	Strong	Adequate	Strong	Adequate-High	0	bbb-	1	BBB	Positive
Orient Securities Co. Ltd.	bb	Adequate	Strong	Moderate	Adequate	Adequate-High	1	bb+	1	BBB-	Negative
Shenwan Hongyuan Securities Co. Ltd.	bb	Adequate	Very Strong	Adequate	Adequate	Adequate-High	0	bbb-	1	BBB	Stable
Zhongtai Securities Co. Ltd.	bb	Adequate	Strong	Adequate	Strong	Adequate-High	0	bb+	1	BBB-	Stable
*External influence reflects government support for all but Dongxing, which reflects group support.

Russia: Increasing Regulatory Oversight And Expanding Retail Investor Base Are Positives

Key expectations

Growth in the number of brokers' mass-market retail clients will continue in 2021-2022.  We anticipate the number of retail investors, as well as brokerage asset volume, will continue to rise in the next two years. We estimate that the number of retail brokerage clients could reach 13 million by year-end 2021, compared with over 7.6 million registered on the Moscow Exchange at the end of September 2020. This creates growth opportunities for all market participants--both independent brokers and banks' brokerage subsidiaries. We note that a sizable part of retail brokerage accounts remains empty, while about 75% of accounts hold below Russian ruble (RUB) 10,000 (about $140), according to Central Bank of Russia. Therefore, growth in clients' brokerage assets lags growth in the number of open accounts (chart 3).

Capital markets conditions are attractive for Russian retail investors because of:

• Popularity of alternative investments, due to decreased rates on deposits, given the Central Bank of Russia gradually cut the key rate to the all-time low of 4.25% as of July 2020, from 10% at year-end 2016;
• Volatility in capital markets and devaluation of Russian ruble in 2020, increasing returns from equities and foreign assets;
• Newly introduced tax on deposits exceeding RUB1 million (about $13,000) from 2021;
• The ease of opening brokerage accounts, which can now be done online;
• A decreasing minimum entry amount for brokerage accounts;
• Developments in electronic trading; and
• Cancellation of commissions by some brokers.

In addition, about 10% of the economically active population of Russia of about 75-80 million people has brokerage accounts--approaching that of China of about 15% but still significantly below the U.S. and the U.K.

Positive outlooks on two of five rated Russian securities firms reflect favorable growth opportunities in the retail segment.  Positive outlooks on two rated largely retail brokers--FG BCS and its operating subsidiaries and on Freedom Finance--indicate our expectation that growth prospects in the retail segment will enable these firms to achieve sustainable controlled business growth and diversify revenue without increasing their risk in the next 12 months.

Higher ratings on Ronin Europe and Veles Capital than on domestic peers reflect their much stronger capitalization and lower risk appetites, as well as their ample liquidity positions, which provide a sizable cushion in case of a market downturn. The lower-than-peers rating on Renaissance is based on its lower capitalization, as well as its vulnerable funding profile due to reliance on short-term collateralized funding.

Regulatory oversight over Russian securities firms is increasing.  We believe that the Central Bank of Russia's progressively stricter regulation of domestic securities firms aims to protect unqualified retail investors and strengthen liquidity and capital requirements. New capital adequacy regulation--the first of its kind in Russian securities market--will be phased in starting from 4% in April 2022 and progressively increase to 8% by April 2025. We expect brokers will reshuffle their balance sheets to optimize capital allocations.

This more comprehensive and supportive institutional framework could improve the resilience of the sector and help to reduce confidence sensitivity. Further, such regulation acts as a barrier to entry to limit new competition. Despite these developments, the regulation of Russian securities firms still lags that for securities firms in the EU, which comply with the European Markets in Financial Instruments Directive (MiFID II) legislation.

Leading independent securities firms will defend their positions in key segments and maintain adequate profitability.  We think that independent securities firms should be able to sustain leadership in their core segments serving institutional investors and high-net-worth individuals, capitalizing on strong customer relationships with their key clients, who value customer service over execution costs. The increasing muscle of large Russian banks pursuing growth in the mass-market brokerage segment therefore does not really challenge key competencies of independent securities firms of proprietary trading and market-making, in our opinion.

