Sir David Li Kwok-po is a pillar of Hong Kong’s financial establishment. In 1918 his grandfather Li Koon-chun and a great-uncle founded the Bank of East Asia, the first Chinese-owned bank in what was then a British colony. In subsequent decades the bank gained a reputation for being one of the best-managed local lenders in the colony. Since the younger Li took over as CEO in 1981, he has cemented the bank’s status as the third largest in Hong Kong, with HK$434 billion ($56 billion) in assets, and dramatically extended its reach by opening scores of branches in China and Southeast Asia and acquiring a bank in the U.S. He has also been a longtime advocate of Hong Kong’s financial sector, both as a member of the local legislature and as a former member of the Executive Council, the city’s ruling body.
As successful as Li and the Bank of East Asia have been in Hong Kong, the banker sees a much brighter future in the city’s big rival to the north. “There is no question that Shanghai will be the biggest capital market in the world in 30 years’ time — bigger than New York, London or Tokyo,” Li, 71, tells Institutional Investor in an interview at the bank’s headquarters in Central, Hong Kong’s business district. “If I were a young man, I would go to Shanghai and be a fund manager and start my career there.”
It’s easy to see the reasons for Li’s enthusiasm. The dynamism of China’s economy and the quick rebound of its stock market from the lows of 2008 have caught the attention of financiers around the world. The Shanghai Stock Exchange was the second-biggest market in the world for equity raisings last year, with 11 initial public offerings attracting a total of $19.5 billion. Only Hong Kong was more active, raising $31.4 billion in 62 IPOs, the majority for companies based in mainland China. Shanghai’s trading volume surged 96 percent in 2009, to a total of $5 trillion, ranking it third behind the New York Stock Exchange and the Nasdaq Stock Market. And Shanghai’s market capitalization jumped 98 percent last year, to $2.7 trillion, boosting it to sixth place globally, behind the NYSE, the Tokyo Stock Exchange, Nasdaq, NYSE Euronext and the London Stock Exchange, and just ahead of Hong Kong.
Foreign banks are moving to get a piece of the action, seeing China as a growing source of fees and trading income. In the past year Credit Suisse recruited Simon Yuan from Bank of America Merrill Lynch to head up its coverage of financial institutions in China and hired Wu Chunlei, a former investment manager at China’s State Administration of Foreign Exchange, away from Deutsche Bank to oversee Chinese fixed-income sales. “With the volume of capital-raising and M&A transactions growing, we will naturally add to our resources to meet client needs,” says Vikram Malhotra, Credit Suisse’s co-head of investment banking for the Asia-Pacific region.
Such activity is bound to increase, if Beijing has its way. In April 2009, China’s ruling State Council announced its intention of turning Shanghai into a major global financial center by 2020. In pursuit of that goal, regulators in recent months have unveiled plans to liberalize the domestic market by allowing margin trading and short-selling of stocks. The authorities have also promised to begin opening the door wider to foreign banks and brokerages, which now face tight constraints on their activities.
“We want a more decentralized financial system, where domestic private capital plays a bigger role and foreign financial firms play a bigger role, so that the needs of small and medium enterprises and ordinary citizens can be better served,” Fang Xinghai, the director general of Shanghai’s Financial Services Office, tells II in an interview.
Yet in spite of the market’s growth, Shanghai has a long way to go to fulfill the government’s grand goal. The city remains predominantly a domestic financial center, not an international one. The renminbi, the Chinese currency whose unit is the yuan, is not freely convertible into dollars or euros, and the authorities continue to tightly control the flow of capital in and out of Shanghai.
Most investors on the Shanghai market are domestic; foreign investors have limited access through the Qualified Institutional Investor funds program, which at the end of last year had 86 funds with a combined $16.7 billion of assets under management — a drop in the bucket compared with the Shanghai Stock Exchange’s nearly $3 trillion market capitalization, according to Shanghai-based Z-Ben Advisors, a firm that tracks China’s fund industry. Similarly, Chinese funds have taken only the tiniest steps into international markets. At the end of 2009, the nine Chinese funds approved to invest abroad through the government’s Qualified Domestic Institutional Investor program had combined assets of only 74 billion yuan ($10.8 billion).
“To say Shanghai can compete in every facet with London, New York or even Hong Kong will be a very difficult scenario to play up,” says Peter Alexander, the principal and founder of Z-Ben Advisors. “If the central government does choose to push in that direction, it can be achieved. The question is whether you have a completely open foreign exchange. We’re a long ways off from that.”
Fang makes no apologies for Shanghai’s domestic focus. “The Chinese economy is big enough for Shanghai to be a domestic financial center for years to come,” he says. “We call ourselves a global financial center, but we will be primarily a domestic financial center with global size.”
