China’s economic boom of the 1970s spurred by Deng Xiaoping’s economic reforms turned entrepreneurs into millionaires. And although China’s economy has slowed recently, in relative terms it is holding up well.
On the back of its economic growth, China has become the second-largest wealth management market in Asia Pacific. According to research by Boston Consulting Group in conjunction with China Construction Bank, the number of Chinese high-net-worth individuals (HNWIs – those with at least $1 million in investable assets) doubled from 510,000 in 2008 to 1,030,000 by the end of 2010.
China’s financial institutions and banks are rapidly adapting to the needs of this growing number of HNWIs. The strength of China’s private banks has been marked by impressive gains in the league tables. According to Euromoney’s private banking survey, China Merchant Bank rose from 26th place to 19th globally last year, breaking into the top 20 best private banks for the first time. Bank of China rose to 21st place globally, up from 27th place the previous year.
For all its recent progress, the Chinese private banking sector is still relatively young, and its development so far suggests that when it matures it will look different to its western equivalent.
"Private banking in China in its current form is more akin to red-carpet retail banking than private banking as you might know it," says Jason Bedford, senior manager, financial services, at KPMG in China.
The closest thing to more traditional private banking in China is the business model of trust companies on the mainland, says Bedford "They have dedicated client relationship managers for HNWIs; they host events; and their product development capability ranges from capital growth products through to capital preservation products and vanity products – such as funds investing in fine wine or tea." However, they do not have an open infrastructure: "[trust companies in China] sell only their own products and not other companies’ products."
Alfred Shang, partner at Bain & Company, says: "Since 2007, when the private banking industry really took off, we have seen competition intensifying as more financial institutions rush to capture market share. Commercial banks are rolling out their own private banking services. Other groups of financial institutions, such as securities houses, third-party wealth management institutions, trusts and funds, have also developed dedicated wealth management services for high-end customers." But despite the range of providers "most of the products and services offered in the market today still tend to be rather homogeneous," he says.
The recent influx of banks seeking to grab a piece of the pie has raised concerns that lax practices and standards could enter the system, according to Bassam Salem, Asia Pacific CEO of Citi Private Bank. But he adds that the hope is that this will eventually rectify itself. "Players without a strong platform encompassing the discipline of transparency, appropriate sales practices and control undoubtedly will be eventually weeded out," he says.
But at this early stage, understanding the differences between a private bank and other types of wealth management has proved difficult for some. According to a report by McKinsey and Mingsheng Bank, around 45% of HNWIs in China have only a limited understanding of what private banking is.
According to Salem, outside the large urban centres there is some misunderstanding of what a private bank can do for clients. "In fact many think they already have a private banking relationship when what they really have is a high-end retail relationship."
"Investors find it exceedingly difficult and frustrating to manoeuvre through the current regulatory environment," adds Kenny Lam, partner at McKinsey and based in Singapore. "Unless regulators pull together a comprehensive framework for private banking in China, the business will lose momentum."
Some argue that the lack of education has an adverse effect on client-manager relationships. "Chinese investors are not the most sophisticated," says one observer. "Trust companies and private banks have often complained that some of their clients have become violent and aggressive when investments haven’t performed the way they expected. The fact is that many HNWIs just do not understand the risks attached to certain investments."
Salem and Lam agree that if private banking is to continue its expansion in China, improved education and understanding will be crucial. Some domestic private banks are starting to pick up on this. China Merchants Bank, for instance, has invested capital and resources in brand building, advertising and organizing upscale events and activities to draw attention to their brand and to make sure that HNWIs understand the services on offer. "As a result, HNWIs have increased brand awareness of our bank," says Ma Wei Hua, CEO of China Merchants Bank. And according to Ma, their strategy has worked: "Over half [of HNWIs in China] list Chinese private banks as their primary wealth management provider."
Attitudes towards risk and portfolio management are also evolving. The heightened market volatility of recent years has prompted many investors in China to re-evaluate their investment strategies. From a culture that used to focus squarely on wealth generation, Chinese HNWIs are starting to embrace wealth preservation through diversification, according to surveys conducted by Bain & Company with China Merchants Bank.
