As China 's financial services open up in accordance with WTO requirements, international banks are looking for the best way to stay ahead of their rivals. Nick Parsons looks deeper into Goldman Sachs' proposed joint venture and asks about the alternatives for the other banks.
International banks have been trying to decide when and how - rather than if - they should enter China 's domestic financial markets ever since China 's accession to the World Trade Organization at the end of 2001. Linking up with a Chinese partner to form a joint venture is the obvious answer but most banks have been reluctant to surrender control.
The potential is enormous and so are the dangers. As a result, each financial institution has been trying to develop a strategy that takes advantage of the liberalization of the financial markets while minimizing the effect of the continuing ownership restrictions.
A bold step forward
But decision time could be getting nearer: on the investment banking side, one of the international heavyweights has upped the pace. Chinese prime minister Wen Jiabao and the state council have given Goldman Sachs permission to establish the country's first foreign controlled joint venture investment bank – a decision that may spur the opening up of China 's financial system to international intermediaries.
Prior to this latest move, there had been no substantive action among banks since two firms, CLSA and BNP Paribas, sought approval for their brokerage joint ventures back in 2002. Most banks were happy to wait and see how the regulatory environment would develop. But now they may have to makes their moves if they are not to be left behind.
If the joint venture gets full approval – and that may take some time – it will be able to underwrite domestic equity and bond issues, giving Goldman Sachs a crucial headstart in earning marketshare. Goldman Sachs believes it has approval to form a joint venture with Fang Fenglei, China 's most prominent Chinese investment banker that allows it to retain management control. It will lend Fang some $ 100m to be their Chinese partner, which Goldman believes allows it to avoid the 33% ownership restriction placed on the foreign party. It has also demonstrated its goodwill by donating a $ 60m sum to a bankrupt securities house.
Rival bankers suggest that Goldman Sachs has not yet got full approval for a call option in the agreement with Fang, or that the bank is taking a massive bet on what is fundamentally a partnership with Chinese government officials. Said one: “They paid an awful lot of money for very little comfort: the proof of the pudding will be if they put Goldman Sachs China on the door – if they do, that would be really aggressive.”
All paths lead to Rome
With envy, awe or amusement, rival investment banks are eyeing the situation carefully. Few will admit they are likely to pursue a joint venture in the Goldman Sachs model, but they are all considering a variety of possibilities.
If Goldman Sachs is one step ahead of its rival in establishing an investment banking operation, Morgan Stanley has had ten years experience already in China through its 33% stake in China International Capital Corp (CICC), a joint venture with China Construction Bank. It was established in 1995 but within six months the venture was in disarray because of the different views the two sides had on how to run the operation. The answer to the problem was that Morgan Stanley exited from management of the investment bank, which is now independent; Morgan Stanley though still maintains its 33% stake.
"We have CICC, which is a great commercial business, a great partner for us and an organization that provides a great service to the country," says Jonathan Zhu, managing director and co-head of China investment banking. "CICC has been hugely successful because it is truly a trusted adviser to the government. It has demonstrated that it has the expertise and the access to expertise; and secondly it is majority-owned by the Chinese government, which is very comfortable working with CICC .”
Morgan Stanley gains from CICC's success – the firm dominates China 's financial securities industry – both financially and via collaboration on several projects, but it still has not trained up the human resources that it would have done if it had stayed within CICC itself. In that sense, it is still on the outside of China 's securities industry – just like everyone else.
JP Morgan is another major player hovering on the sidelines. 'We are building a good wholesale business and one of the areas we are actively considering is the securities underwriting business," says Carl Walter, managing director and chief operating officer for China at JPMorgan in Beijing . "We have watched what other competitors have been doing with a great deal of interest and are thinking about this a lot. If it could be achieved, a securities joint venture that would be a great step to helping us become a complete wholesale bank in China ."
Look before you leap
"The important thing is to look at the partner - it is difficult in the current business environment to have a partner with similar views as you," he says. "It is not just the big issues, but the small issues which turn out to be big issues that you have to worry about."
Walter was previously at Morgan Stanley and seconded to CICC so he knows all about joint ventures in China . "We want to look at something where we have a partner we think we can work with, who has the same views as us rather than relying on continuous senior level support."
Another major firm looking to penetrate further into China is Deutsche Bank. It will have three branches by the end of the year and has built a successful cross border investment banking and strong cash and trade services businesses. It has applied for a derivatives license, having already obtained QFII and e-banking licenses.
Deutsche currently has a $5.5bn cross-border ECM backlog, says Lee Zhang, chairman of Deutsche Bank China . "You can see from that we are very active in major cross-border transactions and we have made no secret of our ambitions to expand in the domestic market.”
“We are interested in participating in domestic M&A and capital markets as well as the domestic equities market. The question is: what's the ideal structure to enter the market and what is the best timing? We are evaluating a wide variety of options," he concludes.
The importance of China for Credit Suisse First Boston's (CSFB) overall strategy in Asia can be seen by the fact that Credit Suisse Group is holding its Group Executive Board meeting in Shanghai this year - the first time ever in Asia .
