Expanding horizons

Can China continue to achieve sustainable growth in an unstable world? Even if corporate earnings continue to rise by more than 20 per cent, is there a risk of exports collapsing if growth begins to slow? What will be the effects of a potential property price drop? Will the Chinese authorities clamp down if inflation spirals out of control?

Yi Tang, Rothschild’s deputy CIO for asset management in China is keen to ask these questions at the beginning of his recent note. But, as with other banks and wealth managers, the conclusion remains a positive one. Rothschild expects exports to diversify, inflation to slow and more housing to be completed for low-income families. The period after the recent meeting of the People’s Congress could be decisive, with the authorities favouring growth-related policies, such as investment in heavy industry, expected in the forthcoming 12th five-year plan.

Strong economic growth coupled with a surge in private sector enterprise has seen tremendous wealth creation in China in recent years. Boston Consulting Group (BCG), estimates the country has the third largest population of millionaires in the world, behind the United States and Japan.

BCG’s latest wealth report states that China had 670,000 households with more than $1m of financial wealth in 2009, up 60 percent from 2008. According to the HSBC Asian Affluent Tracker Survey conducted from February to April 2010, the mainland Chinese held average liquid assets of $126,537, ranking in Asia’s top three behind Hong Kong and Taiwan. Meanwhile, Forbes magazine’s 2011 Billionaires List shows the number of Chinese billionaires has nearly doubled from last year to touch 115, making it one of the few countries with more than 100 billionaires.

It is not surprising that banks are actively courting this wealth management segment. While some of the large local banks had been offering priority banking services since 2002, private banking came into the picture only in 2007 when foreign banks first entered China.

The first bank to offer wealth management in China was Citibank, closely followed by BNP Paribas, Deutsche Bank and Bank of China (BoC). Subsequently, other foreign banks such as Standard Chartered and Bank of East Asia along with leading local banks such as Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB), China Merchants Bank and China Citic Bank also entered the fray. But along with the drive to acquire new clients, there is also an increasing recognition that wealth managers, particularly the home grown ones, need to broaden their range of products and opportunities, if they are not to be outgrown by foreign rivals once currently restrictive regulations are inevitably relaxed.

Despite their global experience in wealth management and dominance of the offshore market, foreign banks currently lag behind local players in the much larger onshore market. Nonetheless, the market continues to lure new service providers.

“The wealth management market in China represents one of the most important business opportunities for UBS anywhere in the world,” states Graham Francis, CEO APAC Hub, at UBS Wealth Management. “Typically, wealth management assets grow at a multiple of GDP growth rates, so in light of the unprecedented economic growth and wealth creation in China in recent years, the market there is growing rapidly.”

In China, UBS offers wealth management services primarily through UBS Securities, a joint venture with state-owned firm Beijing Securities and through its Beijing bank branch as well.

Commenting on the investment preferences of Chinese clients, Mr Francis notes the investment style of prospective clients in Asia and in China is more aggressive than that of their peers in the US and Europe, “Many have accumulated wealth over a relatively short period and demand aggressive investment returns although they remain willing to take on a greater degree of risk in order to achieve relatively high returns.”

Increasingly however, clients in the region are prepared to seek professional advice on asset allocation and investment, he adds. “This offers huge growth potential for the wealth management industry in the region especially in areas such as family governance, and generational asset transfer. More specifically, highly volatile markets in 2010 prompted an increase in demand for discretionary managed products and especially where clients seek absolute returns through a dynamic approach to asset allocation. We see this as especially positive for our longer-term business model,” says Francis.

Andy Koh, head of Customer Financial Services at OCBC China, the China-incorporated subsidiary of Singaporean lender OCBC Bank, which has been present in China since 2007, agrees that the risk appetite for Chinese investors is generally high as compared to developed markets.

“Property and stock continue to be the two types of key holdings of Chinese HNW investors,” says Mr Koh. “However, with a recent slowdown in both sectors, we see customers putting money into more liquid and stable products, although the sense is that money will flow back into these two sectors when the right time comes.”

