Marco Sun sits at his desk in Shanghai every morning, and gets on the phone to 400 of his Citibank colleagues across China to bring them up to speed on overnight market movements in the US and Europe. “We have a 20-minute morning call between the China research team and all personal bankers,” says Mr Sun. This means that clients who walk into any one of Citi’s 28 smart banking branches, in 13 of the country’s first-tier and second-tier cities, can speak to an investment advisor who has their finger on the pulse.
Editor's choice
China is in the midst of a huge wave of urbanisation, which has seen Beijing and Shanghai more than double in size over the past decade, towns mushroom into cities and villages into towns. By 2025, Mckinsey estimates that 350 million people – more than the entire population of the US – will move from China's countryside to its cities.
As a result, cities such as Chengdu and Dalian, which barely registered on the international radar a few years ago, are becoming increasingly important for foreign banks operating in China.
Smart thinking
For Citibank, this has meant opening highly computerised smart banking branches, where information on products can be pulled up on touch screens as clients wait in line, and investment advisors, such as Marco Sun and his research team colleagues in Shanghai, can be video-conferenced into meeting rooms to give advice to customers in Chinese provincial capitals.
“Beijing and Shanghai have strong local advisory teams but this is especially useful for clients in second-tier cities such as Dalian or Guiyang,” says Mr Sun. Citi launched its smart banking model – which tries to make a bank branch look a little more like an Apple store than a traditional bank, with a reception desk, touch screens, internet banking stations and video-conference rooms – in Japan in 2010. The concept debuted in China the following year.
“Consumers in China have been somewhat underserved, and the financial services offered need to keep pace with market changes. That is where we can differentiate with a service based around using the latest technology. Consumers in China will become a more powerful force in the long term,” says Citibank China's CEO, Andrew Au. “In the past 30 years, we have seen our ability to do business increase significantly as the market has developed. Ten years ago we opened in Chengdu, Luoyang and other tier-two cities and we have been proved right by doing so.”
While China’s market is not at the same stage of development as Europe's or the US's, there is a lot of headroom to provide additional services and Chinese consumers are receptive. China now generates more than $1bn of revenue for Citi and is becoming one of the bank's most important markets globally as the outward flows of Chinese capital have prompted the bank to set up China desks across the globe.
“We noticed that Chinese corporates were internationalising and we wanted to stay a step ahead, so that meant setting up China desks on the ground so that whether our clients are in Johannesburg, Dubai or São Paulo, there is a Chinese banker there who understands how Citi operates, and also understands the needs of our Chinese clients,” says Mr Au, adding that the international expansion of Chinese companies hits Citibank’s sweet spot. “Being multinational is part of our DNA. As Chinese corporates expand overseas our competitive advantage is magnified.”
China ushers in new era of reform
China’s shadow banking market will not provoke an economic crisis in the country, but the world’s second largest economy still faces serious challenges on the road to reform, according to Mark Schwartz, chairman of Goldman Sachs Asia-Pacific. “On a macro view of China, we are optimistic about the leadership," he says. "The new government is smart, thoughtful and strategic, and in its first year in office has laid out a roadmap for future growth."
At a key Communist Party meeting in November 2013, Chinese president Xi Jinping and premier Li Keqiang unveiled their new strategy for growth, saying they would allow the market to play a “decisive” role in the country’s economy, rather than a basic one. The new government set out ambitious policy goals at the third plenum of the Chinese Communist Party’s 18th Congress, which aim to trim the role state-owned enterprises will play in driving the country’s growth engine.
“The growth strategies of the past 30 years have exhausted themselves,” says Mr Schwartz. The government has now unfurled a blueprint “to set China on a path to slower more sustainable growth”.
To date, China has lifted 600 million people out of poverty using a government-driven investment model that funnelled cheap credit in the form of subsidies and loans through state-owned banks to state-owned enterprises, but after almost three decades of double-digit growth the model has run out of steam.
“That growth has come at a great environmental cost and there are other issues of growing inequality of opportunity, income and wealth," says Mr Schwartz. “Pivoting to a market economy is not something that will happen in one or two years but will take 10, 20 or 30 years to evolve and the challenge now lies in the execution of that plan.”
