Taiwan's conglomerates need to break free

By Elliot Wilson

The announcement on the website of Taiwan’s central bank was easy to miss. It made no impact in Asia, and was ignored by local newspapers and broadcasters. 

The timing of the release – January 9, just a few sleepy trading days into the current year – probably didn’t help. Nor did the fact that the message was jammed between an update on foreign exchange reserves and details of a new batch of silver coins minted to celebrate the Year of the Rooster.

Yet some in Taiwan hope it will come to be seen as an important event in the development of the island’s capital markets: if not a defining moment, then at the very least a useful stepping stone on the way to a brighter future.

The statement itself was short and simple. Rules would be eased to allow local securities firms to handle spot and derivatives products denominated in new Taiwanese dollars, against foreign currencies, rather than putting the business through a bank. 

It was, the central bank said, a decision designed to bolster competition and boost profits in an industry struggling for traction and growth.

Leading brokers, unsurprisingly, hailed the decision. 

“It’s just a start, but at least it is a start,” says Ted Ho, chairman of Yuanta Securities, the island’s largest and most profitable securities firm. “And not before time. One day in the not-too-distant future, we’ll be able to offer US and Aussie dollar and Japanese yen products directly to our clients. We have applied to be allowed to offer these FX services, and rules are likely to be announced before the end of 2017.”

Some caution is urged. The rule change remains a prospective one. Draft legislation has yet to be drawn up, and both the central bank and the island’s financial regulator, the Financial Supervisory Commission (FSC), have been known to move with glacial speed, unveiling plans only to retract them later.

But it is, surely, a belated sign that the island’s lawmakers are starting to address the real elephant in the room: a financial sector widely viewed as weak, congested, sclerotic, detrimental to the needs of the economy and hamstrung by decades of nonsensical over-regulation.

The broking industry’s delight also needs to be explained and placed in context. Taiwan’s financial sector is unusual in the extreme. Each facet of the industry is strictly channelled and ring-fenced. An insurer provides insurance products. Brokers buy and sell securities to and for their clients. Asset managers create and market mutual funds.

None venture beyond their own territory. Demarcation lines are all but absolute. Even the largest financial groups run each internal division as a completely separate unit. Thus Yuanta Securities is controlled by its parent, Yuanta Financial Holding, whose demarcated divisions offer securities trading, futures trading, investment trust products, asset management, venture capital and insurance, as well as overseeing two commercial lenders, Yuanta Commercial Bank and Ta Chong Bank. The same is true for the likes of Mega Financial Holding, CTBC Financial Holding and Cathay Financial Holdings.

Every financial product is clearly marked and packed away in its own little box. As the head of a local bank puts it: “In Taiwan you need a licence for everything. One licence to buy and sell shares, another to buy and sell futures, a third to run a bank. Everything is compartmentalized. It’s like this because the government has spent the past 50 years erecting barriers between financial services sectors to stem any contagion if anything went wrong.”

Whenever a new product emerges, as was the case with the asset management and futures markets in the 1980s, the natural inclination of the island’s regulators was to ring-fence it – and then ask financial groups if they want a piece of the action. It was, they believed, the best way to maintain stability and ensure that every slice of the financial space remained active, competitive and profitable.

For a long time, this restrict-to-protect attitude worked reasonably well. Backtrack a few years, and you find a highly profitable group of domestic brokers. The decline, when it came, has been long and slow, but visible to anyone working within the industry.

Yuanta’s Ho says profits across the board have dropped significantly in recent years, with trading volumes running at around a third of their highs of a few years ago. He notes that once-hefty margins are “disappearing, partly due to more intense competition and partly because of the crushing effects of new forms of financial technology, which is squeezing fee incomes on broking across the board. Brokerages can’t survive on commission profits alone, and the result is that securities firms are under attack from every side.”

It has taken a long time for regulators to listen to the industry’s woes, in part because, notes a senior securities executive, “they are still living in a mind set from 20 or 30 years ago, when margins where chunky and any brokerage could easily survive from commissions on trades. Put another way: regulators are finally waking up to the fact that Taiwan’s brokerages are dying and that the financial holding model that worked so well for so long, is failing.”