The barriers to Shanghai’s development aren’t only financial. Markets require a whole network of social and political infrastructure, including transparency, open access to information and the rule of law. London and New York didn’t rise overnight; their preeminence is the result of decades, if not centuries, of economic and political development. “The foundation of any financial center is the free flow of information,” says Paul Schulte, Asian equities strategist at Nomura Securities Co. in Hong Kong. “Without that, any discussion is frivolous. China’s willingness to let in free and unfettered ideas is the key to this.”
It’s instructive to note that like many senior bankers working in China, Credit Suisse’s two recent recruits, Yuan and Wu, are actually based in Hong Kong. The attractions are many: Hong Kong’s more liberal political environment; its low, 15 percent income tax rate; the depth of the financial sector, which includes the Asian headquarters of many banks and institutional investors; and a large expatriate community. China, however, is looking to promote cooperation rather than competition between Shanghai and Hong Kong. In January officials from the two cities signed a memorandum of understanding designed to foster the sharing of regulatory information, exchanges of regulators and the joint development of financial products.
Looking forward, the sheer size and growth of China’s economy are almost guaranteed to give Shanghai a much bigger role in global financial markets, observers say. “I think even in five years’ time, if regulators opened it up, Shanghai could easily be the biggest cash equities market in the world,” says Neil Katkov, the Tokyo-based head of research in Asia for Celent, a Boston-based financial sector research firm. Even Schulte regards Shanghai’s rise as a global center as “absolutely possible and probably inevitable.”
Shanghai currently ranks 11th among global financial centers in competitiveness, just behind Sydney and Shenzhen, which tied for ninth place, according to the latest Global Financial Centres index, a semiannual survey for the City of London conducted by consultants Z/Yen Group. London and New York tied for first place, followed by Hong Kong and Singapore. Shanghai’s standing has risen sharply since 2008, when it ranked 35th. Respondents cited Shanghai as the place where financial firms are most likely to open new offices.
In many ways, China is merely seeking to reclaim Shanghai’s historic role. The city has a rich commercial past centered on the Bund, a storied promenade along the Huangpu River. Here, Hongkong and Shanghai Banking Corp., now HSBC Holdings, first made its name by lending to 19th-century merchants in the China trade. In the early 20th century, the city was known as the “Pearl of the Orient,” a freewheeling hub of commerce that housed one of Asia’s largest expatriate communities. The Shanghai Stock Exchange, which has roots going back to 1891, thrived in the baroque Astor House Hotel. American insurance salesman Cornelius Vander Starr founded the company that became American International Group on the Bund in 1919.
All that changed overnight when Mao Tse-tung’s Communist troops marched upon the city in 1949, defeating the ruling Kuomintang government and “liberating” the city from bourgeois capitalists. The Communists shut the exchange and only reopened it in November 1990, more than a decade after former leader Deng Xiaoping began turning China around with market-oriented economic reforms.
In fits and starts, the exchange has grown into a powerhouse, albeit a mostly domestic one. Shanghai itself has been transformed, with developers turning the rice paddies of Pudong, the area east of the Huangpu, into a futuristic cityscape of skyscrapers housing the financial district. The city has spent $45 billion in the past five years to prepare for Expo 2010, which runs from May to October. Shanghai has two new airport terminals; a subway system nearly as large as New York’s; dozens of new office towers, roads and bridges; and a revamped Bund replete with parks and waterfront restaurants.
In outlining its plan last year, the State Council called for upgrading the city by 2020 into a global financial and shipping hub commensurate with the “economic strength of the country and the international status of the renminbi.” The plan was unveiled shortly after the council announced that it would allow companies in Hong Kong and Southeast Asia to settle their China trade in renminbi rather than dollars — the first modest step toward internationalizing the currency. By 2020, the council declared, Beijing intends to loosen exchange controls to the degree that Shanghai will have a “multifunctional and highly internationalized financial market.”
As the language makes clear, China’s plan is cautious and incremental. Beijing has no plans for any Big Bang–style deregulation, as the package of U.K. trading liberalizations that gave London a boost in the 1980s was called. Instead, the authorities appear determined to control the process and ensure that the development of Shanghai serves China’s economic interests as well as those of its leading financial institutions.
“We are not envisioning ourselves taking over London or New York any time soon, though Shanghai will be among the top three in the world as early as 2015” says Shanghai’s Fang, who adds that the pace of reform will depend on the health of the economy. “If the economy slows down, the reform will be faster,” he says.
