According to US President Donald Trump, it was while eating “the most beautiful chocolate cake” that he told Chinese counterpart Xi Jinping the US Navy had just fired 59 missiles at Syria. Xi paused between mouthfuls to ask his interpreter to repeat the information.
Other intimacies of the April tête-à-tête in Mar-a-Largo are sadly lacking, so we do not know Xi’s reaction when Trump suggested lifting the ban on majority foreign ownership of Chinese securities and insurance companies. This, at least, must have been anticipated by Xi’s team as part of horse trading for Chinese cooperation against North Korea. The issue had been part of lengthy negotiations for a bilateral investment treaty (BIT) that almost bore fruit under the Barack Obama administration but which Trump repudiated while campaigning for the presidency.
Was Goldman Sachs, which lobbied hard for the BIT, and now counts several alumni inside the White House, behind Trump’s U-turn?
China had explicitly linked raising the ownership limit to BIT progress. China bankers point to a statement by Fang Xinghai, a vice chairman of the China Securities Regulatory Commission (CSRC), at a press conference on February 28, four weeks after Trump’s inauguration.
“We are preparing measures to further open up the securities and futures market to foreign institutions, including gradually uplifting shareholding limits by foreign investors in joint venture securities and futures companies,” Fang said.
“China attaches equal importance to the two-way opening up on a reciprocal basis under the framework set up by bilateral or multilateral international agreements. We have been working for it in the ongoing negotiations with the US and EU on respective bilateral investment treaties. The CSRC is very willing to facilitate two-way and equal opening up under international treaty,” he continued.
Far less clear is what the revised ceiling will be – or even if it will be removed altogether.
HSBC and Bank of East Asia are also not discussing their planned securities joint ventures in Qianhai, a new free-trade zone built on reclaimed land near Shenzhen, beyond the fact they still await final CSRC approval.
The two banks qualify as Hong Kong financial institutions eligible for extra privileges under the Mainland-Hong Kong Closer Economic Partnership Arrangements (Cepa), the main perks being eligibility for a full investment banking and brokerage licence, and an ownership ceiling of 51%, compared to 49% at the moment for Sino-foreign joint ventures.
Goldman Sachs is more open about its demands.
“We want to own 100% of our business in China. It’s the only market where we cannot. If we did own it, we would invest more capital, we would put more people in,” Goldman Sachs spokesman Edward Naylor told FinanceAsia. “Anything below 51% is a waste of time.”
Ownership restrictions in China are a perennial gripe for international investment banks. The reason for upping the ante now is that new business opportunities are rapidly burgeoning in China. It is not just the backlog of Chinese companies waiting to list, but the opening of direct access to onshore markets for foreign investors, and the tantalising prospect of renminbi shares and bonds being added to major global indices.
The number of IPOs in China’s domestic A-share market doubled in the 12 months to the end of March, and the total deal value rose 60%. Growth was strongest in the first quarter of this year, with the surge attributed to quicker approvals by the CSRC.
“I have not found any other market with as long a primary pipeline as China. Hundreds of companies have applied but not obtained approval, and a lot of companies that could not get approval in China come to Hong Kong or elsewhere to list,” Nicole Yuen, head of Greater China equities at Credit Suisse, told FinanceAsia.
IPOs have long been the main draw to obtaining an onshore investment banking licence.
“The flood of domestic A-share IPOs as well as Chinese companies seeking to list in Hong Kong and elsewhere remain the bread-and-butter business for our investment bank locally,” Eugene Qian, chairman of UBS’s China strategy board, told FinanceAsia. “There remains a hunger for capital. China’s economy is far from being mature. It is still in the capital formation period.”
But not everyone enthuses about the domestic IPO market, which has yielded scant pickings for international banks. In the 12 months to end of March, only one, Citigroup, is listed by Dealogic among the top 20 bookrunners for IPO listings on the Shanghai and Shenzhen exchanges.
“We can take them public in the H-share market in Hong Kong, or on Nasdaq, New York or London, whereas the market for A-share IPOs is hugely competitive and massively over-broked,” an investment banker in Hong Kong complained. “It is also very onerous in know-your-customer. Most of the deals that you see domestically would not pass our underwriting standards. You are competing with guys who don’t even have compliance departments, while we have a hundred compliance people asking questions every step of the way. How can you compete, when a chairman of a Chinese company says, ‘I want to do this deal at 15 times earnings and I want my signoff on your research report,’ and ten domestic brokers jump up and say, ‘Fine, no problem!’”
