At the end of 2017, the Chinese government announced it would be implementing a wide range of regulatory measures aimed at liberalising the country’s financial markets, opening the door for greater participation by foreign institutions.
In May 2018, a number of draft liberalisation measures were formalised by the CSRC (China Securities Regulatory Commission). Among the raft of reforms in the process of being or proposed to be implemented, one of the most significant developments has been the lifting of foreign ownership caps for securities, fund management, and life insurance companies to 51%, with 100% ownership on the table by 2021. This landmark announcement has been viewed as somewhat of a holy grail for foreign players, allowing them to secure something they had been seeking (but couldn’t attain) for many years: management control.
In the securities space in particular, we believe the recently announced reforms are true game changers. In addition to foreign players now having the opportunity to exercise full control of their onshore securities businesses, the relaxation of business scope and domestic partner requirements provide a gateway for aspirant firms to set up a JV without the need to operate an investment banking business (i.e. they can focus on their core competencies) or tie up with a domestic securities firm, which often presents major conflicts of interest. For the incumbent JVs,
the announced reforms also address many issues faced by the global investment banks around scalability and continued management conflicts with domestic partners.
We are already witnessing a number of firms pouncing on these new reforms. In May 2018, JP Morgan announced its plans to re-enter the China securities market, applying for a controlling stake in a new JV. In the same month, UBS further stepped up its efforts by applying for a controlling 51% stake in its China JV, UBS Securities. A number of aspirant entrants, including Nomura, Société Générale, and DBS, have followed suit, recently announcing their market entry plans. We expect to see further application announcements in Q3 and Q4 2018 by both global and regional players.
However, it is important to recognise that the recent regulatory changes are simply levelling the playing field between foreign and domestic players. Most JVs still remain extremely subscale when compared to the leading local securities houses, with operating income and headcount of the top 8 JVs dwarfed by a factor of 43 relative to the top 8 domestic firms. Moreover, many of the JVs are still running at painfully high cost-to-income ratios, weighing on profitability, though we do recognise some improvements in profit margins over the years.
We believe the Chinese securities market is on the verge of explosive growth and forecast the securities fee pool to reach CNY 708 billion (USD 103 billion) by 2023, more than doubling 2017-levels. In particular, the relaxation of business scope requirements will provide opportunities for foreign firms to bring more innovative funding and investment products to the domestic securities market, with appetite supported by the growing sophistication of domestic institutional investors and corporates. In addition, efforts to drive cross-border investments, including various Bond and Stock Connect Schemes, as well as the inclusion of Chinese A-shares in the MSCI Emerging Markets Index, are also expected to deliver a surge in capital inflows.
While the fee pool on offer from the Chinese securities market presents a compelling proposition to foreign players (especially in light of recent liberalisation measures), effectively monetising the JV opportunity isn’t so straightforward (as many of the failed JVs in the past can attest to), necessitating an in-depth understanding and review of the full spectrum of strategic, regulatory, financial, and operational considerations that come with setting up a securities business on the mainland.
It is also critical for aspirant players to appreciate cultural dynamics associated with operating a securities JV in China. While the new liberalisation measures mean domestic partners need not be securities firms (as they were required to be in the past), reducing direct business conflicts between domestic and foreign partners, the strategy and operating model of the JV still needs to work well within the local ecosystem.
In reality, any desire by international players to force-fit their global business models into China will need to be heavily scrutinised, given such an approach is unlikely to result in a successful outcome. Furthermore, full P&L consolidation and the capital implications associated with setting up a majority-owned JV will also need to be carefully considered by incumbent and aspirant players alike, as will a host of local compliance requirements.
While the current Sino-US trade war may put a mild dampener on anticipated liberalisation timelines, for those who can successfully develop and execute an effective end-to-end JV proposition, it’s time to traverse the Great Wall.
Benjamin Quinlan is the CEO & Managing Partner of Quinlan & Associates, a strategy consulting firm specialising in financial services.