Issue 100 June 2016 Lite

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ASIAN PRIVATE BANKER JUNE 2016 • ISSUE 100

ENTER THE DRAGON

ARE CHINESE PRIVATE BANKS POISED FOR OFFSHORE DOMINANCE?

INSIDE:

Straight talk with Wang Jing, CMB Private Banking, pg 11 WMP risks driving due diligence rethink, pg 15 The challenges facing China’s fragmented tech space, pg 18 A chat with Kenny Lam, Noah Holdings, pg 21 + The Scoop with Shruti Advani, p5

PE O PL E MO V ES

MOVERS & SHAKERS

Movers & Shakers is a monthly compilation of the private banking industry’s key talent moves.

For the full version of Movers & Shakers, login or register at:

asian private banker

JUNE 2016

CONTENTS 2

People Moves Movers & Shakers

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Letter from the Editor 100 shades of good

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APB On-the-Spot Online poll results

5

Editorial The Scoop: UBS, BSI, HNWI and other wordplay

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Editorial Crow’s Nest: BSI shutdown in Singapore just another symptom of market consolidation

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Industry Enter the Dragon: are Chinese private banks poised for offshore dominance?

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People Straight Talk: Wang Jing, CMB Private Banking

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Industry Regulatory malaise putting stress on China’s private banking industry amid capital outflows: experts

15

Industry Overdue diligence: China’s WMP time bomb to weed out industry pretenders

18

Technology One bank, two systems: the fragmented tech space in China

21

Industry A chat with… Kenny Lam, group president, Noah Holdings Limited

CHIEF EXECUTIVE OFFICER Andrew Shale EDITOR Shruti Advani DEPUTY EDITOR Sebastian Enberg EDITORIAL Richard Otsuki, Priyanka Boghani, Tom Wan

MANAGING DIRECTOR Paris Shepherd OPERATIONS

DIGITAL DIRECTOR Tristan Watkins

BUSINESS DEVELOPMENT Madhuri Chatterjee, Sonia Lam, Michael Chan, Sam Chan, Stacey Wong

PRODUCTION DG3

Benjamin Yang, Koye Sun

DESIGN Simon Kay

ISSN NO. 2076-5320

PUBLISHED BY KEY POSITIONING LIMITED 1205 The Dominion Centre, 43-49 Queen’s Road East, Wanchai, Hong Kong Tel: +852 2529 5577 Fax: +852 3013 9984 Email: info@asianprivatebanker.com

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LETTER FROM THE EDITOR

100 shades of good Welcome to the 100th edition of Asian Private Banker. The issue you hold in your hands is important in so many ways – not least because it represents a watershed moment in the chronicling of Asia’s tremendous journey towards becoming a wealth management tour de force.

It is not in our DNA to be self congratulatory and so I will spare you any detailed descriptions of our triumphs, though there have been many along the way. Instead, let me share the Warren Buffet quote that guides me and my team into our future: “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”

We think about that – constantly.

This issue features many of your favourites. In The Scoop with Shruti, I address two industry developments that dominated mindspace over the last month – but the focus of the issue is onshore banking in China. We ask if Chinese private banks, given their seismic growth in recent times, will pose a threat to established international players in the years to come. We take a look at China’s limited product universe, the tech challenges facing institutions, and the regulatory response to capital outflow.

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We also sit down one-on-one with two industry heavyweights.

Wang Jing, general manager, CMB Private Banking, who divulges details about China’s largest private bank by assets under management; and Kenny Lam, group president, Noah Holdings, who discusses why Noah sits at the forefront of a new breed of Chinese wealth manager.

Since we’ve really got the quotes flying for this one, here’s another from Bill Gates: “Your most unhappy customers are your greatest source of learning.” I hope we haven’t made you unhappy, but if we have made you think or sparked a debate, we’d love to hear from you.

And before I forget, make sure you drop by our redesigned website that we hope will make your browsing experience just that little bit more special.

As always, mail your comments to editor@asianprivatebanker. com Until we meet again,

Shruti Advani Editor, Asian Private Banker

EDITORIAL

UBS, BSI, HNWI and other wordplay

I

expected last month’s column on UBS to get the conversation started, I simply didn’t anticipate how loud it would get!

Thank you all for your feedback. As a result of that column and the CEO Roundtable at Asian Private Banker’s Investment Advisory Summit in Hong Kong and Singapore, I’ve spent many hours this last month dissecting the existent models for private banking in the region. Which has almost always lead to a disquisition on costs and the (tempting) impetus to spread them over as large a base as possible, thrusting many private banks squarely into HNW territory.

I meant this month’s column to be a meditation on that theme.

Well, the path to hell is paved with good intentions, as Samuel Jackson said and I have had to re-write this column twice. Not, I am (mostly) confident as a result of any lack of skill on my part but because of two headline-grabbing events over the last few weeks in an industry not known for fast-paced change.

The first, in chronological order, was the headcount reduction announced by UBS across its Hong Kong and Singapore offices.

Much has already been written about that on Asian Private Banker, but having penned the column I did last month about the bank’s asset-acquisition strategy, I feel an almost moral imperative to comment.

Fact: When the largest – and some would argue most aggressive – growth engine stalls to shed some load, the industry is electrified.

On the day the cuts were confirmed in Singapore, CEOs and head hunters went into a huddle whilst the rest of us commiserated over coffee at Dimbulah at the Raffles Quay South Tower or over drinks at the Post Bar inn the Fullerton a short walk away.

Fiction: When the largest private bank by assets under management starts rationalising headcount, it’s time to reach for the ripcord. Whilst at the Post Bar, I had to step out to take a call from an institutional coverage banker who was in the throes of

interviewing with a private bank. The tone of the conversation ranged from smug to self congratulatory as the said banker prophesied doom first for the bank in question, then indeed for the entire private banking industry and lastly for any investment banking peers that were foolish enough to be lured into the private banking career he had so narrowly sidestepped.

Ok, let’s all take a breath. First and foremost, no, I absolutely do not think the cuts are indicative of a negative outlook on the industry. If anything, private banking continues to be lighter on capital and higher on return than most investment banking businesses. Secondly, if there was ever a private bank that could afford to rationalise headcount, it would have to be the one with eleven hundred bankers in Asia. Yes, the news is unpleasant and disconcerting but it is not entirely without logic and – wait for it – neither is it as unexpected as the industry believes.

Between 2014 and 2015, UBS was the only exception amongst the Top 5 private banks in the region that continued to grow its AUM base. It did so despite an 8% reduction in RM headcount. Clearly asset gathering is not a problem for the franchise. As first quarter results, released in early May, drove home, profitability is. The solution would elude only the most optimistic of us.

And lastly, to put to rest another tedious moniker – no, I don’t think this signals the start of a “rightsizing” strategy at the bank either. Most industry analysts I have spoken with have been unable to identify a tipping point – the point at which headcount addition stops being an exercise in growth and becomes an exercise in vanity – for UBS in Asia. So who, aside from Sergio and Ed (Ermotti and Koh respectively), knows what the right size for UBS is?

The second (headline grabbing event this month, in case you lost the thread), was the demise of BSI in Singapore and its fall from grace in Switzerland if not the rest of the world.

Fact: MAS’ forced closure of BSI’s Singapore operations was shocking and riveting in the way train wrecks are – this is the first time since 1984 that the regulator has withdrawn a bank’s license.

Fiction: A few rotten apples brought down the bank Barings-style. The issue at BSI was systemic, not precipitated by any one individual (the rogue trader) and – contrary to popular perception – not localised to its Asian operations. Over lunch with a Swiss private banker in Singapore, I was audience to yet another self-congratulatory diatribe. According to the gentleman, “small Swiss banks” who veer away from home market into the big bad world of Asian banking cannot hope the grasp the “realities of doing business” here and hence become victims of their own ambition.

Ok, time to take another breath. Sovereign wealth funds were BSI’s largest and most profitable client group and, as such, were serviced at the highest levels of management, from both Switzerland and Asia. Malaysian sovereign fund 1MDB had 100 disparate client accounts with BSI, surely no single client advisor – irrespective of the size of his bonus cheque – was responsible for all of these accounts?

Doing business in Asia is not without its challenges and corruption – I concede – is more institutionalised here than it may be in the West. But I am afraid I must take exception to the classification of the 1MDB debacle as as either an “Asian issue” or a “rogue banker” issue. I take Swiss regulator FINMA’s scathing criticism of BSI along with its insistence the bank be “fully integrated [into EFG] and dissolved within twelve months” and noone from BSI (and not just BSI Asia) is to take on a senior management role in EFG as confirmation of this.

