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IT’S RAPIDLY BECOMING clear that Beijing, and not London, New York or even Hong Kong, holds the key to HSBC’s future. Business is booming for the bank in Asia’s tearaway economy. In 2007, pre-tax earnings at its mainland China operations surged to $1.28 billion, from $708 million the previous year. Most of that was generated by the bank’s mainland-based joint-venture partners, notably Bank of Communications (BoCom). Pre-tax earnings from HSBC’s non-organic operations surged 89% year on year in 2007, to $1.087 billion.
It’s little wonder then that the bank’s group chairman, Stephen Green, regularly and prominently describes the People’s Republic as set to be HSBC’s single most important market – emerging or otherwise – over the coming decades.
That wisdom is regurgitated almost verbatim down the bank’s food chain. When asked by Euromoney in July if China was the key to the bank’s future, HSBC’s chief executive of global markets and banking, Stuart Gulliver, said: "It has to be".
Gulliver also noted that HSBC, which in April 2007 incorporated itself in the mainland, now boasts the "largest branch network of any foreign financial institution in China", with more than 80 offices across 18 cities. In the first quarter of 2008, according to the bank’s interim statement, a further seven offices were opened across the country.
And in a confidential internal strategy document obtained by Euromoney and entitled China strategic plan: 2006–2010, the bank lays out some self-consciously aggressive – not to say often hubristic – targets.
Our vision
"Our vision is to build the best universal banking franchise in China, and to offer superior China financial services globally," the document says, adding that the country’s re-emergence as an economic superpower offers the bank "an unprecedented opportunity to reinforce our global leadership position".
Growth forecasts for China are sprinkled liberally throughout the document. Some are realistic; others overreach; some seem almost deliberately cautious, designed to promise little in the hope of surpassing expectations.
The executive strategy sets the tone of the document. It forecasts operating profit before provisions (OPBP) hitting $627 million in 2010, up from $101 million in 2005, a compound annual growth rate (CAGR) of 54%. Other key targets for mainland China (referred to throughout the document as Area Office China, or AOC) include raising returns on assets and equity to 2.51% and 27.87% respectively by end-2010, primarily in its personal financial services (PFS) division; and cutting its cost-income ratio to below 50%. HSBC hopes that the PFS division will contribute 25% of mainland China earnings by 2010, up from 5% in 2005.
In commercial banking, HSBC wants to raise OPBP to $250 million by 2010, with the AOC region becoming the most profitable market in Asia-Pacific ex-Hong Kong, underpinned by greater scale, a broader domestic franchise and its ability to lean on its global banking franchise.
The document also paints some broad strokes, to accompany the fine print. By 2010, HSBC hopes to raise performing advances in mainland China to $19 billion and customer deposits to $48 billion, a CAGR of 65% above 2005 levels. Total non-performing loans will rise to $318 million, with the ratio of failing to performing loans declining, to 1.71% in 2010 from 2.14% five years previously. Net interest margins are seen rising to 1.25% from 1.17% over the same period, while interest income on customer deposits are tipped to grow at a CAGR of 59% to $491 million, with non-funds income rising at a CAGR of just shy of 50%, to $359 million, driven by "significant growth in transaction banking fee income". Dealing profits are set to grow at a CAGR of 45% in the five years to 2010, to $116 million.
As HSBC’s mainland China business expands, so will costs. The bank sees total costs rising at a CAGR of 35% in the five years to 2010, to $612 million, with staff costs rising at a compound rate of 36%, comprising 55% of all costs by 2010.
Rather to its chagrin – not to mention its burning sense of corporate pride – much of HSBC’s future success in China appears dependent less on its organic presence in the country than on its vast roster of mainland financial services partners.
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| "We’ve gone from a standing start to $181 million in five years, therefore the growth in profit potential is huge" |
Directly or indirectly, by July 2008 the bank had splashed out just over $4.4 billion on stakes in six finance-related Chinese firms, notably stakes in Ping An Insurance (19.9%), Industrial Bank (15.98%) and Ping An Bank (27%), as well as gobbling up stakes in two smaller city lenders, Bank of Shanghai and, in January 2008, Yantai City Commercial Bank. That’s not to mention the $1.75 billion paid in 2004 to buy a 19.9% stake in Shanghai-based BoCom, China’s fifth-largest lender, a deal that now looks both prescient and, for HSBC, cracking value. When BoCom (already listed in Hong Kong) went public in Shanghai in May 2007, HSBC booked a one-off profit of $1.1 billion on the sale.
