Trade tensions test fund managers’ appetite for China expansion
The race to win a share of China’s fast-growing investment market entered a new stage this week after JPMorgan’s asset management arm acquired majority control of its mainland joint venture, the first foreign player to pass this milestone.
The deal was concluded despite a marked deterioration in relations between the US and China, a shift that has added new layers of uncertainty and complexity to the calculations of other international managers pursuing ambitions in China.
Concerns that the trade war between Washington and Beijing could escalate further have been amplified by the Trump administration’s decision to label China a “currency manipulator”.
“The risk that the [trade] conflict takes on a momentum of its own and gets out of control has risen significantly. A sensible compromise might yet be reached in the longer term but the way there may well cause some headaches for investors,” said Stefan Kreuzkamp, chief investment officer at DWS, the asset management arm of Deutsche Bank.
Military tensions have also increased after China warned that any moves by the US to locate new intermediate-range missile weapon systems in Asia would be viewed as an offensive step by Beijing.
These issues all add to the complex mix of regulatory, operational and cultural challenges of doing business in China, a country that offers the strongest growth prospects of any market globally to international investment managers.
Estimated value of JPMorgan’s Chinese joint venture
China’s pool of investment assets is forecast to increase from about $4tn at the end of 2018 to $14tn by 2025, according to Boston Consulting Group.
Winning even a small slice of the pie will provide a lucrative stream of profits for international managers, but many remain wary of chasing expansion in China.
“Few global managers really want to commit to China. The trade war with the US provides the perfect excuse to wait until the dust settles,” said Peter Alexander, managing director of Z-Ben Advisors, a Shanghai-based consultancy.
Eye-popping deal valuations could provide another excuse for international players to delay efforts to acquire controlling majority stakes in mainland joint ventures from their Chinese partners.
JPMorgan will control a 51 per cent majority holding in its joint venture, China International Fund Management, after paying $35m to acquire an additional 2 per cent. The deal, which has to be approved by Chinese regulators, values CIFM as a whole at $1.8bn. The price paid represents a 33 per cent premium, setting a new valuation benchmark that will delight other Chinese managers.
Other foreign managers, however, will balk at the price tags that could now be attached to similar deals.
“Some of the other joint ventures have also built up significant assets and are making a lot of profits,” said Stewart Aldcroft, Asia chairman of CitiTrust, the securities and fund services arm of US bank Citigroup.
Mr Alexander said the price paid by JPMorgan was “aggressive but not excessive” when compared with the long-term growth prospects of the joint venture. He added that JPMorgan had seen a huge increase in the value of its existing stake in CIFM, which has delivered annualised returns of about 33 per cent since 2005.
“We know now that acquiring control of a mainland JV won’t come cheap to anyone. But the valuations are justified given the outlook for growth and the expected returns of these businesses over the next 10 years,” said Mr Alexander.
Another option for international players is to establish a wholly foreign-owned enterprise (WFOE), which can apply for regulatory permission to launch private funds. These private funds can only be sold to a limited number of rich individuals. This is expected to be a preparatory stage before regulators in Beijing grant approval to WFOEs to launch funds that can be sold to the general public, possibly as early as next year.
BlackRock, Fidelity International and UBS have all recently pumped additional capital into their mainland WFOEs, indicating that they are preparing for further expansion.
China began the process of lifting restrictions on foreign ownership of asset management companies less than two years ago. The rule changes affecting the mainland investment industry are just part of a bewildering array of financial reforms that foreign managers have found difficult to digest and navigate.
Only last month, Beijing announced 11 new policy measures to open the country’s financial sector to foreign investments further. These included advancing the removal of limits on foreign ownership of fund management companies beginning in 2020, one year earlier than initially planned. Foreign ownership limits in other types of asset managers — including those set up by banks, insurers and pension investors — will also be relaxed.
“This is another clear signal of China’s determination to encourage greater foreign involvement in its investment market. Permission to participate in building China’s nascent private pension system will be a very significant development for international managers,” said Mr Aldcroft.
Another important change is the recent ending of the so-called “one plus one” policy. This allowed foreign players to participate in a joint venture with a local partner and to hold a private fund management (PFM) licence but not to sell funds to the general public. Foreign asset managers will now be able to build a public fund company and also maintain their JV and private fund activities.
Peter Harrison, chief executive of Schroders, said this rule change was a “really important step forward” for the £444.4bn London-listed asset manager. “We already have a very good joint venture with Bank of Communications but we also want to grow our own [direct fund] business in China,” he said.
Mr Aldcroft said the end of the one plus one policy opens up other strategic options for foreign managers.
“A global manager can now stay as the minority partner in the JV if that arrangement is working well and aim to convert its WFOE into a public fund company,” said Mr Aldcroft.
Domestic Chinese managers, however, may view this rule change as creating competition or a conflict of interest with their international partners in a mainland JV.
Given these shifts in China’s regulatory framework and the heightened tensions between Washington and Beijing, other global managers might question whether they should follow JPMorgan’s lead.
Mr Alexander said the risks and rewards offered by China are often miscalculated. “Opportunities are being missed,” he added.