U.S. asset managers are making moves to establish a beachhead. BlackRock, the world’s biggest asset manager, has received Beijing’s approval to set up a Chinese venture in partnership with China Construction Bank and Temasek, Singapore’s sovereign wealth fund. Meanwhile, Vanguard, a major U.S. passive investment manager, said in August that it would relocate its Asia headquarters to Shanghai from Hong Kong.
U.S. banks JPMorgan Chase and Citigroup also have announced plans to establish fund management divisions in China.
Regarding securities firms, investment bank Goldman Sachs plans to take full ownership of its Chinese securities joint venture, according to mainland business magazine Caixin. While it currently owns 51 percent of Goldman Sachs Gao Hua Securities Co. Ltd., plans are to buy out its domestic partner, according to those with knowledge of the information.
Other banks with majority (51 percent or more) ownership of their Chinese ventures include Japan’s Nomura Holdings, Switzerland’s Credit Suisse and UBS, and United States’ Morgan Stanley.
The moves by Wall Street investment managers and banks come as Beijing takes steps toward opening its extensive but heavily protected capital markets and financial services industry. Beijing first announced in 2017 that it would allow majority foreign ownership in financial services firms, and in July 2019, said that it would take away all limits on foreign ownership in 2020 related to brokerage, securities, and insurance companies.
But Wall Street banks and investment managers are rushing into China even amid growing political and trade tensions ahead of the U.S. presidential election.
This year, the Trump Administration has put the U.S.–China relationship under additional scrutiny. The United States imposed sanctions on Huawei and a group of other Chinese companies with military and government ties, and stepped up efforts to eliminate regulation loopholes available to Chinese companies listed on U.S. stock exchanges. China has become an opponent to the United States on key fronts such as international trade, technology, and ideology.
A Welcome Mat
Why is China liberalizing its financial industry now? For one, it’s mandated by the phase one U.S.–China trade deal published in January. One of the stipulations states that China must remove all foreign ownership limits on its securities, fund management, and futures industries and remove any “discriminatory restrictions.”
One of the areas the Trump Administration has put pressure on Beijing is regarding reciprocity of market access. Besides financial services, Trump has most recently focused on the lack of media reciprocity by placing restrictions on Chinese media activities in the country. Chinese media are able to freely publish and disseminate their viewpoints in the United States, while U.S. media entities have no such freedom in China.
China also needs to court investment to maintain its U.S. dollar supply. Chinese firms have almost $2 trillion in dollar-denominated debt outstanding that they need to service using U.S. dollars. And Chinese banks have been running out of dollars since 2019, as initially reported by The Wall Street Journal. While the People’s Bank of China has $3.2 trillion in foreign exchange reserves as of August 2020 and can intervene if needed, the veracity of that amount has been questioned by some researchers.
Weighing Risks, Benefits
There are numerous risks for Wall Street firms seeking to operate in China.
The recent snag in ByteDance’s pending sale of TikTok is a prime example of Chinese Communist Party (CCP) intervention. Beijing may scuttle a divestiture deal, which ultimately may complete the destruction of TikTok’s valuation (which was begun by the Trump Administration). Seeing investors such as Sequoia Capital and KKR faced with a large write-off, will other investors be reluctant to invest in the next hot Chinese startup?
Corruption is another potential landmine, one which Wall Street banks have already touched off. In 2016, JPMorgan was fined by U.S. regulators for its so-called “sons and daughters program,” hiring relatives of CCP officials in order to win business for its Chinese subsidiaries. It was a black eye for JPMorgan and other global banks that ran similar plans in hopes of currying favor with local officials. Can wholly owned subsidiaries of foreign financial firms compete effectively going forward?
There are also ESG (environmental, social, governance) issues and other concerns that have taken on added significance for investors. A Chinese bank’s main clients are domestic Chinese companies, many of which have dubious ownership structures and governance issues. And kowtowing to the CCP—a regime with a horrendous human rights record—in exchange for market access won’t be accretive to a bank’s ESG marks. Walt Disney Co.’s recent “Mulan” debacle is the latest reminder that doing business in China carries significant reputational risks.
Assuming the Chinese ventures eventually will make a profit for the parent company, repatriation of cash often is a challenge for multinationals operating in China. Beijing maintains strict foreign capital controls, which means funds flowing into and out of China are heavily scrutinized. In addition to taxes and other prerequisites, companies face additional difficulties when paying dividends to the parent. But given the legal and compliance resources available to Wall Street firms it’s likely a costly—but ultimately solvable—issue.
At the end of the day, the CCP, when it counts, can skew laws to protect local securities firms.
What’s the benefit? A slice of China’s $45 trillion financial services sector, and the fees associated with arranging debt and equity raises, investment management, and mergers and acquisitions advisory. Wall Street is counting on its name brand and vast experience to take market share quickly.
Companies are making a long-term bet that future growth in the industry will likely come from the East, not the West. And if the CCP collapses in the future, that trend would only accelerate and some of these risks could go away.
It may be a valid strategy, albeit with high degrees of uncertainty and risk in the near term.