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Evan Clarence Peter Truong

Financial Services:

Opportunities in

China

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Clarence ConsultingEvan Clarence

EDIS Pty LtdPeter Truong

Executive Summary

The objective of this report is to provide an overview of the

Chinese financial services sector and provide insights for

Australian and other foreign firms seeking to enter the Chinese

market. A combination of primary and secondary research was

used to analyse the sophistication of the Chinese financial

services industry and the needs and opportunities within the

emerging Chinese middle class; focussing primarily on wealth

creation and wealth management. It also identifies discrepancies

between supply and demand for financial services, explains the

reasons why those discrepancies exist, addresses the potential

risks and challenges for financial services firms as a basis to assess

entry in the Chinese market, and provides recommendations and

strategies for these firms intended to operate in China.

We initially conducted secondary research on the Chinese

financial services industry, sourcing from various reputable

research sources over approximately three months prior to

arriving in Shanghai where we conducted further primary

research. Whilst in Shanghai we met with individuals from all

levels of eight different financial institutions where we collected

our primary research materials and verified secondary research

materials. We then consolidated and integrated all information

in the final section of this report.

Although care has been taken to ensure the accuracy,

completeness and reliability of the information provided within

this report, you must not rely on information within this report as

an alternative to tailored advice from a suitably qualified

professional. Any individual, company and/or entities seeking to

establish an office, new market entry and/or joint venture should

perform further analysis and due diligence. Different cities,

regions and provinces will have differing legislative requirements

and hence possibly variations in consumer behaviour relating to

financial services requirements. The recommendations are

general in nature and don’t take into account any specific

considerations associated with entities or individuals.

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Content

04 Chinese Savings & Spending Culture

05 Chinese Middle Class

07 Financial Services in China

11 Market Size of Chinese Middle Class

Investors & Investable Funds

12 Regulation & Risk

14 Challenges - Foreign Firms

17 Challenges – Chinese Institutions

18 Opportunities

20 Recommendations – Foreign Firms

21 Conclusion

23 Appendices

25 References

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Chinese Savings & Spending Culture

Chinese culture and society have evolved and

developed very rapidly in the last few decades. This

has resulted in an impressive growth rate in key

economic indicators relative to Australia, UK and the

US (refer to Appendix 1). The statistics highlight the

significant differences in household spending, savings

and attitude to different forms of investments. An

example is household ownership; this is more

important to the Chinese because it is future planning

for their immediate family, parents and

grandparents, relative to western cultures where

owning a home is about the individual preferences

and not the collective future of several generations.

These cultural differences have influenced

the Chinese middle class to be less reliant on personal

debt. Hence, more and more Chinese are saving

rather than spending because they anticipate the

government pension will be inadequate in their later

years. Thus they must invest and look after their own

retirement needs, which involves saving more and

reducing debt. These cultural factors are key

contributors behind the very high personal savings

rates seen in China. At 30% this easily outpaces the

9% seen in Australia and the 4-5% seen in the UK and

USA. This savings mentality also means that

household debt as a percentage of GDP is

substantially lower for China (38%) relative to the

other developed nations, (average 96%). However,

these numbers from China may be distorted due to

dispersion of wealth between Tier 1 cities and lower

tier and rural areas. As a nation debt has quadrupled

since 2007, largely influenced by speculative real

estate, shadow banking and borrowing by corporate

enterprises.

Another important cultural influence and

societal factor in Chinese attitude to investments is

their retirement age. China’s retirement age is 60 and

amongst the lowest in the world. The age was

determined by the Chinese government in 1963, at a

time when life expectancy was 50 years. However,

with rapid rise of healthcare, economic success and

average life expectancy extended to over 70 years

there is increasing pressure for government to re-

evaluate those figures. It is anticipated that by 2050

there would be over 38% of the Chinese population

over 60 years old relative to today’s 15%. (Credit

Suisse, 2015)

These cultural differences have influenced

the rise of the Chinese middle class. The rapid growth

of China’s middle class is bringing huge economic and

social change and will continue to do so into the next

decade. By 2022, research by McKinsey estimates

that more than 75% of the urban Chinese population

will earn between RMB60,000 (US$9,000) and

RMB209,000 (US$34,000). Evidence suggests that

within the expanding middle class, the upper middle

class is set to become the primary driver of Chinese

consumer spending into the next decade. Whilst this

is happening the new generation of globally minded

Chinese will have a disproportionate influence in the

market place.

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Currently 68% of the Chinese middle class has access to the

internet compared to 57% of the total Chinese urban population.

Research indicates that these middle class online consumers are much

more likely to buy digital goods such as laptops, cameras and specialised

household items. Along with the affluent, ultra-wealthy consumers and

upper middle class consumers they are stimulating rapid growth in

luxury-goods consumptions, resulting in annual growth rate of 16% to

20% over the last 4 years. Currently more than one third of the money

spent around the world on high- end luxury goods such as shoes,

handbags, watches, jewellery and clothing come from the Chinese

domestic marketplace.

Chinese Middle Class

The rise of China’s economic success has seen the emergence of

the world’s largest middle class. Their rapid exponential rise would be

considered a phenomenal achievement for any country. The world’s

second largest economy has seen its middle class accelerate to 109

million individuals surpassing the USA’s 92 million middle class. Even

with fears of a global slowdown in the emerging markets, Asia remains

the greatest expansion area of the world’s middle class.

Figure 1 Number of middle class and region.