Last year, JP Morgan upped sticks, selling its one-third stake in an underwriting and financial advisory joint venture to its Chinese partner.
There are other attractions to an investment banking licence besides A-share underwriting, however. Foreign banks find that having onshore access to Chinese corporates helps them land lucrative M&A deals, as well as IPOs, outside the mainland.
“We use the platform to base a lot bankers in China, which you cannot do through a rep office. If you want to have bankers on the ground next to your clients, you need to have a JV,” the Hong Kong investment banker explained.
Much of the new excitement comes from the opening of the onshore equity and bond markets to direct foreign investment. This is whetted by expectation that A-shares will be added to MSCI’s emerging markets index, and renminbi bonds included in major global bond indices, as early as this year. This should lead to significant buying by foreign fund managers.
Hong Kong is now connected by ‘Stock Connect’ pipelines to the Shanghai and Shenzhen exchanges, allowing direct foreign buying of China’s domestic A-shares, the second-biggest equity market in the world, as well as granting mainland investors access to Hong Kong-listed stocks. In March, Chinese Premier Li Keqiang announced a parallel ‘Bond Connect’ would be launched this year, allowing direct foreign investment into the onshore renminbi bond market, the third-largest bond market in the world. There is also talk of a Shanghai-London Stock Connect, probably starting next year.
Société Générale has no onshore securities presence and does not consider one necessary to cater to ‘northbound’ foreign investment from Hong Kong via Stock Connect.
“I don’t really see why even a long-only foreign fund manager would need a bank to be onshore,” says Stephane Loiseau, SocGen’s head of cash equities and global execution services, Asia-Pacific. “It depends on the client base you are targeting. If you are targeting local funds, then obviously, these funds are going to need you to be onshore.”
Yuen of Credit Suisse disagrees. She considers an onshore brokerage licence essential for attracting inbound equity investors.
“When many foreign investors go to China, they want the same quality they have experienced outside China, with ourselves and other bulge-bracket banks,” Yuen explains. “To know and understand China you also need to be there. If you are an onshore broker, you are a member of the local exchange and privy to all the information it provides. It’s about being in the system, understanding, and knowing what’s going on.”
At present, only UBS and Credit Suisse share onshore brokerage licences with their Chinese partners. By a quirk of history, Goldman Sachs does not own any part of the brokerage that bears its Chinese name [see box]. All the other investment banking joint ventures, including that of Morgan Stanley, now wedded to Huaxin Securities after untying the knot with CICC, are confined to underwriting and advisory.
Uniquely, Beijing-based UBS Securities is not a joint venture, but a fully-licensed domestic securities firm in which UBS now owns 25%. UBS has management control over the sleeping partners, and a call option to buy them out, should authorities permit.
“We started off with a full licence that covers both the primary market for underwriting and the secondary market for equity and bonds, and we are active in both,” Qian of UBS says proudly.
Having applied later, Credit Suisse has two separate joint ventures in China, one based in Beijing for investment banking and the other in Qianhai, for broking.
Goldman Sachs bankers privately admit their envy of UBS.
“Both our domestic security firm, Beijing Gao Hua, and the JV, Goldman Sachs Gao Hua, look, feel and function just like any other Goldman office, so as and when we are able to own them, it will basically be plug and play, because there will be no change,” a source at Goldman Sachs tells FinanceAsia.
Until then, however, the brokerage arm is owned not by Goldman, but by Fang Fenglei and other Chinese investors. “In practice, UBS own a piece of everything that they do. We only have a piece of the investment banking JV,” the source added ruefully.
Meanwhile, HSBC is kicking its heels, with CSRC approval of its Qianhai JV still pending. Last year, HSBC was bragging that it was on course to become the first bank to have majority ownership within a JV in China, as well as having a full underwriting and broking licence.
This provokes no schadenfreude, just sympathy for HSBC among its peers. “They are running around inside a black box in the lobby of some regulator in Beijing trying to figure out how long they have to wait,” mused a Hong Kong banker.