China might finally give Wall Street banks a green light
Main page Finance

Beijing is considering changing China's famous strict trade laws and allow the American investment banks to do their business in China on their own after more than two decades of struggling with restrictions.

The Wall Street Journal was the first one to reveal that Beijing was finally discussing the possibility of softening the trade rules for foreign investment banks operating in China: the news that Wall Street banks have been waiting to hear for years. The long-awaited agreement is being currently discussed as part of the latest U.S.-China trade and investment negotiations, though the officials from both the Chinese and the American sides declined to comment on the news.

In the last years, the $7.48 trillion Chinese market has become increasingly attractive to American investment banks that have been quite successfully expanding their network in the biggest international markets like London and Tokyo. However, it turned out that doing business in China was not even close as welcoming as in other markets, what turned off many interested companies. Previously, the only way an American investment bank could operate in China was through a joint venture with a local brokerage firm. This could still be an acceptable option unless the Chinese government limited the maximum size of a foreign stake in a Chinese joint venture to 33.3%, what only further frustrated the U.S. financials that were not used to such limiting market conditions.

Not surprisingly, most of the banks had to bury their dreams of expanding in this attractive market because of that. The one-third stake rule had been in force for years up until a few years ago when the government decided to raise the threshold to 49%. This was an improvement, however, it did not change much for struggling bankers as only a few of them were actually interested in raising the stake in their joint ventures back in 2012, said the Financial Times.

“The Chinese market can be one of the biggest capital markets in the world, but in terms of what money the JVs can actually make in the near term, I’m not optimistic,” an analyst Victor Wang told the Financial Times.

For such large banks as Goldman Sachs (TOCOM: Futures On Gasoline Feb 2017 [GS]) and JPMorgan (NYSE: JPMorgan Chase & Co [JPM]), operating their businesses through joint ventures meant losing control of strategic decisions and managing funds, among other critical aspects the companies were taking for granted in other markets. The experts add that most of the joint ventures also don't have licenses for trading Chinese securities, what makes it even more difficult for foreign companies to compete with local financials.

Regardless of whether the Chinese legislators would actually finalize this agreement, the very fact that the two countries are discussing this matter gives hope for foreign investment banks that the situation could change to their favor. That is why, the WSJ called yesterday's news a real "breakthrough" for the Wall Street banks after being banned for years from trading securities on their own.

If the U.S.-China agreement works out, the U.S. investment banks will be allowed to run business in China on their own, without forming a joint venture with the local firm. Because of the numerous restrictions, the profits of the American banks from the Chinese market are miniscule compared to their worldwide profits, considering that non-Chinese investment banks currently have a minor 5% market share in the country.

Not surprisingly, just a few weeks ago, one of the biggest Wall Street players JPMorgan was reported to discuss selling its part in a Chinese joint venture First Capital Securities due to depressing business conditions such as lack of control and unsatisfactory contributions to the total revenue, said Reuters. Among the top-tier investment banks running operations in China like Goldman Sachs, UBS (NYSE: UBS), Deutsche Bank (NYSE: Deutsche Bank [DB]), Morgan Stanley (Milan Stock Exchange: Mediaset [MS]) and Credit Suisse (EURONEXT PARIS STOCKS: AXA [CS]), JPMorgan was the first one to consider departing from China altogether.

Yet now, they might have a good reason to stay in China in a long term on way better terms than before. The Wall Street Journal said, referring to people familiar with the matter, that the U.S.-China deal was very likely to be expanded to other non-U.S. banks as well.

"There is no alternative avenue for foreign players to go in and China is sending a clear signal that it is liberalizing and I do think they (foreign banks) will be able to get to a stage where they have effective management control of the entity," a financial consultant Benjamin Quinlan told Reuters.

However, even if the American banks finally get the right to do business in China autonomously, the problem of severe rivalry from China's domestic banks would be stronger than ever. According to the Wall Street Journal, Chinese banks have grown their market share in Asia from 10% a decade ago to more than 60% today. At the same time, the share of the American banks in the sector has dropped more than 30% in the same period. And the main reason for that is that most of the Chinese corporate clients prefer domestic banks over foreign ones when securing deals, meaning that it will not be an easy battle for the Wall Street giants.

Even though there is no official confirmation on how far Beijing is ready to go with softening the business conditions for American banks yet, it is still a very good sign for Wall Street top-tiers unsuccessfully trying to eat into the market of the world's second biggest economy.

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