Defining the criteria for middle class is paramount to

understanding the impact of where new investments in financial services

should be directed. We use the Credit Suisse parameters of middle class,

defined as those with wealth between US$50,000 and US$500,000. The

term wealth is defined as the value of financial assets plus real estate

owned by households, less their debts (Credit Suisse, 2015). Wealth not

income is measured, to avoid temporary changes caused by

unemployment.

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Since 2000, twice as many Chinese as Americans have joined the middle class. Wealth per Chinese adult

have quadrupled to approximately US$22,500. China now accounts for 10% of global wealth whilst containing a

fifth of the world’s population. According to Credit Suisse, China should also experience a 74% rise in the number

of millionaires to approximately 2.3 million by 2020.

Within the middle class, there are different generational segments, the largest of which we will call

Generation 2 (G2). Born during the economic boom time, the G2 consumers are China’s teenagers and those in

their early 20s. Their consumption behaviours are contrary to their parents who were born during the years of

central planning and shortage, where building family wealth and economic security was a priority. The G2s are more

confident, independent minded and determined to display their independence and success through their

consumption. The G2 generation comprised nearly 200 million consumers in 2012 accounting for 15% of urban

consumption and is forecast to rise to approximately 35% by 2022.

Figure 2 – Population Demographics

Source: McKinsey & Company

China is also seeing a rapid shift in the geographic share of their middle class. In 2002, 40% of the urban

middle class lived in the four Tier 1 cities: Beijing, Shanghai, Guangzhou, and Shenzhen. This is set to change by

2022 where the middle class share of those cities is forecast to fall to about 16%. It isn’t cause for concern however,

since the middle class won’t actually be shrinking in those Tier 1 cities, instead the middle class growth rates will

simply be far greater in the smaller cities of the north and west of the country. Many of these high growth regions

are classified as Tier 3 cities, whose share of China’s upper-middle class households should reach more than 30

percent by 2022, up from 13 percent in 2002.

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Financial Services in China

The Chinese financial services industry has

undergone significant changes in the past 10 years

and the transformation is still very much in its infancy.

As the government transitions the industry from

centrally planned to market orientated (Austrade

2014) the industry will face numerous challenges to

adapt, but the long term benefits will be extremely

beneficial for the Chinese economy. Despite ongoing

reforms since its acceptance into the World Trade

Organisation (WTO) in 2001, doing business in China

continues to be challenging as a result of government

legislation and cultural differences in ways businesses

operate. However, companies especially from

Australia face less regulations in China than

companies of most other countries and are provided

greater opportunities for banking, securities and

Funds Management as a result of their country’s

bilateral Free Trade Agreement with China.

Banking

The Chinese banking industry is not too

dissimilar to the Australian banking sector, where the

top 4 banks dominate, accounting for 60.7% of

industry revenue. These 4 institutions; Industrial &

Commercial Bank of China (ICBC); China Construction

Bank (CCB); Agricultural Bank of China (ABC); Bank of

China (BOC); are amongst the top 5 largest banking

institutions in the world (Bhattacharyen 2015). As

government regulations ease, industry rivalry will

increase, potentially forcing domestic banking

institutions to increase efficiencies to compete

effectively. The primary focus for Chinese banks are

servicing the corporate and small medium

enterprises. Figure 3, provides evidence that

corporate deposits account for 50.4% of funds, whilst

36% of funds derived from personal deposits. 56.5%

of these funds are used for short, medium and long

term loans to finance industrial and infrastructure

construction projects.

Figure 3. Banking Products & Services

Source: IBISWORLD - Commercial Banks in China, 2016

Banking products and services primarily cater

for the expansion of State owned or private

enterprises, who are expanding domestically and/or

internationally. This focus has resulted in limited

product innovation for individual investors, hence

product differentiation, diversity and innovation are

lacking in the industry. Retail services, private

banking, deposits, loans, online banking and wealth

management are all very similar and lack

differentiation. This is in contrast to the Australian

financial institutions where product variations,

differentiation and innovation of new products are

diverse and freely accessible for all retail and

wholesale investors. The lack of available products

has limited investment choices for the regular

Chinese population, partially contributing to them

primarily investing in property, cash and shares.

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Competition in Banking

Competition in the banking sector is high despite the top 4 banks

controlling 60.7%. Their prices and product offering are similar due to

government control and intervention, consequently product diversity and

innovation are not a basis of competition. New products require extensive and

lengthy approval processes, unlike developed countries. Outside of the 4 major

banks competition is based on size, channels and network capabilities to service

enterprises and individuals. Most banks will compete and differentiate

themselves on client relationships because most other areas are highly

regulated and controlled.

Domestic Banks have generally been poor in delivering a high level of

customer service, effective marketing campaigns and lack a targeted

segmentation of client base. Hence the private banking areas servicing high net

worth and ultra high net worth customers have been dominated by foreign firms

because they can deliver a skilled and experienced work force to service these

customers. These services however are not widely available to the middle class

or general customers due to the banks inability to service them. With a rising

middle class and approximately 109 million individuals, this is a massive

opportunity for any institution that can deliver the services and capabilities to

this segment. Figure 5 gives you a broad understanding of the competitive

landscape in the Chinese banking industry.

Figure 4 Competitive Landscape of Chinese Banking

Source: IBISWORLD - Commercial Banking in China

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Securities & Funds Management

Stability of the Chinese stock market is critical

for the financial services industry because it

influences investor confidence and impacts corporate

funding. Greater volatility will lessen investor

confidence, translating to less investors participating

in the securities market. The securities and

investment industry is anticipated to grow at an

annual growth rate of 3.6% over the next 5 years to

generate up to $28.5 billion of revenue (IBIS,2015).