As for finding the victim in this particular financial scandal? The more compassionate amongst you may take solace in the fact that most of the “tainted” Singapore team has found alternative employment – at yet another Swiss bank.

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EDITORIAL

BSI shutdown in Singapore just another symptom of market consolidation

T

he BSI-1MDB affair is one those moments that will forever mar the private banking industry. Thus far the scandal has implicated a number management staff at Swiss pure play, BSI, with the Monetary Authority of Singapore moving to shut down BSI’s operations in the city-state.

Much has been (and will be) made of BSI’s alleged complicity and the machinations of those individuals who will be held personally responsible once all is said and done. Indeed, MAS has publically stated that it is the “worst case of control lapses and gross misconduct” in the history of the city-state’s financial sector.

At the same time, there are deeper industry dynamics at play that are likely to have contributed BSI’s involvement - even if indirectly.

Put plainly, the BSI-1MDB saga is redolent of those wider pressures that pervade Asia’s private banking space, as banks struggle to swim against a tide of tightening regulations and slimming margins.

Indeed, there are tell-tale signs that BSI’s troubles - while self-inflicted - were exacerbated by a pressing need to ward off growing cost pressures by achieving scale, even if that meant throwing to caution to the wind and onboarding low-hanging assets.

a little as US$10 billion in AUM can spend upwards of US$7.4 million per annum on AML operations, while the cost to institutions with as much as US$100 billion is only marginally higher, at US$9.2 million.

Similarly, talent acquisition (and retention) is not getting any cheaper. Again, no bank is immune to this trend, but it’s the smaller players that are feeling the pinch. With comparatively meagre marketing budgets and, in some cases, no adjacent businesses (e.g. consumer and investment banking) to refer clients, smaller private banks are having to pay upwards of a 30% premium to land top talent and their books.

Yes, BSI Asia was by no means a diminutive player (prior to being sold to EFG, its Asia AUM totaled around US$20 billion) but it occupied an uncomfortable space, right on nose of the current safety threshold.

Again, BSI’s Asia troubles are rooted at the individual/management level. But what is also clear is that the pressures of achieving and maintaining scale are overbearing, and increase the temptation to acquire cheap assets. In the case of BSI Singapore, MAS criticised the bank for its “unacceptable risk culture, with a blatant disregard for compliance and control requirements”.

CLIMBING MINIMUM BREAK-EVEN POINT

TOUGH TIMES YIELD ROTTEN EGGS

Industry heads, speaking at Asian Private Banker’s recent Investment Advisory Summit, told a largely senior banking crowd that private banks today must adapt to a new minimum AUM threshold if they are to remain viable businesses.

“Private banking is the single biggest opportunity any financial institution can have, but regulatory costs are going up and some players are also facing issues from headquarters [such as bank capital requirements],” according to the head of a major European wealth manager.

No more than a decade ago, a private bank with at least US$1015 billion in client assets was, effectively, ‘safe’ in the region. Today, the threshold stands at about US$20-25 billion, and industry vets expect this figure to breach the US$30 billion mark in the near future.

Put in context, 17 of the region’s top 20 private banks meet the current US$20-25 billion threshold, but only 14 (including the recently-acquired Barclays) exceed the US$30 billion mark.

Regulatory costs for Asia’s financial sector as a whole are climbing. By one estimate, the annual anti-money laundering (AML) budget for banks in the region totals US$1.5 billion, and this is pegged to increase substantially over the next 12 months. Indeed, a recent LexisNexis report finds that financial institutions with

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In this difficult market, private banks not only contend with internal expectations, but often impatient, target-focused shareholders.

Of course, this is not such an issue when targets are being met cast your mind back to 2015 when many banks met annual targets in the year’s first quarter.

2016 is a different story altogether. The year kicked off in uninspiring fashion, with volatile markets and weak investor confidence ensuring that private banks were behind the eight ball at the close of the first quarter. Indeed, a recent survey conducted by Asian Private Banker found that nearly 70% of fund selectors had met less than 15% of their annual targets after the first three months.

Unlike the mature wealth markets of the West, where discretionary management penetration rates hover around 30%, Asia remains brokerage-heavy, with up to 47% of private banking revenue in the region driven by transactional business, such as FX, equities and bonds, according to internal data.

So when the going gets tough, private banks with (comparatively) lax compliance cultures and an acute need for assets run the risk of overreaching.

According to one informed source, BSI did not resemble the handful of other pure plays in Asia which have managed to achieve discretionary penetration rates closer to those found in Europe.

EDITORIAL

ASIA’S OVERSTATED WEALTH OPPORTUNITY

Industry estimates place Asia’s total HNW wealth at around US$16 trillion; but the amount of assets that are either not bankable (at least by the new standards being set in the region) or unlikely to flow offshore, far eclipses this number.

“I will reject up to 15 new clients per quarter,” a rainmaker at an American wealth manager revealed to Asian Private Banker recently, who prefers to target owners of newly listed companies or HNWIs that have secured offshore loans from reputable financiers.

“There’s a lot of wealth in the region but it won’t make it through every bank.”

And then there’s the legitimate assets that families will deliberately keep onshore.

For example, one source estimates that as much as 50% of Taiwanese wealth constantly remains onshore, primarily to fund core businesses that will be passed down to the next generation.

Yet, Asia’s private banking scene is still littered with players that lack the firepower to achieve a critical mass of assets and, in such cases, there will be a greater structural pressure on these banks to lower their rejection rate, even if watchdogs increase their vigilance.

Without revealing names, MAS has said that it is scrutinising compliance standards at other private banks, with global media reports linking a host of other financial institutions to the 1MDB probe.

Watch this space.

WHEN 1MDB BECAME BSI’S PROBLEM: THE TIMELINE

From the minute Malaysian prime minister Najib Razak took over the fund in 2009 to the moment Singaporean regulators announced BSI Singapore would close in 2016, Asian Private Banker lays bare the 1MDB money trail.

• May 27th, 2016: State prosecutor challenges court decision of SG$500,000 bail for Yeo Jiawei • May 26th, 2016: BSI Singapore “operating normally”, according to statement • May 25th, 2016: Swiss court opens criminal proceedings against BSI, amidst allegations of money laundering and bribery of foreign public officials • May 25th, 2016: Yeo Jiawei’s 1MDB charges reach nine • May 24th, 2016: MAS moves to shut down BSI Singapore, calling it “worst case” of gross misconduct ever seen, names senior bankers • May 20th, 2016: Yeo Jiawei could be slapped with new 1MDB charges • May 18th, 2016: BSI to conduct internal probe into bank’s 1MDB involvement, Kevin Swampillai, Jiawei’s manager suspended • May 6th, 2016: Yeo Jiawei involved in 1MDB probe faces 3 more charges • May 3rd, 2016: Coutts is the latest PB to be linked to 1MDB probe • April 26th, 2016: BSI head of private banking Asia, Raj Sriram resigns • April 25th, 2016: Singapore authorities confirm charges of corruption against former BSI banker Yeo Jiawei • April 6th, 2016: BSI Asia COO Gary Tucker steps down • April 5th, 2016: Luxembourg unit of Edmond de Rothschild Group added to 1MDB probe • March 11th, 2016: Yak Yew Chee linked to 1MDB case leaves BSI Bank • February 22nd, 2016: 1MDB slams Wall Street Journal for “outright lie” that funds received by Najib Razak came from 1MDB • February 5th, 2016: BSI banker Yak Yew Chew marred in 1MDB probe granted right to transfer money for expenses from foreign accounts • February 3rd, 2016: BSI private banker, Yak Yew Chee linked to ongoing 1MDB scandal, bank account frozen • February 2nd, 2016: Singapore seizes bank accounts with potential 1MDB links • August 24th, 2015: Swiss authorities investigate two “entities” (highly likely that one is PetroSaudi International) as part of 1MDB probe • June 15th, 2015: Malaysian prime minister promises to resolve 1MDB scandal with BSI Singapore by year-end • March 2015: The Monetary Authority of Singapore (MAS) says it’s helping Malaysian probe into 1MDB after a report that a Swiss bank in Singapore is keeping 1MDB’s money redeemed from investments in Cayman Islands funds.

• December 2009: Goldman Sachs wins approval to set up fund management and corporate advisory operations in Malaysia • September 2009: 1MDB sets up a $2.5 billion joint venture with PetroSaudi International • July 2009: 1Malaysia Development Bhd (1MDB) is born

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Enter the Dragon: are Chinese private banks poised for offshore dominance?