On the other hand, we think that growing retail franchises would boost securities firms' profitability, diversify their customer bases, and improve their overall business stability. Further, this would diversify revenue sources, reduce dependence on trading-related revenue, and decrease revenue volatility.

Larger securities firms with established competencies in market niches, which are able to absorb increasing regulatory costs, adequately hedge market volatility, and compensate lower commissions by introducing new products, are likely to outperform smaller players. The size and revaluation of proprietary securities trading portfolios will cause volatility in earnings.

Key risks

Selling complex products to unsophisticated retail investors could exacerbate principal risks and incur high regulatory and legal costs.  We think the sale of complex products to unsophisticated retail investors increases principal risks for securities firms because it requires hedging, especially in times of increased market volatility. It may also lead to elevated risks of misselling. We have observed increased sales of structured products without capital protection to mass-market retail investors who may lack sufficient financial knowledge, positioning such products as alternatives to bank deposits.

Since the beginning of 2017, domestic brokers have issued about $7 billion worth of structured notes, of which about two-thirds by state-owned giant Sberbank of Russia, 14% by FG BCS Ltd., and the rest by other large Russian banks. In addition, a sizable volume of structured products is issued by their foreign (e.g., Cyprus) subsidiaries and structured products of foreign brokers offered to Russian investors. According to NAUFOR, structured notes in Russian ruble and foreign currency accounted for about 12% of assets in retail brokerage accounts as of year-end 2019. In reaction to growth in structured products, the regulator will require, starting in 2022, brokers to test retail investors on their understanding of complex products.

Rapid business expansion in retail challenges securities firms' risk management.  Expansion into retail brokerage should decrease customer concentration and reliance on key institutional clients for independent securities firms, thus significantly diversifying risks and providing more stable flows of fee income, especially in the volatile market. However, the ability to control business expansion will largely determine securities firms' risk. In addition, retail investors' risk appetite materially increased in 2020, and investment strategies are changing from longer-term to shorter-term investment, spurred by desire to make quick profits on market volatility.

There has been a clear shift of retail investors' interest from bonds to equities, from domestic to foreign assets, and from domestic bonds to structured products linked to performance of foreign equities. If the Russian ruble strengthens or equities fall, leading to retail investors' losses, retail investors could start to panic, leave the market, withdraw funds, and file complaints, thus creating negative publicity for brokerage firms.

Possible increase in volatility in Russian securities markets' in 2021.  We think that the volatility in Russian capital markets, which peaked in March 2020, could resume in 2021, depending on possible sanctions against Russian companies and individuals related to Alexei Navalny. There is a risk of international investors being banned from holding existing or acquiring new issues of debt and equity of sanctioned entities. Sell-off by foreign investors could lead to panic-driven selling by domestic investors, especially unsophisticated mass-market investors.

Banks outpace independent securities firms in gaining mass-market retail clients.  Over the past three years a few large banks have been gaining mass-market retail brokerage clients at a breakneck pace and have announced their ambition to dominate this segment. These banks benefit from their strong brand names and established branch networks and can cross-sell brokerage and asset management products to their traditional banking customers.

Sberbank, VTB, and retail bank Tinkoff had captured about 77% of mass-market retail clients by number (less by clients' assets) at the end of November 2020. The combined market share by a number of retail clients of the four leading independent brokers--FG BCS, Finam Holdings, Freedom Finance, and Aton--decreased to about 10% as of the same date from 34% at year-end 2017. This stiff competition strains independent securities firms' margins and compels them to offer riskier products with higher returns.

Table 3

Russian Securities Firms Ratings And Rating Component Scores
Company	Anchor	Business position	Capital, leverage, and earnings	Risk position	Funding	Liquidity	Comparable ratings adjustment	Group SACP	External influence*	Issuer credit rating	Outlook
FG BCS Ltd.	b	Strong	Strong	Moderate	Adequate	Adequate-High	0	b+	-1	B	Positive
Ronin Europe Ltd.	b	Moderate	Very Strong	Adequate	Strong	Strong	0	bb-	0	BB-	Stable
Investment Co. Veles Capital LLC	b	Moderate	Very Strong	Adequate	Strong	Strong	0	bb-	0	BB-	Stable
Renaissance Financial Holdings Ltd.	b+	Adequate	Adequate	Moderate	Moderate	Adequate-High	0	b-	0	B-	Stable
Investment Co. Freedom Finance LLC	b	Adequate	Adequate	Moderate	Adequate	Adequate-High	0	b-	0	B-	Positive
*External influence reflects holding company structural subordination.