The Chinese stock market comprise Shanghai

Stock Exchange (SSE) and the Shenzhen Stock

Exchange (SZSE). Shanghai Stock Exchange was

established in 1990 and is administered by China

Securities Regulatory Commission (CSRC). The SSE

issues two main type of securities:

A-shares – Ordinary shares available for

domestic investors denominated in Yuan. These

shares can be held by foreign investment participants

who hold a Qualified Foreign Institutional Investor

(QFII) licence (refer to Regulation & Risk for definition

of QFII).

B- Shares – Local company shares traded in

US dollars and are open to foreign investors.

The Shenzhen Stock Exchange is also

administered by the CSRC but operates slightly

differently from SSE. SZSE has half the listed

companies of the SSE and trades on 3 boards, main

board, small-medium enterprise board and the

ChiNext board, for growth and innovative companies

(Austrade, 2014). B-Shares are in Hong Kong Dollars.

More recently, further signs of moving

towards an open market was connecting the

Shanghai Stock Exchange and the Hong Kong Stock

Exchange, to allow mainland Chinese and Hong Kong

investors to trade in either markets (Austrade, 2014).

Trading on the exchange is segmented into

four categories; Bonds, Funds, Futures and Stocks.

The Futures trading dominates the market and

includes financial products, industrial and agricultural

products. Equities trading is second with 31.5%. Due

to the infancy of the Chinese markets, Funds trading

accounts for only 0.5%. This can represent significant

opportunities for fund managers to create better

investment products especially investments in

foreign assets.

Figure 5 Trading Activities - Chinese Stock Exchange

Source: IBISWORLD - Securities Exchanges in China

The Fund Management industry is less

developed than other areas in the financial services

industry due largely to previous restrictive

legislations and processes limiting foreign fund

managers from operating freely. This is changing as

reduction in regulations will support the transition to

a semi-market economy.

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Since the establishment of the first Chinese fund management company in 1997, by 2014 there were more

than 91 funds management companies (48 foreign joint ventures and 43 domestic companies) in China. The

government realised that to encourage further institutional investors into funds management they needed to free

up the process further and by July 2014, new rules were established where public mutual funds only need to register

the product with the regulators rather than seek regulatory approval. (Austrade, 2015)

Competition in Securities & Investments Industry

The Chinese securities and investment market is growing and is nowhere near maturity. China’s stock

market is only approximately 25 years old relative to the likes of Hong Kong, United States and Australia, where

their first stock exchanges were established in late 1800s and early 1900s. As the government transitions to this

open market system, many foreign investment and brokerage firms have entered the market and further

competition is expected, however, new entrance will continue but the entry will be slow due to regulatory issues.

The top 4 securities brokerage firms in the industry only account for 19.1% of revenue (IBISWORLD 2015).

Competition in the brokerage industry is intense because they compete on price and commission.

When looking for brokerage firm investors tend to prefer to deal with reputable and reliable institutions

who can deliver high quality service, encompassing software technology, a diverse suite of investment products

and services. Loyalty is very strong in China, hence once an account is established it is relatively difficult to persuade

customers to change if a good rapport and trust has been established.

Figure 6 Competitiveness of Securities Brokerage

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Market Size of Chinese Middle Class Investors & Investable Funds

The Chinese middle class presents the greatest opportunity in the financial services sector at present

because it is a segment that is large, quickly growing, neglected and underserviced. If domestic and foreign

institutions can provide better services, more product innovation, transparency, trust and education, the

opportunities are limitless. We estimate this market size of investors and investable funds as follows:

Market Size Estimate of Chinese Middle Class Investments in Securities

1. Estimate for total number of Chinese middle class

who participate in direct equities investments.

2. Out of these 16.35 million individuals, average asset allocation towards direct shares is 8% of their

household investments, in which we assumed based on the Credit Suisse net wealth criteria.

3. Current estimated size of the middle class investment in direct securities, based on average investable

funds between $4,000 and $40,000 with a Medium of $22,000.

Estimated current market size of middle class investments in direct equities is between USD$65.4 and

USD$654 billion. Most of these investors do not understand how the market operates and/or are not

seeking appropriate advice.

4. If the middle class were more confident and better educated about direct investments, participation rate

may increase to an average of 34% (Medium between Australian, United States and United Kingdom direct

investment participation rate).

Thus if the Chinese middle class participation rate increases from 15% to 34%, the market potential for this segment

is worth between USD$148.24 billion (min) and USD$1.482 trillion (max), average of USD$815.32 billion market

potential (refer to Appendix 6.0 for assumptions). Very little attention and resources have been given to this

segment. Presently, there are over 100 million equities accounts, therefore the estimates above are conservative.

Middle Class (People) 109,000,000

% of People in Securities 15%

No. of Potential Investors 16,350,000

% of Household Investment 8% Investable Funds in Market

Minimum Wealth $50,000 $4,000

Maximum Wealth $500,000 $40,000

Medium Wealth $275,000 $22,000

No. of InvestorsAllocated funds Per

IndividualMarket Size (USD)

Min Market Size 16,350,000 $4,000 $65,400,000,000

Max Market Size 16,350,000 $40,000 $654,000,000,000

Medium Market Size 16,350,000 $22,000 $359,700,000,000

No. of InvestorsAllocated funds Per

IndividualMarket Size (USD)

Min Market Size 37,060,000 $4,000 $148,240,000,000

Max Market Size 37,060,000 $40,000 $1,482,400,000,000

Medium Market Size 37,060,000 $22,000 $815,320,000,000

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Regulation & Risk

The Chinese financial system is highly regulated with limitations attached to licensing requirements, quotas

and specific conditions for different purposes. However, this transformation and willingness to transition to an open

market has created opportunities for local and foreign institutions. Two important licenses to be aware of are the

Qualified Foreign Institutional Investor (QFII) and the Qualified Domestic Institutional Investor (QDII). These licenses

are in addition to other regulatory licenses required and issued by China Securities Regulatory Commissions (CSRC).