Yet for all of this vicarious success, HSBC is desperate to see its own brand succeed in China. So far, it has done well enough. Pre-tax profits from the bank’s own organic activities are rising steadily – up 36% year on year in 2007, to $181 million. Its global banking and markets division alone saw earnings rise 84% last year, to $149 million.
Talking to Euromoney, the bank’s group head of Asia, Sandy Flockhart, said the bank would only be considered a success in China "when we are organically a $1 billion-a-year profitable business [there]". Flockhart considers that could happen within the next seven years. That would involve the bank growing at closer to 50% than 36% but bank officials believe it can be achieved. "We’ve gone from a standing start to $181 million in five years, therefore the growth in profit potential is huge," adds Flockhart.
Not one or the other
Flockhart rebuffs suggestions that HSBC is overly reliant on profit from its Chinese partners – despite evidence to the contrary. "I would challenge that point very strongly," he says, adding: "If we hadn’t made those investments [such as BoCom] when we had, we would have been accused of not being an emerging market bank." His colleague Richard Yorke, group head of China at the bank, adds: "I don’t think we’re over-reliant on BoCom and our other partners. We’re by far the biggest organic bank in China, and the biggest investor, so we’re well positioned. We haven’t done one thing at the expense of another."
When HSBC bought into BoCom, it reserved the right to double its stake to about 40% by 2009, or when Chinese banking rules shifted to permit that level of foreign ownership. Gulliver notes: "We are looking to increase our stake [in BoCom] and we would be eager to increase it if we are allowed to, but it’s not a decision on the table to be debated."
He adds: "We are comfortable with what we have."
He’s unlikely to say anything different, though. No senior official will publicly admit how desperate HSBC is to increase its stake in its Chinese partner. In its 2010 strategy document, the bank notes that BoCom remains "our primary opportunity to reach China’s mass banking market". That rather counters the bank’s position that its organic and non-organic operations wield equal weight and clout, and suggests that the bank’s future is more dependent on its leading mainland JV partner than it is willing to admit publicly.
In its internal document, HSBC refers – rather hubristically – to the view that "the world is watching" its investment in BoCom. "Anything short of a complete success in the HSBC-BoCom alliance will not be acceptable to domestic... and international stakeholders." It also stresses the need to seek a stake of 40%, while being "cognizant of the sensibilities surrounding ownership issues" and avoiding "making public statements on this subject matter".
Organic growth
If HSBC fails to boost its stake in BoCom substantially, the document adds sombrely, "our fallback position is to launch a direct banking initiative in China". In other words, if it fails to increase its stake in BoCom, HSBC will shift its strategy to focus heavily on building its organic franchise. Although how this can be possible – with foreign banks limited to opening new branches in just three mainland cities each year – remains to be seen: BoCom boasts more than 2,600 branches across mainland cities, compared with fewer than 100 at HSBC.
To be fair, if any bank can convince China’s officials to part with another 20% of such a large domestic lender to a foreign institution, it should be Europe’s biggest bank. HSBC has the largest presence of any foreign financial institution in China; it owns more stakes in mainland banking institutions than any other entity, including Singapore’s carnivorous state investment vehicle Temasek; it was the first foreign bank to buy a stake in a leading Chinese lender, BoCom, which in turn became in 2005 the first mainland lender to list shares overseas. Finally, the UK lender was born on Chinese territory, and it sees itself growing old there. According to Alex Potter, an analyst at Collins Stewart in London: "If HSBC can’t win in China, no foreign bank can."
The bank’s relationship with its strategic partners has not always been plain sailing, however. In March, Ping An bought 50% of Belgian financial institution Fortis’s asset management business for €2.15 billion and a 2.8% stake in the parent company. HSBC’s involvement in the transaction was peripheral at best. Rumour has it that Ping An only informed HSBC of its intentions 24 hours beforehand because of a lack of communication between executives at the two firms. HSBC declines to comment.
