A woman speaks on her mobile phone as she walks past a Hua Xia Bank branch in Shanghai on October 9, 2015. © Reuters
That global investment banks are still having to restructure and come to terms with a very different financial landscape since the global financial crisis is hardly news. But a few weeks ago, Deutsche Bank announced that as part of its latest restructuring plan, it would take a charge on the value of its 20% stake in Hua Xia Bank and that the holding in the mid-sized lender would no longer be considered strategic.
Deutsche first acquired a stake in the Beijing-based bank in 2005, a lifetime ago in the ever changing world of Chinese finance. Its write down is only the latest in a long line of failed joint ventures and strategic investments in the Chinese financial sector by foreign investors.
Yet “failed” is really the wrong term: most of the foreign investors have done very well out of their investments, at least financially, but there was the promise of so much more. The promise started with the first securities joint venture, China International Capital Corp.
CICC was founded in 2005 by Morgan Stanley and China Construction Bank as a joint venture investment bank. Morgan Stanley hoped that CICC would help propel it into a leading position as financial and state-owned enterprise reforms moved forward under then Premier Zhu Rongji.
CICC did indeed prosper and with strong connections and a veneer of professionalism, it became the anointed local house just as a slew of large state-owned “national champions” were starting to list overseas.
Instead of partnering with Morgan Stanley offshore, CICC worked ever more closely with Goldman Sachs. The money rolled in, Morgan received a good dividend and financially the venture was a success. What was not happening, however, was the opening up of the domestic market, nor was Morgan Stanley gaining control of its JV.
Clash of cultures
Over the following years, more and more foreign financial institutions established securities joint ventures, but every deal seemed to be a one off, with no template to follow. A clash of cultures meant that foreign institutions seldom had much ability to manage the joint ventures or implement international best practices.
Finding a suitable partner was always difficult: big domestic firms demanded too much, while small ones offered little to make a joint venture worthwhile. Deals were very expensive, needed a long lead time of negotiation and approval and delivered much less than had been hoped. Even 20 years on, with Morgan Stanley having sold its stake in CICC and entered into a new joint venture with Huaxin Securities in 2011, the terms of entry were really not that much different from when it started with CICC.
The 1990s were no time to invest in Chinese banks. Mired in bad loans, the banking sector was effectively bankrupt at the turn of the century. The slow climb out of that bad debt hole only started in 1999. Yet in just over a decade, the biggest Chinese banks all managed to list onshore or offshore.
The involvement of international banks started early, with pre-initial public offering investments to secure access as deal underwriter in the eventual market listings. Goldman Sachs, Bank of America, HSBC and Royal Bank of Scotland were all active investors and played up the long-term strategic potential of the tie-ups.
For institutions which had missed out on the biggest banks, a second tier of firms like Hua Xia Bank promised perhaps even greater returns. After all, RBS could surely never expect to take over and rebrand Bank of China, but would anyone care if Hua Xia Bank became Deutsche Bank China when the timing was right?
Perhaps the most hopeful was HSBC. It bought a 20% stake in Bank of Communications, which as the country’s fifth largest bank, was less politically sensitive than the four biggest. For HSBC, a bank that was founded in Shanghai, what would be more natural than buying up a major Chinese bank?
But the lesson learned by foreign investors in China was a hard one. For all the financial return generated via these early stakes, foreign institutions remain bit players in the Chinese financial markets.
The chief executives who had been so confident that the Chinese leadership would allow outright control of banks and brokerages were proved wrong. The strategic holdings turned into management nightmares as countless hours were spent dealing with joint venture partners who simply had a different agenda.
They were correct in their position that the Chinese economy would need better financial markets, more IPOs, more investment products, more institutional investors and the like, but foreign firms were not seen by Beijing as instrumental to this.
As foreigners were kept out, local firms changed, adapted and grew. CLSA, the Hong Kong-based brokerage and investment group which in 2004 had inked the first securities joint venture after China’s entry to the World Trade Organization, found itself bought a decade later by CITIC Securities, the country’s biggest brokerage.
As China reformed its state companies, and more importantly as private sector entrepreneurs came to the fore, there was a need for corporate finance and merger and acquisition advisory. But it was local firms like China Renaissance Partners which grabbed the business; foreign firms could not compete.
There does remain a foreign presence in the Chinese financial space, but it remains small, especially given how the markets and corporate landscape have changed over the past 20 years. All industries have war stories of the difficulties of operating joint ventures in China, but the financial sector is perhaps a particularly troublesome one. As a key strategic sector, the Chinese authorities were never going to open it up quickly or without pressing reason. Even now, after the recent financial market turmoil, there are few voices suggesting that opening up is the way forward.
China’s financial landscape will continue to change and China will continue to draw international institutions, but opening up will always be on its terms. The explosion in corporate debt financing, wealth management products and onshore asset managers has happened independently of any meaningful foreign involvement. If the past 20 years is to be any guide, foreign financial institutions whose business plan and growth prospects depend on China opening up in their favor had better rethink their strategy.
Fraser Howie is co-author of “Red Capitalism, The Fragile Financial Foundations of China’s Extraordinary Rise.” He has worked in China’s capital markets since 1992.