QFII is designed to attract financial institutions who are investing in Chinese securities long-term rather than

for short-term speculation and arbitrage trading (Ernst & Young, 2013). This license allows foreign institutions

to invest in the Chinese equity and fixed income products denominated in RMB. Approximately 251 licenses

have been issued with quotas of USD$200.5 billion.

QDII allows domestic institutions to invest offshore to allow domestic investors access to foreign investments

for diversification of their asset allocation. Regulation however dictates how domestic institutions can invest

on behalf of investor, such as specific quality of investment, types of product and particular financial

instruments. Refer Appendix 2.0 for investment criteria. Over 125 QDII licenses have been issued with over

USD$87 billion of assets.

Understanding Chinese Land Rights

Property acquisition and disposals are in fact transfers of leases between buyers and seller, where actual

ownership belongs to the state and the collective. A land user obtains only the land use right, not the land or any

resources below or on the land. These leases are limited to a prescribed periods based on the usage of the land.

Figure 7 highlights ownership types. Government has the legal right to reclaim any property from an individual,

resulting from public policy consideration and are compensated as a result of expropriation and/or requisition. The

time remaining in the lease agreement can have significant negative and/or positive impacts on the value of Chinese

property and must be clearly understood by investors and financial institutions.

Figure 7 – Lease Terms for land ownership

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China-Australia Free Trade Agreement

The China-Australia Free Trade Agreement

(ChAFTA) secures a wide range of unparalleled

financial services commitments from China for

Australian firms. These commitments include access

for insurance companies, a quicker licensing

approval, increased ownership (from 33% to 49%)

and closer collaboration on regulatory decision

making and transparency. ChAFTA represents

substantial opportunities for Australian financial

services institutions to access a new market which is

large and in the infancy of growth. Appendix 3.0

provides the benefits for Australian insurance,

banking and securities institutions who wish to

establish joint venture partnerships in China.

Limitations on Investment Properties

Arguably, one of the Chinese housing

market's largest problems is excessive government

intervention, greatly exaggerating the housing cycle.

The government has repeatedly stepped in to avoid

over-heating within the sector and then stepped in

again to avoid the resulting slump. Consequently

China's housing market moves from one extreme to

the other, all within the general context of an over-

valued and over-stocked housing market.

There are many regulations surrounding

investment properties in China with the general

consensus being that the regulations are constantly

changing in response to economic conditions within

the local economy. Examples of government

intervention include Shanghai's municipal

government tightening its investment policy by

increasing minimum down payment for a second

home (60% to 70%) and the enforcing of a 2

investment property policy within Tier 1 cities to try

limit speculation.

USD$50,000 per annum Limitation on ForexChina strictly controls inbound and

outbound foreign exchange flows. Chinese citizens

are limited to USD$50,000pa of outbound foreign

exchange. The RMB funds can only be converted at an

approved banking institution, who has the obligation

to review whether the outbound capital is for

investment or for regular payment. Despite these

restrictions many Chinese find ways to bypass these

restrictions by utilising friends and relatives to assist

with outbound money transfer. Businesses however

are allowed regular payments above USD$50,000 if

they submit documentations to verify and

substantiate underlying transactions. Appendix 4.0

details the required documents. These restrictions do

limit access to overseas investment opportunities and

coupled with limited domestic investment options,

many Chinese have simply resorted to saving more

and limiting the use of borrowing.

Special Economic Zones of China (SEZs)

The Chinese government understand the

need to continuously modernise and innovate to

advance China’s economy, hence the establishment

of Special Economic Zones where foreign and

domestic companies are incentivised to work and

collaborate to export and/or import products, ideas

and technology to develop and enhance economic

growth and prosperity for the country. There are 15

Free Trade Zones (FTZ), 32 State-Level Economic and

Technological Development Zones (ETDZ), 53 new

and high-tech industrial development zones in large

and medium sized cities. These incentives range from

special tax treatments, greater independence and

collaborative incentives. Appendix 5.0 outline the

incentives for foreign and domestic institutions.

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Challenges – Foreign Firms

Understanding Guanxi

Guanxi refers to the exchange of ‘favours’ or

‘connections’ that are beneficial for the parties involved. On

occasions these exchanges are based on direct cash exchanges

and are hidden from a casual observer. Guanxi should appear to

be made voluntarily and can help minimise many obstacles to

doing business in China. Whilst Guanxi maybe akin to bribery in

the eyes of the casual western observer it is still very much

practiced within Chinese business culture.

Building Guanxi is a process and cannot be achieved with

a single gift or dinner. Similar to most places in the world and in

any relationship it is important to communicate, spend the time,

show respect and reciprocal politeness in business dealings. At

the same time you have to appreciate that if you are not from

China and don't speak the language there is only so much you can

achieve regarding Guanxi. Regardless of your moral compass, you

have to give gifts in China since it is a way to show respect. Many

foreign companies in adapting to the local culture have drawn

policies for their organisation. For example, some foreign

consulting companies operating in China have the policy to only

give gifts with a company logo or if there is a need to give

something more expensive, something that will represent their

country of origin.

