Singapore Exchange - DBS Research 2019-03-14: Bumpy Road To Derivatives Business’ Growth

SINGAPORE EXCHANGE LIMITED (SGX:S68) | SGinvestors.io SINGAPORE EXCHANGE LIMITED (SGX:S68)

Singapore Exchange - Bumpy Road To Derivatives Business’ Growth

  • Derivatives revenues grew at a CAGR of c.8% in the last decade to S$340m in FY18.
  • Impending launch of HKEX’s new MSCI China A Index futures contracts pose potential competition for Singapore Exchange; SGX’s share price has corrected c.6% since HKEX’s announcement.
  • FTSE China A50 Index futures is the largest revenue contributor to Singapore Exchange’s derivatives business; we estimate c.9- 13% revenue contribution to Singapore Exchange.
  • Re-instate coverage with HOLD call and Target Price of S$7.05.



No visible catalysts for now, re-instate coverage with HOLD and Target Price of S$7.05.

  • Although Securities Daily Average Value (SDAV) for February 2019 had rebounded from its lows in previous months to cross the S$1bn mark, we believe Hong Kong Exchange (HKEX)’s recently announced plans to launch a new MSCI China A Index futures could pose competition to Singapore Exchange Limited (SGX:S68). This could cap SGX’s share price in the near term arising from concerns of potential earnings downside.
  • We re-instate coverage with a HOLD call and Target Price of S$7.05, representing c.20x FY20F PE. That said, the impact of this development remains to be watched and may not be as dire should the market growth be buoyant enough for additional player(s).
  • We believe SGX’s share price should find support from its absolute dividends of 30 Scts per year, implying c.4% yield.


Where We Differ:

  • Our earnings are lower than consensus by 4%/5% for FY20F/FY21F as we have lower growth assumptions (c.7% y-o-y) for derivatives contracts post FY19F.
  • We have yet to input potential market share loss to HKEX’s MSCI China A Index futures in our numbers.


Potential Catalysts:

  • A delay in HKEX’s MSCI China A Index futures contracts launch, or failure for HKEX to obtain regulatory approval, may be stock catalysts for Singapore Exchange. New derivative product launches, potential structural changes to boost liquidity in the securities market, and earnings-accretive M&A are also potential catalysts for the stock.


Valuation:

  • Re-instate coverage with HOLD and Target Price of S$7.05. We derive our Target Price of S$7.05 based on the dividend discount model (k=8%, g=4%, ROE=33%), implying c.20x FY20F PE).
  • Although PE valuations is at - 1SD (five-year average), we believe there are no visible catalysts for Singapore Exchange now and re-instate coverage with a HOLD call and Target Price of S$7.05.


Key Risks to Our View:

  • Competition in derivatives business. Singapore Exchange may see potential earnings downside should it face competition from HKEX which announced in March 2019 that it is planning to launch futures contracts which may compete with Singapore Exchange’s FTSE China A50 Index Futures, which accounts for c.40% of SGX’s total derivatives volumes.


WHAT’S NEW - Relooking at SGX’s derivatives business


Ongoing efforts to diversify into non-equity index futures, top four equity index futures now account for c.70% of total derivatives volumes (FY09: c.90%).

  • The top four equity index futures (FTSE China A50 Index futures, MSCI Taiwan Index futures, Nikkei 225 Index futures, SGX CNX Nifty Index futures) used to contribute c.90% of derivatives volume in FY09, but the current contribution stands at c.70% with ongoing efforts to grow FX futures, metal and dry bulk contracts, among others.
  • Among the equity index futures, FTSE China A50 Index futures grew from zero-base to c.50% contribution to total equity index futures volumes in FY18, having benefitted from being the only offshore futures tracking the China A-share market, with close to 30% market share.

Recent developments likely to spur increasing efforts to grow non-equity index futures.

  • In the past year, there have been concerns surrounding
    1. negative developments with India’s three main stock exchanges on licensing of data for offshore derivatives linked to their domestic indices in Feb 2018 which would directly affect Singapore Exchange’s Nifty suite of products and
    2. Hong Kong stock exchange (HKEX)’s unveiling of its 2019- 2021 strategic plan which includes plans to launch futures contracts on MSCI China A Index future contracts, amongst broader plans to develop CNY-based derivatives market, launching additional products in rates, credit and currency.
  • While we believe that recent developments are likely to spur increasing efforts on Singapore Exchange’s part to become a multi-asset exchange, in the short-run, Singapore Exchange is likely to face potential competition from HKEX.

