China reforms: Banks are right to be cautious
China’s extraordinary liberalisation of its financial markets last week, which cleared the way for foreign ownership of a range of financial institutions, has only found mild enthusiasm among foreign banks so far. They can be forgiven for not immediately breaking out the champagne.
There is little doubt China’s recent reforms were designed to turn heads. It may be the most important move since China first opened its capital markets to foreign investment in the early 2000s with the qualified foreign institutional investor scheme. It is also the second big piece of liberalisation to be enacted this year, following the launch of the Bond Connect scheme in July, which scrapped quotas and licences for foreign investors entering the onshore interbank bond market.
In itself, scrapping foreign ownership limits on banks, and raising these limits on securities, fund management and futures JVs, is a revolutionary step. Global banks have long pushed for bigger sway over Chinese securities firms, with all but HSBC being forced to take a minority stake in their joint ventures (although a few have managed to get management control).
Banks have been waiting for decades for this announcement, at least since Morgan Stanley became the first foreign investor in the sector at the time of the establishment of China International Capital Corp (CICC) in 1995. Those in the country have lobbied for more control; those on the outside have tried to claw their way in.
But despite all that, the usual whirlwind of jubilant PR from bank CEOs was conspicuously absent. GlobalRMB, GlobalCapital’s sister publication, contacted 14 foreign banks for a response to the announcement. Half of them refused to comment entirely. Most of the others said little. Why?
The first reason is probably the most telling: no-one saw this coming. Well-worded statements of opportunity and fraternity had not yet done the rounds, from CEOs to global communications teams to China heads and back again. Even President Trump's team was reportedly surprised by the timing. One could hardly expect bank CEOs to be ahead of the Dealmaker-in-Chief.
It is always hard to tell exactly what drives policy changes in China, but from the muted early market reactions it is entirely possible a last-minute nod from high up, possibly from Xi Jinping himself, may have been the trigger, rather than any kind of extensive industry consultation and diplomatic back and forth. The lack of details on the timing and implementation of the new rules add to that impression.
This brings us to the other reason behind the muted response. China’s regulatory system is something of a black box, even to the most avid China-watchers. Liberalisation of foreign bank access is undoubtedly a positive for global financial institutions, but no-one is sure how it will play out. Will there be a quota on foreign banks? Will the regulators still take a year or more to approve new entrants?
Perhaps just as importantly, what does this mean for those already in the country?
HSBC fought hard to become the first foreign bank to get majority ownership of a joint venture, with its Guangdong-based securities JV pretty much operational. Among other foreign banks in the country isa mixed bag of solo enterprises that have been struggling to expand their portfolio of onshore business licences, a few JVs with minority foreign partners, and a few banks, most recently JP Morgan, that got tired of existing arrangements and chose to quit their JVs entirely.
The move is, of course, not just about securities JVs but also wider banking access. But to hear McKinsey tell it, China’s banking sector does not look particularly tempting. The firm recently noted that only about a third of Chinese banks managed to generate profits last year, as the deleveraging campaign takes hold. That said, with the Chinese economy growing at nearly 7%, although the reliability of such statistics is very much in the eyes of the beholder, wealth creation in China is set to continue apace. That means the financial system will continue to see growth.
The asset management market in China will also be affected by the liberalisation push. According to a study by Casey Quirk, part of Deloitte, China’s asset management sector is set to become the second largest globally by 2030, with a size of $17tr. China’s bond market, standing at $11tr, is expected to double by 2020, according to estimates from asset managers and banks.
Banks will need to have clear ideas about what kind of market share they expect to take in the domestic market. Sitting on the sidelines is unlikely to be an option, but they can be forgiven for not celebrating just yet.
This is likely to be a crucial moment in the history of China’s financial system — and for that reason, it requires a careful, deliberate approach from foreign banks.