The good news is the Chinese government is pushing a

strong anti-corruption agenda. The new policy to some extent is

creating a level playing field for foreign companies when it comes

to dealing with pure corruption such as direct request for cash. It

is now much easier for businesses to say no due to Chinese

government policy. The government announcements has led to

a dramatic decline in gift giving and lavish spending by

government officials. The measure is working, evident with

international luxury brands such as Diageo and Jacobs Creek,

where demand has noticeably declined in China recently.

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Joint Venture

ChAFTA has given Australian financial institutions significant

opportunities to operate in China with less regulations and capital

requirements. An example is the opportunity for Australian securities

and future companies, who can now hold 49% of any joint venture,

relative to the previous 33%. Selecting a comparable joint venture

partner is paramount for any success in China. Understanding

consumer perception, behaviour and trends towards foreign

institutions is important to this success. Foreign companies seeking

joint ventures should take some of these points into consideration.

1. Finding an established reputable domestic partner is

important because trusted local brands are perceived as safe

and secure. The reputation will increase investor confidence

and provide a loyal customer base. This provides

opportunities to maintain and/or increase operating margins

and revenue without the need to lower fees and commissions

to compete with rivals.

2. Partially or fully state owned enterprises have greater local

support from both investors and regulators. This support

extends to noticeably quicker approval by regulators and

greater acceptance by investors for new products. Frequently

investors choose local over foreign institutions due to the

known benefits of government connectivity.

3. Domestic institutions with experiences in innovative

product development are highly desirable. This is important

because they understand the approval process, which can be

time consuming and lengthy. This knowledge can accelerate

new product development and provide first to market

advantage. New Products and services are desirable by

investors because present offerings are limited with very

little differentiation, lack of service, uninspiring technology

and a limited portfolio diversification choice. Alibaba, a local

institution with disruptive technology raised billions of dollars

from local investors due to these reasons.

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4. Qualified Work Force – There are over 180 million Chinese older

than 60 years of age and most of these and other middle class

investors have very little financial education. Thus, their

understanding of financial instruments are limited and therefore

require some basic education and training. If qualified staff are

lacking, the resulting poor delivery of information and advice will

lead to client dissatisfaction, underperformance and business

outflows.

5. Market research and analytics – Having a good research team is

important because it allows both internal and external decisions to

be made which can generate revenue for both clients and

proprietary trading. Having a dedicated research team is part of the

product offerings of many firms and encourages investors to

understand the bases of recommendation.

6. Establishment of a brand name – Branding is important to

understand in the context of Chinese culture because of the high

regard held for status, trust and reliability. Marketing campaigns

should be specifically targeted to particular segments rather than

blanket marketing. This is important because people associate a

brand with their certain expectations.

7. Chinese people rely heavily on word of mouth and generally trust

their community more than elaborate marketing campaigns and/or

advisers. Convincing an influential individual can translate into

multiple opportunities as that person would recommend your

product and/or services to their immediate circle. These individuals

can be family members, relatives, friends, neighbours, work

colleagues or acquaintances.

These factors will contribute to the success of any joint venture in

China. If local partners do not possess these qualities, the foreign institution

should compensate for these lack of functions. Our primary research

verified many of these points and that local investors do actively seek

reputation, product diversity, domestic institutions and higher returns

when seeking professional advice.

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Other challenges to consider are:

Ensure small companies which you are

engaging have appropriate licenses and they have the

necessary credentials that comply with local

legislation. Not all businesses operate with

appropriate licences.

Patience is important and should not be rushed, as

it can be seen as disrespectful. Chinese culture

encourages small talk to give the parties a better

opportunity to understand each other. Often, the first

meeting is unproductive and is a formality to establish

rapport. So don’t be frustrated if progress is slow

initially.

Understanding the capabilities in a local

partnership is important and should be taken into

consideration in addition to standard financial due

diligence. It is important to understand the financial

complexity of any organisation which you are

partnering, to avoid potential risks such as shadow

banking.

Challenges - Chinese Institutions

For domestic firms, the opportunities are

significant if they are willing to allocate resources to

service more of the middle class. We understand that

limitation through regulation have prevented many

institutions from expanding and deploying offshore

investment strategies. Despite this, we see several

challenges and potential risks for local companies if

they do not become more innovative and specifically

target their middle class. There is a growing risk of

losing customers to new innovative and disruptive

products and companies. Alibaba has clearly

demonstrated that it can be a disruptor to the

financial services sector in China because it is

targeting the middle class segment with new easy to

use financial apps and have been exceptionally

successful in doing so. To the other spectrum, foreign

competition has also dominated the private banking

domain because local institutions cannot deliver the

exceptional service and/or products to compete with

multinational banks. The challenge for local

institutions is to devise solutions and new or

improved offerings to cater for the burgeoning 109

million middle class. If it takes too long to decide

which path to embark, they will lose further market

share to the likes of Alibaba, foreign institutions and

other potential new entrants to the market.

Upskilling and attracting local staff with the

knowledge and expertise to deliver the right level of

service to any customer will also be a challenge and

opportunity. By actively doing so will allow banks to

attract and retain new, innovative and talented

individuals who can help the company to develop

new services, products and opportunities to tackle

the middle class opportunities. Without adequate

training and knowledge about the products on offer,

it is very difficult to generate revenue and compete

on a level playing field.

With increasing debt concerns amongst

corporate institutions, being able to diversify revenue

streams away from the corporate institutions will also

pose longer term challenges.

