The fight now, the market of the future

To ensure that your interview is rejected, you can ask Western financial companies to talk about the impact of geopolitical tensions on their Chinese strategy. “This topic is a bit sensitive.” A banker declined. “We don’t want to appear in Trump’s tweets.” Another said. The journal requested interviews with 15 international banks, insurance companies, and asset management companies, and they all rejected them—unless they made their comments from anonymous sources.

The arrogant financial giants have become so twitchy, which in itself explains the problem. They are facing a strange situation. For many years, the US government has been calling for China to open up to foreign investment, and China has been procrastinating. Suddenly, the role was reversed. The Trump administration wants global financial institutions to withdraw from China. China is attracting them to enter, creating various opportunities. No one thought that such an opportunity would appear, and it would come so soon.

This created a disconnect between the political and financial fields. Many observers are concerned about the decoupling of China and the United States. However, to those who manage the trillions of dollars that flow daily in the global market, the main trend is more like a peg. Let’s take a look at the movements of investment banks and commercial banks in the past six months. Goldman Sachs and Morgan Stanley have acquired multiple CNC stakes in their joint venture securities company in China. HSBC’s China life insurance business has become completely wholly-owned; Citigroup has obtained the coveted custody license to provide services to institutional investors in China. Among asset management companies, BlackRock was approved to sell its own public funds in China, and Vanguard decided to move its Asian headquarters to Shanghai.

The trend of capital flow is even more alarming. In the past year, about 200 billion US dollars have entered China’s capital market from abroad. As of the end of June, foreign holdings of Chinese stocks and bonds have increased by 50% and 28% respectively over the same period last year. As global index compilation companies such as MSCI include Chinese assets in their benchmark indexes, these trends reflect to a certain extent the attractiveness of the Chinese market that cannot be ignored. Fund management companies that passively track these benchmarks must allocate funds according to the new weights. But the reasons why China attracts funds don’t stop there. China has greatly improved the convenience for foreigners to enter the Chinese market, and it has also provided two things that are currently rare in other parts of the world: GDP growth and higher than zero interest rates.

Although public opinion talks about the new Cold War, there are two reasons to think that linkage rather than decoupling will still be a more appropriate description of Sino-US financial relations. The first is China’s own actions. It is pursuing the “connection strategy” called by the famous economist Yu Yongding, and strives to establish more connections with foreign companies. Since the end of 2019, the Chinese government has lifted foreign ownership restrictions on asset management companies, securities companies and life insurance companies. MasterCard and PayPal were finally allowed to enter the Chinese payment market. China has also allowed foreign rating agencies to rate more Chinese companies.

Even without this linkage strategy, China still has ample incentives to further open its financial system. In the past 10 years, China’s current account surplus as a percentage of GDP has been gradually decreasing (although due to the impact of the new crown epidemic, it will increase significantly this year); this has put pressure on China to attract more capital inflows through its capital account . At the same time, reform officials hope that foreign capital will participate more in China’s financial system. Zhou Xiaochuan, the former governor of the People’s Bank of China, believes that competition from abroad has helped Chinese manufacturing companies become one of the most popular in the world, and it can also improve China’s financial industry. Regulators also hope that companies will increase financing through the issuance of bonds and stocks and reduce their reliance on bank loans.

Chinese domestic assets held by foreign countries

Data source: Wind Information

The trend of deregulation in China is in line with the second factor-the interests of foreign financial companies. The Chinese market is so big that they can’t ignore it. According to Oliver Wyman, the investable wealth of retail customers is expected to increase from approximately US$24 trillion in 2018 to US$41 trillion in 2023. Now, few experienced asset management companies with a global perspective are doing business in China.

Today, foreign institutions have become more aware: China’s large economy does not mean that it has more business. In the first few years of this century, China began to open its commercial banking sector to foreign capital, but the market share of foreign banks has been small and has continued to shrink until it only accounted for about 1% of domestic bank assets, which is of little importance in the market.

However, foreign businessmen may have a better situation in industries that have recently opened up to them. No global bank can compete for deposit business with institutions such as the Industrial and Commercial Bank of China, which claims to have approximately 15.7 thousand branches. However, the success of investment banking and asset management businesses relies more on experience than on hyperscale. Can a consulting company help design the structure of a cross-border acquisition? Can an asset management company correctly use interest rate swaps to hedge currency risks? “In these areas, foreign companies think they have an advantage,” said Mark Austen, head of the Asia Securities Industry and Financial Markets Association. The members of the association include many of the world’s largest financial institutions.