Obstacles to the project
The internal strategy document also highlights many of the serious challenges and issues facing China’s leadership. These include a deteriorating environment, limited natural resources, an ageing population and an economic structure that focuses too heavily on agriculture and low-value-added enterprises. A rising regional urban-rural imbalance is also highlighted, as is the "lack of [a] developed capital market, legal and corporate governance frameworks". HIV and Aids are also highlighted as hurdles for China’s rapid development, as are rampant corruption, tensions with Taiwan and potential future outbreaks of diseases such as Sars, which brought China’s economy to a virtual halt in 2003.
It adds that the performance of China’s business sector would be strengthened through better corporate governance, "as well as better enforcement of laws in the economic sphere, especially those for intellectual property rights". It also notes that although "substantial progress" has been made in many facets of China’s financial system, difficult challenges remain, in particular a lack of consumer financing channels and the absence of an all-encompassing national credit rating system.
One of the key markets for HSBC, wherever it operates – whether China, the Middle East, Europe, Africa or Latin America – is in its roster of mass affluent customers: high-net-worth individuals who drive its mass-market wealth management services. China’s middle class in particular is becoming richer by the day, and in its internal strategy document, HSBC predicts the total number of mainland-based high-net-worth individuals growing to 6 million in 2010, from 4 million in 2004, one-fifth of whom will be focused in four tier-one cities.
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"We’re by far the biggest organic bank in China, and the biggest investor, so we’re well positioned. We haven’t done one thing at the expense of another" |
The bank aims to have built up a 16% share of such customers by 2010, enabling it to become "China’s leading wealth management service provider among all local and foreign banks". That’s a hugely optimistic target given the press of competition entering China in the form of foreign banking rivals such as Citi and Standard Chartered, not to mention private banking and wealth management specialists such as UBS. Then there’s the country’s fast-improving commercial lenders, from China Merchants Bank to Industrial and Commercial Bank of China, each of which is targeting the savings piling up in the accounts of countless millions of wealthy customers.
Wealth management
And mass affluent customers aren’t concentrated solely in mainland cities such as Beijing and Shanghai. As in the US or Europe as they industrialized in the 19th and 20th centuries, personal wealth is increasingly widely spread in China. HSBC is hoping to grab a 12% market share in the high-net-worth sector in second- and third-tier cities by 2010, from Xi’an in the west of the country, to the central city of Zhengzhou, where a full-fledged HSBC branch, which will include banking for its premier customers, will open in August 2008. That, the bank hopes, will help it become the leading wealth management services provider (not to mention cash management services) by the end of 2009.
That’s backed up by senior HSBC officials. China chief Yorke says the bank is targeting mainland Chinese with a minimum of Rmb500,000 ($73,000) to invest through 47 premier wealth management centres. He also notes that premier customers are increasingly local people rather than expatriates. "In terms of pure growth", says Yorke, services targeted at higher-net-worth individuals are "the fastest-growing business we have".
Again, painful thought it might be, HSBC acknowledges in the internal document the need to lean on BoCom’s "broader customer focus and natural franchise in mass-market banking" to ensure that it succeeds. The London-based bank hopes to operate 100 premier centres by the end of 2010, focusing on the mass affluent market, including 23 in Shanghai, 18 in Beijing, 11 in Shenzhen and 12 in Guangzhou, with the remaining 36 based in smaller urban centres.
To be sure, the two sides – HSBC and BoCom – have learnt to help each other. The British lender benefits from BoCom’s domestic scale and ability to reach customers across even smaller third-tier cities. In turn, the British lender’s storied history provides its partner with everything from wealth management advice to basic wholesale services such as cash management, treasury and foreign exchange. Yorke says: "With BoCom we have done 80 strategic initiatives across different products and successfully co-branded a credit card. The latter business sits within Bank of Communications but we have 12 senior HSBC business managers allocated to the project."
In its internal document, HSBC predicts that the bank will have 5.9 million credit cards co-branded with BoCom in circulation by 2010, yielding $138 million in earnings.