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Opportunities

There are significant opportunities for Chinese and foreign financial institutions to specifically target the

burgeoning Chinese middle class who have wealth ranging from USD$50,000 to USD$500,000. Presently, this

market segment is under-serviced and not a lot of resources or effort have been deployed to meet their financial

needs. This market is potentially worth $30 trillion dollars (Median Wealth of $275K multiplied by 109 million

people), and yet their main asset allocation is limited to cash related products, direct property and the share

market. We understand that regulations are partly to blame however as these ease significant opportunities will

arise. Some of the likely opportunities within the Chinese financial services sector are for the middle class segment

have been separated below into products, services and innovation categories:

Products

The funds management market is in its infancy and hence there are not a lot of funds available to domestic

retail investors. There are a lot of opportunities for more specialised funds designed to look for opportunities in

mainland China and Hong Kong. These funds could range from Private Equity and venture capital investments for

the more aggressive investor; property trusts for those that cannot afford a home directly; or hybrid securities and

fixed interest funds designed to capture a higher return than the typical cash return. Whilst many of these funds

may exist already, they are likely directed more towards high net worth individuals, private and state owned

enterprises. Giving more of the middle class an opportunity to participate in these investment mechanisms could

be a substantial opportunity for the financial services sector as a whole.

Exchange traded funds is another product opportunity for local investors and institutions alike. Instead of

being exposed to company specific risk, exchange traded funds are a cheap way for investors to diversify their

investment risk and yet be able to trade the fund like a listed entity, subject to liquidity. This will give investors a

basket of investments rather than individual exposures. These funds can compose of any particular asset class,

sectors or industries and can help reduce risk whilst still building long term wealth.

For the more highly educated and young aspiring new affluent generation, derivative related products could

also be an opportunity, however, the market segment may be limited at present because of the complexity of the

instrument, risk involved and education required surrounding this investment instrument. As investors become

more familiar with them over time, derivatives related products will grow substantially.

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Services

With any product launch and investment, there must be extensive education and training to investors about

both the downside risk and upside risk of the investment. There have been a number of fraudulent financial

instruments in China where people have lost substantial savings, especially in P2P investments, which has made

them more conservative and sceptical of some new financial products. It is this reason that any new services and/or

products must be completely transparent, allowing investors to judge the validity of the investment or services on

offer. Being able to provide transparency and tailored services will help to build trusted relationships which will

lead to more financial success for both investors (middle class) and financial institutions.

Superior service can be as simple as keeping the investor informed about their investments, economic

conditions and/or regular contact. Understandably due to the size of the market frequent one on one contact is not

always possible or efficient, however communication efficiencies could be easily derived by streamlining

information messages and channels to cater for the masses. This can be as simple as creating an email distribution

list to provide market updates and information on investment strategies. Whilst this solution may sound logical,

the Chinese middle class are largely ignored and there are definite opportunities for firms to enter this space with

superior service offerings catering for the middle class investor.

With the government slowly transitioning from a centrally controlled financial services industry to an open

market industry it is important that domestic firms try to form strong partnerships and alliances with foreign

institutions to learn more about new products, services and innovations which they can replicate domestically in

China. A good example of the benefits of an alliance is the exchange of staff on both sides to learn about each

other’s businesses. As government regulations ease, the domestic and foreign firms will then be more ready to

launch their new products and services more efficiently to cater for the middle class investors.

Innovation

The financial services industry in China is moving very rapidly. If domestic institutions are not at the

forefront of innovation in their product offering, their market share is likely to decline as government regulations

ease. Developing technology to deliver better services, quicker response time and less human intervention will be

critical to future success, not only from an operational view but more importantly to cater for the increasingly tech

savvy investors, predominately the younger, growing middle class generation. We have seen this with Alibaba, who

have used their reputation from online retailing, popular with younger segment, to launch financial products via an

app catering specifically for their middle class users. Using their Yu’e Bao app as an example, they raised US$90

billion in only 10 months. If local institutions want to continue to dominate they need to be more innovative with

their technology offering and product diversity. Given the relative infancy of the Chinese financial services industry

and the ability to leverage the expertise of more mature foreign firms there are significant opportunities to be had

for innovative companies who enter this space.

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Recommendations - Foreign Firms

Our recommendation for any foreign financial institution who wish to do

business in China, is first understand the culture and the way business is

accomplished before pursuing any forms of negotiation, joint ventures or

partnership. This is critical in understanding how decisions are made and knowing

what is important to your new potential partner and customers. This cultural lesson

will alleviate potential stress when negotiations are slow and decisions are not made

on the day. Understanding Guanxi is paramount and is a starting point.

For large organisations, any strategies involving China would need to

seriously consider their team composition and locations to manage the political

situation and customer expectations. Having a team well connected with Beijing and

likely located within the city, or close to the appropriate political powers and decision

making is quite important. All companies, especially foreign enterprises need to work

closely with government officials to understand all regulatory and legislative

requirements and to ensure smooth approval processes since political discrimination

against foreign firms is not uncommon.

Having a dedicated team responsible for deploying the strategies and general operations encompassing

sales and marketing, product development, finance and distribution is also important, as is their geographic

location. Strategically locating the strategy and operations teams either in Shanghai and/or within the designated

free trade zones in other cities should also be given thorough consideration. As such, having staff located in

different cities such as Beijing and Shanghai is worthy of due consideration since connectedness to political forces

and utilising the benefits of Free Trade Zones within cities close to the customer base are vitally important within

China.

