2016 could well be a very difficult year for incumbents in China’s financial sector as decisions made this year that open up the market really start to have impact at scale.
Most visible is the relaxation of interest rates which squeezes the wide margin between borrowing and lending rates that has allowed Chinese banks to cover bad debts and report high profitability for many years. Of course, there were ways around the restrictions with wealth management products and the like, but those impacted only a fraction of the deposit base.
Now, the cost of competing for deposits will likely become much higher for the traditional banks. Competition in many ways has been very modest in the past and allowed the Big 4 Chinese banks to become not just some of the largest, but also the most profitable banks in the world.
This is not likely to continue and, as in many service sectors, change can happen very quickly once it starts to take hold. It will be a tough time for the traditional market-leading banks to hold onto their position. There are numerous examples of why this will be the case:
The launch of online only financial competitors. MyBank (Alibaba linked Ant Financial, Wanxiang and Fosun as investors) and WeBank (Tencent as lead investor) have been the highest profile entrants this year, leveraging their relationship with (and knowledge of) hundreds of millions of individuals and businesses and their increasing leadership in payments systems in China.
By offering low hassle loans and investment products with very attractive returns that are marketed through their online platforms at almost zero incremental cost, they are able to offer greater convenience at lower cost. The only question is how willing will Chinese consumers be to switch their primary banking relationship. Precedent from other sectors suggest they will not be slow. Indeed, WeBank announced last week that it has 1.6 million individual customers for its personal loan products.
HSBC is opening up this month the first majority-owned joint venture securities company, based in Qianhai. This leverages the CEPA structure which permits Hong Kong businesses unique access to mainland opportunities. While no details have been confirmed, the JV’s business scope will be domestic and broad, something other foreign joint ventures have struggled to achieve.
Hang Seng Bank (majority-owned by HSBC) also launched a JV fund management company in Qianhai in October. HSBC has taken advantage of a priority development zone in Qianhai that had been struggling and created a first in terms of foreign control in the sector. CEPA allows for Hong Kong- and Macau-funded financial institutions (a limited number of qualified companies) to obtain varying degrees of majority ownership onshore. Hang Seng’s 70% and HSBC’s 51% JV stakes are a result of a major HSBC effort from the Chairman down to expand its mainland presence.
The partner in both of these agreements is a Chinese government entity suggesting that HSBC’s expansion plans are aligned with both central and regional regulators’ plans. Certainly majority ownership does not always lead to effective control in China, but the intent is clear – allow a foreign enterprise more control of a securities company than has been the case in the past, and the move is clearly aligned to its commitment to growing aggressively in the Pearl River Delta. Even if they don’t get a particularly large market share their presence is likely to stimulate others to improve their operations. And I am sure other banks will be following the path that HSBC has taken through Qinhai.
Also last month, Fidelity followed Aberdeen Asset management in applying to launch a 100% foreign-owned investment management company in China. And now it seems as though everyone else in the global asset management industry is also jumping in to form one of 3 types of permitted asset management WFOEs. Fidelity has a track record in being a late entrant into Asia markets, but then successfully growing a leadership position through a controlled entity – look at their position in Japan today.
- The QDLP WFOE:The Qualified Domestic Limited Partner (QDLP) WFOE can immediately raise funds on the mainland for offshore investment, typically from qualified HNWIs and institutions. Many use this model including from Citadel, Deutsche Bank, Value Partners, BlackRock and UBS.
- Investment Advisory WFOE: In addition to its traditional research and operational functions, the investment advisory WFOE can service existing clients, sign contracts with new clients (or new partners) and act as a servicing coordinator for funds introduced through Hong Kong’s Mutual Recognition of Funds (MRF) or other cross-border programs.
- Investment Management WFOE:The recently created investment management WFOE is probably the right long term model. Introduced in September, it is the most flexible structure for foreign managers. It can do everything the QDLP WFOE can do and more: after registering with the Asset Management Association of China, it can create funds that raise money on the Mainland to be invested in mainland markets. Depending on the regulator we could see 40-50 of these in place within 18 months. (Note: thanks to my friends at Z-Ben for the insights on the different types of WFOE available today)
Noah, one of China’s leading wealth management companies (listed on Nasdaq) felt it worthwhile to hire a Chief Investment Officer in Hong Kong to identify funds and other investment opportunities outside China for their Chinese investors. This is in response to the massive increase in money that they are obtaining from their clients domestically to be invested outside China. Given Noah’s share of the “entrepreneur’s wealth” in China, this is for sure a leading indicator of greater diversification and internationalization of China’s investable wealth and that non-Chinese fund managers will be receiving this flow in the coming years.
Caixin, one of the shrewdest players in China’s media industry, is moving into financial services through the creation of information-based services, investments into Chengxin Information Technology, and a partnership with CEBM. The vision, recently stated by their CEO, is to become a comprehensive information-based business that combines the businesses model of Bloomberg with The Economist. This move indicates their belief that the financial services industry is at a tipping point, that there is about to be an explosion of demand for trustworthy data and interpretation on the sector, that companies will be willing to pay for this data and, almost certainly, that a Chinese player will be encouraged to be a winner in this space. (They are recruiting if you are interested).
Overall, this shows a financial system that is experiencing an increasing pace of change, that is more market-based, has more opportunities for attackers, and provides more opportunities for international players.
There’s still a long way to go on the journey toward a fully modernized financial sector, but let’s not ignore the positive changes that are underway.