C

hina’s still embryonic private banking industry has been in the pink of late, even as the wider national economy loses its steam. So much so that industry watchers are beginning to ask whether the scale many of these onshore institutions have achieved will, in time, translate into offshore dominance – if and when Chinese authorities decide to liberalise capital accounts.

It’s an argument that, though replete with hypotheticals, merits exploring. It’s also an argument that finds no easy middle ground, with industry leaders unable to agree on the threat level posed by Chinese private banks, whose offshore setups are, for the most part, diminutive.

A recent poll conducted by Asian Private Banker exemplifies this impasse. When asked if Chinese private banks will be in a position to mount a serious offshore challenge once capital flows free up, 54% of respondents said “no”, 38% said “yes”, and the remainder didn’t know.

MEETING CRITICAL MASS

Where the industry does see eye to eye is over the importance of scale in the current market environment. As Julius Baer CEO, Boris Collardi, told Asian Private Banker last year, “It requires scale and some other elements to make necessary investments in talent, platform and technology to meet sophisticated client needs and regulatory requirements.”

Today, that ‘safety threshold’ is around US$20-25 billion in client assets under management (AUM), but tomorrow’s banks will likely require AUM in excess of US$35 billion to break even in Asia’s congested offshore market, according to industry leaders speaking at Asian Private Banker’s Investment Advisory Summit last month. Little wonder then that M&A and restructuring activity has ramped up in recent times, as banks rationalise their business models.

Scale is not a point of deficiency for China’s major players. In the past four years, the top five onshore private banks by client assets have increased their AUM by an average of 31% year-on-year. By comparison, the top 5 private banks booking out of Hong Kong and Singapore have averaged just 10% growth – and between 2014 and 2015, total AUM contracted 5%.

Yes, growth figures will always seem impressive when starting from a low base, but China’s private banking industry is already approaching par value with Asia’s offshore players.

At the turn of the year, the top five onshore institutions controlled a total of RMB 4.3 trillion (US$651 billion) in client assets at an average of

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around US$130 billion per bank, while the top five Asia offshore banks had US$822 billion in AUM, averaging US$164 billion per bank.

The largest onshore player is China Merchants Bank (CMB), whose private banking business is still young by international standards, having launched in 2007 with just over 3,000 clients and AUM of RMB 64.3 billion. Fast forward to 2015, and CMB Private Banking had approximately 49,000 clients and AUM of RMB 1.25 trillion (US$187 billion) – and at the time of going to print, its client assets had breached the RMB 1.4 trillion mark.

And CMB is no anomaly. State-owned ICBC’s private banking arm has amassed over RMB 1 trillion in client assets as of end-2015, and third placed Bank of China Private Banking is not far off the pace with RMB 810 billion in AUM, up 12.5% on the previous year.

Still, as impressive as these numbers are, not everybody is convinced that China’s onshore scene is flourishing.

In a recent conversation, a major industry figure with deep onshore experience privately questions the veracity of AUM reporting and of Chinese banks’ accounting standards in general.

“These [figures] are misleading,” he counters.

“The question we have to ask ourselves is whether they are reporting as a separate business or as a virtual business, in which case their numbers shadow the entire bank’s P&L.” Indeed, one common criticism that is levelled at onshore private banks is that they often double count when reporting client numbers and AUM. However, Wang Jing, CMB Private Banking’s general manager, tells Asian Private Banker that her clients are exclusive to the private bank, and that once a retail client meets the RMB 10 million threshold – or

INDUSTRY

is adjudged to have the potential – their “assets are transferred in their entirety.”

THE LAY OF THE LAND

Explosive growth is one thing, but every market has a saturation point that, when reached, forces participants to revisit their growth strategies. But the current penetration rate for private banking services in Mainland China is as low as 7-10% by one estimate, with the bulk of HNW assets sitting in retail accounts. This is less than almost every other major onshore market in Asia, including South Korea (20-22%) and Japan (10-13%), according to industry figures.

Thus, while growth rates have been phenomenal, there is still plenty of room for onshore expansion.

Furthermore, China’s onshore landscape is as complex as it is vast, with private wealth creation no longer confined the south’s manufacturing hubs and the eastern seaboard. It is, to risk cliché, a country stitched together by networks and relationships, and private banks must conform to the lay of the land.

While not a deal breaker (or maker), it is nonetheless a compelling reason why foreign players will struggle to carve out a substantial onshore private banking business and, by that same token, why Chinese players with an intimate knowledge of the human terrain will be well placed to leverage their onshore ties when expanding offshore.

“The problem with foreign banks is that they can’t build enough of a network,” points out Kenny Lam, group president of Noah Holdings, whose wealth management business is the largest of its kind in China.

“But it’s not just networking, it’s about product speed. Foreign banks’ compliance sits in Hong Kong and Zurich. Our compliance sits in Shanghai, so I know what risks to take and what risks not to take.”

Indeed, more than a few eyebrows were raised when Swiss major UBS opened a ground-floor branch in Xintiandi, Shanghai, earlier this year, in a move that Wealth Management president Juerg Zeltner believes will bring the bank closer to a wealth pool “growing at two times [China’s] underlying economy” (UBS also plans to double its onshore headcount to 1,200 over the next five years).

Others are less convinced that UBS’ onshore venture (as well as its foray into Kowloon) will pay the expected dividends on the grounds that potential clients are less captivated by headline branding exercises.

“If you had this office five years ago, I think people may have been attracted to it, but I think [Chinese] investors are more sophisticated today,” says a managing director at a rival private banking major.

“I’m not saying that investors will not be allocating assets to UBS – of course they will because they have global coverage – but I think that the share is more split than ever before. So going onshore will take more than branding.”

By comparison, Chinese private banking branches tend to be modest affairs, their meeting rooms spartan and refreshments services limited to tepid water or tea (and, occasionally, coffee with whitener).

But that’s the point.

The Chinese wealth story is no longer just about the glitzy tier-one megalopolises. Between 2012 and 2014, the most pronounced growth occurred in China’s western and central provinces, and particularly in Xinjiang, Hubei and Shaanxi where the HNWI population increased by 25-35%, “contributing to a more balanced geographic distribution of wealth”, according to a recent Bain & Co. report.

Having an on-the-ground presence in these zones is source of competitive advantage that cannot be discounted. Connections made early on in an investor’s life have the potential to evolve into a sticky, total client relationships that transverse borders.

For instance, ICBC, which has 496 million personal banking clients as of end-2015, has a vast network of branches throughout second, third and even fourth-tier centres, giving it ‘coalface access’ to China’s booming entrepreneur class (ICBC Private Banking clients must meet a minimum threshold of RMB 6 million). Similarly, Noah Wealth Management, while not a private bank per se, has over 95,000 private clients with an average net worth of US$30-50 million.

What is noticeable about Noah’s operations is that they are skewed towards second and third-tier cities (60%) where the entrepreneur class is flourishing.

These are the types of clients that are less enamoured with plush meeting rooms, and more focused on generating alpha. “[T]he richer you are, the less you care about how nice the branch is and the more you care about the investment capabilities,” says Lam,

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INDUSTRY

when asked why investors would opt for Noah over a ‘traditional’ private bank. “[I]f you look at our [WM] offices, they tend to be less opulent and lower profile, and not one of those ‘singing and dancing’ private banking wealth centres.”

Across the border in Hong Kong, things are a little more salubrious, and Chinese private banks have adjusted accordingly.

Just this month, Bank of Communications (BOCOM) Private Banking (China’s fifth largest by AUM) cut the ribbon on its new Landmark offices on Hong Kong Island, where rent is around HK$145 per square foot. It’s a spacious, architectural affair that is more reminiscent of a certain Swiss boutique’s set up in Singapore than a Mainland private banking branch; and not far from the Landmark lies the offshore branch of another Chinese private bank that recently redecorated its offices with contemporary Chinese artwork.

These offshore enclaves are by no means hives of activity. In fact, they’re quiet – very quiet. When asked if things are always like this, a Hong Kong branch head nods, adding that the bank is “waiting” – referring to the moment when Chinese authorities decide to loosen capital controls. Indeed, the bank’s Hong Kong branch has around 10 RMs on the ground.

Without a doubt this is a costly endeavour to fund, but then China’s major institutions are turning healthy profits. For instance, CMB’s private banking business, which posted a profit of US$759 million in 2015, has a cost/income ratio of 25% – substantially below the APAC average of 66.3%, as detailed by a recent Boston Consulting Group (BCG) report.

If these banks have the financial stamina to play the long game – and by many accounts they do – then it is only a matter of time before that initial relationship forged with a young entrepreneur in Hubei evolves into total client relationship that spans multiple jurisdictions. Offshore branches in Hong Kong are already seeing this dynamic in action: according to another head of private banking for an offshore Chinese lender, around half of her new clients are opening an offshore account for the first time.