FTSE China A50 Index futures is the largest contributor to SGX’s derivatives business.

  • Since its launch in 2006, it took about three years before Singapore Exchange started seeing a ramp-up in volume. Volumes have grown multifold to account for about half of Singapore Exchange’s equity index futures contract volumes.
  • Currently, it is the only A-share futures available offshore for investors. In the last 12 months, the FTSE China A50 Index futures accounted for c.40% of Singapore Exchange’s total derivatives volumes. As the single largest product (in terms of volumes) among Singapore Exchange’s suite of derivative products, we believe that it is the largest contributor to Singapore Exchange’s derivatives revenues.

Potential competition from HKEX.

  • On 11 March 2019, MSCI and HKEX announced that they will launch futures contracts on MSCI China A Index futures contracts. According to HKEX, the deal still requires regulatory approval, subject to market conditions, with no launch date announced as yet. HKEX will be informing the market of the launch date and provide further product specifications details once the launch date is determined.
  • We note that HKEX had previously offered offshore Chinese derivatives in 2017: HKEX launched China treasury futures contracts but pulled the product a few months later, citing Chinese regulatory concerns.

Regulatory approval pending.

  • According to HKEX Chief Executive Charles Li, the HKEX has submitted all papers to the Securities and Futures Commission for regulatory approval and it is up to them to decide if it would work with mainland regulators on the matter. In our view, given China’s ongoing efforts to open up its domestic derivatives market, there is high likelihood that approval for MSCI China A Index futures contracts will be given in due course.
  • Currently, while there is no launch date targeted, there are expectations that the futures contracts on MSCI China A will be launched following the completion of MSCI’s inclusion process of China A-shares in November.

Difference between HKEX and SGX’s products.

  • While Singapore Exchange’s A50 Index futures currently allows offshore investors to track the biggest 50 Chinese A-shares by market capitalisation directly, according to Charles Li, the new HKEX futures will track the entire 421 large-and mid-cap-A-shares included in the benchmark MSCI Emerging Markets Index. We believe the two futures index will be highly correlated. According to Charles Li, the futures are likely to be traded in USD.

Impact on SGX; sensitivity analysis suggests potential -4% to -11% impact on bottomline.

  • Based on our understanding, > 95% of Singapore Exchange’s FTSE China A50 Index futures clients reside outside of Singapore, with US and European clients being FTSE China A50 Index futures’ biggest clientele as they seek USD-denominated exposure.
  • Should HKEX decide to go after the same clientele type, there might be pressures on Singapore Exchange’s derivatives volumes should clients decide to switch over, or if HKEX competes on pricing to gain market share. Assuming a 20% decline in FTSE China A50 Index futures contract volumes in FY20F, our revenue and net profit forecasts will be affected by -4% and -7% respectively.

Likely that some customers would make the switch to HKEX.

  • They key to success for derivatives contracts for exchanges lies in the liquidity. Without deep liquidity in the futures contracts, HKEX is unlikely to be able to attract international investors to come onboard. HKEX may initially compete on pricing to gain market share, as well as leverage on market makers to boost liquidity in its new futures contracts.

Is the new futures contracts definitely a negative to SGX in the long run?

  • Not necessarily so if market growth buoyant. Singapore Exchange is currently the only exchange offering the sole offshore futures tracking the China A-share market. Arguably, in the longer term as more international investors increase their China exposure, Hong Kong as a financial centre might also be able to attract more Asia demand on top of ex-Asia demand, which may lead to a bigger market for A-share index futures collectively, especially with MSCI’s move to increase the weighting of Chinese-listed stocks (A-shares) in its benchmark indices.
  • Having two different exchanges offering highly-correlated futures tracking the China A-share market may also bring about a new class of clients: the arbitrage traders. There is possibility of Singapore Exchange losing market share, but ending up with increased number of absolute contracts cleared due to a bigger market.

Updates on Nifty arbitration proceedings: contracts continues to trade for now.

