Wall Street Braces Itself for Trade War With China
WHY YOU SHOULD CARE
As China opens up its banking sector, the trade war could upset calculations of American banks.
By Martin Arnold and Gabriel Wildau
As the trade war between the U.S. and China intensifies, there is a growing expectation that collateral damage could spill onto Wall Street, disrupting U.S. banks’ plans to expand in mainland China.
Since the Chinese authorities lifted the cap on foreign ownership of securities trading and fund management companies from 49 percent to 51 percent in April, many of the world’s biggest banks have been scrambling to take full control of their operations in China. Bankers view the ability to own more than 50 percent of their Chinese ventures as important because it gives them full management control, including hiring staff, IT systems and compliance checks.
However, several bank executives say they fear U.S. banks may find themselves at a disadvantage because the trade war between Washington and Beijing could delay or prevent them obtaining approval to increase their Chinese stakes.
“If the trade war and tariffs escalate, it will be interesting to see how regulators allow liberalization to tie in with the trade rhetoric,” says Carsten Stoehr, CEO of Greater China at Credit Suisse. “Getting management control and a 51 percent stake is a very appealing opportunity from a strategy perspective, especially if it ultimately leads to an opportunity to raise to 100 percent.”
European banks are hopeful that the diplomatic tension between China and the U.S. could play to their advantage by allowing them to steal a march on their American rivals in the fast-growing Chinese market.
“Given the tensions between the U.S. and China, I have a question of whether the U.S. banks will ever be that strong in China,” says Frédéric Oudéa, CEO of Société Générale. “We are in a world where everyone is trying to show their muscle.”
We are in a world where everyone is trying to show their muscle.
Frédéric Oudéa, CEO, Société Générale
So far, three banks have applied to increase their stakes in Chinese securities joint ventures to 51 percent — Switzerland’s UBS, Japan’s Nomura and JPMorgan Chase of the U.S. One rival banker said it was no surprise that the first bank to submit its application was UBS — “not a U.S. bank, but a European” — in early May, just as the U.S. and China started to step up their trade war rhetoric.
Liberalization is often used by China as a political bargaining chip. Last month, Deutsche Bank’s China business received a long-awaited license to underwrite bonds in China’s onshore market days after Premier Li Keqiang visited Germany. Goldman Sachs and Citigroup own 33 percent of their Chinese securities ventures, while Morgan Stanley last year increased its holding to 49 percent. All three have said they plan to take advantage of the new rules to go to 51 percent.
“I’m not good at speculating about what would happen if there was an all-out trade war,” David Solomon, the incoming CEO of Goldman, told Bloomberg TV recently. “We are moving forward on the basis that it is constructive for us to continue to invest in our business … and are looking to get our application filed as quickly as we can.”
Bank of America does not have a Chinese securities venture but has been working on a plan to set up a fully incorporated business in China for four years, according to a person briefed on the matter. “Joint ventures are miserable,” says the person. “When they allow us to own 100 percent, then they are opening up, but anything else is a complete fallacy.” A Shanghai-based executive at a European bank says China’s recent banking liberalization moves were “not enough — it’s too little and too late.”
The inability to own a majority stake has held back foreign banks in China, where they have struggled with low profitability and limited market share. On average, foreign banks have made a return on equity of about 7 percent in China over recent years, half the returns made by the big Chinese state-controlled lenders, according to KPMG.
Securities trading revenue is the largest slice of the Chinese revenue pie for foreign banks, but that has declined for several years — not only because of weaker stock market trading volumes but also because brokerage margins are falling due to competition. “For foreign players, trying to make money on brokerage is not an ideal approach,” says Arthur Wang, head of banking for KPMG China in Beijing. “Even for domestic players, brokerage income is falling, and competition is extremely heavy. It’s more appropriate to look at growth areas like wealth management.”
Foreign banks have about a 2 percent share of the Chinese banking market by assets. Their share is higher in investment banking fee revenue, but even there it has been shrinking from more than 60 percent when China first opened up the sector in 2006 to less than 30 percent this year.
“There are more than 100 licensed Chinese securities firms operating in the People’s Republic of China,” says Eugene Qian, president of UBS Securities in China. “If through industry consolidation that number shrinks to, for example, 30 to 40 major domestic firms, which could take five years or more, the foreign firms will be in a better position to compete onshore.”
One foreign bank with a head start in China is HSBC, which last year became the first to launch a majority-owned securities venture in Shenzhen. HSBC, which made $625 million of pretax profits from its mainland China operations last year, also has a wholly owned retail and commercial bank in the country as well as joint ventures in asset management and insurance. “For those foreign banks that haven’t got approved yet, they will need to agree with their partner to increase their shareholding and work out how it will work for the foreign investor to have majority ownership,” says Helen Wong, head of Greater China at HSBC.
Bill Winters, CEO of Standard Chartered, predicts that it and bigger rival HSBC will have an advantage in China because of their common roots in Shanghai, which he says will help them gain a strong position in trading the renminbi.
“In the long run, as the euro and eventually the renminbi become reserve currencies, you are going to want people that have a natural position in those markets accessing capital markets,” says Winters. “But it is not going to be an American bank in China. It is going to be a Chinese bank in China. Maybe HSBC and Standard Chartered too if we play it really well.”
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