After the United States, China is the second largest economy in the world. It has long been recognised as the fastest-growing globally, having recorded annual average growth rates in excess of 10 percent over the last quarter-century. In Q2 2010, China’s economy was valued at $1.33trn, and it is estimated that by the end of the year the nation’s total GDP will be approximately $5.7trn. Given these impressive figures, for many years global financial institutions have been holding their breath, waiting for an opportunity to tap into such a potentially lucrative market.
Their wait has been a long one. It was in 1978 that investors first pricked up their ears, when China began to make wholesale reforms to its economy in order to address its burgeoning social and economic problems. One key aspect of such a restructuring was that – for the first time in the 20th century – the government began to encourage foreign trade and permit foreign direct investment (FDI) in the areas of the country where it was most needed.
Following this, throughout the 1980s, the number of regions that could accept FDI grew and China began to adopt some ‘western’ principals, particularly in the fields of legal and financial infrastructure, which were key to handling FDI.
Recent developments within China’s financial infrastructure have left the door ajar for international banks, wealth managers and fund management firms to make their moves.
The Chinese banking sector has traditionally been dominated by four institutions: the Industrial and Commercial Bank of China, the China Construction Bank, the Bank of China, and the Agricultural Bank of China. Today these banks hold between them more than half of China’s total banking capital.
However, change is afoot. Recent years have witnessed a glut of high-value IPOs, which have seen the top five Chinese banks raising almost $60bn. Capping this trend, in July this year, the Agricultural Bank of China achieved a $19.2bn public listing, valuing the company at approximately $128bn – bigger than the likes of Goldman Sachs or Citigroup. These listings have allowed international investors to take significant shareholdings in the Chinese banking industry.
Of course, doing business in China has often been fraught with difficulties, with excessively high minimum capital adequacy requirements proving prohibitive for foreign firms. But, in 2001, upon accession to the World Trade Organisation, the Chinese government consented to the creation of a more level playing field for foreign banks.
Whereas some British banks have been well established in China for some time – HSBC and Standard Chartered have managed operations for over a century – these have been the exception to the rule. The figures show that today overseas banks are taking full advantage of this new freedom. According to figures published by UK Trade & Investment (UKTI), between 2003 and 2008 foreign investments in Chinese commercial banks stood at $783m, and the number of Chinese banks with foreign capital grew from just five to 32.
And the expansion has continued. To date, foreign banks from 12 countries have established a total of 28 foreign-funded banks, in addition to two joint-ventures and two overseas-funded finance companies. In total, 196 foreign banks from 46 countries have set up 237 offices in China.
The boom in commercial and investment banking has already begun, but there remains a huge opportunity in the localised retail banking sector. In 2007, HSBC was the first bank to receive approval from the China Banking Regulatory Commission to establish a bank in rural China, and although the hook has not yet caught, given China’s eye-catching demographics, many others are sure to follow.
Fund management and private equity
The fund management industry in China has played an increasingly important role with the Chinese economy over the last 10 years. Formally established in 1998 when the government launched the first batch of six fund-management firms, China is currently home to some 60 fund management organisations, bearing total assets under management of some Yuan Renminbi (RMB) 2.3trn (around $350bn).
The private equity (PE) industry, as a sub-sector of general fund management, is also in overdrive. A report published in August by M&A advisory firm China First Capital, details how China is flooded with PE capital ready for investment, having raised over $50bn over the last four years.
Driving this innovation is the Chinese government, which in 2007 pushed through a Partnership Enterprise Law, effectively imitating a western LLP structure and thus allowing the development of PE and venture capital investment into China. Steps have also been taken to ensure a sound and accountable professional services environment, allowing for the development of a supporting legal, accountancy and corporate finance services community.
The enormous flow of capital is not looking to dry up. As recently as August this year, CDH Investments, one of China’s leading PE firms – with $4bn of committed capital – closed its fourth investment vehicle on $1.46bn.
Furthermore, according to Deloitte’s annual Private Equity Confidence Survey, published in September, over three-quarters of respondents expected levels of PE investment to increase over the next 12 months, and not one respondent predicted it to decrease.