“CSFB is taking a broad-based approach in China , and we expect to eventually be able to deliver the full range of products and services to our clients across banking, fixed income, and equities businesses,” says Paul Calello, chairman and CEO Asia Pacific at CSFB in Hong Kong . “These include equity, M&A, A-share research, NPLs, derivatives, QFII, and bond issuance, as well as several other products.”
He sees some strong China opportunities in early 2005 for both investors and issuers. “ There will always be strong demand for unique equity stories and high quality issuers,” he says. “Foreign listings will be key for large deals. However, recent developments in local regulations aiming to boost transparency may ultimately allow more dual listings in China and internationally over the longer term.”
An improved opportunity to underwrite equity offerings in the domestic market is one key reason why foreign firms are showing so much interest in establishing a joint venture securities business.
Historically
Investment banking in China has been run along two lines - the domestic business and international business. The latter comprises M&A and raising funds overseas through IPOs, secondary offerings and bond issuance. As China 's international business offered significant opportunities for global investment banks, the domestic business did not become a focus. Thus, during the WTO negotiations – while commercial banks and insurance companies, for instance, with no China-related international business opportunities were very focused on gaining as quickly as possible access to China's domestic markets – this was not a priority to the investment banking community. This was clearly a missed opportunity.
The investment banks didn't think the domestic market was important enough because they were focused on the international flow, whereas the commercial banks and insurance companies didn't have that and were focused on cracking the domestic market.
Historically investment banks have been wary of the opportunities of doing business in China 's domestic capital markets. They thought the market was unattractive: it was highly and unusually regulated, government-controlled and the investor base was primarily retail. In addition, all China's high quality companies were seeking international listings, so effectively the investment banks could focus on the international business and still work with the cream of corporate China.
“The listing of BaoSteel in Shanghai in late 2000 changed many peoples' perceptions and opened the industry's eyes to the potential of the domestic opportunity,” says Zhu at Morgan Stanley. “That deal opened the gates and other quality names such as China Merchants Bank followed with local listings. “
The realization that significant Chinese companies would seek ‘A' Share listings and that the domestic market could absorb such large deals created real interest among investment banks, he adds.
China 's biggest steelmaker has played another unusual role in developing relationships with international financial institutions when one of its units, Fortune Trust and Investment Co, linked up with French investment bank, SG CIB, to form a successful asset management joint venture. So far Fortune SGAM has raised over $1bn in China . "When people looked at our joint venture with the steelmaker, they thought we would get a tremendous amount of good will but little capital market benefit," says Marc Poirier, SG country manager for China. "But in fact we gained a great deal on regulatory issues, and things like applying for a license."
He is pleased not to have linked up with a local asset manager. "If joint venture partners are in the same industry, they could try to cross each other,” he says. “It is an affair that in three, four or five years could fade away."
"We don't like to do orthodox joint ventures,” says Poirier, and one of those negatives is the securities industry in China . "Commission is very low: you have 110 houses and in 2003 there were only 68 IPO's, generating $ 30m in fees. With the exception of CICC, it is hard to make a profit from the industry - just as the old model has disappeared around the globe."
Nor is Poirier optimistic about the chances of making money from the lending business in China . But he admits: "Like everybody we are looking at potential Chinese partners. Investing in a Chinese bank could be an interesting adventure but we need a little bit more clarity about what we could do with our shareholding, what would be our role and what we get from our investment.”
Must be here
Lehman Brothers also has firm ideas on partnerships. "Our QFII operation is indicative of how we think about partnerships and joint ventures," says Tim Throsby, head of equities, Asia at Lehman Brothers. "Agricultural Bank of China is our custodian, which is more than just a basic function. We have got to know them better and being their first client has led to a longer term dialogue." Similarly with securities, Lehman works closely with Orient Securities, which acts as its executive broker.
"It is not just these two; inevitably these kinds of commercial arrangements produce a strong education relationship and also the potential to develop into something more,” says Throsby. “All the people we work with we are thinking not just in the short term but after an internal assessment we are looking at whether it will evolve beyond that.”
Merrill Lynch and UBS are two more of the big players that have been looking at joint ventures and possible partners. UBS has made major strides in the asset management business in particular. It would not comment on the status of UBS strategy vis-à-vis joint ventures in China , but a spokesman says: "For all its businesses including investment banking and wealth and asset management, UBS remains committed to the bank's previously stated organic growth strategy. In light of its deep commitment to the mainland and the massive potential of the market, it remains open to taking advantage of opportunities to develop the wealth management business as, and when, the regulations allow."
For the large commercial banks, the domestic securities side is just a part of their overall strategy in China . HSBC and Citigroup have made major investments in Chinese commercial banks - HSBC most recently in Bank of Communications and Citibank in Shanghai Pudong Development Bank - and they too are believed to be considering other investments.
" China remains a top international priority for Citigroup and one of the world's most exciting markets,” says Catherine Weir, Head of Greater China at Citigroup. “We want to bring our full suite of products across corporate, investment, insurance and retail banking to the market as the jurisdiction permits.”
"We are pleased with our close cooperation with Shanghai Pudong Development Bank,” she adds. "We are both committed to the market and continue to look for opportunities to participate in the financial services sector in China to complement and enhance our existing commitments."
