Drift and despair weigh on Taiwan

By Elliot Wilson

Taiwan should have little to worry about. The island off the coast of China has spent decades transforming itself into the perfect exporting machine. Names such as ASE Group, the world’s largest chip packaging and testing company, and Foxconn Technology Group, maker of Apple’s iPhones, are deeply embedded in global supply chains, as are the likes of laptop maker Quanta Computer. If you’re reading this on a screen, the chances are a Taiwanese firm made that screen.

That exporting prowess generates wealth and growth. Taiwan’s economy is Asia’s sixth largest, with a nominal GDP of $519 billion last year, or the size of Singapore and Bangladesh combined. It is tipped by the IMF to grow 1.7% in 2017: not great, but not bad either. In purchasing power terms, it ranks 18th globally, ahead of Japan and South Korea. A typical Taiwan citizen is three times wealthier than his counterpart from China, and four times richer than the average Thai.

Yet you wouldn’t know this from being there. A sense of drift and despair hangs over the capital, Taipei. Domestic companies put their cash to work in the US, China, southeast Asia – anywhere but Taiwan itself. Bustling young firms choose to list shares in Shanghai or Hong Kong, giving the Taiwan Stock Exchange, with its sinking turnover and stingy valuations, a wide berth.

The financial services sector faces its own challenges. Securities firms, hemmed in by onerous regulations, watch as margins and profits are pared to the bone. Local banks, unable to merge with one another for political reasons and struggling to expand on the mainland, seek new opportunities in southeast Asia with mixed success.

A nation that once prized innovation is now an also-ran. In January, Bloomberg ranked South Korea the world’s most-innovative economy, with Singapore sixth, Japan seventh and China 21st. Taiwan didn’t even make the top 50. 

This fall from grace is most visible in financial technology. With its decades of excellence in digital electronics, Taiwan should be a global leader. Yet it lags far behind the likes of the US and China, lacking drive and creativity, and a cohesive government policy.

Talent and capital is draining from the system, with young bankers seeking work in Shanghai and Singapore, and wealthy citizens putting their cash to work in Hong Kong. 

“If you are young and you have ambition, the first thing you do is leave,” says CY Huang, a former JPMorgan banker and chairman of FCC Partners, an M&A consultancy with a focus on Greater China. “No one wants to be here. No one wants to invest here. This is a country going backward fast.”

Taiwan’s issues are complex, but they boil down to a trio of challenges: how to deal with China; how to deal with its friends (or the lack of them); and how to deal with itself.

The first one is the biggie. Taiwan simply cannot compete with its vastly more powerful and influential neighbour. Beijing considers China and Taiwan to be one and the same, part of the same ancestral land, and has pledged to take back the island – by force if necessary.

To that end, the People’s Republic of China has spent decades and many billions of dollars systematically isolating the Republic of China (to use Taiwan’s official name) from the rest of the world. In 1971, the former joined the United Nations, supplanting the latter and all but eliminating Taiwan from diplomatic circles. The island competes in the Olympics and the World Cup, but only under the apolitical name of Chinese Taipei. It has formal relations with just a scattering of tiny Caribbean and Pacific states such as St Lucia and Nauru. No one rings to say hello; no one comes to stay.

The suffocation continues to the present day and far into the economic and financial realm. A formal request to join the Asian Infrastructure Investment Bank (AIIB), a new and ambitious China-led multilateral, was rejected in 2015 – although Beijing has left the door ajar. Nor is the island part of the One Belt, One Road (OBOR) project, another mega-scheme designed to rebuild the world in China’s image, or at least redraw the economic map in its favour.

Even small wins become chastening defeats. One of Donald Trump’s first phone calls in November 2016 was from Taiwan president Tsai Ing-wen, a decision that angered Beijing. But when the US president met his Chinese counterpart, Xi Jinping, and found cordial and common ground, he turned his back on Taiwan. When Tsai suggested a second chat in April, Trump turned her down flat. 

FCC Partners’ Huang fears that Taiwan will “over time become like North Korea, locked out of the world and completely isolated”. But perhaps the better comparison is with Cuba, another island that long ago fell out with its dominant neighbour, and which only now is emerging from the crushing effects of sanctions.

There is a simple solution here, one that would simultaneously delight Beijing and solve many of the island’s woes. If Taiwan were to engage in concrete talks about unification, capital would immediately flood in from the mainland, giving the economy a quick and much-needed hit of growth.