PRODUCT PAINS

Most would agree that the Achilles’ heel of the onshore industry is the paucity of product, with strict restrictions limiting investor access to anything other than vanilla strategies. Critics point out that client AUM are effectively dormant deposits that need to be converted into profitable assets.

Afterall, “product drives profitability,” observes a greater China head at a major international private bank, when asked whether these platform limitations are having a material impact on the onshore industry. “[Onshore private banks] are most restricted in terms of their product platform,” confirms a former onshore private banker who now works on the sell side.

“The only thing these banks can offer their customers is concierge service – whether a private jet trip or concert tickets. When you drill down, there is not that much else there.”

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In recent years, Chinese investors have channeled their assets towards the shadow banking sector and its cluttered shelf of wealth management products (WMP) that promise surreal rates of return.

But the risks are high, and authorities – mindful of social stability – are clamping down, as evidenced by the collapse of three high-profile wealth management firms in the past year alone, including Shanghai-headquartered Zhongjin Capital (at one time a posterchild for China’s booming wealth management scene) which was outed as a Ponzi scheme and closed “on suspicion of illegal fundraising”. And there may be more to come according to sources close to regulators, who say they have seen a list of firms that are now under close scrutiny.

At the same time, HNW and UHNW Chinese investors, seeking diversification and exposure to overseas opportunities, are shifting money offshore at a quicker rate. Alongside the UK and US, China is a top three source of offshore wealth, with just under half of all Chinese HNW and UHNW investors holding offshore investments. This has been to the benefit of Hong Kong and Singapore. Both centres account for 18% of global offshore wealth and, by 2020, this share should rise to 23%, according to BCG. However, as more sophisticated product comes online, the burden on Chinese banks will only increase. Frontline talent – in short supply on the Mainland – will need to evolve with the product suite to ensure that client needs are being met (a recent Bain & Co. report finds that the most important factor for Chinese HNWIs when selecting a private bank is expertise). Similarly, more spend will need to be devoted to tech solutions across the front, middle and back offices, given that pre-existing systems are largely outmoded and fragmented.

Still, these coming challenges, while fundamental, are common to all ambitious private banking businesses that aim to crack the majors.

If Chinese authorities make good on their pledge to open the capital account by 2020, the omens are good for Chinese private banks that want to challenge the globals on their own turf. The prognosis is perhaps less cheery for those global banks looking to make a Mainland play.

“All signs are pointing to the Renminbi opening up, and when this happens, [international players] in Hong Kong and, to a lesser extent, Singapore, should be worried, especially if their core business is the US$2-10 million segment,” points out the aforementioned head of greater China at an international private bank.

“Afterall, isn’t it better to be an important client with a Chinese bank for all business, than a nobody at an offshore foreign bank?”

PEOPLE

Straight Talk:

Wang Jing, general manager, CMB Private Banking China Merchants Bank Private Banking is today China’s largest private bank by client assets, having achieved phenomenal growth since its doors first opened in 2007. Asian Private Banker speaks with its general manager, Wang Jing, who has overseen CMB’s transformation into a private banking major.

As of Chinese New Year, 2016, CMB Private Banking had RMB1.3 trillion (US$197.4 billion) in assets under management (AUM). Has there been any change since then?

Our latest figure for 2016Q1 is RMB1.4 trillion (US$212.6 billion).

Is this figure specific to the private bank or does it shadow the entire bank’s assets?

These figures are specific to the private bank. Yes, some of our [private banking] clients used to be clients of our retail banking business. But once they meet the RMB10 million (US$1.5 million) threshold, or they are adjudged to have the potential to be upgraded, then their assets are transferred in their entirety to the private bank.

You continue to experience rapid AUM growth at a time when private banks in Hong Kong and Singapore are struggling to maintain past momentum. What’s driving this growth?

The impetus for growth today is the same as previous years – though I am not so sure the same can be said about Hong Kong. In Mainland China, the first quarter – more than any other – typically sees an immense surge in individual wealth.

Why? It’s partly because companies often pay out bonuses in the first quarter, especially in January and February. We also observed that some major shareholders sold their stocks last year. I believe these are the major reasons why our AUM increased over the past few months.

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PEOPLE

Of course, there was significant unrest in the stock market midlast year. The government launched a policy imposing certain restrictions on how big shareholders offload their shares. However, the policy expired at the beginning of this year. Therefore, the ones who planned to sell their shares but were held up due to the policy likely sold in Q1, leading to a surge in AUM. Cost/income (CI) ratios in Hong Kong and Singapore remain high.

How profitable is your business, and how does your CI ratio compare across the industry?

As far as discipline and compliance goes, we have several measures in place to ensure that our RMs remain above board. We conduct internal training sessions, regular post-sales checks and, in fact, our system only allows trades that have met certain compliance-related criteria to go through.

From the first day an RM steps into the office, we [provide training] on compliance, products and investment[s], whether for Mainland China, Hong Kong and overseas. That’s why some banks – including Goldman Sachs – come to our Shenzhen office to contribute to our training programme and exchange experiences. We even send some RMs to Hong Kong to train.

Our income last year was around RMB$7.5 billion (US$1.1 billion) Who are your biggest competitors? while profit was around RMB$5 billion (US$759 million). In Mainland China, banks don’t share CI ratios, so it’s difficult for me to There are two major types of financial institution doing private make a comparison. banking in Mainland China today.

Presently, CMB Private Banking’s CI ratio is 25%. I understand The first is large local banks with private banking arms, such that this is an [unusually low] number, as European banks tend to as ICBC. ICBC has a considerable base that reaches small cities hover around the 80% mark. This shows that there is still plenty of across Mainland China, including cities where we do not yet have room for us to invest in the business. a presence. This is perhaps why Our biggest expenses are wages, ICBC maintains a close relationcompensation, and personnel-reship with the general [mass retail] lated costs. Also, because my client segment. Equally, there are clients use services provided by Our income last year was around many HNWIs in smaller Chinese other divisions – e.g. overseas or RMB$7.5 billion (US$1.1 billion) while cities, and so ICBC has a great credit card services – we must also share these costs. However, profit was around RMB$5 billion (US$759 foundation to tap into this market.

Our branches only cover first and I believe that offering all-round million). second-tier cities at the moment. services is one of our points of We have 42 private banking cencomparative advantage. tres nationwide.

For example, we have a dedicated 24 hour call center service But there is patent opportunity for our private banking clients. in these smaller cities, even given We run three eight hour shifts your RMB10 million threshold? per day, with three staff assigned to each shift. Each time a client calls in, he or she will speak to the Yes. For example, southeastern parts of China, like Zhejiang, same operator, depending on the time of day. So they feel that their Jiangsu, Fujian and Guangdong are where property and assets tend service is customised. to accumulate. These provinces harbour a lot of potential. Take Zhejiang as an example. ICBC has a great number of clients in Zhejiang What’s your relationship manager (RM) headcount? since it has branches across the province. We only have one branch in Hangzhou. As far as I can remember, ICBC’s number of [private Right now we have 1000 RMs. banking] clients in Zhejiang will exceed 10,000 very soon. So there is a plan to move into these smaller cities, but it is a bit difficult for With such a large number to manage, how do you ensure that us to hire suitable RMs or related professionals in those cities. your RMs remain compliant, and that their level of service is up to scratch?

And the second source of competition?

That’s actually a very good question, and one that I think about Yes, the other major type is non-banking institutions – asset manevery day. It is very difficult to coordinate a group of this size. Of agers and investment banks – such as CITIC Securities and Noah. course, we demand a high degree of professionalism and sophistiEven though Noah is not a private bank, its business is set up like a cation from our RMs. 70% of my RMs previously worked in CMB’s private bank. Similarly, CITIC Securities has set up a new departcorporate finance or retail banking departments – some for as long ment that caters to HNWIs brought across from its investment four years. The remaining 30% were recruited from fund or trust banking and wealth management businesses. houses.

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PEOPLE

What about the foreign players?

I’m sure most private banks would say the same thing.

Many people assume that foreign banks, given their maturity and experience, are a natural source of competition for onshore majors in China. However, their growth has been unexpectedly slow due to licensing and product-related issues. Some foreign private banks have even laid off staff in the Mainland, or have merged with retail banks. It seems to me that that they do not have a consolidated foundation to grow in a profitable manner.