Korea: Adequate Capitalization Should Support Continued Business Growth For Rated Securities Firms

Key expectations

Business diversification will continue amid a structural decline in domestic brokerage commission rates driven by the proliferation of online trading systems.  We expect large securities firms will continue to diversify sources of revenue generation through business growth in corporate lending, sell-down of overseas real estate or alternative investments, or sales of structured securities. In our view, stock brokerage commissions will contribute about 25%-30% of total net operating revenues for rated securities firms in the coming years, compared with about 35% in 2016.

Profitability will likely remain largely stable after some improvement in 2020.  High retail investor participation in the stock market in 2020 resulted in strong brokerage commissions and margin lending interest income for Korean securities firms, and we think this trend could continue in the coming year. That said, if market volatility increases, resulting in lower retail investor participation in the stock market, that could strain securities firms' profitability. This could happen if economic recovery is delayed in Korea because of a prolonged impact from the COVID-19 pandemic or if interest rates increase.

Large securities firms are well-positioned amid digital transformation and rising competition, thanks to their established online trading systems and comprehensive product and service offerings.  We believe rated securities firms have been solidifying their presence in response to increasing retail customer demand for domestic and overseas stock brokerage and various financial products sold online.

Increasing regulatory oversight over securities firms should help improve the resilience of the sector, in our view.  The regulator is planning to implement stricter liquidity requirements in domestic and foreign currency related to structured securities sold by securities firms and more closely monitor stress testing under highly volatile market scenarios, similar to those seen in March 2020. These are in addition to higher liquidity and capital requirements on contingent liability and real estate exposures implemented 2020. We think these measures will give securities firms an incentive to strengthen their liquidity and manage business growth in 2021.

Key risks

Increasing exposure in less liquid assets, such as corporate lending and overseas real estate or alternative investments, could strain rated securities firms' funding and liquidity.  This is particularly the case under stressed scenarios, given securities firms' reliance on short-term wholesale funding. That said, we expect rated securities firms under major bank holding companies will likely maintain adequate funding and liquidity, backed by potential support from their parents as needed.

Capital buffers could decline if business expansions are not supported by adequate capital generation or replenishment.  Korean securities firms have been expanding into businesses that could bear higher credit and market risk than traditional stock brokerage, such as corporate lending, overseas investments, and structured securities. Securities firms under major commercial bank holding companies have received sizable capital injections from their parents in the past few years, which will likely support their capitalization.

Internal controls related to sales of financial products will likely be strengthened amid rising regulatory oversight.  This follows a few incidents in the past two years where some private equity funds or complex products sold by securities firms incurred losses to customers. We believe risks related to product sourcing and sales processes remain relevant for rated securities firms, considering their large retail customer base and cross-selling practices with group affiliates. If these are not managed well, it may result in higher reputational risks or potential financial burden.

Table 4

Korean Securities Firms Ratings And Rating Component Scores
Company	Anchor	Business position	Capital, leverage, and earnings	Risk position	Funding	Liquidity	Comparable ratings adjustment	SACP	External influence*	Issuer credit rating	Outlook
Mirae Asset Daewoo Co. Ltd.	bbb-	Strong	Adequate	Adequate	Adequate	Adequate-high	0	bbb	0	BBB	Negative
NH Investment & Securities Co. Ltd.	bbb-	Strong	Adequate	Adequate	Adequate	Adequate-high	0	bbb	2	A-	Stable
KB Securities Co. Ltd.	bbb-	Adequate	Adequate	Adequate	Adequate	Adequate-high	0	bbb-	3	A-	Stable
Shinhan Investment Corp.	bbb-	Adequate	Adequate	Adequate	Adequate	Adequate-high	0	bbb-	3	A-	Stable
Hana Financial Investment Co. Ltd.	bbb-	Adequate	Adequate	Adequate	Adequate	Adequate-high	0	bbb-	3	A-	Stable
*External influence reflects group support for KB Securities, Shinhan Investment Corp., and Hana Financial Investment, and government support as a government-related entity for NH Investment & Securities.

