9 minute read 7 Nov 2019
Aerial view shanghai city center evening

How China’s financial liberalization can unlock new opportunities

Authors
Andrew Gilder

EY Asia-Pacific Banking and Capital Markets Leader; Global Corporate, Commercial and SME (CCSB) Banking Consulting Leader

Banking and Capital Markets Leader. Over 20 years of experience in the field of auditing.

Jack Chan

EY China Chairman, EY Greater China Regional Managing Partner and EY Global Emerging Markets Committee Member

Professional experience in the financial services sector. Frequent speaker in events. Excellent trainer to banking executives, government officers.

Alex Jiang

EY Japan Business Services Leader, Greater China Financial Services

Ambassador between Chinese financial institutions and the global community. Trusted advisor focused on China’s opening-up and financial reforms. Family man. Golf fan.

Li-May Chew

EY Global Banking and Capital Markets Senior Analyst

Analyzer of developments impacting global financial markets. CFA charterholder. Lover of the outdoors. Experimental home baker. Budding sketch artist.

9 minute read 7 Nov 2019

Foreign financial institutions should seek greater presence in one of the world’s most enticing financial markets.

For years, China’s huge financial markets have been largely closed to foreign financial institutions (FIs), but this looks set to change as evolving global relationships and the demands of a growing middle class reinvigorate its globalization agenda. As authorities make genuine moves to open the country’s financial sector to both attract foreign capital and broaden the financial system, inbounds should move fast, but strategically, if they are to seize opportunities to participate in the Chinese market.

As reforms gather pace, we see these spurring genuine energy and opportunities for international financial institutions. While inbounds should be cautiously optimistic, the current deregulation provides a window of opportunity for them to actively participate in this exciting next stage of market expansion in China.
Jack Chan
EY China Chairman, EY Greater China Regional Managing Partner and EY Global Emerging Markets Committee Member
Chengdu china city skyline
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1

Chapter 1

The case for inbound interest

Significant potential upside for foreign FIs.

Contributing one-third of total global economic growth and boasting the world’s highest GDP (as measured in purchasing power parity terms), China is not a market that foreign FIs can afford to ignore. Now, the prospect of greater access to the country’s booming financial sector offers these institutions significant and broad-ranging prospects, from basic retail services to wealth management, private banking and retirement business.

China’s financial sector was worth:

US$44t

in 2018 and continues to expand exponentially.

Potential retail banking customers:

1.1b adults

becoming increasingly educated, sophisticated and transitioning into middle-class.

World’s fastest growing asset pool under management:

US$14t

by 2022, doubling from US$7.4t in 2017.

Given such impressive statistics, capturing a mere single-digit share is enough to generate massive absolute returns. Foreign FIs understandably desire a slice of China’s bourgeoning financial services market.

However, until recently, options to participate in China’s financial markets have been limited due to regulatory barriers and a complex operating environment. Although foreign banks in China have grown their aggregate assets (Figure 1), the pace of expansion is slow - these institutions account for less than 2% of total assets in the Chinese banking system, compared to about 10% in OECD countries. Moreover, this market share is trending down, with corresponding net profit also disproportionately lower at 0.7%.

Market share of assets and net profits chart

Foreign insurers are in a similar position, securing just 2% of all premium income in China (compared with 20% in OECD countries). Meanwhile capital controls limited foreign FIs to capturing just a little over 2% of China’s US$13t3 onshore bond market in 2018.

Road junction buildings shanghai blue cloud sky
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2

Chapter 2

How financial liberalization differs this time

China’s new policies are attracting first-movers into its financial services markets.

While efforts to reform China’s financial markets have progressed gradually so far, there are clear signs that the liberalization agenda is beginning to gain real momentum. President Xi’s commitment to quickly implement the country’s “Opening-up Initiatives” has spurred the Financial Stability and Development Committee to loosen restrictions on foreign institutions and encourage their participation, particularly as China’s economic growth begins to taper. The Chinese government is also keen to increase international links to drive innovation, expand business and consumer choices, enhance capital allocation and potentially reduce systemic risks.

