When a Chinese regulatory agency banned investors from opening accounts with online brokers Futu and UP Fintech, both companies were hit. These two companies have regarded mainland China as the main source of growth for many years.
But then the stocks of the two companies listed in the United States surged, what is the reason for this?
Futu and Tiger Securities had previously catered to the needs of mainland Chinese traders until earlier this year when Chinese securities regulatory authorities stated that their cross-border securities business with domestic investors did not comply with legal regulations. In May, the applications of these two companies were removed from the online app store. In the days following the news, the stock prices of both brokers fell.
But now, Futu's stock price has risen by over 40% this year, while Tiger Securities' stock price has jumped by about 33%. The Nasdaq Golden Dragon Index, which tracks dozens of Chinese companies listed in the United States, has fallen by about 8% this year.
Both brokers experienced a decrease in trading volume in the second quarter, but their revenue increased significantly. Futu's revenue increased by approximately 42% compared to the same period in 2022, with a net profit of $143 million, an increase of three-quarters compared to the same period last year. Tiger Brokers' net profit for the quarter reached $13.2 million, and its total revenue surged by nearly a quarter, compared to a loss in the second quarter of 2022.
The performance of the two brokers was boosted by a significant increase in interest rates, and they also caught the opportunity.
The Federal Reserve is about to end a historic cycle of interest rate hikes. This round of interest rate increase has pushed the yield of treasury bond to a 16 year high and created an easy way for brokers to make profits. Hong Kong's interest rates have increased in line with the pace of the Federal Reserve's interest rate hike, and both Futu and Tiger Securities have clients in Hong Kong.
Due to the fact that most brokers pay relatively low interest rates for their clients' funds, they only need to invest a portion of their funds in low-risk securities, and then take the difference between the interest paid and the profits into their pockets to make a lot of money. This is the classic business model of commercial banks, but brokerage clients usually pay little attention to the interest rates they receive.
Jason Hsu, founder of Rayliant Global Advisors, an asset management company, said that this spread is currently the main source of income for most brokers and the main driver of revenue for Futu and Tiger Securities.
In the year when the Chinese stock market stumbled, these brokers also shifted their focus from the Chinese market to other places. There are more than 300 million small investors in Chinese Mainland, but they have become more cautious this year, shifting funds from stocks to safer investments. Since the beginning of this year, the benchmark Shanghai and Shenzhen 300 Index in China has fallen by nearly 10%. The Chinese economy is suffering from a long-term slowdown.
Before the Chinese government banned the two brokers from acquiring new customers in Chinese Mainland at the end of last year, Tiger Securities said in its 2022 financial report that its customers were mostly mature Chinese investors living in China and abroad.
These two brokers have now turned to other places to expand their business. Tiger Securities stated that 45% of the newly opened and funded accounts in the second quarter were from Singapore, nearly a quarter were from Australia and New Zealand, about a fifth were from the United States, and a tenth were from Hong Kong. Interactive Brokers Group Inc. (IBKR) is one of the investors in Tiger Securities.
Futu is partially controlled by Chinese internet giant Tencent. Futu stated that mainland Chinese customers account for less than one-third of its total customers. Quaero Capital, an investor of Futu, made an estimate based on the information provided by Futu, and concluded that 41% of Futu's paying users will come from Chinese Mainland in 2021.
Alice Wang, portfolio manager at Quaero Capital, mentioned Fortu's expansion in overseas markets and said that Fortu has been heavily regulated in the past two years, but did you know? This has made its business even stronger.
Foreign investors have contributed to the decline in the stock prices of Chinese companies, including many Chinese concept stocks listed in the United States. However, Hou Xiaotian, founder of T.H. Capital LLC., a research and investment consulting company focusing on the Chinese market, said that Futu and Tiger Securities did not have many shareholders outside Hong Kong and Chinese Mainland, which to some extent helped them avoid the sharp decline caused by the withdrawal of foreign investors from the Chinese stock market this year.
Hou Xiaotian said that a negative factor has to some extent become a positive factor.
Although Futu and Tiger Securities removed their trading apps from online app stores in China in May this year, the two companies said at the time that their existing customers in Chinese Mainland could still use their apps for trading.