Chinese Securities Sector Offers More Risks Than Opportunities for Foreign Firms

January 27, 2019 Updated: January 28, 2019

News Analysis

Wall Street is getting ready to unlock its coffers.

A key Chinese regulatory authority recently said that Beijing will grant more approvals during the next six months to foreign banks desiring majority ownership of their Chinese securities joint ventures.

It’s a sign that Chinese policymakers are beginning to ease restrictions on foreign firms and give them more access to its $45 trillion financial services sector. The trend is a welcome headline in the short term, especially given the ongoing trade dispute with the United States. But in the long run, China is more likely to benefit from this relationship than foreign banks.

In December 2018, Swiss banking giant UBS Group AG became the first foreign bank to gain approval to purchase a majority stake in its local securities venture, following a 2017 announcement from the Chinese authorities that they would allow a more open financial-services sector.

Despite—or perhaps because of—the ongoing trade war with the United States, China appears willing to go ahead and open its financial sector. There are other banks with applications in the queue, such as Japan’s Nomura and U.S. banking giant JPMorgan Chase.

“We do have a few companies in the process of applying for 51 percent (majority ownership),” Fang Xinghai, vice chairman of the China Securities Regulatory Commission, said Jan. 24 in an interview with Bloomberg TV at the annual World Economic Forum in Davos, Switzerland.

During “the next six months, you will see more licenses being granted,” Fang said.

Fang also noted that, while regulators may approve expediently, the process of obtaining majority ownership could take more time. Foreign banks must negotiate the purchase of a greater stake from their domestic partners, which may be less willing to sell.

No Slam Dunk for Foreign Banks

Assuming Chinese regulators follow through and foreign banks pony up the cash, there are several implications to unpack from this development.

On the surface, this is a welcome development for foreign banks. China has the world’s third-largest equity and debt capital markets.

But not many have indicated a desire to dive in, at least not yet. Several of the biggest global banks, including Goldman Sachs, Citigroup, and Bank of America, haven’t applied.

There are near-term risks from the global banks’ perspective. Uncertainties about how the new rules will be implemented, the risky business landscape from the ongoing trade war, and most importantly, China’s short-term growth challenges are major deterrents.

Unofficial data pegs China’s overall debt-to-GDP ratio at around 300 percent as of the third quarter of 2018, according to the Institute of International Finance. That’s a higher level than the United States had before the 2008 financial crisis. In addition, domestic companies are defaulting on bonds at a much higher rate—relative to China’s recent history—and growth has slowed.

China has also lifted foreign ownership caps on commercial banks. But the country’s high minimum-capital requirements make running a commercial bank very expensive for anyone except the world’s largest banking giants. And even if they have the resources, they must adhere to domestic regulatory guidelines that are unpredictable and may not align with business interests. For example, regulators recently implored domestic banks to support and lend to China’s private businesses.

Taken together, the financial-services environment in the world’s second-biggest economy isn’t very positive for new entrants.

More Beneficial for China

The benefits from China’s perspective are clearer.

More foreign involvement provides a timely investment for an industry that is stagnating amid an economic slowdown.

In the short term, China’s heavily fragmented securities sector will see some consolidation as firms brace for greater competition. “The key is to make oneself stronger by merging with others or by some other means. You can scare away wolves if you become a tiger,” Zhao Xijun, deputy dean of the school of finance at Renmin University of China, told the South China Morning Post in a late December 2018 report.

Late last year, state-owned Citic Securities, China’s biggest securities firm, announced it would acquire rival Guangzhou Securities Co. for about 14 billion yuan ($2 billion). In a response to questions from the Shanghai Stock Exchange, Citic cited increased competitiveness and the need to expand its presence in the southern region of China as a rationale for the deal.

Some smaller and less-profitable brokerages will likely fail, but the looming entrance of foreign competition is generally positive for the sector and policymakers. Over the first month of 2019, shares of listed brokerage firms in China have outperformed the wider Chinese stock market, according to Bloomberg data.

But the biggest benefit is also one that’s least talked about.

Strategically, the Chinese Communist Party typically takes a long view. Forced technology transfer is a major impetus for President Donald Trump’s trade dispute with China, and that’s a verifiable, tangible action for most industries.

Banking and financial services are among the pillars of a service-driven, post-industrial economy such as the United States. The greatest assets of a bank or securities firm aren’t equipment or technology. It’s the know-how and expertise—often intangible and not physically transferable—developed through decades of experience in the global capital markets.

Inviting foreign banks and securities firms to have a tangible presence in China, and, in turn, transferring a greater portion of their key foreign staff, will allow Chinese domestic partners to gain valuable experience and savvy over time. And that’s a type of “technology transfer” that likely won’t ruffle any feathers.

Banking is a relationship- and experience-driven business. It’s one reason why foreign banks in the past have tried to hire “princelings” and relatives of Chinese officials to win deals. Chinese securities firms already have relationships with state-owned enterprises. But they lack the experience and savvy for dealing with global capital markets, and that’s where their foreign partners come in.

“We don’t expect to get a ton of business in China, even with the recent announcement,” a source at a foreign bank, who declined to be named, told The Epoch Times. “For now, the focus is on serving our global institutional clients [within China].”

Wall Street firms dreaming of billions of dollars in new profits should think twice before diving in head-first.