To their credit, regulators do seem finally to be listening to bothered brokers, rather than tuning out. Leading financial voices point to a new and more open-door policy adopted by central bank governor Perng Fai-nan, who is set to stand down in February 2018 after 20 years in office, and FSC chairman Lee Ruey-tsang.

“The head of the central bank is willing to listen to us and to change the rules to accommodate our needs,” says a senior official at a Taipei-based brokerage. “That hasn’t happened for 50 years. If the central bank can change, then surely the securities industry can, too.”

Experts say the shift in attitude has come from the very top. Tsai Ing-wen, the island’s first democratically elected female president, voted into office in May 2016, isn’t universally popular at home. But she does “recognize the problems we face, and she seems to want to help,” says one leading banker, adding that the same could not always be said of her predecessor, Ma Ying-jeou.

But from a regulator’s or a politician’s point of view, wanting to help and actually effecting real change by manipulating the levers at their disposal are different things, particularly on this contrary island. One of the key reasons brokers are so keen to tap into new revenue streams is because the rules of the financial game, as they stand, hinder them at every turn.

Take January’s announcement, which came four years after the central bank first granted brokers the right to carry out basic foreign exchange services. Before that, securities firms had to channel all their foreign exchange transactions through the banking sector, eating into earnings.

For years, that situation had worked to the benefit of Taiwan’s largest financial groups, simply because most brokers would use the parent company’s in-house bank to settle trades. But it did little to help smaller stock-trading firms. And even the big boys had reason to moan. Running well-staffed brokerages at a time of falling fees was a drain on the parent’s bottom line.

By relaxing rules that prevent brokers from buying and selling foreign exchange derivatives, Taiwan’s regulators are hoping to begin to tackle the serious imbalances that exist in the financial sector. For while brokers (or asset managers, or insurers, or private equity firms) are forced to operate within their own walled gardens, domestic banks are allowed to roam free, offering customers pretty much any financial service imaginable.

It’s hard to overstate the power local banks have, at least compared to non-bank finance providers. As Yuanta Securities’ Ho notes, Taiwan’s lenders are the biggest domestic vendors of insurance products and mutual funds, outselling insurers and brokerages in equal part. He compares the situation in China – where commercial banks are prevented from directly selling equity products – with Taiwan, where commercial lenders are the dominant force.

“In order to rebalance the situation, the government needs to cut banks out of this market, or at least allow securities firms to join the banking business,” Ho says. “As things stand, they aren’t fair. For our part, we would like to diversify from being a pure brokerage into providing asset management and trust fund services. We want to transform Yuanta into an all-encompassing financial entity with the ability to gather and manage assets and offer a full range of services.”

On the surface at least, granting local securities firms the right to roll out a raft of first-rate financial services makes a lot of sense. Taiwan’s leading companies instinctively turn to their banking providers when in need of cash, rather than the capital markets, says CY Huang, chairman of Greater China-focused M&A adviser FCC Partners.

“Bank loans make up 80% of the funding market, with the remaining 20% sourced by the capital markets,” he says. “That ratio is all wrong. In most advanced countries, the ratio is 50/50 or even 40/60. Taiwan needs broader and deeper capital markets, and that can only happen by fostering a new generation of well-run, broking-driven investment banks.”

But as logical and desirable as that sounds, it’s unlikely to happen without a struggle. Finance is too fragmented and dominated by big, but weak, conglomerates. Companies casting around for funding face an embarrassment of riches: Taiwan boasts 39 full-service commercial lenders, 16 financial holding firms, 100 brokerages and more than 40 asset managers.

Huang says the problem is that the FSC “has no clear vision and policy, and no idea of what the industry should look like 10 years from now. It focuses only on trivial regulatory detail and lacks an ability to see the big picture.”

Taiwan’s overseers know the truth of this, just as they recognize the need to foster a financial sector that does not act as a drag on the wider economy. In private, regulators recognize the conflicting demands they place on the largest financial groups. How, after all, is it possible to boost efficiency, cut costs and use capital reserves to maximum effect at home and overseas while running colossal and duplicated rosters at each divisional silo.

But again, there is a stark difference between wanting and doing. Taipei has passed a raft of legislation down the years, aimed squarely at forcing banks to merge with or buy one another. Take the 2000 Merger Law, which was followed a year later by the Financial Holding Company Law.