Perhaps the strongest indication of China’s genuine willingness to change is the recent unification of its banking and insurance regulators to form the China Banking and Insurance Regulatory Commission (CBIRC) in 2018. This establishment simplifies regulatory structures, creates transparency and efficiencies, and allows for more robust coordination with China’s central bank.

Since then, the CBIRC and the China Securities Regulatory Commission (CSRC) have implemented significant reforms to standardize market entry rules and remove ambiguity around foreign FIs’ entry policies. These include:

  • Lifting foreign ownership limits to enable foreign FIs to strategically raise ownership and influence key decisions in domestic subsidiaries. The standardization of entry requirements highlights an important transition towards greater equality in the treatment of foreign and domestic banks.
  • Removing the minimum total asset to establish a Chinese entity which means asset size will no longer be a hurdle for smaller, nimble inbounds seeking new prospects domestically. This change also benefits the Chinese market by introducing diversity and competition to improve the depth and quality of local financial services.
  • Allowing foreign banks to immediately apply for RMB business licenses, instead of waiting a year under previous rules. Administrative procedures have also been simplified to encourage foreign capital into sub-segments such as trust business, financial leasing and consumer finance.
  • Modifying existing rules to allow flexibility to exit business lines. For example, removing the approval for repatriation of assets by liquidated foreign FIs shows that regulators are not just enhancing the ease of market entry but also providing viable exit options.

Read more on China’s key financial markets reforms here (pdf).

Already we see early movers taking advantage of China’s financial liberalization to enter the market and scale up. Global institutions strengthening their Chinese presence include:

  • UBS, which in December 2018 secured a 51% controlling stake in its local securities business4, making it the first foreign bank to do so under new rules.
  • Germany’s Allianz that launched its 100% foreign-owned subsidiary, becoming the first fully-foreign-owned insurer in China5.
  • France’s Axa with full control of a local joint venture (JV) in November 20186.
  • American Express that won approval to operate a bank card clearing and settlement institution and payments network JV7.
  • JP Morgan and Nomura that will both set up their securities JVs after receiving regulatory approvals in March 20198.
Cityscape of wuxi
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Chapter 3

Next steps for foreign financial institutions

Strategy and speed are key to cracking the Chinese market.

While some details surrounding reforms are yet to be fleshed out, inbound FIs have greater clarity than ever around their regulatory standing in China. Those keen to take advantage of the opportunities on offer must act now to:

1.  Find a strong value proposition for the Chinese market

Foreign FIs should begin by determining where they fit in the Chinese market and then craft a strategic entry strategy. They cannot typically compete on size against huge domestic institutions, but should instead differentiate through advanced expertise, specialty services or by carving out a niche within a specific geographic region or customer group.

International experience does give foreign companies an edge over traditional incumbents and state-owned banks, and they may also benefit from the (real or perceived) advantages of international branding, wider product knowledge, advanced risk management and service capabilities. They could further lead in trade finance, cash management, cross-border businesses, foreign exchange and derivatives trading.

Emphasizing such nuanced differences strengthens inbounds’ brand presence, enhances their share of revenue from the Chinese market, while concurrently creating new financial services experiences for clients.

2.  Identify the appropriate entry and investment approach

While reforms have made it easier for foreign companies to broaden their Chinese presence, most will still find it challenging to compete against local institutions given their sheer size, industry influence, experience, and for state-owned bodies, government and financial backing. More effective entry approaches may be to:

  • Collaborate within the financial ecosystem: Foreign institutions face competition not just from traditional local banks but bigtechs like Alibaba and Tencent increasingly embedded into the financial services system. Rather than attempting to compete, newcomers should seek to collaborate with these non-banks by joining their platforms to access millions of potential clients. And as ecosystems continue to mature and market dynamics evolve, it is important to continually scan the horizon for new potential partners and shift alliances accordingly.
  • Invest in incumbents but manage associated acquisition risks: Acquiring a controlling stake in domestic institutions may be the quickest route to expansion but it is also expensive. As majority shareholding is costly, most foreign institutions would likely be limited to buying smaller city commercial or rural commercial banks. But these operate under specific conditions unique to their localized regions, with differing levels of market maturity, financial and consumer culture and risk characteristics. Enhanced due diligence can help financial investors identify the potential hidden risks of these acquisitions.

