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Wall Street banks have spent more than a decade chasing profits in China with scant success.
Now, as the nation opens its doors to more competition, the global banks’ renewed ambitions risk being stunted by the same strategy pitfalls, culture clashes, licensing and regulation hurdles that marred previous ventures.
The first taste of China for the U.S. and European banks came through joint ventures with local partners that have largely been duds. Goldman Sachs Group Inc., Morgan Stanley and their peers are now free to take full ownership or set up new operations, a once-in-a-lifetime opportunity that they say will propel growth, investments and innovation.
But China’s market thrives on small deals, connections and transactions among state-backed entities. It’s also open to nasty surprises, as the recent Luckin Coffee Inc. and TAL Education Group accounting scandals show. For the biggest prizes, the global banks will compete not only against each other, but also local behemoths — all under the watch of the Communist Party.
“Having majority control is a nice step, but it won’t solve all of the issues” for foreign banks in China, said Brock Silvers, a managing director at Adamas Asset Management in Hong Kong. “The financial market is still highly political, plagued by an unclear regulatory environment.”
Morgan Stanley’s experience underscores these challenges. The bank’s top brass has over the past two years shuttled in and out of Shanghai to impart the firm’s stamp on its partnership that lost $15 million in 2019. Even as a minority owner, the company has been able to place its staff in the most senior roles, according to people familiar with the moves.
The New York bank is betting the changes will pave the way for a new strategy of pushing local colleagues to target more profitable business lines such as private placements, restructuring, technology listings and spinoffs, the people said. Morgan Stanley will also pursue additional licenses in brokerages and asset management.
Still, its bankers caution that a further expansion hinges on China easing regulations that stunt growth and limit foreign brokers’ participation in more lucrative businesses such as market making and securities lending.
Morgan Stanley and the joint venture declined to comment.
Directing the China business from New York or Zurich hasn’t always paid off either. For years, joint ventures with greater overseas influence like Morgan Stanley Huaxin Securities have underperformed units that were largely left alone, such as Citigroup Inc.’s Citi Orient Securities.
Goldman’s venture, where the bank wielded control through a loan extended to the China partner, made just 69 million yuan ($10 million) in 2018. UBS Group AG, exerting its influence with the help of non-financial shareholders, had a profit of 10 million yuan. By contrast, Citi Orient made 132 million yuan, off revenue that was four times higher than Morgan Stanley’s.
Yet Citigroup, which doubled China revenue to more than $1 billion in the last decade, has faced challenges of its own. It exited the partnership last year, and is setting up a new venture.
Apart from failing to gain control, the U.S. bank viewed Orient’s focus on smaller companies as incompatible with its strategy. The venture was also marred by poor governance, including being punished by regulators for failing to ensure qualifications for senior managers and for failed due diligence on a merger.
Citigroup continues to explore opportunities to further grow its China business, said James Griffith, a bank spokesman.
Deutsche Bank AG has also had issues. The German bank snubbed small deals offered by its partner, while its pursuit of bigger clients failed because the joint venture Zhong De Securities wasn’t able to compete with bigger firms such as Citic Securities Co., people familiar said.
The German bank has tightened its focus on the debt capital markets business, shifting away from equities, and sees scope for more collaboration with Zhong De after attaining a full bond license in 2019, a person familiar said. The bank has also discussed selling its stake in Zhong De, the people said.
A Deutsche Bank spokesman in Hong Kong declined to comment.
China’s investment-banking market will likely continue to be dominated by these type of small deals, according to a senior official at one of the joint ventures. Last year, more than 70% of 201 initial public offerings in Shanghai and Shenzhen were listed on the boards targeting smaller companies, according to PricewaterhouseCoopers.
Authorities in Beijing are also raising the ante, calling for the creation of “aircraft-carrier sized” brokerages that can compete as the outsiders pile in. China’s two biggest domestic brokerages, Citic Securities and CSC Financial Co. have kicked off a process to potentially merge, people familiar said this month.
Thomas Fang, head of China global markets at UBS, estimates that the nation’s brokerage industry will generate revenue of $100 billion by 2025, with foreign capital grabbing 25% of the pie. The biggest hurdles are building the right distribution channels, getting licenses to issue products and finding talent, he said in a recent interview.
The global banks have ambitious recruiting targets. Goldman plans to double its workforce to 600 as it gains control. UBS has similar plans and Japan’s Nomura Holdings Inc. is looking to get to 500 employees in China by 2023. JPMorgan is expanding by a third its office space in China’s tallest skyscraper.
The locals are keeping pace, with Citic adding about 1,500 investment advisers since 2017, an increase of 73%, according to a Goldman report.
“We embrace the financial opening without a shadow of doubt,” Huang Zhaohui, the CEO of China International Capital Corp. said at a briefing last month.
— With assistance by Cathy Chan, Evelyn Yu, and Amy Li