China's financial opening still leaves uneven playing field
Relaxation of foreign ownership limits comes too late to have much impact
Did U.S. President Donald Trump's visit to China really play a role in Beijing's decision to relax its limits on foreign ownership in the financial sector?
For over two decades, foreign financial institutions have been lobbying and begging for majority, and ultimately full, control over their onshore operations in China. Instead, there has been a string of failed partnerships with hopes far outstripping reality, yet still providing some decent financial returns.
But last week just after Trump left China, praising $250 billion in signed trade deals, Vice Minister of Finance Zhu Guangyao detailed a number of rule changes that would open domestic securities firms, commercial banks, asset management companies and insurers to full foreign control in stages.
Was this not what the financial sector had been wanting all this time? Some observers even called it a "big bang."
Perhaps a "small pop" would be more apt. In markets, timing is everything and sadly, this move has come far too late. While technically true that late is better than never, this opening will still leave a very uneven playing field for foreign financial institutions.
Full control does not mean equal treatment with local peers. In today's China, domestic financial institutions and foreign financial institutions are most certainly not equal.
There are few reasons to think that foreign institutions will ever be given the leeway to operate as local institutions can, nor indeed would foreign institutions' compliance departments allow them to. The role of guanxi and cozy relations between the regulated and the regulators in China means that a level playing field is virtually impossible.
In the banking sector, many if not most foreign banks have now incorporated their operations locally anyway, so the impact of full control, when it eventually comes -- and that it is still years away -- will be limited.
The real hurdles that foreign banks face in China are lack of good knowledge of the local customer base and small branch networks. These problems, coupled with fraudulent practices in Chinese banking where loans are disguised and shifted around the financial system, certainly leave foreign institutions in a difficult position.
Securities will present less of a challenge, but again lack of local knowledge of upcoming enterprises and existing businesses mean that winning a bigger role in the primary market will be an uphill climb while secondary market operations are driven by a vast retail network that few foreign institutions would want to build out.
Will the new rules allow for the clean, outright purchase of an existing Chinese financial institution? They might, but who would sell a profitable business to a foreign company except at a substantial premium?
Foreign asset managers and insurers will remain under substantial disadvantage. The Chinese financial market has boomed over the last decade and the marketplace is, not surprisingly, dominated by large state-owned players. Foreign participation by almost any metric is tiny.
Once again, China has played its hand very well. It has granted full access, at some time in the future, and it no longer matters. Chinese banks, brokers and insurers are simply too entrenched by virtue of size and influence to be challenged by upstart foreign institutions.
Even if foreign institutions do bring better corporate governance and risk management to the domestic marketplace, which would surely be a good thing, China has embarked under the direction of President Xi Jinping in extreme micro-control of financial institutions' activities. Fund managers are told not to sell or risk suspension of their trading privileges; banks are told not to lend to politically out-of-favor companies; and insurers seem to face an ever-changing rule book, whether in regards to their investments or new products.
There could hardly be a worse time to enter the marketplace, especially if you think the market should be the decisive factor. The Communist Party is the decisive factor.
Even this analysis only partially reflects the changing Chinese landscape. Over the past two decades or so while foreign institutions have been trying to play more of a role in China, not only have its markets vastly increased in size, but the very nature of Chinese finance has changed dramatically.
The country's largest payment systems are now run by Tencent Holdings and an affiliate of Alibaba Group Holding which is also now the nation's biggest money manager. China leads the world in e-payments and a cashless society already exists in many parts of Shanghai and other cities.
In effect, the Chinese financial system has changed its address and foreigners have just gotten the keys to the old apartment. On reflection, Trump has not achieved a great financial sector victory. He was merely the guy in the White House when the Chinese realized such a concession no longer mattered to them.
The ability to control foreign institutions and keep them in line is, frankly, easy for the Chinese. With these new rules, it remains inconceivable that any foreign institutions will ever buy a major Chinese bank, if for no other reason than most remain state-owned.
In the exciting new world of Chinese fintech, foreign financial companies will have little, if any, advantage and most likely face a slew of barriers to entry. If nothing else, how does one work a global payments system when Chinese capital controls show no signs of loosening in any meaningful way?
Foreign financial institutions will be subject to technology transfer requirements as they always have been and under Xi's cybersecurity umbrella, the localization of data storage, access and processing have become key requirements.
There will be some winners from the change in ownership rules. Some foreign institutions will be able to compete in niche areas, but this will be no game-changer for foreign bottom lines or for the maturity or trustworthiness of Chinese capital markets.
If another American president had won this concession from China, Trump might well have called it "fake news."
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.