Yet it is not clear if this is possible. It is 20 years since China took back Hong Kong with a view to one day doing the same with Taiwan. Yet a dwindling number of Taiwan’s 24 million people consider themselves solely and ethnically Chinese: just 3% in 2016, according to an annual survey from the Taiwan Election and Democratization Study. By contrast, 70% of those aged 40 or under identify as Taiwanese. Most do not want unification. So, while engaging in direct talks with Beijing is an economic and financial imperative for Taipei, it would be an act of political suicide for the island’s democratically elected officials.

For its part, Beijing can feel the island drifting away. And with each year that passes without concrete talks, it turns the screw a little. Banking is the latest industry to feel the squeeze. In April, the China Banking Regulatory Commission, or CBRC, ordered Taiwanese lenders operating on the mainland to carry out a review of their local due diligence and credit risk systems, adding that it reserved the right to conduct inspections of individual branches without prior notice.

China’s banking regulator also ordered any Taiwan bank with two or more local branches to designate one of them a key branch, responsible for all mainland operations. 

“It’s Beijing’s way of reminding us who’s in charge,” said a Taipei banker. No other nation’s lenders were singled out for the same treatment.

Taiwan’s main bourse, once a thriving securities hub, has seen its lustre fade as China’s markets soared. On average, 36.5 million shares listed on the Taiwan Stock Exchange changed hands a month in 2016 – both Shanghai and Shenzhen, China’s two main bourses, boast 10 times that turnover.

The TSE’s market capitalization was $975 billion at the end of April 2017, against $3.2 trillion for Shenzhen, $4.2 trillion for Shanghai and $3.6 trillion for Hong Kong’s main board.

And while the last three have joined forces in recent years to create a stock connect programme that allows $6.8 billion to flow between Greater China’s largest bourses daily, Taiwan has been shunted into the weeds.

The TSE would benefit enormously from a four-way stock connect, says Ted Ho, chairman of Yuanta Securities, one of Taiwan’s leading brokerages. 

“I used to advise the previous government [under former president Ma Ying-jeou] that we should join the stock connect programme, where each bourse has its own distinct advantages,” he says. “Hong Kong is strong on real estate, Shanghai on financials and Shenzhen on industrials. Joining forces would give Taiwan’s electronics firms far more global visibility, and the chances of local stocks being snapped up by global investors would increase markedly if Taipei joined a Greater China stock connect scheme.”

But this opportunity has also passed the island by. Taiwan’s current president has shown no inclination to engage with the mainland on the issue, nor is she likely to. 

In the current political climate, it’s just not possible to move forward with a four-way stock connect, concedes one banker: “There’s so much distrust between Beijing and Taipei, and Hong Kong doesn’t want to rock the boat.”

It’s also worth remembering that China’s inexorable rise, in terms of the power and vitality of its capital markets, has only just started. Beijing is slowly peeling away the layers of its capital controls, allowing global investors greater access to local securities. In March 2017, Chinese premier Li Keqiang pledged to roll out a bond-trading link with Hong Kong, again bypassing Taiwan, by the end of the year. And there are very real hopes that mainland-listed A shares will be incorporated into the key MSCI Emerging Market index, with an announcement expected as early as June. 

With mainland-listed securities now more plugged into international capital markets and typically offering higher price-to-earnings ratios, Taiwan is falling further behind. Many thriving young companies are opting to list shares on the mainland, now home to higher valuations and a larger investor pool.

Shenzhen Huiding Technology is a case in point. Based and owned in Taiwan, it supplies chips to Amazon and China’s largest smartphone makers. It reported a 130% jump in net profit in 2016 and should by all rights have been a classic listing target for the TSE. So its decision last year to select Shanghai as its listing venue, rather than Taipei, came as a bitter blow.

Not that the firm’s thinking can be faulted. Huiding’s shares have surged since completing its Rmb873 million ($130 million) stock listing, jumping 365% between October 10, its listing date, and May 23, while its P/E ratio is hovering at a little over 41 times forward earnings.

And more Taiwan firms, hungry for capital, are likely to follow in its footsteps, bankers say. 

“Corporates listed in Taiwan now trade only at 16 times [forward earnings] compared with 22 or 23 times in mainland China and Hong Kong,” says Stephen Chan, head of corporate finance and deputy head of institutional banking at Taipei Fubon Commercial Bank. “That makes a listing in Taiwan far less attractive. Turnover rates in Taiwan have dropped below 100 and that affects issuers’ willingness to tap equity markets here. The liquidity is very important to the stock market. It has become more difficult to sell equity stories at a premium, so it scares away big IPO candidates.”