This year should see the authorities introduce a number of significant reforms. In January the Beijing-based China Securities Regulatory Commission announced that it would allow experiments in margin trading and shorting. Six firms — Citic Securities Co., Everbright Securities Co., Guangfa Securities Co., Guosen Securities Co., Guotai Junan Securities Co. and Haitong Securities Co. — were due to begin offering margin trading and short-selling services on March 31, according to China Business Daily. Investors reportedly must have a securities trading account of between 500,000 and 1 million yuan open for at least 18 months to use the services. The CSRC has also said that the China Financial Futures Exchange, which opened in Shanghai in 2006 and has been conducting mock trading of stock index futures, will be allowed to launch a futures product based on the benchmark CSI 300 stock index as early as this month. The authorities believe these new products will boost trading volume significantly.
“I think the government realizes that a well-developed capital market is a centerpiece of its economic development strategy and global economic influence,” says Fang Fang, JPMorgan Chase & Co.’s Hong Kong–based vice chairman of Asia investment banking and its CEO of China investment banking. “Whatever it takes to move in that direction will become priorities for implementation. To make a global financial center, you need three main elements: capital flow and a deep bench of financial expertise to manage capital; strong and experienced regulators running an efficient and transparent regulatory system; and a professional society with a large pool of fund managers, accountants and lawyers.”
Officials are preparing measures to address all of these issues. Last July, CSRC chairman Shang Fulin said the agency would this year resume processing applications by foreign brokerages for joint ventures, ending a four-year moratorium on such requests. So far China has given licenses to only seven foreign banks for joint ventures: Morgan Stanley, Goldman Sachs Group, Credit Suisse, UBS, Crédit Lyonnais, Daiwa Securities Group and Deutsche Bank. At the moment, foreign firms are capped at holding either a 20 percent stake in an existing firm or a 33 percent stake in a new joint venture. Most foreign capital markets players are eager to establish their own ventures, but the authorities imposed the moratorium to give breathing space to China’s 107 domestic brokerages, which authorities feared were incapable of competing with foreign rivals. In addition to opening up to non-Chinese securities firms, the government has also announced plans to expand opportunities for foreign reinsurers to create joint ventures with Chinese partners.
Foreign firms have been itching for greater opportunities to expand in China. Morgan Stanley, for example, has reportedly struck an agreement to sell its 34.3 percent stake in China International Capital Corp. to the U.S. buyout firms Kohlberg Kravis Roberts & Co. and TPG Capital. The investment bank has been trying to sell the stake for two years to free itself to pursue a new Chinese securities venture over which it could exercise management control. “We continue to focus on gaining domestic licenses, building on our wholly owned commercial bank and asset management and trust ventures,” says Nick Footitt, a Morgan Stanley spokesman in Hong Kong.
The development of the Shanghai market, however, may offer fewer opportunities than foreign firms expect. Chinese firms held the top six places in arranging equity issues in China last year, led by CICC with $10.2 billion of offerings and a 30 percent market share, according to data provider Dealogic. The highest-ranked foreign firm was UBS Securities, a joint venture between the Swiss bank and Beijing Securities Co., which ranked seventh with $1.1 billion. Chinese banks also dominated the domestic debt market, led by Industrial and Commercial Bank of China, which handled $28.3 billion worth of offerings. UBS ranked ninth, with $7 billion. In mergers and acquisitions, Citic Securities and CICC topped the league table with market shares of just over 10 percent each; Morgan Stanley ranked third, and Goldman Sachs was fifth, with 5.9 percent and 3.8 percent, respectively. Foreign firms did better in overall investment banking fees when offshore deals on behalf of Chinese companies are combined with domestic offerings, according to Dealogic. CICC came in first with $232 million in fees, followed closely by UBS with $225 million, Citic with $223 million, Morgan Stanley with $132 million and Goldman Sachs with $121 million.
“The domestic brokerage industry is so profitable,” says Shanghai’s Fang. “The general sense is, why would we let these foreigners come in and make this money?”
The 2009 State Council directive also includes a plan to allow foreign companies to issue renminbi-denominated bonds and to list shares on the Shanghai Stock Exchange — something that bankers expect to happen after new leaders take over from President Hu Jintao and Premier Wen Jiabao in 2012. In the past five years, authorities have permitted a few multilateral development banks to issue bonds in renminbi. In December, the Manila-based Asian Development Bank issued 1 billion yuan of ten-year, 4.20 percent bonds, its second such offering.
Executives at HSBC, who ask not to be identified, confirm that the bank is in talks with Chinese officials to become the first foreign company to be listed in Shanghai. Other multinationals rumored to be interested in a Shanghai listing to promote their brands and raise funds for expansion in China include Bank of East Asia, French retailer Carrefour, General Electric Co. and Wal-Mart Stores.
