Donald Trump isn’t the only leader with a sense of drama.
The timing of China’s announcement that it will remove foreign ownership caps on financial services firms next year is no accident. It arrives as the climactic day of trade talks is about to get under way in Washington, and presents a challenge to the US president’s efforts to limit portfolio flows to his geopolitical rival. Just as the US is telling Americans not to invest in China, President Xi Jinping is welcoming them with open arms.
Certainly, China’s offer is tempting. The biggest online brokerages in the US are entering a bloody price war, eliminating trading commissions on stocks and options. China remains the last major market on Earth where traders can still make money. And the stock market is significantly cheaper than its US counterpart.
Asset management, in particular, can be lucrative. Unlike much of the world, where passive indexing is on the rise, investors in China still have faith in active managers. Star investors can attract billions of dollars and are able to charge handsome management fees.
Moreover, foreigners can be comforted that China is serioUSabout luring portfolio inflows. As we’ve written, the country is edging dangerously close to twin deficits in its fiscal and current accounts. So it needs as much foreign capital as it can get — even in the form of hot portfolio flows — to keep control over the balance of payments and avoid a further buildup of debt.
Lurking behind the open invitation, though, are many unanswered questions.
For instance, how will foreigners make money from plain-vanilla securities brokerage? While advanced technology has eroded commission fees in the US, China’s brokers can’t charge a penny either. That’s for a different reason — an extremely crowded field. With more than 100 players, the return on equity for publicly traded Chinese brokers is just 2.5% compared with 7.8% globally.
The biggest can make money by lending to credit-strapped China Inc. Fidelity Investments is adopting a similar model by expanding into the field of alternative credit. Whether foreign institutions will want to wade into the murky world of China’s shadow banking is debatable, though.
There’s also the challenge of overcoming entrenched local rivals that dominate the market. Foreign institutions already active in China are candid that even having 100% control of their operations won’t be a game-changer in the near term.
Chinese securities firms will fight to defend their turf. Foreign firms will have to pay up to hire staff and build out offices, and then face a time-consuming wait to obtain licenses. Winning deals won't be easy. So far this year, the top 19 underwriters on Chinese domestic IPOs are all mainland firms. Goldman Sachs Group Inc. was the highest-ranking foreign firm, in 20th place.
For all that, China has shown that it’s delivering on plans to open its financial markets further. The message for US trade negotiators sitting down in Washington on Friday is not to expect a comprehensive deal. Even as China seeks an end to the trade tensions, it’s moving ahead with Plan B.