European Institutional Securities Firms: Solid Franchises And Capital Bases Will Help Offset The Impact Of Uneven Market Activity

Key expectations

Institutional securities firms are well-positioned to face uneven market activity in 2021.  Following record volumes through the first six months of 2020, Europe's wholesale securities firms saw volumes retreat through the second half, with some seeing falls in revenue and volume relative to 2019. This reflected a broad repricing and rebasing of risk in the institutional market, with institutional clients bringing less volume to the market as the interest rate and macroeconomy were increasingly priced into their portfolios. For example, the international interest rate derivatives market had a steady decline in notional traded volume through the second half of 2020. In the final full week of 2020, volume fell roughly 10% from a year earlier as interest rates looked set to remain at historic lows across the world into 2021.

On top of this, Europe has not yet seen some of the trends that supported volumes in other global markets. For example, in the U.S. and Russia, where retail investors have helped to support market volumes during periods of volatility, with some institutional brokers picking up volumes. That said, European wholesale firms remained profitable, and we expect increasingly well-managed operating costs to enable stable, if lower, profitability and capital generation over the next 12 months as volumes remain uneven across asset classes.

Well-established prudential capital requirements in the U.K. and Europe should support capitalization.  Our rated European institutional securities firms entered 2020 with solid capital bases, and these remained broadly stable through the year with reasonable headroom above our ratings targets. These strengths are not purely idiosyncratic, and we would expect the continued formalization and rationalization of prudential capital requirements for securities firms--through the implementation of the Investment Firm Regulation and Investment Firm Directive in EU27 countries and in the U.K.--to support a stable capital base in the U.K. and Europe for our rated issuers, and in the market more broadly.

The simplification of MiFiD II will begin to ease regulatory burdens for EU27 securities firms.  In late December, the EU announced its plans to modestly roll back some of MiFiD II through the first quarter of 2021. Although the impact of these measures has yet to be seen, the simplification of certain informational requirements, for instance on disclosure of costs and charges, should ease the burden of regulation on market participants (see "MiFID II: Disruptive Regulatory Change For European Financial Markets, Winners And Losers To Emerge Over Time," Jan. 2, 2018).

Funding and liquidity will support ratings in a period of economic turbulence for the U.K. and European economies.  Our funding and liquidity measures are solid for rated wholesale firms in Europe, and we see this as an important rating factor as the firms face still weak economic conditions in 2021. U.K. financial markets will be further affected by the lack of equivalence between the EU and the U.K. in several markets, not least in the trading of shares and derivatives following the U.K.'s exit from the EU on Jan. 1, 2021, which saw significant volumes move to European venues. That said, cross-border access to core infrastructure, such as clearing and settlement, remains in place.

Key risks

Following a challenging period for global corporates and financial institutions, clearing brokers that lend to clients and customers could see elevated credit risk.  In general, most European securities firms do not engage in margin or Lombard lending to clients. That being said, some of our rated wholesale institutions lend directly to clients through their clearing brokerage activities to fund client exposures at clearinghouses. Marex Spectron Group Ltd. (BBB-/Negative/A-3) in particular is materially exposed to commodities producers through its clearing brokerage operations.

2020 saw a surge in leverage, and a general downward shift in global credit quality, and we do not expect these securities firms to be immune from credit risk as it materializes through insolvencies and defaults in the global economy. Although, securities firms are well-placed to manage these credit risks.

Continued tight risk control and assurance will be essential strengths to the sector's credit profile.  Further risk management and mitigation will be key over the next 12 months--not least in the area of cyber risk as global cyberattacks have steadily grown in number and sophistication over the past year. We expect to see our rated firms continue to invest in building robust defenses.

Rating outlooks

Despite broadly supportive market trends, our rated European securities firms both have negative outlooks due to idiosyncratic ratings risks. Marex Spectron's risk profile and capitalization remain under pressure as the group continues to expand and diversify its operations--supporting profitability but straining its broad capital position. Our negative outlook on Exane reflects the possibility that, in the pandemic's wake, the environment for French securities firms generally, and for Exane in particular, could be materially weaker, with pressure on the companies' revenue and earnings possibly more intense than what we expect in our base case. Consequently, Exane's strategic refocusing conducted in 2019-2020 could fall short in gradually restoring its earnings.

