How China Can Create Its Own Goldman Sachs
(Bloomberg Opinion) -- An age-old question has reared its head again: Why can’t China create a globally competitive investment bank in the mold of Goldman Sachs Group Inc. or Morgan Stanley?
It’s not like the country hasn’t tried. China International Capital Corp., a venture formed in 1995 with New York-based Morgan Stanley, foundered amid disputes between the local and U.S. partners and slipped behind newer rivals without ever becoming a global heavyweight. Citic Securities Co. made an unsuccessful attempt to buy into Bear Stearns Cos. in 2007 (which was probably a lucky escape). Now add CLSA Ltd. to the list of failures.
A common theme running through the exodus of foreign executives from Citic’s CLSA, detailed by Cathy Chan of Bloomberg News this week, and the earlier strains at CICC is the clash of cultures between Wall Street’s freewheeling practices and the more staid, hierarchical approach of Chinese state-controlled financial institutions. U.S. investment banks are highly competitive and individualistic, studded with rainmakers, big-hitting traders and star analysts who may earn vast pay packages and hold power that’s disproportionate to their place in the management structure. It’s a way of working that doesn’t gel easily with China’s top-down state industrial model.
When one senior CLSA executive had concerns about the direction of his unit, “colleagues from Citic advised him to steer clear of conversations with the boss that didn’t involve flattery,” Chan wrote. Compare that with this profile of CICC from 2005: “Morgan Stanley's Western bankers were used to disagreeing openly with colleagues. CICC's Chinese employees preferred to resolve differences without confrontation, and in private.” Not much seems to have changed.
These tensions took a toll on CLSA, a Hong Kong-based outfit with a reputation for independent-minded research that was acquired in 2013 by Citic Securities. The Chinese brokerage is an arm of Citic Group, a state-owned pioneer of the country’s economic reforms set up under the direction of Deng Xiaoping in the late 1970s. Before the takeover, CLSA was ranked in the top three for Asian research by institutional investors, along with Morgan Stanley and Deutsche Bank AG. By last year, it had dropped out of the top six, according to Greenwich Associates.
As a group, Chinese investment banks and securities firms have failed to make much impact on international markets. The combined overseas revenue of the country’s 11 largest brokerages was just $3.5 billion last year, according to Bloomberg Intelligence analyst Sharnie Wong. That’s roughly on a par with the Asian revenue of BNP Paribas SA, which doesn’t rank among the biggest global investment banks.
Chinese brokerages are relatively unsophisticated beside their Wall Street rivals, focusing mostly on equities trading – a business that Deutsche Bank AG said this week it’s exiting amid increased automation and low margins. Mainland firms have less of a presence in bond trading and structured products, which remain driven by humans and are the bread and butter of international banks.
It could be argued that China doesn’t need a world-class investment bank, given the dominance of local firms in its increasingly important domestic market. The inclusion of the country’s shares in the MSCI Emerging Markets Index and its bonds in the Bloomberg Barclays index has driven billions of dollars of foreign money into Chinese capital markets. Chinese firms have also made headway in IPO underwriting in Hong Kong, dislodging Wall Street rivals in the league tables.
Besides, global investment banking revenues have been sliding since the financial crisis, amid low interest rates and the trend toward automated trading.
That would be a short-sighted view, though. If China is serious about modernizing its capital markets, it needs the expertise developed by leading international investment banks to provide better fundraising options for its companies. It may be no coincidence that Beijing has finally relented and allowed overseas banks to control their Chinese ventures, among them UBS Group AG, Nomura Holdings Inc., JPMorgan Chase & Co., Morgan Stanley and Credit Suisse Group AG. A slowing economy means efficient allocation of capital has become more more important than ever. Exposing local brokerages to overseas competition may spur them to raise their game.
Chinese firms operating in Hong Kong are already moving up the curve in research as they try to make their way in the city’s more robust environment. An example is CGS-CIMB Securities, a venture between China Galaxy Securities Co. and Malaysia’s CIMB Group Holdings Bhd.
A world-class investment banking operation needs more than research, though. Much of the competitive advantage for bulge-bracket firms derives from networks of relationships with companies and investors that have been cultivated over decades. Building such capabilities will take time.
It’s hard to see this happening until China stops using financial firms as tools of the state. In 2015, the government leaned on brokerages to rescue a crashing stock market. Last month, it asked large securities firms to take over the role of providing financing to small and medium-size enterprises. If China is to produce its own Goldman Sachs, it’s unlikely to come from the sclerotic state economy. Look instead to the wellspring of Chinese innovation: the private sector. For that to happen, though, the state has to get out of the way.
Ultimately, the biggest block to Beijing’s ambitions is Beijing itself.
Morgan Stanley sold its CICC stake in 2010.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Nisha Gopalan is a Bloomberg Opinion columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.
©2019 Bloomberg L.P.