Jesse Lentchner, Asian chief executive of institutional brokerage firm BTIG, has more than 20 years in the industry, including stints running Goldman’s Asian execution business and Indian securities business. We talk to him about the competition these days, especially in light of Chinese brokerages looking to branch out, a move signalled by the upcoming Hong Kong IPOs of Citic Securities and Haitong securities.
Why are Chinese brokerages such as Citic Securities and Haitong expanding overseas?
I think the expansion is driven by two factors, one offensive and one defensive. Offensively, public companies are always paid for growth so they look for new markets no matter what industry they are in. At first glance, being a banker or broker in one market is a skill you can replicate in many so they assume they can and should expand beyond their home market. Defensively, there is an assumption that the Chinese market, like all others, will slowly open.
Firms that do not have international experience will be at a disadvantage once it does. Using the history of Japan as an example, the firms with the most international experience kept the most market share as the market opened up; the firms that were only domestic did less well.
Why hasn’t China internationalised sooner?
I don’t think it has been possible before. It was difficult or impossible to take renminbi out of the country. And they did not have the retained earnings from their domestic base to reinvest overseas.
Is the domestic market slowing down?
The domestic market is growing more slowly, but it is still growing. There are many private companies that will go public, many public companies that will raise more capital, and equity savings penetration in retail t is still low. Even with increasing competition, the Chinese market will be profitable for brokers and bankers for years to come.
Will domestic Chinese capital be able to flow into new international markets?
So far, Chinese domestic retail funds can only flow out of the country through QDII funds. Unless the Chinese decide to significantly relax their capital account, which in the short run looks unlikely, that will be the way it stays. The problem is that early QDII funds entered the international markets before the global financial crisis, and so many retail investors had a loss as their first experience of investing overseas. It takes a while for people to move past that and decide to invest again. Remember, for an investor in China to invest overseas they have to believe that overseas markets are going to provide a strong return, and that return is going to be higher than their domestic market, which is much easier to invest in. It’s unclear to me that those conditions will exist in the next year or two.
That is different from the public institutions that are responsible for recycling the Chinese current account surplus. That money was traditionally invested in US Treasuries, and their remit has slowly expanded to allow them to invest in other fixed income and equities.
Since the surplus will decline slowly, if at all, and since the allocation to Treasuries was excessive, that diversification has a long way to go. You will find them to be large investors in many asset classes during the next few years.
Is this a part of the overall internationalisation of the Chinese financial system?
When a currency is pegged, like the renminbi is now, it provides speculators with asymmetrical risk/reward.
Everyone believes the renminbi will appreciate, the only question is how much and how long it will take. So every speculator will want to own as much as they can. This gives an inflated view of how attractive that asset is for investors. It’s not the case that they simply have to open up and everyone will want to invest. If the Chinese relax their controls and the renminbi really does start to float, those free bets no longer exist.
Will the renminbi strengthen because of the relative strength of their economy? Or will it weaken because of the massive monetary growth they have had?
No one knows for sure. My point is that it will take a long time for the Chinese currency and Chinese bonds to be a significant portion of any international allocation pool.
They need to liberalise capital flows, they need to write rules for contracts and default events, the world has to learn what the new, post-float valuation should be, and then they need to get comfortable that the changes that were made are permanent. I am not saying that this will not happen, just that it takes longer than people sometimes think.
What are the challenges Chinese brokerages will face as they expand?
The biggest challenge the brokers will face is a differentiating strategy. From Europe, Japan, South America and other parts of Asia, there is a long list of brokers who, flush with profits from their domestic base, expanded internationally. But the list of brokers who have been profitable and competitive outside of their home market is very small.
When you are competing against the global giants on your home turf, you have a natural advantage and clients actually want to favour you. Once you are competing internationally there is no home bias and it is a whole new ball game. A Chinese broker should be better at Chinese equities than other brokers.
Can they be better than Goldman Sachs in the US or better than Deutsche Bank in Germany?
It’s not easy, and history has not been kind to most who have tried.
This story was first published in the May 2011 issue of FinanceAsia magazine