When seeking a joint venture partner in China, foreign firms also need to be careful and selective because

success in China will largely depend on their partner’s reputation and abilities to work with the local and provincial

government and regulators. Failure to perform proper due diligence on a joint venture partner may result in

substantial losses for foreign institutions and substantial gains for domestic firms. It is not uncommon for large

foreign firms to exit China after considerable resources have been expensed. There are examples of foreign firms

deploying their resources to build infrastructure only to later leave the country due to difficulties, allowing the

domestic partner or other domestic firms to acquire the infrastructure at a much cheaper price once the

partnership is dissolved.

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Chinese people are proud of their traditions and history and are very patriotic. Do not discuss political

matters, give negative comments about the country or enforce western business methodology and ideology on

business partners. Tailor your business techniques around local culture, customs and influences. This includes

having flexible business strategies which are adaptable to sudden changes in legislation and which can quickly

respond to changing market conditions. Companies such as eBay have failed and lost substantial amounts of money

(US$100m+) when entering China because they didn’t adapt their global business strategy specifically for the

Chinese market.

Conclusion

The Chinese middle class are proud people who embrace family, education, reputation, trust and wealth

creation as key characteristics on how they live their life. Their decisions are often based on advancing their family

unit and planning for the future. Hence their relationship with others often involves dependency on word of mouth

rather than formal advice from unknown professionals. Our primary and secondary research identified that most

Chinese investors, especially middle class, lack thorough financial education, understanding of financial markets

and/or financial instruments. Thus when their contacts, family, relatives, neighbours and/or acquaintances advise

them to take action, whether to buy or sell investment products, they regularly do so without hesitation. This

creates a herd mentality and chain reactions, leading to greater trading volumes and volatility, as can be evidenced

on the Chinese stock markets and has somewhat caused the perception that Chinese investors are punters.

Therefore, any new products and/or services should focus on educating the consumer about the risks and returns,

provide thorough transparency, have a fast and simple application process and endeavour to build trust and service

levels above the historical norm.

China is transitioning from an industrial and centrally controlled economy to a market driven economy with

an emphasis on services. This is an exciting time as it represents substantial opportunities for both domestic and

foreign companies. Whoever, can implement a clear and consistent strategy which cater for the needs of the

Chinese middle class will undoubtedly reap substantial rewards. Targeting the middle class represents the greatest

opportunities for financial services firms because this segment has been historically underserviced, is extremely

large and growing rapidly. The lack of available services, investment alternatives and lack of knowledge have led

these investors to invest conservatively in standard products like cash deposits, property and limited investment in

shares. If institutions can allocate the appropriate resources to build trust, build innovative products with limited

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risk and educate investors, revenue opportunities could be substantial. The sheer size of the market is so significant

that competition will not necessarily lower prices, provided that institutions can clearly differentiate their offerings

and the benefits of diversification in asset allocation.

Doing business in China will continue to be challenging for any foreign institutions due to cultural and

regulatory limitations. It is important to seriously consider and research a joint venture partnership and conduct

proper due diligence, whilst establishing consistent and proper procedures to address potential conflicts relating

to cultural differences. The saying ‘think global, act local’ holds greater weight for firms wanting to enter and expand

within the Chinese marketplace than in almost any other country.

Clarence Consulting Evolution Diversified Investment Services Pty LtdEvan Clarence Peter Truong+61466315343 +61418223608evan@clarence.consulting peter.truong@ediservices.com.au

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Appendices

Appendix 1.0 – Country Statistics (2015)

Appendix 2.0 - Restrictions on Qualified Domestic Institutional Investor (QDII) License

Qualified Domestic Institutional Investor (QDII) LicenseThese licenses come with conditions, quotas and limitations to exposure of various products (Austrade, 2014).

Commercial Banks can only invest in foreign assets with a BBB rating or higher such as fixed incomeproducts, derivatives, structured products, certain equity products. License prohibits the use of commodityderivatives, hedge funds and any investment below BBB.

Securities and Investment firms can only invest in pre-approved products associated with deposits, bonds,property trusts, structured products and derivatives.

Trust companies are limited to approve cash related products, bonds and derivatives.

Initially the QDII investments were unfavourable with domestic investors because the returns were not as attractiveas domestic cash products, due to the limitations placed on these licensees (JPMorgan, 2008).

Appendix 3.0 - China-Australia Free Trade Agreement (ChAFTA)

Benefits for Australian financial institutions:

Insurance

For the first time in any FTA, China has allowed Australian insurance providers access to China’s third-partyliability motor vehicle insurance market, without form of establishment or equity restrictions.

Banking

The waiting period for Australian banks to engage in local currency (RMB) business has changed from 3years to 1 year. China has also removed the two-year profit-making requirement as a precondition toprovision of local currency services.

Where a branch established in China by an Australian bank already has permission to engage in localcurrency banking business, other branches established by the same bank will be eligible for streamlinedapprovals to conduct RMB business.

There will be the removal of the minimum RMB100 million working capital requirements for branches ofAustralian banks operating as subsidiaries in China, facilitating faster growth and new businessopportunities.

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Australian bank subsidiaries in China are the only foreign bank subsidiaries to enjoy an FTA commitmentguaranteeing their eligibility to engage in credit asset securitisation business provided for under China’sFinancial Institution Credit Asset Securitization Pilot Program.

Australian banks are now well positioned to benefit as financiers of the expansion in trade in goods and servicesfrom the wide range of market opportunities made available under ChAFTA.

Securities and futures

For the first time in any FTA with China, Australian financial service providers can now establish joint venturefutures companies with up to 49 per cent Australian ownership (foreign participation was not previouslypermitted).

The extension of national treatment to Australian financial institutions for approved securitisation business inChina.

