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Trading  | November 10, 2017

That was quick.

Trump leaves China (only to go back on the offensive about unfair trade practices in his APEC speech) and just hours later Trump’s new Beijing friends announce that foreign firms will be permitted to take majority ownership in Chinese financial firms… well capped at 51% for now anyway. We doubt that this occurred out of the blue and was surely being worked on in the run-up to Trump’s visit. Furthermore, we suspect that Bloomberg’s Chief Asia Economist, Tom Orlik, had got wind of it ahead of time. In our preview of Trump’s visit (see “Will Xi Offer Trump A Small Victory On Trade As Cover For His Longer-Term Ambitions”), we noted this comment of his.

“In an optimistic scenario, Trump’s appetite for tweetable wins and China’s longer-term focus could coalesce around financial market opening — a boon for the U.S. investment banks, and a support for China as it attempts to tame its credit boom,” Orlik said.

Bloomberg is describing China’s move as “China’s Big Bang moment”, harking back to the deregulation of the London Stock Exchange in 1986, which permitted commercial and investment banks, both UK and foreign, to own brokers and dealers, all backstopped by deposits. Following today’s announcement foreign firms will be able to take a majority ownership in banks, securities brokerages (China’s term for investment banks), asset managers and life insurers. The chatter on the financial news networks this morning is beyond superlative, including comments such as “giant step”, “milestone”, “timing auspicious” and “the timing is conciliatory”.  In reality, it could be a giant headfake.

Here’s Bloomberg.

China took a major step toward the long-awaited opening of its financial system, removing foreign ownership limits on its banks and asset-management companies, and allowing overseas firms to take majority stakes in local securities ventures and insurers. Regulators are drafting detailed rules, which will be released soon, Vice Finance Minister Zhu Guangyao said at a briefing in Beijing on Friday. Foreign firms will be allowed to own up to 51 percent in securities ventures and life-insurance companies, caps that will be removed gradually over time, he said.


China’s steps look poised to end years of frustration for foreign banks, who have long been marginal players in Asia’s largest economy. The announcement could be seen as a major win for U.S. President Donald Trump, whose first official visit to China was followed by a string of Sino-U.S. deals. On Thursday, China’s Foreign Ministry foreshadowed the latest moves, with a statement saying that entry barriers to sectors such as banking, insurance, securities and funds will be “substantially” eased. Those comments came following a meeting between Trump and his counterpart Xi Jinping.

On the surface, this is the most significant move to deregulate China’s financial system for a decade when foreign banks were allowed to set up minority-owned operations in 2007. Furthermore, the new regulations will remove the 51% cap in securities brokerages after three years. In the life insurance sector, foreign firms will be allowed to own 51% after three years with the cap being removed after 5 years.

Prior to this announcement, foreign banks had diverging China strategies. In a high-profile announcement last year, JP Morgan announced that it would sell its stake in the JPMorgan First Capital Joint Venture – a securities trader – due to poor profitability. In contrast, likes of UBS and Morgan Stanley have stated their intention to raise ownership in their joint ventures.

The South China Morning Post reported on the response to the news.

International banks doing business in China welcomed the news. “The Chinese government’s decision to allow foreign companies to take up to 51 per cent in securities joint venture represents an important step in further opening up China’s financial sector. China is a key market for UBS and…we continue to work towards increasing our stake in [joint venture] UBS Securities,” Eugene Qian, chairman of UBS’ China Strategy Board, said in a statement. Securities trading in China has been dominated by large domestic players, with the foreign banks’ joint ventures struggling to gain market share. In 2015, UBS Securities was ranked the best performing foreign joint venture among securities firms in terms of net profits, but was still 95th overall in the country, according to data from the Securities Association of China.

However, the ongoing internationalisation of China’s capital markets will provide an opportunity for the foreign players to help them overcome domestic competition. “Domestic players are already strong in areas like securities brokerages. However, with China’s capital markets opening up to foreign investors through the connect schemes, China’s securities brokerages might need more foreign strategic partners to help them better serve these new investors,” said Wang Cong, professor of finance and co-director of the centre for globalisation of Chinese companies at the China European International Business School.

The key question regarding China’s “Big Bang” moment is whether the motivation was mainly directed at placating Trump, who was always going to return to the trade issue, which had been a major part of his campaign. That was undoubtedly part of it, although Trump’s APEC speech in Vietnam in which he reverted to slamming China for its trade practices has probably caused some loss of face and irritation in Beijing.

However, what if it was more than that… and here we return again to China’s need to deflate its obscene credit bubble in an orderly fashion. No matter if we view it as a near impossibility. However, they at least need to try and outgoing PboC Governor, Zhou, has been warning of “Minsky’s moments” and “debt disguised as equity” in the last few weeks.

China’s credit bubble is far more fragile than most western investors want to acknowledge and the local authorities know this only too well. Consequently, we were impressed by these comments from Bloomberg’s Shuli Ren, who’s thinking along the same lines. Her angle, and China’s credit bubble is awash wish them, is non-performing loans and medium-sized banks.

China desperately wants to recapitalize its mid-sized joint-stock commercial banks, which it sees as posing systemic risks. Last year, the People’s Bank of China said that if a mid-sized bank were to default, on average, four to five other lenders would also be affected and more than 8 per1cent of the industry’s capital would be wiped out. Taking a look at 41 publicly listed Chinese banks shows that only the very largest — Industrial & Commercial Bank of China Ltd., China Construction Bank Corp., Bank of China Ltd. and China Merchants Bank Co. among them — are reasonably capitalized. Plenty of lenders, from Postal Savings Bank of China Co. to Bank of Jiangsu Co., are in need of cash. Except for China’s largest banks, mid-sized and regional lenders are in need of greater capital buffers.

Ren speculates where foreign firms might be able to play a role in saving some of these banks.

The one area that may be of interest to foreigners is bad-debt asset management firms. Beijing has been urging lenders to set up soured-loan managers to conduct debt-for-equity swaps and offload unmet obligations. Pricing and restructuring bad debt, however, is so technical and tiresome that even China’s two most prominent specialists, China Huarong Asset Management Co. and China Cinda Asset Management Co., have been busy earning their keep in the offshore high-yield corporate bond market. But, as I wrote in August, Beijing is serious about reducing corporate debt and establishing new asset-management companies for that purpose. Authorities want the firms to have a wide range of financing options open to them, from bond issues to private placements and perhaps even tapping interbank liquidity. Although China’s capital markets are getting deeper by the day, more external expertise wouldn’t go amiss. So far, only about 10 percent of the announced 1 trillion yuan ($151 billion) of debt-swap deals have been funded, in part because private-sector investors aren’t interested. That’s where foreign financial institutions should be turning their attention. There’s business here for the taking.

We wouldn’t disagree, which that’s why our initial reaction to the news last night was… skeptical.

To be sure, a foreign bailout masked as investment would certainly help, however, we share the sentiment that it’s probably too late.

A revolutionary initiative is helping average Americans find quick and lasting stock market success.

275% in one week on XLF - an index fund for the financial sector. Even 583%, in 7 days on XHB… an ETF of homebuilding companies in the S&P 500. 

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