Mr Schwartz says that China will push through as much reform as possible, while continuing to generate 15 million new jobs a year and keeping economic growth at 6.5% to 7%.
China’s state-run firms have gobbled up the lion’s share of the country’s capital energy and land at knock-down prices which has led to excessive reliance on infrastructure spending and wasteful investment in excess industrial capacity. One indicator of the problematic quality of Chinese growth is the performance of the country’s domestic A-share market, which has lost two-thirds of its value since its October 2007 peak.
“Gross domestic product growth has doubled while A-shares dropped from 6000 to 2000, which is very unusual and it reflects a lack of confidence in the quality of Chinese growth,” says Mr Schwartz. “There has been some misallocation of capital and there is now excess capacity in industries from steel and cement to financial services."
And the misallocation of capital has led to widespread fears about the size of China’s so-called shadow banking system. Many local governments have raised loans using off-balance-sheet funding vehicles and invested the money in dubious ventures while informal private lending has also ballooned, fuelling concerns that China’s debt burden could trigger a financial crisis in the way subprime loans triggered a financial upheaval in the West or a lost decade as seen in Japan.
Pessimists estimate that the worth of China’s shadow banking system could be as large as $7000bn to $8000bn, almost level with the country’s officially stated economic growth of $9300bn, while optimists place the sector’s value at only $1000bn to $1500bn.
Goldman places the size of the country’s shadow banking system at $3000bn to $4000bn, which is manageable, says Mr Schwartz, likening the country’s off-balance-sheet loans to the US securitisation market in the 1990s and early 2000s before the credit bubble blew out of control.
“Shadow banking is neither good nor bad, and there are valid reasons for it. I think that it is not such a big problem and I am confident that the People's Bank of China has a handle on what is happening,” he says.
Networks count
HSBC has taken a similar route. In 2012, it set up a global network of 19 China desks as part of a initiative to capture Chinese outbound investment.
“A growth strategy today for any business in China is only as good as its ability also to connect China’s growth with the rest of the world,” says Helen Wong, CEO of HSBC China.
"HSBC China has an even wider network than Citibank, with 165 outlets in 50 cities. That network expansion extends the opportunities we have to serve the evolving needs of our customers across the country – the growing mass of affluent individuals and both outbound Chinese companies and multinational corporations investing in China."
For foreign banks operating in China, there are two key aspects of the market to keep an eye on: the rise of the Chinese consumer and the globalisation of Chinese corporates. Chinese customers are set to make up a larger slice of foreign banks’ business in the China market than Western multinationals if they do not do so already. Citibank saw Chinese customers make up the majority of its business five years ago, with Western multinational corporations playing a smaller role.
Matchmaking mergers
Both retail and investment banking growth in China rests on the relationships banks can build with clients. This can mean anything from being the bank of choice for Chinese students in the US, with the ability to link up retail networks in China and abroad, or building such close relationships with Chinese clients that banks are in a position to help them formulate their international expansion strategy.
The past year has seen a number of high-profile merger and acquisition (M&A) deals by Chinese companies, including the $2.6bn acquisition of US entertainment giant AMC by China’s Wanda real estate conglomerate, and pork producer Shuanghui International’s $4.7bn acquisition of US pork producer and processor Smithfield Foods (Shuanghui International has since changed its name to WH Group). Goldman Sachs advised on the latter deal, bringing the two companies together thanks to its long-standing relationship as an advisor to Smithfield and an investor in Shuanghui.
Nomura China's CEO, Zhizhong Yang, says that the Smithfield and AMC acquisitions point to a clear trend of international Chinese corporate expansion and M&A, and even smaller banks without Goldman’s global economies of scale can also play a vital role in China’s growing wave of outbound investment, as Nomura’s experience shows.
“Last year was a relatively slow year because of the leadership transition [see sidebar] but in the next five to 10 years, with stabilisation, a new round of reform and restructuring kicking off, there should be more interest in looking at offshore assets,” says Mr Yang.
Nomura lined up Chinese real estate and transportation conglomerate Yuexiu’s acquisition of a 75% stake in Hong Kong’s Chong Hing Bank. Bankers who knew the Guangzhou-based company well were able to bring the principals of the deal together and explain how the acquisition fit into Yuexiu’s expansion strategy, allowing Yuexiu to gain a foothold in the financial services sector and get Hong Kong regulators onboard with the deal.