This is not to say that China will let them succeed easily. BlackRock felt the potential complexity after being approved to set up a fund management company. Unlike previous approvals obtained by Chinese-owned holding entities, regulators have added a condition requiring BlackRock to comply with the Cybersecurity Law.

Foreign companies will also compete fiercely with Chinese companies in an environment where the balance is tilted to the other. “They will never be fully open and let us break local companies.” said a banker. State-owned enterprises will leave their most profitable transactions to domestic banks. The Chinese government is planning mergers to create so-called “aircraft carrier-class” investment banks to repel foreign competitors. And global asset management companies have no choice but to distribute products through Chinese banks and technology platforms. Chantal Grinderslev, the founder of Majtildig, a Shanghai-based consulting company, believes that foreign companies can be divided into two categories. One is based on long-term investment in China, and the other is less patient. She said: “If you must be profitable in 3 years or less, then don’t enter the Chinese market.” She pointed out that JPMorgan Chase is advancing to acquire all the shares of its local partners in its asset management business for US$1 billion. , A premium of 50%. The price is high, but it also proves that the CEO of this banking giant, Jamie Dimon, attaches importance to China. “He wants to develop real business.” She said.

A dark cloud of political disputes between China and the United States hangs over corporate decisions. “Global headquarters requires us to plan for optimistic, realistic and pessimistic scenarios,” said the China CEO of a U.S. bank. “I laughed when I heard it, because it doesn’t make sense to think about the situation improving. The reality is either one or the other. You can continue to do business in China, or you can’t.” So far, the situation is obviously inclined to “stay in China”. Although the US financial measures against China have caused some inconvenience, they have not completely stopped the existing system.

The Trump administration has banned a federal government pension plan from investing in Chinese stocks. It threatened to delist Chinese companies listed on US stock exchanges and imposed sanctions on Chinese officials in Hong Kong, China and Xinjiang, China. Overall, these three measures are considered moderate. Federal government pension plans that can no longer invest in Chinese stocks now account for only 3% of American pension assets. No Chinese companies will be delisted before 2022, and China has proposed a settlement plan to give American auditors more authority to view the accounts of Chinese companies. At the same time, the overall market value of Chinese companies listed on Wall Street this year has risen (see Exhibit 2). As for sanctions, this will make some individuals feel painful, but if actions are taken against one bank as a whole, the harm to China will be much greater.

Chinese companies IPO in the US

Data source: Dealogic

Companies need to prepare for the United States to take tougher measures against China. This is a prudent approach. However, the financial sector is affected differently from industries such as industry. The factory requires a large amount of fixed investment and a well-configured supply chain. In contrast, bond or stock investments are much easier to adjust—at least if China allows investors to withdraw funds from its markets. Even for companies that have established brokerage or asset management businesses in China, their investments are only a small part of their global assets. For example, UBS’s holding securities company in China only held 5 billion yuan ($730 million) in assets by the end of 2019, which is higher than any other foreign securities company in China, but only accounts for 0.2% of UBS’s global investment bank assets. .

One action in the United States that can disrupt the financial linkage almost immediately is to drive China out of the US dollar payment system. The Trump administration can put pressure on the Belgian messaging system SWIFT (which supports most cross-border payments) to kick its Chinese members. The Trump administration can also order major banks that settle U.S. dollar payments to stop serving Chinese banks.

These once unimaginable possibilities worry Chinese officials, who have held meetings in recent months to discuss countermeasures. They discussed promoting the replacement of the US dollar with the renminbi and promoting their own payment network to replace SWIFT. In practice, neither of them can help much. Restricted by capital controls, the RMB’s status in global finance is still low, and the system China wanted to replace SWIFT failed to gain influence.

The biggest constraint to the United States is its countermeasures against itself. Cutting off China’s U.S. dollar payment channel will not only harm the interests of Chinese banks, but also Chinese companies that account for more than one-tenth of global exports. This will cause the collapse of international trade, severely disrupt the supply chain, and is likely to exacerbate the global economic recession. U.S. policymakers must indeed weigh the consequences, which supports China’s linkage strategy. “The only option is to be more open,” said Hu Weijun, chief China economist at the Macquarie Group. “You must create a situation where your opponents are more expensive.” For foreign financiers in China, this is very pleasant to hear.