He also sees a definite shift from traditional investments in funds, equities and fixed income bonds to alternative investments like structured products, real estate, private equity, trusts and hedge funds as investors and customers are getting more sophisticated. “We do see a possible need for banks to consider what they are doing beyond just selling products, but to focus on the ability to provide sound financial advice as well,” he adds.

Wealth management products in mainland China are currently limited compared to developed markets like Hong Kong, observes Vanessa Chan, wealth management head of personal finance services at HSBC Bank (China), which launched private banking operations in China in March 2008.

Mainly focused on investing in local unit trusts (UT) and securities, mainland investors have limited options in terms of varied wealth management products that can offer international exposure and diversification, she says. According to the HSBC Asian Affluent Tracker Survey, the HNWs in mainland China hold most of their liquid assets, about 60 per cent, as some form of deposits, either in local or foreign currencies. Local securities and local UT investments account for 29 per cent and 10 percent, respectively.

HSBC, says Ms Chan, has been focusing on providing a variety of investment products linked to international markets through the QDII Investment Plan as well as structured products in China. “Our view is that a wider range of investment products with overseas markets exposure could provide a channel for diversification, which would be one of the key elements in wealth management development in China in the future.”

Another key area of interest for HNWs in China is succession planning, states Hsiao-Yun Lee, CEO of Société Générale Private Banking (China), which has been operational for the past two years. “HNWs in China are mostly successful entrepreneurs. New wealth has been created by very young and talented business people and succession planning is a key topic of concern for them.”

While the liberalisation of China’s financial markets has been accompanied by an increase in the knowledge and sophistication of clients, the wealth management market is a relatively young industry constrained by regulations, exchange controls and a non-convertible currency. Foreign banks may dominate offshore services, but they are constrained by stringent regulations, product design restrictions and limited branch network, meaning they lag behind local players in the onshore market.

“For Western fund houses and private banks, China offers a huge opportunity,” comments Amin Rajan, CEO of the Create consultancy, adding that the country’s regulations are keenly focused on developing their own investment and wealth managers rather than making it easy for foreign groups. “It won’t be a gold rush for the foreseeable future. It will be a matter of small steps, not giant leaps.”

Beijing-based Hua Zhang, an analyst at research firm Celent’s Asia Research group, confirms there are more restrictions imposed on foreign than Chinese banks. For instance, foreign banks in China are allowed to invest in overseas stocks and structured products. Investing in commodity derivatives and hedge funds is howevever prohibited, while investments in stocks are highly regulated, he explains. In addition, Mr Zhang says foreign banks are highly restricted in many aspects such as financing, establishment of the branch network, design and promotion of new products and opening of accounts.

Brand recognition is another key challenge for foreign banks, observes Timothy Driscoll, vice president of software vendor, SunGard which is in the process of launching its wealth management platform in China. “The preference of the local investor is for local brands, not foreign brands,” he says.

OCBC’s Mr Koh says a big weakness of local players is lack of product differentiation. “Local banks are struggling with differentiating their products and services while foreign banks are struggling with finding products for these groups of customers within the heavily regulated environment,” he says.

“Local banks have extensive retail networks and enjoy local recognition but we are ahead in terms of innovation. We bring in global expertise to provide a more diversified long-term wealth management experience,” adds Ms Lee of Societe Generale.

For foreign wealth managers, the offshore market will continue to be the main driver of growth and profits in the near term, but the future lies in the domestic market due to its tremendous growth potential and because it is still relatively under-developed, says Lok Yim, head of North Asia at Deutsche Bank Private Wealth Management. However he cautions that the domestic market has several challenges too. “Over the next two years, the regulations might ease a bit but there will not be substantial changes. The challenge for wealth management service providers will be to successfully build their business in the onshore domestic market under these regulatory conditions.”

Additional reporting by Yuri Bender