Investments

China Eyes Open Markets, Wide Shut

On the face of it, China’s announcement that it would open its financial markets to increased ownership by foreign companies seems a sea change.

But then again, refocus a bit and the waves look like ripples.

The facts are thus: Earlier this month, Finance Minister Zhu Guangyao said foreign stakes in financial companies can increase as caps are lifted, and in many cases eliminated.

The end result is that companies outside China will be able to, eventually, control Chinese securities and asset management firms, insurance companies (through joint venture majority stakes) and banks.

By the numbers, foreign firms will be able to own as much as 51 percent of domestic securities firms (including those in the fund and futures markets) operating in China, bumping the 49 percent cap up by two points. That 51 percent limit will be phased out after three years. In reference to life insurance firms, a 51 percent limit will take effect and will be eliminated in five years. Investment limits for bank stakes — now at 20 percent for group investors — will eventually disappear.

So, with the caps uncapped, it follows that Western firms and companies will be operating in environments where investment pickings might be relatively slim. Or to put it another way, with valuations stretched across bourses and asset classes outside China, wouldn’t it follow that there would be a rush into this new open market?

Not necessarily, because those firms may eye wider access to the financial sector — gargantuan as it may be — as an overture that comes a little bit too late.

Scan the headlines, and there would seem to be some enthusiasm bubbling up, enough to take advantage of the invitation just extended by the Chinese government.

Earlier this month, and just before the “open market” initiative was announced, The Financial Times reported that international banks stepped up their lending to China to a record high, as measured through the first half of the year. Now, total exposure to China, through lending, stands at $1.89 trillion, the FT reported, which compares to the previous record of $1.84 trillion at 2014’s end. Importantly, that number includes not just loans that cross borders into the mainland, but also what the financial publication termed “most lending by foreign bank subsidiaries incorporated on the mainland.”

Don’t conflate enthusiasm for lending to, and within, China for an earnest desire to have boots on the ground, so to speak. Lending does not translate to having as much skin in the game as actually owning a stake in a local company, where culture, regulations and already dominant players can make day-to-day operations a bit difficult.

Consider the fact that many of the global banks have walked this road before, pulling out of China, where once they had presence as recently as a decade ago. Back then, those financial giants had to refocus their energies in the wake of the financial crisis that rocked the world beginning in 2008, had to bolster capital reserves — and frankly, the risk for appetite waned. Of the marquee names in banking, as Reuters has noted, HSBC remains one of the singular players on a global field to have a proverbial foothold in a Chinese bank, with a 19 percent equity stake in Bank of Communications.

The initial response after China’s announcement seemed a bit tepid. Reuters quoted Citigroup’s Christine Lam, who leads Citi China as chief executive, as stating that the bank “welcomes” the recent actions and has been boosting its banking business within China. Credit Suisse, said Reuters, simply “looks forward to being a part” of China’s financial markets.

However, look at the scale of U.S. and European firms via joint ventures (JVs), and the playing field is decidedly tipped. Within China, Guotai Junan Securities does investment banking business worth $1.5 billion in the country, which dwarfs, say, the $8 million JPMorgan made in profits through its own JV there. Not too much farther ahead, in terms of profit, was UBS Securities, which had $14 million in profit last year (and remember JVs divvy up the profits). That comes amid a backdrop where JPMorgan sold its 33 percent stake in the JV last year but now is in talks to start a new JV, said the newswire.

All told, foreign holdings have been growing by about 20 percent annually, and the total pie has grown too, so much so that foreign companies hold only 1.4 percent of a market that is worth as much as $27.4 trillion.

With such low numbers, one might argue that the banks have nowhere to go but up. But the low numbers might be there for a reason. The hurdles are numerous toward gaining traction.

Fitch said in its own report right after the announcement that the scale of the bigger banks in China (five lenders, backstopped by the government, are among the heaviest hitters) may preclude outright acquisition, and “it is not yet clear how the strategic benefits would compare against the costs. The more likely acquisition targets in the banking sector would be the relatively smaller city commercial banks or rural banks.” Those banks have more risk, said the ratings agency, and making a push into the investments space may not be a salve, where commission rates on brokerage activity are basically nil.

Against that backdrop, China may face some pressure, it seems, to attract capital, where worries about bubbles, such as those in housing/construction and even corporate balance sheets have arisen time and again. By bringing in foreign money, banks and insurance companies would have a bit of “additional” money on hand to help weather economic slowdowns (or even investors stampeding for exits) amid rising debt. Government officials, notably Bank of China Governor Zhou Xiaochuan, have warned of as much — encapsulated in a warning against a “Minsky Moment,” where optimism precedes a sudden collapse in asset prices.

Most recently, the vagaries of operating in new markets (and those beleaguered by debt) came to light in startling fashion, showing that just as quickly as Chinese markets are opened, they can be shuttered. In price action to open the week, shares in Chinese firms skidded as regulators suspended approval for online companies offering small loans — for firms both extant and nascent.

The writing may be on the wall for outside investors to stay outside.

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