Andrew Collier, Orient Capital Research
China has promised a new round of financial opening to foreign firms, its biggest overseas incursion since the country’s entry into the World Trade Organization fifteen years ago. But the reality is likely to be far less than expectations.
First, the history of western financial institutions in China is pretty dismal. After promising full bank entry within five years of WTO access, foreign firms now have less than 1.5%, compared with an average of 20% in emerging markets. Most of that hasn’t been terribly profitable. The commercial banks don’t reveal their onshore profits but most bank executives will admit they have struggled; the one exception may be HSBC, which would be partly due to Hong Kong’s special status that grants access to the Pearl River Delta. However, one banker from Hong Kong who split her time in Guangzhou said she struggled to find decent corporate borrowers. The good ones (usually state owned) were snapped up by the local banks while the poor ones had such bad credit they weren’t worth the bother.
The flourish of investments by foreign banks into China in the early heady days post-WTO did not turn out well. For example, the Commonwealth Bank of Australia suffered through a case of fraud at one of its equity holdings, Qilu in Shandong Province. Bank executives stole $292 million in commercial paper. Later on, when I asked one Qilu executive what they did to work with CBA, she said, “I think we’re doing local student loans.” Not much to build a foundation on.
The investment banks have had an even worse time. Although some of the big names like Goldman Gaohua and UBS Securities have broken into the top ten of A share bookrunners (at least before regulators clamped down on IPOs), the profits of all the western brokerages in China have been meager. Meanwhile, they are getting attacked in what was once their home turf – Hong Kong – by increasingly aggressive Chinese brokers who have access to cheap capital and are desperate to prove to Beijing that they are “going global” – even if that means losing money. The Chinese are rapidly gaining market share in Asia, contrary to what the foreign banks expected as recently as ten years ago.
That’s not to say there aren’t opportunities. Just today, leaving my television interview with Bloomberg News on this subject, I ran into the chief investment officer for one of America’s largest funds. He said he is eager to his $200 billion portfolio into domestic Chinese stocks and is looking for ways into the market. But he also said the state regulators are on his back about compliance issues in China.
I believe certain things are likely:
- Domestic commercial banking market share will stay flat or actually increase. However, smaller banks may fail (due to domestic asset problems and shadow banking), a possible opening for western banks willing to take on a risky project in order to gain share.
- Western securities firms will immediately attempt to buy market share through acquisitions or joint ventures. However, domestic Chinese firms have done quite well, some through the sale of dodgy shadow banking products, and will be reluctant to sell unless they are capital constrained.
- However, securities firms will be sought to expand capital raising ex-China. The domestic firms will try to “ring-fence” them to provide this without granting them domestic access.
- Fund managers are well placed to enter the market and offer access to global investments. This is a definite opportunity — assuming the regulators allow capital to move offshore, which is an open question. Domestic funds know they are completely outclassed globally and need to gain international experience.
China may open faster than I expect, simply as a repeat of the success of WTO entry, which pushed state firms to become more efficient, a difficult experience that sped up China’s modernization. But I remain skeptical due to the tremendous domestic politic forces in opposition – including financial institutions and others, such as local governments, that rely on banks as credit piggy banks.
Don’t expect too much action soon. There may be a flurry of deals as big firms test the waters. But they will be just that – tests – and won’t truly crack the barriers.