The former sought to boost bank consolidation while the latter took aim at the big holding firms, hoping to make them better run, with fewer bad loans and higher capital adequacy ratios. Nor did the avalanche of legislation stop there. The 2015 Financial Institutions Merger Act offered tax cuts to any financial institution that merged with another.

And it worked – sort of. In the 11 years up to the end of 2015, according to data from the Federal Reserve Bank of San Francisco, there were 52 successful bank mergers in Taiwan. But most of these, the federal bank said in a May 2016 report, were “relatively small in size”, and did “little to reduce fragmentation in the banking industry”. The number of banks did fall over that period, but by just 10, from 49. 

Years of attempted reform, the federal bank added, had achieved little. Unlike, say, South Korea, Malaysia and Thailand, economies dominated by a small number of big lenders, Taiwan’s banking sector was still horribly fragmented and, on the whole, unprofitable.

More than half the industry’s assets were in the hands of stodgy state lenders. Forced to compete for the same pool of customers, Taiwan’s banks engaged in “unhealthy competition”, offering services at “below-cost, to capture market share”. Few were able to achieve true economies of scale, undermining the island’s overall financial stability.

It’s hard to see how this can change. Every few years, Taipei trots out a new law or incentive designed to accelerate consolidation. But when a big merger is mooted, it is always dead on arrival. The process is three-fold. First, a deal is proposed. Second, powerful financial unions send pliant souls into the streets to protest against feared job cuts, garnering media coverage. Third, government, fearing a backlash, scraps the deal.

Sometimes the nightmare is repeated. Taishin Financial Holding’s attempt to buy Chang Hwa Commercial Bank for $1.9 billion was called off in 2008, because of pressure from unions. The deal was revisited in 2013 and scrapped again, after the ministry of finance warned any deal would “significantly hurt the public interest”. 

A bitter battle over Chang Hwa, which is 22.5%-owned by Taishin and 30%-owned by various governmental bodies, continues still.

Other deals are quietly nixed for more abstruse political reasons. When International and Commercial Bank of China announced plans to buy a 20% stake in the banking arm of Sinopac Financial Holdings for NT$20 billion ($664 million) in 2013, the deal was contingent on the passage of a trade services agreement between Taiwan and mainland China. The bilateral pact was never passed and two years later, ICBC threw in the towel.

The collapse of the Taishin-Chang Hwa deal, not once but twice, was a defining moment in the eyes of senior bankers. Politicians knew the industry was crying out for change. They talked about it constantly, in public and in private. But they couldn’t summon up the will to see it through.

Consolidation, when it does take place, has been a “painful” process, admits Stephen Chan, deputy head of institutional banking at Taipei Fubon Commercial Bank, with acquisitions “often driven by political fiat rather than commercial needs”.

Taipei Fubon’s Chan believes politicians and regulators genuinely want to create a thriving banking sector, driven by a handful of bona-fide national champions “able to compete with Asia’s best”. But for one reason or another, the big deals never happen.

“Some mergers are approved by one administration then scrapped by the one that follows,” Chan sighs. “Then there have been some political scandals connected to M&A deals. It has been really painful and really slow.”

“Merging with other banks won’t be easy,” says Joseph Jao, president of Taishin Financial Holding, one of Taiwan’s largest financial conglomerates. “There are targets that are approaching us, but we did due diligence on them, on their asset bases and on the potential synergy, but we couldn’t make the numbers work. In terms of future bank acquisitions, we will not give up any opportunity, but the choices are limited. There are no tax incentives in buying a bank.” It can be argued that financial services in Taiwan are less at a crossroads, than stuck on a roundabout, going round and around. Regulators clearly want to break down many of the artificial barriers they have spent decades erecting across and within the financial sector. For proof of that, look no further than Taiwan’s central bank, and its efforts to save the ailing securities industry by allowing brokers to offer new foreign exchange services, direct to customers, perhaps by the end of the year.

But there remains so much more to be done, and so far to go. Taiwan’s banking sector is likely to remain one of the most fragmented in Asia so long as consolidation remains so politically unpalatable. 

And a public that loves its leading industrial brands, but fears and distrusts the banks and brokers that excel at financial engineering, is unlikely to look on serenely as barriers are broken down, injecting greater competition – and thus more uncertainty – into financial matters.