14 November 2006

Canadian Banks in China

Investment Executive, Rudy Mezzetta, 14 November 2006

China’s sizzling economic growth and vast pool of untapped savings wealth is spurring Canada’s largest financial firms to establish beachheads in the Asian country, hoping that investments they make today will pay off big tomorrow.

In October, Royal Bank of Canada announced that it had struck a deal with a Chinese bank to launch a mutual fund joint venture in China.

“As China continues to do extremely well, in terms of growth, and as the population ages, as it is doing in other countries, there will be more focus on savings and investments — even more that there is now,” says George Lewis, executive vice president of wealth management for RBC and chairman and CEO of RBC Asset Management Inc. “That is something that we see as an opportunity, particularly because we’ve done very well serving the investment needs of Canadians.”

In our domestic market, RBC Asset Management accounted for almost a quarter of all mutual fund sales in 2005.

Canada’s largest bank is taking a 30% ownership position in the China-based joint venture, valued at about US$25 million, with China Minsheng Banking Corp. Ltd. holding 60% of the firm and Three Gorges Finance Co. Ltd. claiming 10%. The deal, which is still pending regulatory and other approvals, would see the creation of Minsheng Royal Fund Management Co. , to be based in Shanghai.

The Chinese economy grew at a torrid rate of almost 10.9% in the first half of 2006, bettering last year’s growth rate of 10.1% in the same period, according to the Chinese government. The savings pool in the country is estimated by some to be about US$1.7 trillion, with less than 1% of that figure actively invested.

RBC isn’t the first Canadian bank to enter the mutual fund business in China. Bank of Montreal has held a minority interest in Fullgoal Fund Management Co. Ltd. since 2003, when it bought a 17% share in the venture. BMO increased its equity position to 28% the next year to become equal partners with China’s two largest securities firms. A third China-based financial services company holds the remaining 16%.

In fact, four of Canada’s Big Five banks have significant business operations in China, mostly focused on institutional banking rather than retail. TD Bank Financial Group is the exception, electing to concentrate on its U.S. businesses for now.

The joint venture between RBC and China Minsheng Banking, the latter a 10-year-old firm with assets of $78 billion and 240 branches, is in its early days, Lewis says, so specific plans for what kind of funds it will offer have not been determined. Domestic regulations limit mutual funds to investing only in Chinese securities and, as the yuan is not convertible, all funds must be in denominated in the Chinese currency. Foreign financial institutions must also partner with Chinese companies in order to enter the financial services business.

“This is very much a long-term-horizon venture, from our perspective,” says Lewis, suggesting the regulatory approval process might take a while. “We would expect to be in the market in the next one to two years. Hopefully, it will be sooner than that.”

Lewis says that RBC’s role in the joint venture will be to provide guidance and expertise in investment management, multi-channel distribution and in-branch sales to the fund company’s local management and employees. The venture’s funds, he says, will be targeted at individual and commercial clients of China Minsheng Banking, other financial institutions and the institutional market.

“The investment RBC is making here is pretty small. It allows the bank to get in without taking any significant risk,” says Brenda Lum, managing director of the Canadian financial institutions group at Toronto-based Dominion Bond Rating Service Ltd. “It’s an opportunity from RBC to learn and lend some expertise in the Chinese market.”

RBC has had a busy year in China. In October, its investment bank, RBC Capital Markets, participated as co-lead manager in the US$21.9-billion initial public offering of Industrial and Commercial Bank of China, the largest IPO in history. In August, RBC Life Insurance opened a representative office in Beijing. In February, parent RBC received approval from Chinese authorities to upgrade its representative office in Beijing to a branch.

“The mutual fund joint venture should be seen in the context of RBC’s overall strategy in China,” Lewis says. “We are focused on targeted businesses and targeted investment opportunities, not providing across-the-board financial services in China. We’re looking at areas in which we have some unique expertise and in which we can find strong local partners.”

The Beijing branch allows RBC to provide personal banking services to Chinese emigrants headed to Canada, in effect setting them up as customers before they arrive.

Ed Legzdins, president and CEO of BMO Investments Inc. , sees RBC’s entry into the Chinese mutual fund market as a positive: “It’s a terrific market for foreign firms. RBC’s joint venture will hasten the development of the market, which is good for all of us.”

Legzdins says that the Chinese fund market has grown to $65 billion today from about $10 billion in 2001, with the potential to grow to $300 billion by 2011. Today, Fullgoal Fund Management, BMO’s Chinese joint venture, offers 11 funds and has assets of $2.5 billion.

BMO has deep roots in China, undertaking its first foreign-exchange transaction in support of trade with the country in 1818. BMO has branches in Beijing, Guangzhou and Hong Kong, as well as a representative office in Shanghai. Investment banking arm BMO Capital Markets has a representative office in Beijing and was one of the co-lead managers of the I&C Bank of China IPO in May.

“We’ve been in China a long time,” Legzdins says. “There has been a tremendous effort on the part of our senior executive to cultivate business relationships in China. The more relationships you develop, the more business you can land, and vice versa. We’ve created a nice spiral.”

Legzdins acknowledges that dealing with the regulatory environment in China is a much different proposition than it is here in Canada. “Whether it’s banking or securities, there are a lot of regulations,” he says. “In Canada, as long as you meet the regulatory requirements, you don’t need to approve a product. In China, you not only have to meet the compliance requirements, but you have to have the product approved. If you want to launch an equity fund, they can say, ‘No, we have enough of those. Why don’t you launch a bond fund instead.’ It’s somewhat paternalistic.”

Bank of Nova Scotia and CIBC have also established business links in China. In September, Scotiabank, which entered the Chinese market in 1982, received approval to upgrade its representative office in Shanghai to a bank branch. It already has branches in Chongquing and Guangzhou and a representative office in Beijing. Two years ago, Scotiabank bought a minority stake in Xi’an City Commercial Bank, which serves a city of seven million.

Although CIBC is active in the Asia-Pacific region, with more than 200 employees in its Asia division, its involvement in China is limited to an office in Hong Kong and a representative office in Beijing.