Another big attraction for foreign investors is sure to be the forthcoming launch of what will prove to be the largest pool of investment capital within the global PE industry. With assets of close to $120bn, China’s National Social Security Fund is mandated to commit over $3bn a year in new capital for PE investment in China.
Currently the fund is in the process of selecting suitable private equity fund managers and fund-of-funds to make investments on its behalf.
Given the government’s commitment to supporting the industry and with such prizes at stake it is no surprise that international funds are flocking to China, hungry for a piece of the pie.
However, they now have a great deal of competition on their hands. Until now, many domestic Chinese PE funds have operated on an opportunistic basis, aiming to make a ‘quick flip’ of an entrepreneurial business into an IPO, but without fully grasping the long-term effectiveness of a sustainable PE investment model.
But now, many Chinese funds have become enlightened and are contending on a credible – if not financial – level with the international funds. One of the key ways they are gaining a competitive advantage is by setting up RMB-denominated funds, which are able to invest more quickly and effectively into local businesses than foreign USD funds. Furthermore, their understanding of the dynamics of their home market often surpasses those of funds that fly in from London or New York. In short, local players have the advantage of speed of execution and local knowledge.
As testament to this, Deloitte’s survey states that “2010 will be remembered as the year the RMB funds found their pace and became a major factor in China’s capital landscape.” Also according to the report, “In the first half of the year, some 32 new PE funds were set up, 26 of which were RMB denominated.”
However, the foreigners are fighting back. It is for this reason that it is widely believed that Carlyle, one of the largest global PE players, is looking to launch a RMB fund, and Reuters reports that major US investor Blackstone has this year made a further three additional commitments to its $732m RMB-denominated fund.
As the Deloitte report also points out, “Foreign funds have encountered regulatory and market challenges in meeting their RMB funding goals.” Nevertheless, foreign-run RMB funds have raised a disclosed RMB 23.8bn ($3.5bn) to date.
All told, there is a massive opportunity for international funds to make their move on the sizeable Chinese PE playing field. However, in order to play their part they will need to act fast to compete with the growing masses of local funds and – perhaps more importantly – get to grips with an unfamiliar environment.
According to Celent, a research consultancy firm focused on the financial services industry, wealth management services provided by Chinese banks have shown impressive growth in recent years and have an even greater potential going forward. In 2007, for example, the size of the market for individual wealth management in China was over $350bn – more than double that for the year 2000. Furthermore, this figure is expected to double again by 2014.
Celent’s research reveals that at the end of 2007 China boasted almost half a million individuals with a net worth of more than $1m – an increase of over 20 percent from the previous year. Also, the number of ultra-high net worth individuals (those with assets exceeding $30m) now exceeds 6,000.
According to UKTI statistics, the wealthiest one percent of Chinese households own more than 70 percent of the country’s total personal wealth. Over the past five years the astronomic rise in the number of millionaires has meant that China now holds the global rank of fifth place in terms of the number of millionaires. All told, China’s richest people have an aggregate wealth of more than $2trn.
The concentration of wealth among such a small proportion of the population makes China a huge market for wealth management services – in fact the second largest in Asia outside Japan.
Unsurprisingly, there is a sizeable opportunity for international firms to take a foothold in China’s wealth management market, and there are opportunities to exploit such a market.
Economists have long commented that many of the local banks lack a sufficient portfolio of investment products to cater for the increasingly affluent class of Chinese high net worth individuals. Also, as investments through private structures such as venture capital trusts are not fully available to the wealthy, the best that they can achieve is high interest rate accounts offered by local banks. As such, there is an enormous opportunity for foreign private banks – especially those that have lost clients in their home markets thanks to cautionary measures caused by the recession – to enter the market with their full portfolio of products and services to cater to the needs of private banking customers.
Over the past few years China has experienced a continued expansion and diversification of financial players seeking to take a share of the market. As the sophistication of domestic investors has improved, so too has the window for foreign financial investment widened, as many sectors of the economy have become more liberalised.
Against the backdrop of global economic turmoil, China’s economic growth remains impressive, and international investors of all kinds will continue to find China hard to ignore – especially if opportunities remain thin on the ground in their home markets.