Table 5

European Securities Firms Ratings And Rating Component Scores
Company	Anchor	Business position	Capital, leverage, and earnings	Risk position	Funding	Liquidity	Comparable ratings adjustment	Group SACP	External influence*	ICR	Outlook
Marex Spectron Group Ltd.	bbb-	Moderate	Strong	Strong	Adequate	Adequate-High	0	bbb	-1	BBB-	Negative
Exane S.A.	bbb-	Moderate	Strong	Adequate	Adequate	Adequate-High	-1	bb+	3	BBB+	Negative
*External influence reflects holding company structural subordination for Marex, and group support for Exane.

Taiwan: Strong Capitalization Helps Ease The Potential Impact From Heightened Market Volatility

Key expectations

Operating performance could be volatile in the coming quarters, since it's highly correlated to the global and domestic stock market conditions.  Taiwanese brokers reported another year of good earnings in 2020, with un-annualized return on assets (ROA) of 1.99% in the first three quarters of 2020, benefiting from increased market turnover and good performance of domestic and overseas major stock markets after the severe market shock amid the COVID-19 pandemic. Nonetheless, we expect a slightly lower ROA in 2021 considering the global economic uncertainty as the COVID-19 impact evolves.

Rapid development of fintech and ongoing deregulation are unlikely to change the industry landscape over the coming quarters.  The regulator has opened up high-net-worth wealth management business, margin lending of overseas securities, and odd shares trading in recent quarters, and it's likely to extend the business scope of overseas brokerage and wealth management businesses. We believe larger players with more extensive resources and stronger fintech capacity could gain business opportunities as deregulation gains pace.

The sector's strong capitalization should provide a buffer against potential market volatility in 2021.  The sector's adjusted assets-to-equity ratio was about 3.3x in December 2019 and 3.5x in September 2020. While leverage could gradually rise in the coming quarters along with business expansion, we expect it to remain manageable and at a low level relative to global peers. In our assessment, all rated brokers in Taiwan have strong or very strong capitalization, and we expect this will continue for the next one to two years.

Key risks

• Increased appetite for market risk--to capture the opportunities of good market conditions since second-quarter 2020--could weaken individual brokers' risk positions and capitalization if the risk control capacity cannot catch up with the expanded risks.
• Higher fixed-income securities amid low interest rates and increasing new bond issuance in the market could also weaken some brokers' funding and liquidity, given a reliance on wholesale funding to support fixed-income investments.
• The growing threat from cyberattacks remains an emerging risk, given the global rise in the number and severity of such attacks in recent quarters. Risk controls are increasingly important for brokers to manage the greater use of more complex digital and fintech activities.

Table 6

Taiwanese Securities Firms Ratings And Rating Component Scores
Company	Anchor	Business position	Capital, leverage, and earnings	Risk position	Funding	Liquidity	Comparable ratings adjustment	SACP	External influence*	Issuer credit rating	Outlook
KGI Securities Co. Ltd.	bb+	Strong	Strong	Adequate	Adequate	Adequate-High	0	bbb	0	BBB	Positive
SinoPac Securities Corp.	bb+	Adequate	Very strong	Moderate	Adequate	Adequate-High	0	bbb-	2	BBB+	Stable
*External influence reflects group support.

Latin America: Expectations For Lower Profitability In 2021

Brokerage houses in Latin America saw lower transaction volumes during 2020 due to the slowdown in the economy coupled with the reduction in the risk appetite of clients because of the pandemic. But, they kept a conservative approach to their property positions and derivatives. Because of this, we expect lower profitability than pre-pandemic levels, but it will still be driven by fees and commissions and lower gains from proprietary portfolios. A large share of brokers in the countries we follow usually belong to financial groups. Their financial arms provide additional business products, such as wealth management or other investment alternatives, to their clients.