In corporate, investment banking and markets, HSBC sees itself expanding beyond its physical presence in Shanghai and Beijing, capturing north Asia investment flows while "working closely with [its] Taiwan desk and... Korea desk". It’s striking here that the bank, at least in internal documents, would appear to view Taiwan as being an external market to China – something that might surprise Beijing’s legion of nationalistic bureaucrats, who view the island as a breakaway province and an inalienable part of the motherland.
In commercial banking, too, HSBC has big plans in China. It wants the mainland to become its most profitable market for commercial banking operations in Asia-Pacific by 2010 after Hong Kong, dragging in $250 million in annual profits. To that end, it wants to fuse its strong global commercial banking and its growing mainland presence, pushing lending to private-owned and state-owned Chinese enterprises to 25% of its loan book in 2010, from 10% in 2006.
That will still leave the bank heavily dependent on its global corporate customers in mainland China, which by 2010 will make up 75% of its loan book, which HSBC predicts will include 18,750 corporate customers, up from 5,684 four years previously. In private banking – a key plank of the bank’s strategy in the mainland – HSBC wants to welcome in 1,500 high-net-worth clients by 2010, with assets under management of $4.6 billion and annual revenues of $50.6 million.
Staff numbers are also rising fast as business grows in the mainland. Total full-time mainland employees are set to rise to 6,484 by 2010, with marketing expenses set to increase by 18.7%. And at the retail level – an area in which HSBC can viably argue to be a global force – it has set its sights on dragging in $156 million-worth of pre-provision operating profits by 2010 from 302,327 Premier banking customers. Those would be sourced from 64 retail centres based in first-tier cities, and 36 in second- and third-tier cities, mostly smaller towns in the Yangtze and Pearl river deltas, and in the northeastern Bohai industrial rim encompassing Beijing and Tianjin.
Meanwhile, after steadily scaling back its investment banking franchise in China, HSBC is also quietly re-engaging with its natural merchant banking-style roots in the country that gave us silver coinage and the banknote. Its origins lie in financing the early operations of the hongs, 19th-entury trading houses that, among other things, sold Bengal opium to China and shipped Chinese tea to all corners of the British empire.
| "We are looking to increase our stake [in BoCom] and we would be eager to increase it if we are allowed to, but it’s not a decision on the table to be debated" |
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As Chinese corporates grow, they need old-fashioned global wholesale banking services – cash management, treasury, foreign exchange and so on – that might not be glamorous but certainly rake in the cash, year after year. The country’s corporates are scouring the land for energy, brands, minerals and metals – anything to keep the booming economy growing above 10%, and HSBC is trying to intermediate the trade flows going into and out of the country.
Bank of choice
Bilateral trade between China and the Middle East – a region in which HSBC posted pre-tax earnings of $1.3 billion in 2007, up 25% year on year – is set to grow to $100 billion by 2010, from half that in 2006. Africa, another increasingly vital trading partner, saw two-way trade with the mainland hit $73.8 billion in 2007, a seven-fold rise from the start of the decade. "We want to be an international bank of choice for foreign companies investing in China, be that for ultimately export reasons or, increasingly, because they want to tap into the domestic consumption story," says Yorke. "As these companies expand they need a bank with a strong network in China and that can deliver in areas such as trade finance, FX and cash management."
At the same time, he adds, the bank is focusing on local companies seeking to expand abroad. In its internal document, HSBC notes that China will become "less reliant on the US and Europe, while trade and partnerships with other developing countries... are expected to increase". It adds, a touch optimistically: "This geopolitical shift is expected to continue for the foreseeable future and should benefit HSBC, given HSBC’s natural strength in Asia and other emerging markets."
Yet it is to China that HSBC’s senior executives increasingly look, straining to build up their presence in an economy with 1.3 billion potential customers, and which continues to regularly grow at between 10% and 12% a year. The bank’s aggressive aims, as set out openly by officials and less publicly in strategy documents, bear out this shift in the bank’s fortunes, and in terms of where it sees itself five, 10, 50 years down the line and how it sees its own brand developing, both organically and vicariously, via its mainland financial partners. Maybe it’s a conceit for HSBC to say that the whole world is watching its performance in China. But it’s certainly fair to say that the London-based lender, which started its life 143 years ago on a rocky island off the Chinese coast, does finally seem to be coming home.
