As the world considers the financial impact of the coronavirus pandemic, China is quietly getting on with opening up its financial services sector. On March 27th, China granted approval for both Goldman Sachs and Morgan Stanley to take majority (51%) ownership stakes in their Chinese securities company subsidiaries. This is the latest evidence of China’s commitment to open up its domestic financial markets to foreign players. China’s plans for opening up are not new, but the dates imposed by the phase one US-China Trade agreement and the impetus to stimulate the Chinese domestic economy in the face of pandemic-related recession make the next few months ripe for progress. Unfortunately impacts of COVID-19 also suggest the opening up will not include opening up of capital outflows from mainland China and progress remains focused on foreign inflows.
While foreign firms were previously required to maintain a minority stake in a joint venture with a domestic Chinese partner in many financial services businesses, since the July 2019 “11 Measures” announced to explain China’s opening up plans by the State Council, the ownership cap on foreign ownership has been relaxed. New areas within the financial ecosystem have also been opened up to foreign participation.
The new rules allow majority foreign ownership in securities businesses, fund management, futures businesses, life insurance companies, and currency brokerage companies. Foreign players are additionally allowed to participate for the first time in pension fund management, credit rating agencies and domestic bond underwriting.
Furthermore, limits to ownership or participation in other areas have been raised in sectors including foreign invested insurance companies, insurance asset management, wealth management and pension fund management.
Encouraging foreign institutional investment in China’s bond and equity markets is a priority for China. This has been evidenced by abolishing the quotas (both QFII and RQFII) for inward investment announced by China last September.
Combined with the announcements of licenses being granted to foreign securities firms, asset managers, insurance companies and payment companies over the last 12 months, the financial services market should prepare for a changing landscape in China’s domestic financial industry.
An April 2020 watershed
The time frame for significant milestones is approaching soon, with April 2020 designated under the US-China Phase 1 trade agreement. Foreign institutional investment in China’s markets is also being encouraged by abolishing the quotas (both QFII and RQFII) for inward investment which was announced by China last September. The table below shows how both the 11 Measures and the US-China trade pact influence the timeline and where some foreign firms are already players in the domestic arena.
The Asset Management market was the first to announce opening up measures in late 2017 and as of April of this year, the first foreign firms will be allowed to operate after attaining licenses. The Chinese market has strong appeal; it has a projected annual growth rate of 13% and is set to eclipse the UK as the 2nd largest global asset management hub, by AUM, by 2021. The effects of COVID-19 may accelerate this repositioning as mature markets like the UK take a significant hit to portfolio valuations. Meanwhile China’s savings rate (as a percentage of household income) is upwards of 35% compared to the UK’s rate of approximately 2% or the USA’s rate of approximately 7%. The opportunity is clear.
The long march to success
While this is a positive direction of travel, there remain a number of barriers to implementation for foreign players: licenses granted to take up these onshore opportunities may require additional approvals, quotas or regulatory green lights. Bureaucracy allows China to manage the speed of opening up and to maintain a degree of control over the financial systems to promote stability.
Moreover, foreign players have key decisions to make as well. They need to balance the opportunity for control with the continuing need for local partners to help with distribution, fund allocation and local knowledge. Many foreign companies – including Goldman Sachs and Morgan Stanley – already participate in the Chinese domestic market through functioning JV’s. The opportunity to take more control nevertheless requires negotiation with partners in businesses that are going concerns. In addition, onshore operations entail adherence to a myriad of data localisation requirements and rules for sharing of software and technology with the Chinese government.
Foreign firms have to consider relationships, valuations, governance, IP protection and competition. The relaxation of rules is uncharted territory for both Chinese regulators and foreign financial institutions. It requires a sophisticated approach.
It is important to note that “opening up” is not synonymous with free-flowing capital across China’s borders. All of the 11 Measures are relaxing the flow of capital into China but does nothing to increase flows of capital out of China. While the quotas for inbound investment have been abolished and Bond Connect (established with Hong Kong in 2017) offers an additional route for foreign investors to access China’s CIBM (China Interbank Bond Market), outbound quotas remain and a Bond Connect to allow Chinese investors to invest in international bonds via Hong Kong is still nowhere in sight. QDII (Qualified Domestic Institutional Investor) quota and its Renminbi-denominated sibling RQDII give fund managers the ability to invest domestic funds internationally. They were last granted by China’s SAFE at the end of April 2019 to four securities businesses – none of which included foreign JVs. All that quota is long gone through allocation.
A 50x increase in data demand
As foreign players ready themselves, their strategy, their talent and their balance sheets for new opportunities in China, an integral part of their success will be access to global market data to make decisions for themselves and their clients. As China opens up to inward flows of investment the ability for investors to compare opportunities onshore to opportunities in other markets will be essential. The demand for Chinese data is increasing. Refinitiv data on Chinese financial instruments and markets has seen a significant increase in usage over the last few years. American demand for Chinese government bond data has risen by over 50x between 2017 and 2020 and data from China’s Commodities Exchanges has seen a 2.5-fold increase in the same period. Futures data has seen an increase in demand by 48% and 64% from the UK and USA respectively.
The coronavirus is likely to add to this pivot in demand as China emerges ahead of the west from the peak of the pandemic.
China has committed to opening up its financial services sector through both announcements and actions. First the thorny US-China trade dispute and now the COVID-19 outbreak have not thwarted China’s planned changes and granting of licences and opportunities to foreign players. There would have been ample opportunities in the last 24 months to significantly delay the opening up policies and the fact that China has not taken up these opportunities can give the markets comfort in their dedication to the 11 Measures and overall plans for liberalization.
Foreign firms have been lobbying for decades for access to China’s $45Tr onshore financial services market. China will be planning carefully how this opening up affects domestic competition, the demand for talent and – most importantly – the flows of capital across its borders. Now, arguably more than ever, China needs to attract capital to boost its economy. However, now that foreign firms finally have the invitation to enter the market, what will that market hold for them as the economic impacts of the coronavirus play out?