Well, you would be interested to know that the reason why we have become such a large private bank and have grown our AUM by 30% over the past year is because we offer clients solutions when everybody else talks about products. This means that we have been able to build deep and sticky relationships with our clients, and to enhance our brand. Clients notice that CMB is different to its competitors because it doesn’t just push you to purchase products.

If and when capital account liberalisation occurs, will you be better placed to challenge these foreign banks in Hong Kong and Singapore?

How do go about constructing a diversified global portfolio given that there is limited access to foreign markets in China?

I believe that liberalisation will happen in the near future. At CMB Even though restrictions remain on the inflow and outflow of we are preparing for this by establishing a worldwide service net- capital, our clients have on average 20-30% of their total assets in foreign countries, for reasons work by inking international such as investment immigration partnerships and enhancing our or perhaps they have children ability to service clients from all studying abroad. Of course, capover the world. From my expeMany people assume that foreign banks, ital outflows are increasing. rience with clients, mutual trust determines where they choose to given their maturity and experience, Do you think politics plays put their money. Building trust are a natural source of competition for a significant role in offshore takes time, and so I doubt that our flows? clients will look elsewhere when onshore majors in China. However, their that time [liberalisation] comes. growth has been unexpectedly slow due to No, I believe outflows are driven primarily by a concern Have you formed any strategic licensing and product-related issues. for diversification and the need partnerships with foreign players? to achieve growth.

No. We are still in discussions The fintech revolution is very throughout various regions, and much in full swing in Hong no final decisions have been made.

Kong and Singapore. How are However, I believe that our partneryou coping with these changes? ships will be diverse in terms of the areas they cover and the types of cooperation they involve.

It is the biggest item on our offshore budget sheet. We have a tradiA common line of thought is that China’s private banking industry is tional platform for our onshore business, but we are now building an independent platform for our expanding offshore business. But effectively handstrung by the lack of product available to investors. it’s a challenge. Our offshore platform must be localised according to I think this is more about how one understands the word “prod- jurisdiction. So we have a team that is dedicated to offshore system uct”. Products are essentially tailormade solutions for clients. So innovation. The design of the whole system is coordinated by our solutions like non-banking products or legal advice can also be con- headquarters, but engineers from all over the world are involved. sidered products.

Clearly you see sufficient promise in your offshore business to Do you think business would be easier if you had access to a wider dedicating such a large amount of resource to it? range of more complex offerings?

Everything revolves around our clients. Our offshore plans are These are early days for China’s private banking industry. We do not driven by our clients’ demand for offshore services, even though simply rely on financial tools to attract clients. We believe that by the offshore business is not where our strength lies. We are still in providing clients with customised solutions, we are more likely to the process of figuring out how best to build our offshore business. contribute to the long-term development of the business and of the What I can say is that whatever we do will reflect our core belief that “our clients come first”. industry as a whole. We are not strictly profit-oriented.

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INDUSTRY

Regulatory malaise putting stress on China’s private banking industry amid capital outflows: experts Chinese authorities are not moving fast enough when it comes to compliance reporting and the tracking of illegal cross border capital flows, industry experts tell Asian Private Banker.

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hile the State Administration of Foreign Exchange (SAFE) has seen some success in recent months, swooping on several underground banking dens – including a US$64 billion Zhejiang-based operation – for illegally moving money offshore, a cadre of Chinese banks have themselves been implicated in money laundering incidents, or have been the subject of punitive action for having inadequate controls.

Most notably, Bank of China (BOC) is currently embroiled in the ‘River of Money’ investigation into a flow of over €4.5 billion (US$5.1 billion) from China into Italy between 2006 and 2010, of which €2.2 billion (US$2.5 billion) is alleged to have come in via BOC’s Milan branch, netting the bank an alleged €758,000 (US$855,627) in commissions. In a similar case, ICBC, the world’s largest lender by assets, had its Spanish headquarters raided by European authorities over the alleged laundering of €40 million (US$45 million). Five of the bank’s directors were arrested.

Illegal capital outflows can have a dual impact on institutions’ private banking clients. First, they can weaken a bank’s credit stability, potentially compromising the value of client assets. Second, private banks face additional pressure (and costs) to assess their own clients to ensure compliance.

And yet, as Yang Tiecheng, Beijing partner at law firm Clifford Chance, explains, neither issue has been effectively addressed by Chinese authorities, who have yet to offer clear guidance as to what their approach will be to the Chinese private banking industry.

“I think the market, especially from investors’ point of view, is looking forward to consistent rules on investor protection [because] different regulators issue different rules on private banking business,” Yang says.

In China, private banking and wealth management services for high net worth individuals are not only offered by banks, but also by trust, securities, asset management and insurance firms.

But because the private banking industry is not directly regulated, it must contend with multiple watchdogs issuing inconsistent regulations.

Currently, the two most fundamental legal documents Chinese authorities rely on to track capital outflows and to regulate banks’ antimoney laundering measures are the Guidance on the Statistics and Declaration of International Receipts and Payments via Banks (Huifa [2016] No. 4), and the Guidelines for Financial Institutions (FIs) on Their Risk Assessment on Money Laundering and Terrorist Financing and Classified Management of Clients (based on Yin Fa (2013) No. 2).

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The former is issued by SAFE, while the latter is jointly issued by the People’s Bank of China (PBoC) and the China Anti Money Laundering Monitoring Analysis Center (CAMLMAC).

Both documents are limited in scope, however, and Chinese private banks await further guidance on how to better to protect the interests of clients – and themselves.

The Guidance document was most recently updated in March this year. The intention behind the amendment was to make domestic banks and relevant parties provide more detailed statistical declarations of international receipts and payments via banks.

This is an integral part of SAFE’s day-to-day surveillance process, given the prevailing trend of falsifying trade records and invoices to move funds offshore, according to Michael Thomas, AML senior advisor at global financial services firm, Wolters Kluwer.

“The PBoC introduced regulations to make the banks do risk-based assessments on their clients in Jan 2013 [referring to Yin Fa (2013) No. 2], but the authority doesn’t seem to be enforcing them rigorously,” points out Thomas.

“Now the industry is waiting for new regulations to work with.”

With major Chinese institutions allegedly finding themselves on the wrong side of the law, the challenge facing Chinese regulators is to balance the dual task of controlling turgid capital outflows in the aftermath of the A-share market meltdown, and regulating onshore Chinese private banking operations overseas.

But without a comprehensive regulatory framework to latch on to, Chinese private banks must themselves shoulder the burden of due diligence – particularly when onboarding new clients – notes Thomas.

Indeed, in the wake of the Panama Papers fiasco, there has been a sudden shift of money away from exposed shell companies and into new structures involving onshore private banks and wealth managers.

Presently, the Enterprise Credit System (ECS) – established by the PBoC as the standard for compliance reporting – does not extend across all banking areas, and is therefore unable to account for the overall credit risk facing banks.

“Because business in Chinese banks is more complicated than ever, [it is expected that the ECS remit will expand] from the basic corporate banking business to derivatives,” says Jocelyn Gao, banking regulatory intelligence expert at Wolters Kluwer.

But China’s regulators must move faster, given the rise of non-banking financial players such as P2P lending platforms. To be sure, the onshore rise of fintech solutions will only make it more difficult for authorities to monitor – and regulate – capital flows.

INDUSTRY

Overdue diligence: China’s WMP time bomb to weed out industry pretenders

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Around one third of China’s gargantuan RMB 70 trillion (US$10.6 trillion) wealth management product (WMP) market – or RMB 23.5 trillion – has been issued by commercial lenders, with investors egged on by sky-high advertised yields and the government’s (implicit) seal-of-approval. However, after a string of major defaults, Chinese investors may now be primed to alter their approach to risk. This bodes well for the country’s ‘more serious’ wealth managers if they are willing to play the long game and demonstrate their acumen as providers of advice and product to China’s blooming investor class.

I am grateful for the life-saving advice you all offered me back then,” writes an anonymous individual on a Chinese user-generated Q&A forum with 250 million monthly page views.

In 2014, the user asked the online community if she should buy product from Zhongjin Capital, a wealth management firm that, earlier this year, was outed as an archetypal Ponzi scheme that allegedly cheated investors out of RMB 39.9 billion (US$6.1 billion).

Zhongjin’s deceit had been well-masked by its multiple highend offices in Shanghai, an endorsement from pioneering female pool player, Pan Xiaoting (nicknamed “Queen of Nineball”), and an advertising campaign on state-run Shanghai TV that ran during a prime time dating show.

Still, the collapse was by no means an outlier incident.