“We don’t have a very big operation in China yet, but we have been able to provide bespoke, tailor-made financial solutions for clients in the public and private market,” says Mr Yang. Nomura also acted for Weichai Power when the Shandong-based company made China’s largest investment in Germany, a €738m investment in forklift truck manufacturer Kion.
Foreign advisors need to be able to think strategically on behalf of their clients, and really know their Chinese clients business inside-out in order to drive the internationalisation of Chinese corporates. These firms now expect a higher standard of service and will push back if bankers come to them with poorly thought out strategies, according to Mr Yang. “You really need bankers on your team who can think outside the box and join the dots for the client,” he says.
Pot of gold?
On the asset management side, Chinese clients have very specific needs with ultra-high-net-worth individuals getting more sophisticated and increasingly seeking professional advice on asset allocation and investments. UBS has organised its whole operation in China to meet the specific needs of Chinese clients.
“In particular, for ultra-wealthy clients, we see their needs usually falling into three tiers – investment, business and family needs – and we have organised ourselves in that way to meet their demands,” says UBS China's CEO, David Li. “This is very [rare] in China.”
Through UBS Securities, a fully licensed securities firm, the bank gives clients access to its wealth management offering, and its investment banking and asset management business, offering everything from initial public offerings and rights issues to shares-based transactions.
UBS was able to acquire the licences of Beijing Securities, a distressed company undergoing restructuring in 2005, but for many banks, restrictions on ownership of both banks and securities ventures holds back their aspirations.
“Overall, the most significant restrictions are in terms of the ability to buy into local entities. I think a lot of foreign financial institutions would like to take over or have majority control of a financial institution but that is an impossibility in China,” says a foreign investment banker who spoke on condition of anonymity.
At the moment, foreign ownership is limited to 20% stakes in banks and 49% stakes in securities ventures, and after acquiring primary market underwriting licences, banks still face a seasoning period of several years before they can get a secondary market licence. Foreign banks are still constrained in the services and coverage they can provide in China, accounting for only 1.93% of the market; by contrast, foreign banks in the US account for more than 20% of total assets, according to the American Chamber of Commerce.
Loosening up
China’s capital markets are still at an embryonic stage, with most companies growing by borrowing from the banks or the informal shadow banking system. Goldman Sachs estimates that 70% to 80% of corporate finance is done through the banking sector in China with only 20% to 30% of funds for corporate growth coming from capital markets.
“The American Chamber of Commerce in China hopes that the Chinese government recognises the value and efficiency that foreign operators provide in the sector and, accordingly, embark on further reform to improve market access and regulatory clarity,” the chamber says in its most recent white paper aimed at lobbying the Chinese government.
One step the Chinese government has taken is that it opened the Shanghai Free Trade Zone in September 2013, as a pilot area to try out full convertibility of the Chinese currency and the liberalisation of the county’s interest rate regime amid the opening of the capital account. So far, there has been a lack of clarity from regulators about exactly what reforms foreign banks can implement, but banks will be paying close attention to developments in the area.
The internationalisation of China’s currency opens up further opportunities for global financial institutions. The renminbi surpassed the euro in December to become the world’s number two trade finance currency and now ranks seventh in the world as a payment currency.
“With China already the world’s top goods trader and second largest economy, there is already good momentum and still wide potential, for the renminbi’s continuing rise, and HSBC is committing strong efforts to remain at the forefront,” says Ms Wong, pointing to the bank’s February 2014 launch of cross-border renminbi settlement for individuals in the free-trade zone.
Ms Wong hopes that cross-border financial solutions in the zone will enhance efficiency and lower costs of renminbi funding and settlement for the bank’s customers, while UBS’s Mr Li is optimistic that the zone will provide a platform for foreign banks’ Chinese customers to invest overseas with greater ease, and open up great opportunities for foreign financial institutions.
“As more reform initiatives are rolled out, the China market will become even more integrated with the global market and the global best practices and professional expertise will play a key role in driving business success,” he says.
