Illustration: Peter C. Espina/GT

China's financial sector is still dominated by the banking sector, both in terms of the size of branch networks and total assets, while the securities market - an important source of liquidity and a greater diversity of funding - plays a much smaller role.

The composition of China's financial system indicates that there is still plenty of room for the country to develop its securities sector, which lags far behind developed economies, the US in particular.

With over 100 securities firms operating in China, the country's securities market as a percentage of its entire financial sector in terms of assets stood at just 1 percent in 2013, according to calculations by the Boston Consulting Group (BCG), based on publicly available data. This compares to a ratio of 18 percent in the US in 2013. The relevant data for 2014 is not yet available.

The gap, however, is set to gradually diminish, as China's economy is going through a rebalancing period. The central government is attaching unprecedented importance to mass entrepreneurship and innovation, and one way to support this would be to establish a multi-layered capital market and reduce the country's reliance on bank-based finance, also known as indirect finance.

A makeover of the domestic securities sector is also needed, as it is far from reaching a level of sophistication that can effectively serve the wealth management needs of increasingly affluent Chinese people. Further development is also needed for the sector to be able to provide sufficient financing for the flood of start-ups expected in the coming years.

A promising scenario for China's securities sector could be a divide between a few leading brokers - which may turn out to be China's equivalents of Goldman Sachs or Merrill Lynch - and a larger number of smaller firms competing for a foothold in either specific market segments or particular regions of the country.

Such a scenario would draw parallels with the experience of the US in the arena of investment banking. While there are several thousand investment banks in the US, only a few of them are prominent Wall Street names.

The relatively paltry leverage ratios at China's securities firms as compared to those held by the likes of Goldman Sachs are one of the major differences between domestic brokers and US investment banking institutions.

Domestic securities firms are expected to increase their leverage in years to come, albeit in a gradual manner, as the regulatory authorities are keen to avoid excessive risks to overall financial stability.

Integration of the Internet into the changing landscape of the securities market is also worth considering. The rise of Internet firms in the finance sector, especially the three domestic giants - Baidu Inc, Alibaba Group and Tencent Holdings - has appeared to pose a challenge for brokers, amid speculation of merger and acquisition deals between brokers and Internet firms.

Such speculation is not unreasonable. Mergers and acquisitions are set to be a trend during the development of the securities sector and as Internet firms branch out into the financial sector. 

Tie-ups between top brokers and giant Internet firms may be obstructed by regulatory concerns, so it is more likely that the Internet behemoths will seek opportunities by buying smaller brokers, while big brokers acquire small to medium-sized Internet firms.

This would offer new hope for the smallest brokers in the country, which have been struggling to survive in recent years.

The 10 smallest brokers in the country in terms of revenue accounted for a mere 0.5 percent of the total market, also measured by revenue, in 2013, according to the BCG data. This situation is unlikely to have changed significantly in 2014.

The emergence of Internet finance in China could serve as a powerhouse for the country's securities sector as a whole, rather than being a threat to it. Facing opportunities as well as challenges, the country's brokers are likely to gain steam amid the transition.

The article is based on a group interview with Richard Huang, a Beijing-based partner at BCG, Nick Gardiner, a Hong Kong-based partner at BCG, and Liu Bingbing, a Shanghai-based project manager at BCG.