Taiwan’s reaction to all this has been a curious mixture of abnegation, denial, self-harm and poor decision-making. Its political leaders are of course aware of Beijing’s plans to isolate the island and sedate it into economic submission. Taipei, recklessly or bravely, depending on your point of view, appears determined to delay real unification talks for as long as possible.

But the pragmatic reality is that China is both far more powerful than its island neighbour and utterly vital to its long-term economic and financial well being. According to the CIA World Factbook, China accounted for more than a quarter of all Taiwan’s exports in 2016, making the mainland crucial to the island’s leading companies and to the banks that finance them.

So it seems strange to find the island’s lenders scaling back their presence in China and cutting their local credit lines to both Taiwanese and mainland firms. Yet that is exactly what’s happening. In February, Fitch Ratings said Taiwan’s banks lenders had cut industry-wide exposure to mainland China to 6.2% of total assets, as of the end of 2016, from a high of 8.4% two years earlier. At the end of March 2017, according to the Financial Supervisory Commission (FSC), Taiwan’s financial regulator, outstanding interbank loans and deposits by Taiwan banks operating in China amounted to NT$1.54 trillion ($51 billion), also a two-year low.

Some downsizing makes sense. The mainland economy continues to slow, and Taiwan lenders also need to set aside capital to fund their clients’ global operations outside China. Moreover, while precise data is hard to obtain, most Taiwan banks complain of unusually high non-performing loans ratios at their mainland branches. This problem, believes Chan of Taipei Fubon, is in large part due to the lack of direct, real-life relationships with China-based privately owned enterprises. “Poor corporate governance in China always is the big problem – we cannot get enough information on the corporate governance side from those big auditing firms,” Chan says.

But it isn’t immediately clear that Taiwan’s decision to switch its focus from China to southeast Asia will work. President Tsai’s so-called New Southbound Policy (NSP), unveiled in December 2016, aims to boost exports and lending to southeast Asia, south Asia and Australasia, while convincing companies from those regions to put their capital to work on the island. 

In May, the FSC set a target for Taiwan’s banks: to increase their credit lines to 18 economies in Asia Pacific ex-China by between NT$22.8 billion and NT$53.2 billion in 2017.

It’s clear that banks are listening. All talk loudly and openly about the branches they aim to open, the financial assets they hope to buy, and the returns they expect to make. Many are proving true to their words. In March, CTBC Financial Holding agreed to buy a 35.6% stake in Bangkok-based LH Financial Group for Bt16.6 billion ($480 million), the first big investment in Thailand by a Taiwan lender. The same month, Cathay Financial Holding said it was in talks to buy the Malaysian unit of Canada’s Bank of Nova Scotia, for between $200 million and $300 million.

Few Taiwan lenders miss a chance to talk up their ambitions in the region. Taishin Financial Holding says it is actively looking for opportunities in southeast Asian countries. It has operations in Singapore, a Vietnam branch is opening soon, and a senior executive at the lender says there are “lots of opportunities in Myanmar too”, adding the rider that he “doesn’t know much about the market”. Yuanta Securities’ Ho points to the broking firm’s operations in Indonesia and Thailand and its joint venture in Vietnam, as well as a small subsidiary in Cambodia. “The target is to build up our southeast Asia and south Asia operations. The government talks about going south. We are following their lead,” Ho says. 

Taipei Fubon’s Chan stresses that the bank is still keen to expand within the Greater China region and is keen to acquire banks in Hong Kong and Shanghai. But there is little doubt in his eyes that the future lies to the south of the island, not west.

He points to the bank’s Singapore office, opened in March 2016, which will serve “as our home base in southeast Asia, expanding outward to serve clients in India, Indonesia, Thailand, Malaysia and, to a lesser extent, the Philippines. We are the largest Taiwanese bank in Vietnam with three branches in Hanoi, Ho Chi Minh City and Binh Duong.”

Chan adds: “We will continue to look into the possibility of buying equity stakes in a financial institution in a particular country if a good opportunity turns up. You are [also] seeing this with the likes of CTBC, Cathay United Bank and E.Sun, all of which have made significant inroads into southeast Asia. Everyone is doing the same thing. That’s where revenues are growing. Southeast Asia has become the first choice of expansion for most Taiwan banks.”