In a similar episode last year, peer-to-peer lending firm Ezubo was also revealed to be US$7.6 billion Ponzi scheme; and yet, the firm - named 2015’s “online credit financial brand of the year” by National Business Daily in China - had looked like a sure thing: it had held an annual meeting in the Great Hall of the People in Tiananmen Square; participated in the 12th China-ASEAN Expo; and even debuted its own militia at an event attended by the People’s Liberation Army.

If nothing else, both incidents point to the risks of conflating due diligence with ‘implicit state approval’. In this sense the grateful forum user can consider herself to be among China’s more diligent class of investors, having reached out to the online community for advice before pulling the trigger.

But research shows that many Chinese investors are still overconfident in their abilities and generally unwilling to pay for advice when peers continue to reel in yields, whether from sound loans, risky credit assets or Ponzis.

And this overconfidence is not limited to the retail community.

According to a 2015 report by Scorpio and UK-based asset manager, M&G, individuals with a networth of US$15 million rated their own investment knowledge at nearly 70/100; but in a simple test scored less than 45/100, giving a gap of 25 points (for individuals with less than US$5 million net worth, the average gap was less than 10 points). Chinese HNW investors fared marginally better, with an average gap of 15 points.

Perhaps more worryingly, however, is the emphasis Chinese investors place on digital media when making investment decisions. In a recent survey, 48% of respondents ranked digital media as their primary source of advice. The survey also revealed that those who rely on digital media tend to have the weakest financial knowledge.

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INDUSTRY

The danger of relying on the digi-sphere for advice was brought to a head when cancer victim, Wei Zexi, used a Baidu search result that was skewed towards advertisers to inform his decision to borrow money for treatment at a Beijing military hospital.

Following Wei’s death, cyberspace regulators told Baidu that it had until 31 May this year to clean up its search engine.

More optimistically, Chinese investors are among the world’s most ambitious when it comes to advancing their investment knowledge, on average aiming to achieve an 80/100 score, according to Scorpio and M&G’s report.

Just how deeply investors decide to probe underlying assets going forward remains to be seen, but one would suspect that, in the face of defaulting WMPs and waning confidence in the state’s implicit seal-of-approval, more Chinese investors will be rethinking their approach to due diligence.

A WHOLESALE RISK PROFILE SHIFT

Following the 2013 taper tantrum, Asian HNWI’s previously insatiable hunger for control and yield subsided, as evidenced by turgid inflows into lower yielding income funds and an increase in discretionary portfolio assets (an Asian Private Banker survey found that 44% of private banks grew their discretionary assets by 20% in 2015). According to multiple sources, this switch was especially pronounced amongst Chinese clients who, exasperated by market turbulence, curtailed their self-directed ways.

To be sure, onshore Chinese wealth managers are unlikely to channel the country’s still nascent wealth pool towards mature strategies such as discretionary mandates; but if they can tame those wilder expectations of 25% yield and better educate investors on the value of risk, then this will have a long-lasting effect on China’s investment industry.

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This is especially true for wealth managers that remain confident in the Chinese Communist Party’s ability to transition the economy towards domestic consumption. If and when this happens, Beijing’s reliance on providers of goods and services to the middle class will only increase, and this should give rise to a universe of stocks and bonds whose value is supported by bottom-up analysis.

Regulators this year have already provided a leg up by asking commercial banks to cut rates for WMPs, according to media reports. By all accounts this was a welcome move for lenders that did not want to be the first to lower yields amid margin pressures.

INDUSTRY

trustworthy providers of product and advice. Indeed, should the Chinese government allow a material number of banks to default on WMP payments, investors will likely pay less attention to advertised returns and, instead, home in on those distributors with low default rates.

This goes for international and domestic players alike.

Already Morgan Stanley, UBS and Goldman Sachs are among the biggest onshore bond arrangers, ranking 24th, 32nd and 47th, respectively. International financiers of this ilk possess a wealth of resources and intellectual capital that can help them build out their bond advisory offerings and challenge the local competition.

REMOVING THE PARTY’S TRAINING WHEELS THE LONG GAME

From a commercial perspective, a Chinese slowdown, mounting bad loans and, most recently, the People’s Bank of China’s decision to hold rates in anticipation of a Fed hike, are putting undue stress on banks’ profits, with the sector growing at its slowest rate in a decade.

In 2015, profits for all commercial lenders rose a mere 2.4% compared to 9.6% a year earlier, and this stagnation is expected to continue through 2016, according to J.P. Morgan analysts.

Furthermore, high-profile China watcher, Charlene Chu, estimates that bad loans could reach as high as 22% this year, dwarfing the official state figure of 1.75%.

Those banks that are tempted by short-term profit generation are doing two things to weather the WMP storm. One is to maintain or increase distribution to feed local demand, as deposit rates remain artificially low (the 12-month rate for fixed deposit rates is just 0.6%). The other is to sidestep the risk posed by non-performing loans by shifting them from balance sheets into WMPs and having Ma and Pa investors foot the bill – a practice that remains widespread according to sources.

But for those wealth managers that are happy to play the long game, they have the opportunity to establish themselves as

The Chinese world of income investing has traditionally operated on a central tenet - that the Party’s blessing, explicit or implicit, is a hallmark of security (Daiwa analysts point out that state-owned enterprise ratings are traditionally taken as near-sovereign in the credit market). Even this year, investors followed this rationale, with the S&P China Corporate Bond Index yield-to-worst falling to 3.41%, buoyed by a record RMB 158 trillion issuance of WMPs in 2015.

“This is the moral hazard WMP buyers are applying, not just to underlying assets, but to issuers and distributors,” comments an alternatives specialist from an offshore private bank.

“They believe that as long as there is [implicit governmentbacking], products will not default.”

But on March 29, yields spiked by 35.9% following a RMB 852 million default by Dongbei Special Steel, mere days after 53-year old Yang Hua, chairman of the state-owned Liaoning-based steelmaker, reportedly hung himself in his home.

Fast forward to the end of May, and there have been 22 domestic bond defaults - as many as there were for the whole of last year while corporate bond yields have climbed to 3.8%.

It’s anyone’s guess just how toxic the WMP pool which accounts for 16.8% (2015) of the deposit system is, and whether things will unravel as a result of government inaction or, conversely, overzealous government bailouts.

Hedge fund manager, Kyle Bass, has said that potential losses in the overall system could dwarf those experienced during the subprime mortgage crisis by five times. Other less bearish onlookers believe that PBoC governor, Zhou Xiaochuan, has enough fiscal firepower to avert a major disaster and is, in fact, calmly observing the situation as it evolves.

Irrespective of the outcome, there can be little doubt that China’s growing investor class will come to learn that nothing can substitute for sound fundamentals and research when picking a play. Serious wealth managers with their eyes on US$4.5 trillion China prize would do well to nurture this windchange.

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TECHNOLOGY

One bank, two systems: the fragmented tech space in China The digitalisation dialogue is well underway on the Chinese Mainland, with private banks dedicating chunky budgets to ambitious blueprints. Industry experts, however, are less convinced that Chinese private banks are where they need to be. Describing the market as fragmented and straddled, with a number of players operating two different systems, those in the know tell Asian Private Banker that Chinese private banks are today are facing a host of tech challenges.

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at Mainland banks prefer “building systems” over “buying off the t’s what Wang Jing, general manager for China Merchants self ”.

Bank Private Banking, calls “a big challenge” for her business.

However, building a platform from scratch means that a bank “Our offshore platform must be localised according to must be ready to maintain and tweak the system itself – which is no jurisdiction. So we have a team that is dedicated [solely to] small task, according to Peter Scott, general manager Asia Pacific offshore system innovation,” Jing tells Asian Private Banker. at Avaloq.

Indeed, running two systems without fragmenting client data is “Systems at Chinese private banks are still aggregated, bespoke a major imperative for any private banking outfit, for the simple and built over a period of time,” he points out. reason that when systems talk to one another, the opportunities “They are not as integrated and harnessing big data are that much this will prove to be a hurdle as regmore. ulatory requirements change.”

However, with onshore systems While Ong agrees, he expects typically characterised as “prehisSystems at Chinese private banks are that things will change as regulatoric”, private banks are finding still aggregated, bespoke and built over a tory requirements become more it difficult to adapt to the rapidly onerous. evolving regulatory demands period of time. They are not as integrated “The trend at the moment is very offshore, George Ong, CEO of Axiand this will prove to be a hurdle as much to build rather than buy syssoft, a private banking technology tems,” he confirms. vendor based in Hong Kong says. regulatory requirements change.

