OREANDA-NEWS. The risk profiles of Taiwan's largest securities firms could be hurt as they accelerate overseas expansion and raise leverage, if foreign investment appetite becomes excessive relative to their loss-absorption buffers and liquidity profiles, says Fitch Ratings. The agency expects leverage at the top two - Yuanta Securities and KGI Securities - to continue to rise, albeit from a modest level.

Large brokers in Taiwan have boosted leverage and overseas exposure since 2014 as domestic stock market turnover has remained subdued and local interest rates stayed low. As a result, the proportion of revenues for these firms originating from offshore operations grew to 29% in 2014, up from 17% and 22% in 2013 and 2012, respectively. Offshore investments as a percentage of equity also rose sharply.

The results from Fitch's stress tests - assessing the risks from rising leverage - suggest that the risks are still manageable. The large brokers maintain healthy loss-absorption buffers, and hold generally lower-risk investments such as government and investment-grade private-sector bonds. These firms should be able to maintain the minimum regulatory capital adequacy ratio of 150% at a maximum gross leverage of 6x even if their investments were to face a severe correction defined as a 60% decline in the stock market and an 8%-20% drop in bond values over one year.

Furthermore, leverage compares favourably with Taiwan's regional peers in Korea and Japan. This is due in part to simpler business models, and as active market-making and proprietary trading are less prevalent in Taiwan.

As overseas expansion continues, the risk profiles of Taiwan's brokers should remain unchanged should the investment risk taken be incremental and in line with capital and loss-absorption buffers. However, it is important to note that these firms have limited experience and familiarity with some of the markets where exposure is rising.