“The whisper in the marketplace is that many foreign companies are thinking of IPOs in Shanghai,” says JPMorgan’s Fang. The banker is a member of the Chinese People’s Political Consultative Conference, a government advisory group, and he presented a list of proposed financial reforms, including the authorization of foreign listings, to Chinese leaders at last year’s National People’s Congress and CPPCC gathering.
The State Council plan emphasizes the aim of developing investment banks, fund and asset management companies, and leasing and financing concerns. The program also calls for the development of various kinds of private equity and venture capital funds, private banking, and commercial bank financing for mergers and acquisitions. The ruling body provided no specifics or timetable for developing these business lines.
Since 2006 more than 1,000 domestic private equity and venture capital funds have been established in China, says Jingjing Bai, the Shanghai chief representative for C.P. Eaton Partners, a Rowayton, Connecticut–based firm that asserts it has helped Chinese fund managers raise just over $1 billion from abroad since 2007. “Private equity is critical to China’s development,” she says. “Private equity supports entrepreneurs, and it is entrepreneurs who ultimately will launch public listings and drive the Shanghai stock market to global leadership.”
So far, according to city officials, more than 370 foreign financial institutions and Chinese-foreign financial joint ventures have representative or branch offices in Shanghai, including 17 banks and five insurance companies.
The city is also spending heavily to upgrade its infrastructure — everything from education and health care to an improved legal system — to lure more global firms to set up regional headquarters, says Shanghai’s Fang. Officials are willing to offer inducements, including lowering the top income tax bracket for senior executives from 45 percent to about 25 percent for selected firms that invest certain amounts, he adds. Since Lehman Brothers Holdings collapsed in September 2008, Shanghai officials have made numerous trips to New York in an effort to recruit some of the best and brightest overseas Chinese finance professionals. They recognize that attracting top talent is essential. The quality and availability of staff is the second-most-important factor in the competitiveness of financial centers, after the overall business environment, according to consultants Z/Yen Group.
“The government must allow foreign influence to bring about a ‘soft’ infrastructure bailout for foreigners — schools for children, world-class hospitals, clean air, outdoor activities, restaurants, entertainment,” says Nomura’s Schulte.
One of the biggest investors in China, London-based Standard Chartered Bank, employs 5,000 people in the country, including 2,000 in Shanghai, who support its fast-growing branch network. About 10 percent of staff are expatriates.
“We have had no difficulty attracting talent to Shanghai,” says Lim Cheng Teck, the bank’s CEO for China. “If you look at the infrastructure, I think Shanghai is really up there with any other international city — say, Frankfurt, Hong Kong or Singapore. The living environment is comparable with modern international cities as well.”
Up-to-date infrastructure and market liberalization can take Shanghai only so far. Without a significant loosening of foreign exchange controls, the city is unlikely to join the top tier of international financial centers. The prospects for currency liberalization remain uncertain at best. Beijing is facing growing pressure from the U.S. and Europe to allow the renminbi to appreciate, a move that Western policymakers believe would help reduce China’s massive trade surplus and give an economic stimulus to their battered economies. In the U.S. congressional critics are stepping up calls for the Treasury Department to label China a currency manipulator in its next report on the subject, to be released later this month. Premier Wen rejected the criticism last month, though, warning the West to stop “finger-pointing” on the issue. Many Chinese economists expect the government to allow the renminbi to appreciate by a modest 3 to 5 percent a year beginning as soon as this year.
Shanghai’s Fang insists that China is moving toward a more relaxed currency policy, but how soon that will happen is unclear. He suggests that the government might double the amount that Chinese individuals can send overseas, to $100,000 a year, by 2020. He also predicts that foreign companies that raise money with secondary stock listings on the Shanghai market will be allowed to take capital out of the country, but only under the close supervision of the authorities. “Whether foreign companies can list public offerings will be determined on a case-by-case basis by the China Securities Regulatory Commission,” he says. “The issue size will also be limited.”
China has been following its own distinctive path since 1978, when Deng’s reforms set out to develop a “socialist market economy with Chinese characteristics.” Officials are determined to do the same in the financial sector. Given the astounding growth of the country’s economy, it would be foolish to bet against Shanghai’s increasing prominence.
“It is too early to tell if Shanghai will be the global financial center in the 21st century,” says Shelley Yang, a managing director at Shanghai-based Guotai Asset Management Co., which has 59 billion yuan in assets under management. “But I think China is large enough to have several international financial centers, and Shanghai definitely will be one of them.”