  • In July 2018, Singapore Exchange and National Stock Exchange of India (NSE) deferred the arbitration proceedings and have resumed discussions on potential collaboration in Gujarat International Finance Tec-City (GIFT). Collectively, the Nifty suite of products accounted for c.10% of total derivatives volumes in CY18, which could account for c.5% of Singapore Exchange’s net profit.
  • According to Singapore Exchange, it has together with NSE submitted a joint proposal to both countries’ regulators to connect international participants trading Nifty products within the GIFT city. In the meantime, SGX Nifty contracts are still being traded.

Derivatives revenues saw good growth through the last ten years with CAGR of 8%.

  • Prior to FY09, more than 50% of Singapore Exchange’s revenues were derived from Securities Trading and Clearing (FY18: 26%). Over the years, Singapore Exchange has seen lower revenues from the securities market due to lower turnover, velocity, and commissions among others amid the growth in Singapore Exchange’s derivatives business, which accounted for 40% of Singapore Exchange’s revenues in FY18 (FY09: 26%).
  • Derivatives revenues grew at a CAGR of c.8% in the last decade to S$340m in FY18 while Singapore Exchange continues to build up volumes in FX futures, metal and dry bulk contracts amongst others.

Bringing FX trading onto the exchange.

  • Asian FX futures was introduced at end-CY13 and have started to gain traction over time, more than doubling in volumes since launch. FX futures now contributes just under 10% to total derivatives volumes. The growth is mainly driven by INR/USD currency pair, followed by USD/CNH, as both the currency pairs continue to gain volume market share y-o-y: USD/CNH market share improved from 55% to 72%, INR/USD market share improved from 36% to 41% as of 3QFY18.
  • We continue to see potential in FX futures volumes growth as Singapore Exchange allows customers to manage both FX and equity risks under one roof.

Continued efforts in commodities derivatives.

  • Singapore Exchange’s metal and dry bulk contracts, SICOM and energy contracts accounted for c.7% of total derivatives volumes in CY18. Since pioneering the world’s first iron ore swaps in 2009, Singapore Exchange’s iron ore-related contracts accounted for c.82% of total metal and dry bulk contracts in CY18 with close to 100% market share in international cleared iron ore and coking coal derivatives.
  • As Singapore Exchange continues to cement its position across the steel value chain, it believes that it is well positioned to become the Digital Freight Marketplace as it leverages on the existing cargo and freight franchise.
  • Notably, Singapore Exchange led a US$44m Series C funding round in Freightos, an online freights marketplace.

Launching new products.

  • Singapore Exchange continues to launch new products across various asset classes as it continues to build new product streams. Having launched single stock Daily Leveraged Certificates (DLCs) on ten Singapore and Hong Kong companies, there are further plans to expand single-stock DLCs.
  • Singapore Exchange also continues to build its position across the steel value chain by launching high-grade 65% Iron Ore Contract. Other new products include the expansion of MSCI Net Total Return Suite and FlexC FX Futures.


Outlook and recommendation


No visible catalysts for now, re-instate coverage with HOLD, Target Price of S$7.05.

  • We derive our Target Price of S$7.05 based on the dividend discount model (k=8%, g=4%, ROE=33%), implying c.20x FY20F PE). As HKEX awaits regulatory approval for the proposed new futures contracts on the MSCI China A Index, HKEX may also take a few months to finalise contract specifications a well as complete programming and testing into its clients’ systems.
  • In the meantime, while we continue to expect selling pressures on Singapore Exchange, SGX’s share price should find some support from its absolute dividends of 30 Scts per year (at current prices Singapore Exchange is yielding c.4%). Should competition from HKEX heat up, there may be further earnings downside for Singapore Exchange which saw its derivatives business grow from c.26% of its revenue in FY09 to c.40% in FY18.

Potential catalysts to the stock.

  • We believe that there are two main catalysts to the stock at this juncture:
    1. Stronger than expected growth in SDAV, which has been known to be a key driver to SGX’s share price. While Securities Daily Average Value (SDAV) for February 2019 had rebounded from its lows in previous months to cross the S$1bn mark, the current levels are still low compared to historical averages.
    2. Delayed launch of HKEX MSCI China A Index futures or limited liquidity in futures market post-launch.





Rui Wen LIM DBS Group Research | https://www.dbsvickers.com/ 2019-03-14
SGX Stock Analyst Report HOLD INITIATE BUY 7.05 SAME 8.900



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