“However, as the industry goes Ong believes that these banks through standardisation and the would be better off installing agile need to be more customised at a systems that are easily adaptable. pace that is in line with regulatory “Onshore banks need flexible changes, there will be a change in systems that can aggregate data the way private banks use technolwith minor configurations, for ogy, with the introduction of external vendors to add adaptability.” example a rule based system that allows various types of account Yong Zhao, general manager China at Wolters Kluwer, believes structures, easy change of telephone numbers and variances in zip this preference for inhouse technologies is a symptom of the code addresses,” he notes. onshore industry’s adolescence.

“The system needs to have a strong data dictionary.”

“Currently, many domestic private banks in China [use] in-house technologies, ” he says.

BUY VS BUILD “However … the motivation [to use external vendors] is cerTo the dismay of external technology vendors vying for a slice of tainly higher [among] the bigger banks that sit on more consumer China’s private banking pie, a major reason why onshore systems data to harness and analyse.” are lagging behind their international competitors is that COOs

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TECHNOLOGY

Many Chinese private banks are opting to ‘build’ when it comes to their onshore operations, but ‘buy’ for their offshore businesses.

Salomon Wettstein, an integration advisor at Synpulse, says that, until now, banks’ energies have been directed towards their offshore systems, where use of external technology vendors is more pronounced.

“Rather than focusing on internal operations ... Chinese private banks are looking at how they can best optimise solutions in their Hong Kong and Singapore branches,” Wettstein observes.

Indeed, a number of Chinese private banks currently use Avaloq or Temenos systems offshore.

For example, China CITIC Bank International and Agricultural Bank of China use Avaloq in Hong Kong, while CMB and Bank of China use Temenos. Bank of China also uses FinIQ, a structured product distribution provider and its Singapore branch has invested in a reporting and risk management tool built by AxiomSL. By comparison, non-Chinese private banks remain ahead of the curve.

Major players, including Credit Suisse, DBS, Julius Baer, UBS, Standard Chartered, Bank of Singapore and Deutsche Bank, all believe that the days of purely inhouse systems are numbered, and have opted to import tech solutions from external vendors.

SHRINKING BUDGETS

Buying a system is an expensive endeavour, and beyond means of many onshore players.

Compared with their American, Swiss and pan-Asian counterparts, Chinese private banks dedicate considerably less of their total spend to tech, according to Charles Wong, CEO and co-founder of Hong Kong-headquartered private banking solution, Privé Financial.

“Budgets for private banking technology developments [at Chinese private banks] are smaller than they are for regional counterparts such as the Swiss-headquartered private banks in Asia,” he comments.

The reason why, according to Ong, is that many Chinese private banks have yet to reach critical mass, and so investing external technologies for a single unit is financially imprudent.

“While many Chinese private banks do have a sizeable budget dedicated to their tech spend, it is often not as big as their retail arms, and so private banks use shared resources” says Ong. A recent poll of tech vendors conducted by Asian Private Banker reinforces this point. When asked if Chinese private banks’ tech budgets will come to outsize those other their regional counterparts, an overwhelming 72% of technology vendors said they did not think so.

For instance, COOs are spending north of US$60 million and Credit Suisse Private Banking, DBS Bank and Deutsche Bank Wealth Management have outlined 5-10% year-on-year increases in technology spend in 2015.

ALLOCATING TO THE MIDDLE

Even if tech budgets ultimately fall short, a useful (if crude) indicator of where a private bank stands with its digital strategy is the distribution of its budget across the entire business.

For example, China Merchants Bank (CMB) Private Banking, the largest onshore player by client assets, spends more on technology than any other item on its offshore balance sheet, with the private bank currently building “a set of brand new systems for its offshore expansion,” according to general manager, Wang Jing.

More specifically, the tech focus at Chinese private banks tends to be on product lifecycle management systems that sit across the middle and back offices. “[Onshore banks] are at a very early stage where investments remain in the middle to back office dealing with the operations of the bank, such as risk management or portfolio management systems,” says Ong, adding that when private banks tend to leech off the group’s stronger retail arm, there’s a greater need for robust middle office trading systems.

“They are at a very early stage where investments remain in the middle to back office dealing with the operations of the bank, such as risk management or portfolio management systems,” says Ong, adding that when private banks tend to leech off the group’s stronger retail arm, there’s a greater need for robust middle office trading systems.

AND FINALLY, FINTECH

Particularly in China, the fintech space is alive and kicking, as evidenced by the successes of early movers Alibaba, Baidu and Tencent. For this reason, industry experts expect to see more

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TECHNOLOGY

fintechs masquerading as financiers and, ultimately, eating into private banks’ business.

For one, fintechs have the upper hand in terms of being able roll out their product offerings on a large scale, Zhao points out.

Wong agrees, observing that there are already a number of mobile apps that allow high net worth individuals (HNWIs) to trade for free.

The meteoric rise of Alibaba’s money market fund, Yuebao, is a compelling case in point. In 2014, Yuebao raised a few billion renminbi over a three-day period, with a total of 2.5 million users signing on in the first month of its release. Over eight months, it gathered RMB 400 billion (US$65.3 billion) in assets under management; and by 2015, Alibaba’s ANT Financial Group was valued at a staggering US$60 billion.

Even so, private banks, at risk from disruption, are choosing to accommodate these upstart fintechs rather than fight them.

As Zhao points out, it makes little sense for private banks to change their operating models to cope with a multiplying army of fintechs. Partnership, on the other hand, can be a mutually beneficial exercise.

“This would also benefit fintech firms who are looking to leverage off a large consumer base and harness higher volumes of data for their big data and mobile solutions,” adds Zhao.

Wong, too, believes that cooperation is the best option for Chinese private banks hoping to keep pace with fintech startups.

“What we will see in the future is for fintech companies to connect to centralised platforms and leverage their digital capabilities to trade all asset classes,” he says.

So, in the face of countless challenges, whether tight budgets, clunky inhouse systems, regulatory demands, and the headache of monitoring two systems in two separate jurisdictions under

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one bank, are domestic wealth managers fighting a losing battle on the digital front?

The simple answer is no; and, oddly enough, the silver bullet may be regulation.

REGULATORY REWARDS

In a survey conducted by Asian Private Banker, 58% of respondents cited regulation as the biggest barrier for a private bank that is mapping out its technology strategy.

However, regulation is also a catalyst for change, with many institutions turning to tech solutions to stay compliant.

With anti money laundry (AML) guidelines becoming more onerous, Chinese private banks will focus on technology that helps it meet these requirements, says Davis Wong, from law firm Simmons and Simmons.

“Technology investments will be regulatory driven in China, particularly as the People’s Bank of China (PBOC) is increasing its understanding of the high net worth space and enforcing stricter AML guidelines to combat the finance of terrorism services,” he says.

Zhao agrees, listing a number of major onshore players that have turned to Wolters Kluwer’s AML solutions due to tightening regulations.

The PBOC has been relatively lax on banks over the past few decades. However in 2014, it published new guidelines through the Anti-Money Laundering Monitoring and Analysis Centre (AML MAC) and the anti-money laundering bureau.

Thus, as the regulatory landscape continues to evolve and interact with private banking models onshore, so will private bank’s tech blueprints. And may erode the glaring gap between banks’ onshore and offshore systems.

INDUSTRY

A chat with…

Kenny Lam, group president, Noah Holdings Limited NYSE-listed Noah Private Wealth management is the largest independent wealth manager in China, with almost 100,000 clients, each with an average net worth of US$30-50 million. Asian Private Banker sits down with Kenny Lam, group president of Noah Holdings, to discuss the firm’s strategy for the China onshore market.

Kenny, 2015 was a good year for Noah.

Yes, in terms of scale of business, 2015 was a good year. We did around US$16 billion in new assets – US$1 billion came from our Hong Kong office, which grew more rapidly than our China [business] given the need for global diversification. At the same time, our China business grew around 30% last year and should maintain strong growth amidst global volatility. But we are also learning from mistakes we have made and are still trying to improve. We are a small firm in many ways and in order for us to stay competitive with the established global players and leading banks in China, we have to stay focused and agile.

At 95,000 HNWIs, your client base is the biggest in China and almost twice the size of leading Chinese private banks. How have you gone about raising the firm’s profile?

Not simply by chest pounding, but by explaining our proposition to clients. If you asked me five years ago why clients should choose Noah, it would be difficult to answer because we didn’t have a global network. But now you see a lot of Chinese clients, when they go offshore, they come to us. A major reason for this is that our relationships are all onshore.

So imagine all these HNW clients who are now in second-tier cities, many of whom have businesses and are extremely wealthy but are not high profile. Many of these clients are covered by our physical network. That’s our strength. We cover around 67 cities with 135 branches and 1,100 relationship managers (RMs).

And your presence is concentrated in second and third-tier cities?