Australian securities firms operating in China are allowed foreign equity limits of up to 49 per cent (above China’sWTO commitment of 33 per cent) for participation in underwriting of domestic ‘A’ and ‘B’ shares as well as Hshares (listed in Hong Kong) and guaranteeing the ability to conduct domestic securities funds managementbusiness.

Under its Most Favoured Nation (MFN) commitments, China has agreed to confer any future more preferentialtreatment for securities providers of other countries to Australian providers. This commitment will protectAustralia’s international competitiveness in this sector into the future.

Funds Management

China’s allocation to Australia of a RMB 50 billion quota for the first time will allow Australian fund managers topurchase equities and bonds directly from China’s mainland securities exchanges in Shanghai and Shenzhen.

China has agreed to guarantee Australian securities brokerage and advisory firms, with access to provide cross-border securities trading accounts, custody, advice and portfolio management services to Chinese QualifiedDomestic Institutional Investors (Chinese investors allowed to invest offshore).

The China Securities Regulatory Commission (CSRC) and Australian Securities and Investments Commission(ASIC) have agreed to strengthen cooperation and improve mutual understanding of Australia’s and China’srespective regulatory frameworks.

Appendix 4.0 – Verifying foreign contracts for regular payment over USD$50,000

Outbound regular payments above US$50,000 from Chinese companies to international businesses are permittedhowever subject to the Chinese company submitting documents verifying the underlying transaction. Theapplication documents generally include the following:

1. An engagement letter/contract signed between the Chinese party and the foreign company;2. Notarization and legalization of the engagement letter/contract;3. Tax return certificates of the international recipient;4. A request for payment from the international company.

Appendix 5.0 – Incentives for Special Economic Zones in China

The general economic policies of the SEZ’s are as follows:a) Special tax incentives for foreign investments in the SEZs.b) Greater independence on international trade activities.c) Economic characteristics within the zones are represented as "4 principles":

1. Construction primarily relies on attracting and utilizing foreign capital.2. Primary economic forms are Sino-foreign joint ventures and partnerships as well as wholly foreign-

owned enterprises.3. Products are primarily export-oriented.4. Economic activities are primarily driven by market forces.

SEZs are listed separately in the national planning (including financial planning) and have province-level authorityon economic administration. The local congress and governments within the SEZs also have their own legislationauthority.

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Appendix 6.0 – Assumptions for Market Estimate of Middle Class investment in direct equities

Assumptions:

15% of urban Chinese (middle class) invest in share ownership direct or indirectly. Source: Bloomberg.

8% average Chinese household allocation to stock market investments. Source: Bloomberg & HSBC.

109 million Chinese middle class. Source: Credit Suisse Wealth Report 2015.

$50,000 Min wealth classification to $500,000 Max Wealth allocation with a medium of $275,000. Source:Credit Suisse Wealth Report 2015.

Australian Share ownership 36%. Source: Australian Stock Exchange.

US Share ownership 55%: Source: Gallup Poll -2015.

UK Share Ownership 12%: Source: Office of National Statistics.

Average Participation rate for of the 3 country is 34%.

References

CNN Money, Ananya Bhattacharya, 04/08/2015

http://money.cnn.com/2015/08/04/investing/worlds-biggest-banks-china/

UK Office of National Statistics

http://www.ons.gov.uk/ons/rel/pnfc1/share-ownership---share-register-survey-report/2014/index.html

US Gallup Survey: http://www.gallup.com/poll/1711/stock-market.aspx

TOM ORLIK AND FIELDING CHEN, BLOOMBERG INTELLIGENCE ECONOMISTS

http://www.bloombergbriefs.com/content/uploads/sites/2/2015/07/China%E2%80%99s-Equity-Investors.pdf

IBISWORLD

Commercial Bank of China – Industry Report October 2015

Securities Brokerage and Transaction Services in China - Industry Report November 2014

Securities Investment in China – Industry Report December 2015

Investment and Asset Management in China – Industry Report January 2015

Securities Exchanges in China – Industry Report March 2015

Austrade – December 2014: http://www.austrade.gov.au/Australian/Export/Export-

markets/Countries/China/Industries/Financial-services

Rodrigo Lluberas, Global Wealth Report, Credit Suisse, October 2015

Professor Kerry Brown, The University of Sydney – Finsia Australia, The Development of Financial Services in

China: The role for Australia, Research report 2014

Ernst & Young, Investing in Chinese Securities Market through the QFII Scheme, 2013

China Securities Regulatory Commission: http://www.csrc.gov.cn/pub/csrc_en/OpeningUp/

Yu’e Bao Wow! How Alibaba is reshaping Chinese Finance

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http://www.institutionalinvestor.com/article/3346365/investors-sovereign-wealth-funds/yue-bao-wow-how-

alibaba-is-reshaping-chinese-finance.html#.VqcZZfl97IU

McKinsey & Company, Mapping China’s Middle Class: http://www.mckinsey.com/industries/retail/our-

insights/mapping-chinas-middle-class

Interviews (names & institutions withheld)

In order to obtain first hand insights and verify our secondary data we conducted interviews with Chinese nationals

in Shanghai of different occupations and involvements within the Chinese financial sector. These interviews

included individuals with the following experience profiles:

● Investment banking.

● Chinese IPO’s.

● Chinese MBA students.

● Big 4 Accounting firm.

● Chief Risk Officer of large Chinese Investment company.

● President of a large Chinese Financial services company.

● Two Chinese interns at a large Chinese bank.

● University professor of Chinese Financial Markets.