This is a laudable and understandable reaction from Taiwan’s top lenders, many of which are sizeable, profitable and well run. They need to expand somewhere, and with many scaling back in China and struggling to boost profits at home, where a politicized regulatory regime makes financial-sector mergers all but impossible, southeast Asia might seem as good a place as any.

But the region is relatively new territory. Taipei Fubon’s Chan admits that local banks “haven’t [always] focused there as much”, in large part because the “penetration rate of Taiwanese corporates in southeast Asia is low”. 

Together, Singapore, Vietnam and the Philippines, Taiwan’s largest regional trade partners, accounted for $34.5 billion worth of the island’s exports in 2016. Compare that with exports to China ($73.9 billion) and Hong Kong ($38.4 billion). That doesn’t bode well, given that southeast Asia is already flooded with reputable and super-competitive lenders from the US Europe, Australia, Japan and China, not to mention from the Asean region itself, ferociously guarding their own market share and likely to resent any newcomers.

Nor is it likely that Beijing will look favourably on any southeast Asian nation that flings open the door to Taiwan banks and firms. China is now a big beast in the region, more influential than Japan or India, and competing tooth-and-claw for regional commercial, diplomatic and even military superiority with the US Beijing barely waited for President Trump to withdraw the US from a planned 12-nation Pacific free trade deal, before ramping up its funding of, and ambitions for, the AIIB and the increasingly global OBOR project.

“Our banks may want to expand into southeast Asia, but guess what – southeast Asia is in reality part of China now,” says FCC Partners’ Huang. “All these Asean countries want to be part of the AIIB. They all adhere to Beijing’s interpretation of the One-China policy” that views Taiwan as part of the mainland.

“We are cutting ourselves off from China, our biggest market, and hoping that our future lies in a region filled with countries with which Taiwan has no formal diplomatic relations. It’s a really dangerous strategy,” Huang says.

Sometimes, Huang adds, Taiwan can be its own worst enemy. He points to China’s offer in 2013 to allow Taiwan-based funds to invest up to Rmb100 billion worth of offshore yuan in mainland-listed securities, as part of the Renminbi Qualified Foreign Institutional Investor scheme. Only Hong Kong’s quota, set at the time at Rmb270 billion, would have been higher. But when students in Taipei protested at perceived Chinese attempts to curry favour and buy influence, the government took fright and dropped plans to join the scheme.

Taiwan is also acutely sensitive about selling local assets to foreign – particularly mainland – companies. This has led to a legacy of failed inbound acquisitions. In 2013, after three painstaking years of talks, regulators blocked the $2.4 billion sale of China Network Systems, Taiwan’s largest cable TV operator, to a consortium led by Want Want China, a Shanghai-based food producer. Two years later, FarEasTone, a Taipei-based telecoms firm controlled by billionaire Douglas Hsu, teamed up with Morgan Stanley’s Asia private equity fund to buy the same asset, this time for $2.5 billion. In February 2017, regulators again nixed the deal due, insiders say, to Hsu’s alleged affiliations with China.

And in October 2016, Taipei-based CTBC Financial Holdings and China Citic Bank mutually scrapped a much-vaunted deal to invest in one another. Both claimed the decision was not politically motivated yet the annulment came at a time of rising cross-strait tensions.

“The Taiwan government is so afraid of the Chinese government, they are trying to block out anything that is even rumoured to be connected to or controlled by Beijing,” says FCC Partners’ Huang.

This leads to the final problem: how to convince investors to put their capital to work in Taiwan and to compel the island’s brightest minds to want to stay. The island still sucks in a good amount of foreign direct investment, the bulk of it from Japan, South Korea and China, with inbound FDI hitting $11 billion in 2016, according to data from the ministry of economic affairs.

But compare that with outbound FDI, which has increased for the past seven years, reaching $12.1 billion in 2016, a record high. Leading Taiwan firms are investing everywhere but at home. In January, Foxconn said it planned to build a $7 billion display-making facility in the US; two months later it broke ground on an $8.8 billion factory in southern China. In May, the firm said it aimed to open 12 factories in India, creating 1 million new jobs in south Asia. And in February, Formosa Plastics, one of the world’s largest chemicals firms, lodged plans to build a $9.4 billion petrochemical plant in Louisiana.

Human capital is also following real capital as it leaves the island. Not long ago, white-collar salaries were higher on the island than on the mainland. Now, the reverse is true. 