3.  Manage local IT system complexities

Entering the Chinese market requires foreign investors to carefully consider multiple technological complexities. For example, operating systems and underlying processes must be robust enough to support the huge transaction volumes and processing speeds of China-based businesses. System infrastructure also needs configuration and inter-connectivity that are consistent with local country requirements which may differ from those at home.

While these issues could pose challenges to newcomers, inbound FIs have many options to develop suitable IT infrastructure for their Chinese operations. These include engaging infrastructure and software-as-a-Service (IaaS and SaaS) vendors, considering API-driven open banking platforms to reduce application development and maintenance cost, or exploring shared utility models with other institutions.

4.  Keep pace with China’s advancing technological revolution

China is fast becoming a global hub for accelerated innovation and foreign FIs must keep pace with the lighting speed of local FinTech evolution. By 2017, China’s digital economy had already grown to one-third of the country’s GDP, - and as 5G mobile technology, e-payments, advanced data analytics and non-banks reconfigure the financial landscape, inbounds will need to develop sophisticated, innovative digital strategies to compete effectively.

Fortunately, choices abound. For example, foreign FIs could embed a new digital culture and develop innovative offerings that leverage emerging technologies such as blockchain and robo-consulting. They could also establish networks with innovation communities or collaborate with external developers on APIs and cloud-based architecture to build innovative financial solutions.

5.  Acquire and retain domestic talent

As inbounds expand their Chinese presence and scope, they will need to build local workforces with the right skills and cultural knowledge, and that are aligned with their own organizational brand language and corporate ethos. Herein, finding top talent is a perennial issue for foreign companies needing to compete not only with other established institutions but more dynamic, enticing new non-banks.

Hiring priorities include branch staff and retail bankers for those expanding their front-office retail presence, as well as staff skilled in risk management, cyber security, and digital professionals such as data scientists and user-experience designers. Talent management programs should include grooming local management pools to support succession planning and future leadership requirements.

6.  Engage with market experts to formulate effective strategies

While reforms increase the regulatory consistency and international accessibility of China’s financial sector, this market still presents a unique, multifaceted and challenging operating and business environment. Apart from the constantly shifting macro geopolitical issues, foreign institutions must grapple with local legal, licensing, compliance and risk management requirements, as well as differences in conduct, culture and general ways of doing business in China.

For inbound FIs keen to stake a claim in this attractive but highly complex market, deep industry and local knowledge is critical. Consulting those with on-the-ground experience and business connections can help guide effective investment strategies, identify target acquisitions and manage the myriad of risk, cybersecurity, digital and talent issues that can make the difference between success and setbacks in the Chinese financial market.

For deeper insight on the impact of China’s financial liberalization on foreign institutions, read the full report (pdf).

Summary

China is reinvigorating its financial globalization agenda and presenting immense prospects for foreign FIs’ international businesses. The opportunity is now ripe for inbound institutions to strategically participate and reap rewards from one of the worlds’ most exciting financial markets.

About this article

Authors
Andrew Gilder

EY Asia-Pacific Banking and Capital Markets Leader; Global Corporate, Commercial and SME (CCSB) Banking Consulting Leader

Banking and Capital Markets Leader. Over 20 years of experience in the field of auditing.

Jack Chan

EY China Chairman, EY Greater China Regional Managing Partner and EY Global Emerging Markets Committee Member

Professional experience in the financial services sector. Frequent speaker in events. Excellent trainer to banking executives, government officers.

Alex Jiang

EY Japan Business Services Leader, Greater China Financial Services

Ambassador between Chinese financial institutions and the global community. Trusted advisor focused on China’s opening-up and financial reforms. Family man. Golf fan.

Li-May Chew

EY Global Banking and Capital Markets Senior Analyst

Analyzer of developments impacting global financial markets. CFA charterholder. Lover of the outdoors. Experimental home baker. Budding sketch artist.