In line with China President Xi’s speech promoting openness during the recent Boao Forum, it is widely expected that foreign ownership limits of various financial sectors will be scrapped within 3 years. This is another step in China’s financial market reform (see China’s $3 trillion bond index inclusion, GFI Blog, April 19, 2018) and we believe this is also part of US-China trade negotiations. The relaxation of foreign ownership limits may allow foreign players to exercise greater control and enhance risk management around their China operations. China’s banking industry is sizeable, with $27.4 trillion of total assets at year-end 2017, relative to $35.1 trillion for the Eurozone area, $16.8 trillion for the US and $11.1 trillion for Japan. Recently announced regulations in the asset management industry also help promote a level playing field for foreign fund managers. China’s fund business has grown to $3.5 trillion, while the overall global asset management sector reached $15.6 trillion by 2017.
Foreign banks: Beauty in the niche
Foreign banks invested in China over the last decade have been limited to participating in niche sectors. The market share of foreign banks was only c.1.2% for loans and this is declining. Foreign banks’ profitability is also weak: return on assets was 0.48% for 2017, lower than the industry’s 0.92%. Net interest margins were 1.71%, below 2.10% for the industry. However, capital adequacy ratios were 17.8% vs. 13.7% for the industry. Foreign banks such as UBS, Royal Bank of Scotland, Deutsch Bank, Citibank, Bank of America, Goldman Sachs and Australia and New Zealand Banking Group sold their equity interest in various China banks during 2009-2016. However, some foreign banks, such as HSBC, BNP Paribas and DBS, continue to invest in China. Instead of directly competing with the domestic incumbents for traditional general banking business, they focus on multi-national customers in China as well as Chinese companies expanding overseas, areas where they hold some competitive advantage. Some also see opportunities in underserved sub-segments such as derivatives-based structured products and affluent customers who are looking for more sophisticated banking services and better international reach. We believe foreign banks will continue to have a role in China despite the benefits not being reflected in their profitability metrics in the short-run.
Asset managers: Riding the waves of greater relaxation
Since the early 2000s, foreign asset managers have rushed to the China onshore market through joint ventures (JV) with local partners but still remain marginal players. They are currently only allowed to set up private securities fund management businesses through wholly foreign owned enterprises (IM WFOE), and/or to lift their ownership of broader asset management businesses to 51% of their current JV. Global players such as UBS, Invesco, and Man Group have been in this market for some time, but strict regulations around business models and challenging corporate structures constrain their ability to grow. First, it takes significant effort to resolve disagreements and conflicts between JV partners. Even if majority foreign ownership is allowed, the JV partner’s willingness to sell shares and cede control is not a given. Setting up both a JV and an IM WFOE may complicate a foreign asset manager’s relationship with its JV partner. In light of these challenges, foreign managers need to focus on their core areas of strength such as greater access to global markets, wider product range, adherence to international standards and meeting the needs of more sophisticated clients. Nevertheless, we think that the trend of greater flexibility in foreign ownership and opening up of markets will continue to attract foreign asset managers to participate in China’s sizable domestic market.
Implications to financial institutions:
This relaxation on foreign ownership encourages further expansion in China and thus brings growth opportunities, which, however, could come at the expense of a negative impact on small foreign banks. For example, local banks in Hong Kong with a substantial presence in China have raised volatility in their asset quality. For the domestic Chinese banks and fund managers, we believe the impact is fairly limited, as foreign banks and fund managers don’t compete head-to-head on the traditional businesses. Rather, foreign financial institutions’ participation in the local market broadens the investment scope. As the foreign institutions obtain wholesale funding by issuing certificates of deposits and negotiable time deposits in China, the domestic investors, including banks and fund managers, have more choices to diversify their investment portfolio.
 Xi Jinping Promotes Openness at a China Forum Rife With Restrictions, New York Times, 11 April 2018 (link: https://www.nytimes.com/2018/04/11/business/xi-jinping-china-trade-boao.html)
 China Makes Historic Move to Open Market for Financial Firms, Bloomberg, 10 November 2017 (link: https://www.bloomberg.com/news/articles/2017-11-10/china-to-allow-foreign-firms-to-own-51-of-securities-ventures)
 People’s Bank of China statistics (link: http://www.pbc.gov.cn/eportal/fileDir/defaultCurSite/resource/cms/2018/01/2018011515414112923.htm)
 People’s Bank of China statements (link: http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/3529603/index.html)
 Mainland China Banking Survey 2017, KPMG, August 2017 (link: https://assets.kpmg.com/content/dam/kpmg/cn/pdf/en/2017/08/2017-mainland-china-banking-survey.pdf)
 China Further Opens Up Financial Sector, EY, November 2017 (link: http://www.ey.com/cn/en/industries/financial-services/ey-pov-china-further-opens-up-financial-sector)