For the past decade, global investment banks have attempted to establish a presence in China. The benefits of doing business in the country are clear: it is the second largest economy in the world with multibillion-dollar corporates and a vibrant and innovative technology ecosystem that regularly births unicorns. In 2021, China, including Hong Kong, amounted for 78% of the total investment banking fees generated in the Asia-Pacific region. This means that the likes of J.P. Morgan, Goldman Sachs, and Morgan Stanley can collect millions of dollars in fees, advising companies on mergers and acquisitions and public listings.
The lucrative opportunity in China, of course, comes with many risks. Foreign financial institutions have faced higher barriers to entry, such as restrictions on foreign shareholdings, obtaining business licenses, and fierce competition from local lenders. Furthermore, the CCP closely monitors and regulates all foreign businesses in China, and the geopolitical tension between China and the United States is a major risk for especially U.S.-based lenders.
In light of such special circumstances, banks have come up with their own ways to mitigate the risk and win business in the region, often outside the boundaries of the law. For example, in 2017, J.P. Morgan was charged with a $264m fine by the SEC to settle charges that it put in place a special hiring program for “princelings,” or children of CCP officials, in exchange for dealmaking favors.
Around 2019, however, China’s need for foreign capital took a new turn. With growth slowing and the country shifting from being a net saver to a capital importer, China began to embrace larger amounts of foreign capital to prevent a sustained period of current-account deficits and keep its balance of payments in check.
In line with the need, the CCP gave more independence to global financial institutions operationally through a major policy reversal, in hopes of creating an influx of foreign capital. Previously, foreign banks were allowed to establish a subsidiary in China only in the form of a joint venture, with ownership capped at 51%. Under the new rule, foreign banks would be permitted to own 100% of the Chinese subsidiary.
Immediately, some of the largest financial institutions jumped at the opportunity by buying out the stakes of their JV counterparties. As of 2022, seven global lenders control their investment banking operations in China, including J.P. Morgan, Goldman Sachs, Morgan Stanley, UBS, Credit Suisse, and Deutsche Bank.
Although these institutions are largest banks in the world with a global footprint and a 100+ year history, they face a unique challenge in China. Far used to being the Goliath, taking on challenges from “elite boutique” investment banks and fintech companies, these institutions are now positioned to be underdogs, tasked to take on local Chinese behemoths.
Banks’ performance so far seems to confirm the gravity of the challenge. Compared to their European and American arms, whose profits are in the multibillions, the profits from China are rather insignificant: for example, J.P. Morgan made $11m in profits in 2021, after losing a total of $39m for 2020 and 2019 combined since the lender founded its Chinese subsidiary.
Nevertheless, investment banks believe they can capture a niche industry within the Chinese market, specifically around utilizing their global footprint. Focusing on cross-border transactions, including debt and equity offerings in the U.S. and European capital markets, could be an area that local lenders will lack expertise, although it will take longer-term relationship building and rebuilding Western investor confidence.
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