For 2021, political and economic conditions will continue to be a key factor for securities firms in the region, in addition to the financial system's performance. In the case of Chile, the country maintains high financial flexibility compared with other Latin American economies and has shown healthy indictors within its financial system. However, the impact of last year's social unrest, the pandemic, and political challenges strain the financial system's operating conditions.

Mexico has been struggling with private investor confidence since the presidential transition in 2019, as well as fiscal pressures due to contingent liabilities from the energy sector. These factors could hurt the financial system's performance and, consequently, securities firms' business volumes during 2021 and 2022.

Chile

Key expectations. 

• We expect profitability to remain subdued in 2021, since we foresee some agents maintaining low risk appetite, which affects brokers' margins and business volumes. Although volatility will continue in the face of the uncertain constitutional process, the recovery of the global economy will be a bigger factor for investors.
• Securities firms in Chile face elevated economic risk. If this increases, we could lower the ratings on securities firms operating in the country.

Key risks. 

• Uncertainty and potential additional episodes of market volatility could result from the new constitutional process or the presidential elections during 2021.
• Securities firms may feel the indirect impact from credit risk in the banking industry if the economy recovers more slowly than what we expect--below its potential growth trajectory--or due to additional internal or external episodes of market volatilities.
• Pension funds are an important part of the domestic market, providing stability to brokers' revenues. The two different approvals of pension fund withdrawals have resulted in an overall $30 billion withdrawal of the private pension system in the country, from a total of $200 billion. However, it's still unclear how much of this was reinvested back into the system.

Mexico

Key expectations. 

• Low and manageable property positions limit potential unexpected losses and rapid capitalization erosion. Despite adverse operating conditions and market volatility across the region, we expect most entities to maintain as their core business line fees and commissions rather than trading revenues.
• We expect lower bottom-line results due to a decline in business volumes as a result of the slowdown in the economy, coupled with the reduction in clients' risk appetite.
• We expect a gradual transition to ESG transactions in the Mexican capital markets, which could be relevant in terms of volumes in the long term.

Key risks. 

• The government's very small fiscal stimulus package to diminish the pandemic's impact on the economy, along with limited support to the labor market and businesses, will delay recovery in consumption and investment.
• Effective economic management that raises investor confidence and encourages private investment could mitigate structural weakness in GDP growth prospects, helping to reinforce sound public finances.
• These factors could hurt the financial system's performance and, consequently, securities firms' business volumes during 2021 and 2022.

Table 7

Latin American Securities Firms Ratings And Rating Component Scores
Company	Anchor	Business position	Capital, leverage, and earnings	Risk position	Funding	Liquidity	Comparable ratings adjustment	Group SACP	External influence	Issuer credit rating	Outlook
Larrain Vial S.A. Corredora de Bolsa	bb+	Strong	Strong	Adequate	Adequate	Adequate-high	0	bbb	0	BBB	Negative

Japan: Next Step In Structural Changes, Stable Revenue Buildup In Retail Business Remains Key

Key expectations

Structural pressure on retail profitability.  We expect that for traditional securities firms' retail business, less turnover of client assets, asset outflow of senior generations, and competition with online brokers could weigh on profitability. That could be somewhat offset if retail clients' trading flow remains elevated, as it has been during the pandemic.

Strong capitalization as well as continued business restructuring should support financial strength.  We expect the rated securities firms will maintain strong capitalization against risk assets, which is a supporting factor for their financial strength. Also, we expect firms, building on their earlier cost cutting, to focus on increasing stable revenue.

Capital markets performance is likely to be company-specific given firms' different focus areas.  In their overseas businesses, we believe it is important to manage revenue and scale relative to risk and costs by focusing on franchise strengths. At the same time, the focus on overseas businesses could result in volatility of performance, depending on market conditions.

Key risks

Progress on restructuring to stabilize revenues stalls.   We think it will be important for firms to increase steady revenue to secure profit through downturns and, in turn, stabilize their overall businesses. Rated securities firms have made progress cutting costs as part of their restructuring programs. Now, they are moving toward increasing and stabilizing revenue. A key to this is accelerating measures to accumulate asset-based, recurring revenue, particularly from retail businesses. Such revenue is relatively resilient to market conditions. On the other hand, it will take at least a few years to achieve benefits after implementing measures to increase stable fees.

