As Napoleon Bonaparte once said of China, "Let her sleep, for when she wakes she will shake the world." To this day, it proves true in the private banking world. As the wealth management sector gains momentum in the country, the world attempts to predict and adapt to the new financial powerhouse. However, will China even be able to cope with the great changes on the horizon? Patrick Brusnahan and WealthInsight examine the ever-transforming sector.
Private banking in China is going through a rapid period of change. When considering that private banking was not even legal until 2006, the changes seem even more quick. Prior to this, Minsheng Banking Corp was the only bank that could provide a wealth management service. Since then, there has been a flood of large banks wanting to exploit the new opportunities in China, whether they’re on the mainland or offshore. The reverse is also in flow. The Bank of China opened its first abroad private bank in 2008. The rest of the ‘Big Four’ state owned banks quickly followed.
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The rate of change is set to speed up after the Communist Part of China’s (CPC) Third Plenum which announced a range of private banking reforms. These reforms are allowing up to five private banks to launch within a trial basis under the supervision of Chinese banking authorities. The private finance will be used to either restructure existing banks or set up new ones ‘bearing their own risks.’ Gary Dugan, CIO for Coutts in Asia & Middle East said "longer term, the reforms should be undeniably good news for the Chinese economy." Assets under management (AuM) totalled at approximately $1 trillion, mainly composed of funds managed by asset managers.
As the wealth management industry starts to develop further, this number should rise exponentially. Dugan added "reforms to the banking sector and financial markets should mitigate some of the risks that investor worry about." Not everyone is as thrilled. Xavier Denis, global strategist for Société Générale, said that reform "means there will be less public investment which has been a key driver for Chinese economic growth." He adds that they will ‘need to continue to rebalance.’
None of the interest is surprising as the wealth in China has greatly increased in recent years. The research carried out by WealthInsight reports that between the years 2008 and 2012, the number of high net worth individuals (HNWIs) increased by 89.9% to 1,481,363. This increase hugely over performs in comparison to the global average. The wealth rose even more dramatically. Local HNWI wealth is valued at $5.2 trillion, a 171% increase in the review period, which is equivalent to 27% of the country’s wealth. HNWIs’ growth is forecast to improve even further. The number of HNWIs in China is expected to grow by 34% to reach 2.2million in 2017, with wealth to increase by 50% to a staggering $9.4 trillion in the same year.
Moreover, the prime target for any wealth sector professional is the ultra high net worth individual (UHNWI). Currently, there are 9,087 UHNWIs in China, 195 of them in the billionaire category, with an average wealth of $1.3 billion per person. Between 2008 and 2012, the number of UHNWIs increased by 106.8% and this growth is expected to continue. By 2017, 13,959 individuals are expected to be at the ultra band, an increase of 34%.
Untapped potential
Another factor which makes China an appealing prospect is that only 9% of Chinese HNWIs use a private bank or a wealth manager. This leaves a huge majority of the wealthy population as potential targets for the sector. Competition to take advantage of this untapped market is high. Large national banks, regional stock banks, foreign banks, insurance companies, asset managers and independent advisors are all vying for attention from clientele. Many banks are partnering with trust advisors to get around regulation and gain a foothold. International banks are slowly creeping into the country. Deutsche Bank set up private banking services in 2007 with Credit Suisse following the next year. Smaller, local banking companies and advisors are also popping up.
What the CPC’s reforms could bring is a shift in power between offshore and onshore private banking. While the reforms are long-term and any true development is still a while away, we could see big changes within the next decade. Currently, offshore is the only option for many clients and banks because of the heavy regulations and the strong support that the government supplies to local banks. International private banks provide these offshore services as they are authorised legal entities in countries with lower tax jurisdictions. They display themselves as a diversification option for those who want to include foreign securities to spread out the risk in their profile. Dugan believes that there will be a ‘two way pull’ between the options with a large number of small to medium banks taking the risk with mainland China. However, he also said that the current reform project is "not one which will open up the Chinese banking industry to substantial foreign competition in the near term." He also believes that "Hong Kong will remain the premier offshore banking centre for the foreseeable future."
In addition, competition does not only come from abroad. The organised wealth management industry within China has recently become incredibly competitive due to the emergence of diverse business models. These include universal private banks, standalone boutiques, investment banking and product distribution. Due to the market domination of the four national banks offering a range of private banking services, the fight to attract the wealthy population becomes aggressive. Domestic banks try to gain the advantage through their vast networks, existing client bases and support from government policy. On the other hand, foreign banks also have their plus points, especially their global networks and services, as well as being able to help clientele with tax and legal issues.
With increased competition come new strategies to try and combat it. Wealth management firms in China traditionally focused on below-the-line marketing to HNWIs through sales drives and investor functions. However, with the target market widening, wealth managers are looking, and might need, to enhance their reputations. The current generation of Chinese HNWIs demand transparency when investment decisions are made. Firms are beginning to benefit from educating their clients through their own resources. Second generation HNWIs are more western-educated and their recognition of foreign brands is stronger than ever. As a result of this, more are looking towards foreign banks to handle their finances and provide services. Their education also makes them more comfortable in approaching western financial services when compared the previous, more traditional generations.
The generational divide
The relationship between generations in China is an interesting one, especially when considering intergenerational wealth transfer. WealthInsight forecasts that after two decades of solid, sustained growth, China will record their first ever large intergenerational transfer of wealth from first generation entrepreneurs to their family members. This event is something private banks need to be wary of, yet could also prove to be quite a coup. As there is a distinct lack of proper communication between generations in wealthy families, advisors could be the necessary bridge to force the transfer to run as smoothly as possible. This could make wealth mangers crucial. However, despite many in the younger wealthy generations have received good educations, both in the West and within China, many are not yet experienced or responsible to be managing these huge sums of money. While this may cause a major downturn in the success rate of a wealth manager, it could once again be an opportunity to prove themselves to be irreplaceable.
However, both generations are concerned with transparency and a more personal, hands-on approach. Many HNW clients are beginning to prefer managing their own money while being advised by professionals, rather than letting their advisor take complete control. This movement away from the more discretionary investment control is forcing private banks and wealth managers to adapt and change their structure. One common way is to restructure their product portfolios to cater to the client’s needs for transparency and adapt to the increased risk profile.
Challenges to the traditional business model are also being brought upon by new technology and regulation. Widespread investment losses during the global financial crisis, not only in China, but worldwide, caused many unfavourable experiences with costly complex products and forced a change in the regulatory environment. A consequence of increased regulation is increased costs. Despite this, wealth management firms are lowering their fees to combat competitors. This highlights the need for cost-cutting in the industry, through methods such as consolidation, outsourcing back-office functions and utilising more efficient technology.
Overall, the future of private banking in China is unclear. There are many positive signs, but many foreseeable problems that come with them. While the wealth sector is broad and largely untapped, the strict regulation and lack of experience could hinder progress. One thing that is certain is that the private banking industry in China is beginning to move, but nobody is sure in what direction.