Joseph Jao, president of Taishin Financial Holding, one of Taiwan’s largest financial conglomerates, believes stagnant wages are driving more Taiwanese to pursue careers overseas and that human capital outflow is a genuine threat to the island’s economic future, with talented young finance professionals able to earn more in Shanghai and Shenzhen than they can in Taipei. 

“We have tried to recruit overseas Chinese students while they are in Taiwan, but honestly it’s not easy,” he says.

Chan of Taipei Fubon sees a similar trend. “People are complaining that salary rises are too slow, and this is driving more Taiwanese talents to pursue their careers overseas,” he says. “The authorities aren’t making much progress on stemming this outflow of financial and managerial talent. There is no easy solution. Taiwan is a free economy, so it’s up to the employer to determine their HR policy. This is basically a supply-and-demand issue. However, if the trend continues, the human capital outflow will become a real threat to our economy.”

It’s hard to see where Taiwan heads from here. The island state is open, friendly, proudly democratic and largely free of capital controls. It has a world-class health system – one of the main reasons that make it such an attractive destination for Hong Kong and Chinese citizens looking for a safe, quiet and largely pollution-free place to retire.

But growth is slowing. Talent and capital are leaching from the system. Bustling young companies are choosing to invest – and list shares – anywhere else. And the island’s ambitions are slowly but persistently being undermined, both by China and by the often baffling decisions and actions of its own government and regulators. 

Taiwan might be quite developed and fairly rich, but that, alas, is not always enough. 

Taiwan should be a leader in fintech – if not globally then certainly in Asia. 

The island is hardware heaven, its technology firms are at the forefront of chip design and responsible for producing many of the world’s laptops and smartphones.

Yet in financial technology, Taiwan trails badly. In KPMG’s 2016 survey of the best fintech firms, the US and China dominated, with Hangzhou-based Ant Financial named the world’s top innovator. No Taiwan-based firm made the top 100. 

Many in Taipei believe the capital to be digitally innovative and creative, but reality doesn’t bear this out. In an annual survey of global smart cities by the IESE Business School, Taipei ranked 64th, below Hong Kong (39th), Singapore (22nd) and Seoul (8th).

Ko-Yang Wang, founder and CEO of blockchain firm Fusion 360, is widely seen as the island’s leading authority on fintech. He agrees that Taiwan came late to the party, and views the problem as one of over-regulation and risk aversion. 

“Our government has been pretty conservative,” he admits. “It is afraid of fintech firms disrupting banks and sowing chaos, which is why we have moved so slowly.”

This risk aversion has stymied the industry at every step. In China, Beijing has made a grand bargain with itself. It is willing to accept a certain amount of digital disruption to its banks and to deal with problems (such as the scams that riddle its peer-to-peer lending industry) as they arise in exchange for fostering a world-class fintech industry. So far, they are winning. 

Taipei has gone for the opposite, taking fintech out of the hands of young tech entrepreneurs and asking banks to spearhead innovation. It isn’t working. “Banks are not leading the fintech process,” says Wang. “They invest but not in the right ideas. Personally, I don’t think any financial institution in the world is capable of leading innovation in fintech. It’s not in their DNA.”

For their part, banks are happy to admit they are not natural disrupters. 

“In the US or China, tech firms dominate innovation, but here we are expected to play that role,” says a senior Taipei based banker. “We are not natural innovators.”

This risk aversion runs deep in the financial sector. Taipei has approved dozens of bank mergers over the years, only to scrap them, fearing the union-led protests that always ensue. But there are signs that politicians are learning. Taiwan’s financial regulator, the FSC, is mulling a so-called sandbox law, similar to those passed in Singapore and Hong Kong, that will allow banks to experiment with new, non-compliant financial technologies. 

Fusion’s Wang, who has agitated for the rule change for more than a year, sees the FSC approving it as early as July.

The public appetite for new technologies that disrupt in a healthy manner is palpable and is having trouble waiting. When reputable firms launch new services, the Taiwanese public laps them up: Apple launched its digital wallet service Apple Pay in March, it attracted 415,000 local users in the first two weeks. 

The island hosts a sprinkling of solid start-ups, from online payment system OnePaid to crowdfunding platform WeBackers, but regulators need to act fast to catch up with the likes of China, South Korea and Singapore, and to prevent a brain drain of talent. 

Many of Taiwan’s leading fintech minds are already leaving, opting to start firms and generate ideas in pro-fintech cities like Singapore and Shanghai. Banks do not want to innovate; tech firms do. The government should let them.