"In our 2007 report, we observed that customers’ top investment objective was to maximize their returns," highlights Shang. "By the time of our latest report in 2011, customers had shifted their priorities to wealth protection and security. They are also becoming increasingly sophisticated. Most are picking their providers based on brand recognition, and are looking for offshore investment opportunities."
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| Edmund Koh, CEO of UBS wealth management Singapore & APAC hub |
Edmund Koh, CEO of UBS wealth management Singapore & APAC hub, highlights how this is expressed through HNWIs’ buying patterns: "While traditional asset classes such as equities, bonds and mutual funds continue to form the majority of clients’ portfolios, interest in alternative investments such as hedge funds, private equity and commodities is increasing." When it comes to onshore investments, domestic private banks have the advantage over international competitors. "In China, private banking onshore is limited by regulators, so domestic and international banks play by the same rules," says Lam. But because Chinese investors have closer ties to domestic bank branches, they gravitate towards them. "Building trust with the customers is an important cultural aspect, and many HNWIs still choose their providers through friends’ or family’s referral," explains Shang. "This gives local banks an edge over foreign banks."
This isn’t to say that Chinese private banks necessarily outperform well-established international private banks. Indeed, domestic-based private banks can be at a disadvantage when it comes to offshore investing. "Often, there is a divergence in the types of products and services that banks based in China offer compared with a bank based in Hong Kong for instance," says Lam. "For offshore purposes, Chinese HNWIs are most likely to bank out of Hong Kong, Singapore or even the US and Europe." According to Wealth X, a provider of intelligence on ultra-high-net-worth individuals, 64% of Singapore’s ultra-wealthy community, with at least $30 million in assets, are non-Singaporeans. Of this number, mainland Chinese HNWIs account for about 21%.
There are several other factors that can motivate a customer to go offshore, some more extreme than others. "There is a decent chance that those that have amassed large amounts of wealth have done so in a way that is not entirely legitimate," says one commentator. "For argument’s sake, say an international private bank and a domestic private bank or trust company offer the same products at the same price, the Chinese investor would most likely choose to go offshore. The investment is safer and so is their private information. If the Chinese authorities were to make a private investigation, the Chinese company would be obliged to divulge its client’s information; the international company, on the other hand, wouldn’t."
The case of Bo Xi Lai is a prime example. Following the downfall of the former politburo member, Beijing seized a majority of Bo’s onshore assets. But official accounts of his offshore assets are unknown and therefore beyond the reach of the authorities.
"HNWIs in general tend to have more than one banking relationship, and this is true of Chinese clients too," says Salem. "They prefer domestic banks when it comes to plain-vanilla banking at home, mainly because they have larger branch and ATM networks. But business owners who are active in the region or globally quickly realize the benefits of a global foreign bank compared with a local bank."
Chinese private banks are not blind to offshore competition. "Domestic banks are also expanding their coverage regionally, in particularly in Hong Kong. This will result in more intense competition with foreign banks in the future," says Shang.
In the case of ICBC, by the end of 2012 its private bank had established 36 locations across China, along with Hong Kong and Europe. In the next couple of years, the Chinese private bank plans to expand into markets such as the Middle East, Singapore and farther into southeast Asia to keep up with the growing market and the competition.
Some argue that the importance of competition between domestic and international banks might be overblown and that there is enough business to go around. "It is unlikely that HNWIs will use one private bank for all their investments," explains Shang. "Entrepreneurs and professional managers account for approximately 60% and 15% of HNWIs respectively. Given their profile and needs, they usually use one or two providers for their transactional banking, another one or two for private banking, and others for their businesses and offshore assets. It is unlikely that one bank will fulfil all of these functions."
Ultra-HNWIs will always maintain several banking relationships, if for no other reason than because they want a diversity of choice, explains Salem. "However, it is our experience that clients will often have one major or house bank that completely understands their financial picture, and other smaller banks for product or service purposes. The key to becoming a client’s house bank is to offer the most comprehensive set of products and services."