Therefore, we view that the risk for firms would be turning their attention back to flow-based revenues. This is because an increase in client flow promptly pushes up revenues, though that is temporary and not sustainable.

More volatile capital market businesses.  While capital markets conditions will normalize in comparison with the first half of 2020, market volatility may create earnings opportunities through high volume in clients' activities and gains from the firms' own positions. Also, easing corporate debt levels and low interest rates would increase corporate demand for capital refinancing, including a shift from bank borrowings to debt issuance or issuance of equity-type securities to enhance their balance sheets. However, risks accompany such opportunities. Unexpected volatility surges and other market turmoil can hurt position values or substantially increase risk assets.

Rebound in cost in capital market businesses.  If firms expand their global operations to achieve revenue growth and we see a rebound in costs in their overseas businesses, that would work against the effect of their cost-reduction efforts.

Rated securities firm groups

We rate five in Japan: Nomura Holdings, Daiwa Securities Group, SMBC Nikko Securities, Mizuho Securities, and Mitsubishi UFJ Securities Holdings. However, only Daiwa is rated under the nonbank financial institutions rating methodology.

Table 8

Japanese Securities Firms Ratings And Rating Component Scores
Company	Anchor	Business position	Capital, leverage, and earnings	Risk position	Funding	Liquidity	Comparable ratings adjustment	Group SACP	External influence*	Issuer credit rating	Outlook
Daiwa Securities Group Inc.	bbb-	Adequate	Strong	Adequate	Adequate	Adequate-high	0	bbb	1	BBB+	Stable
*External influence reflects holding company structural subordination (-1) and government support (+2).

Related Research

• An Update On Securities Firm Anchors By Country (December 2020), Dec. 17, 2020
• Global Credit Outlook 2021: Back On Track?, Dec. 3, 2020
• Global Leverage | With Debt At $200 Trillion, Is A Crisis Inevitable?, Dec. 3, 2020
• Corporates | A Long Cycle Of Defaults And Debt Restructuring?, Dec. 3, 2020
• China | Do Recent SOE Defaults Indicate Systemic Risks?, Dec. 3, 2020
• Global Economic Outlook: Limping Into A Brighter 2021, Dec. 3, 2020
• Credit Conditions Emerging Markets: A Vaccine Won't Erase All Risks, Dec. 3, 2020
• Economic Research: Staying Home For The Holidays, Dec. 2, 2020
• Economic Research: The Eurozone Can Still Rebound In 2021 After Lighter Lockdowns, Dec. 1, 2020
• Economic Research: Asia-Pacific Forecasts Stabilize, Risks Now Balanced, Nov. 29, 2020
• China Recovery Could Bring More Defaults, Nov. 17, 2020
• Global Financing Conditions: Bond Issuance Is Expected To Finish 2020 Up 16% And Decline In 2021, Oct. 26, 2020
• Global Credit Conditions: The K-Shaped Recovery, Oct. 6, 2020

Primary Credit Analyst:	Robert B Hoban, New York + 1 (212) 438 7385; robert.hoban@spglobal.com
Secondary Contacts:	Thierry Grunspan, New York + 1 (212) 438 1441; thierry.grunspan@spglobal.com
	Chizuru Tateno, Tokyo + 81 3 4550 8578; chizuru.tateno@spglobal.com
	Emily Yi, Hong Kong + 852 2532 8091; emily.yi@spglobal.com
	Xi Cheng, Hong Kong + 852 2533 3582; xi.cheng@spglobal.com
	Jesus Sotomayor, Mexico City + 520445513524919; jesus.sotomayor@spglobal.com
	Eunice Fan, Taipei + 886287225818; eunice.fan@spglobal.com
	William Edwards, London + 44 20 7176 3359; william.edwards@spglobal.com
	Roman Rybalkin, CFA, Moscow + 7 49 5783 4094; roman.rybalkin@spglobal.com
	Maria M Cangueiro, Buenos Aires + 54 11 4891 2149; maria.cangueiro@spglobal.com
	Francois Moneger, Paris + 33 14 420 6688; francois.moneger@spglobal.com
	Annette Ess, CFA, Frankfurt + 49 693 399 9157; annette.ess@spglobal.com