About 60% are in second and third-tier cities. We started in Shanghai, but we quickly moved south and west. We think that

China’s wealth growth is driven by entrepreneurs, and for us to be a unique player against the big banks and globals, we need to start with the engine of the economy, which is entrepreneurs.

The banks focus on their wealth management arms, because they have a selling machine. The problem is, the richer you are, the less you care about how nice the branch is and the more you care about the investment capabilities. Today, our average client is worth US$30-50 million, and he purchases three products a year, at US$1.5 million per transaction.

So we’re the largest private equity (PE) fund and real estate fund of funds in China. If you’re thinking about buying PE, there’s nowhere else to buy, because we are the exclusive distributor for leading global PE firms. The way we’ve been able to capture the market against the big [banks] is by treating our asset management business as the core engine. So if you look at our [WM] offices, they tend to be less opulent and lower profile, and not one of those ‘singing and dancing’ private banking wealth centres.

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How do you identify and target prospective clients?

We start in each city the same way. There’s usually some business association that we can look at and say “what are the top 30 firms in that city”, and we start building from that point on.

rodent but after the type of wood that was used to construct Noah’s ark. Second, the team mix. Third, my view of the market. If you look at the whole private banking market globally, the biggest pie no doubt will be Asia. But there are two types of market: onshore and offshore.

I think the offshore market is highly saturated, and is a small piece of the pie. The real money still sits onshore – in China, Taiwan and Indonesia. The problem with foreign banks is that they can’t build enough of a network. But it’s not just networking, it’s about product speed. Foreign banks’ compliance sits in Hong Kong and Zurich. Our compliance sits in Shanghai, so I know what risks to take and what risks not to take. Foreign banks have dominated the offshore market and they have great global expertise. But in the onshore market, domestic players may have more of an advantage.

So you cold call?

Our method is to explain our investment philosophy. If you look at our client numbers, they were flat for a long time, before growing substantially around 2012 due to word of mouth. So it’s not how well you sell, but how well your investments have performed.

When noone was talking about PE, we were telling investors about PE. After a three or four year period, when we started having some distribution (around 2011/2012), our clients started seeing some amazing returns from our investments. You don’t see any commercials or public advertiseI think the offshore market ments. We try to be discreet.

Does your sheer size today make you more of a regulatory target or is highly does it shelter you?

Currently the regulators treat us saturated, and is a small piece of the as a prime partner. I’ve seen the Why did these global PE firms pie. The real money still sits onshore – regulators more in the past two choose Noah to be their exclusive months than in the last year and a distributer? in China, Taiwan and Indonesia. The half. Why? We are one of the largest I’ll use an example. One of these problem with foreign banks is that they in wealth and asset management, firms DD’d (due diligence) us for and so they come and say to us, two years. I said to them at the can’t build enough of a network.

“We want to see what you’re doing.” time, “We’re a pretty small-capped We’ve been screened three times in firm, so why us and why not large the last twelve years to make sure bank?” They said, “Look, we need we’re doing the right things in terms to first diversify into the HNW of sales, risk profiling etc. After that, retail space, and where is the biggest space in the world? It’s China. And if you’re looking for a partner they asked us to work with them to define certain standards in the in China, you need to find a LP [limited partner] base that is edu- market. There’s no private banking regulation in China – just securicated, because these are not easy products.” Last year we put on ties and insurance regulation.

The story of Noah’s roots centres on the firm’s ability to exploit a 60-70 seminars, each attended by 300-400 clients. These are not to push product but to educate clients. We created an education unit loophole in domestic regulations, to gain first mover advantage, and about two years ago – the only one owned by a wealth manager that to effectively force the regulator’s hand by getting yourself listed on is licensed by the Education Bureau in China. Last year we trained the NYSE. How accurate is this?

I DD’d this firm a lot when I was at McKinsey. It’s indeed a grey 20,000 prospective and existing clients on WM. So when these guys saw us, they said, “Wow, we’ve never seen a firm spend so much time area when this firm was started, because nobody was focusing on private banking in 2003. [Our endorsement by authorities] was not and resource on education.”

If you look at these big banks, they tend to be volume driven and driven by our listing on the NYSE; it was much more about a surge very transactional. And so if you’re selling PE products – how do in client acceptance between 2007 and 2010. Because we are not you explain to your client what a PE fund is, and that you must lock state-owned, clients were asking, “How can I give you more wallet your money in for 7 years? You can’t do that on a typical bank plat- share if you are not supported by a big state-owned and I can’t see form. We think that super HNWIs will have a lot of allocation to PE your numbers because you’re not listed?” So we realised that in hedge funds and real estate, and those investments need education order to gain scale and trust in this space – and Sequoia Capital as a starting point. You can’t just say “Buy this product, one million was behind this – we either needed to be part of a big bank or get listed in the most stringent market. And that’s why we didn’t pick dollars, seven years, and come back later.”

NASDAQ – it had to be NYSE. After that, we got more attention, because we were the first firm listed. The regulators came in and What led to you to join Noah from McKinsey?

Three reasons. First, the culture is extremely values driven. Noah’s said “Wow, you’ve created an industry (there are now about 130 Chairman, Ms. Wang Jingbo is a devout Christian – hence the name firms like us in China, even though some are much smaller) and so Noah. The asset management firm is called Gopher – not after the you need to get a license.”

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What was that license?

The CSRC (China Securities Regulatory Commission) came to us first, and told us to acquire a fund distribution license. A few years later, in 2012, we decided that we wanted to manage, so we got an asset management licence. We are now fully governed by CSRC. In Hong Kong, we were the first Chinese firm to be fully licensed with series 1, 4, 9, trust and insurance.

I don’t think so. You see clients shifting in product mix. Before it was mostly about fairly active PE investments. Now it’s PE, fixed income and insurance. They’re even shifting assets out of China. Two years ago we were talking about a USD product that’s only single digit returning and nobody would listen. Now they come and say, “If it’s stable, high single digit, then fine.” Clients are starting to understand that they can’t be Warren Buffet everyday.

So you’re saying that it’s a misconception that Noah is operating is Is it difficult is it to do DD on WMPs? We have product people at each of our branches in China, and these regulatory ‘no man’s land’?

A lot of foreign banks’ perceptions about us are misguided. They professionals actually go and look at the underlying assets. In 2015 we could have said this about us six years ago, but if you knew the looked at 2000 products, and after DD and screening, only 151 were amount of times the regulators have visited us, there’s no way you approved. This process it what you usually see at a global bank. For Noah, it’s the core, because othercould conclude that we’re operating wise, if you burn your client once, in a ‘no man’s land’. Last year we sold the trust is gone and it will be very US$16 billion of products – that’s We consciously sold a smaller amount hard to recover from that. more onshore than some leading banks were selling across Asia in one of fixed income products in the fourth How do you manage your cost year – so there’s no way the regulators quarter (2015) because we believed that base? would say “Please go ahead in this no Our margin has always been man’s land and continue operating.” a substantial proportion of the products around 30-35%. Most of the cost being offered in the market as “fixed is people – and half goes to the What impact have the recent Ponzi front line, which totals 1,100. scheme revelations had on your? income” were, in fact, Ponzi-like schemes.

We consciously sold a smaller Where do you find your talent? amount of fixed income products in We get a lot of talent from major the fourth quarter (2015) because we banks. I remember an institubelieved that a substantial proportional investor asked three of my tion of the products being offered in the market as “fixed income” were, in fact, Ponzi-like schemes. These top performing RMs why they would come to Noah from a major. other WMs go on the market and say “Here’s a 13% product guaran- Their response was that they find our platform deeper and products teed for 5 years.” Of course they’re able to attract funds – but we’re more unique, so they find it easier to talk to clients about asset allonot doing any of that. In the first quarter of this year, the regulators cation. clamped down on a lot of those guys.

Once you reach bulge bracket status, oversight of your branches and RMs becomes a much more onerous task. How are you managing?

Does this competition worry you?

Our worry is much less about competition in general, and more We’re experiencing this right now, managing 1,100 RMs in 67 cities. about the market. The HNW take-up of private banking is very low in We are a lot more stringent. We have an audit team of 12 that goes China. In China if you are rich, you put your money in a retail bank. around conducting spot checks, and a stringent compliance system The question is not for me is to compete with large private banks for where we publically name and shame any RM that breaches regulaclients that are already with a private bank. Our challenge is in con- tions. vincing clients to put money in active investments. The one worry I have is this: in the early stages you have a lot of players coming in Is there any concern that if Governor Zhou keeps his word and interclaiming to be wealth managers, and they are attracting less-educated nationalises the RMB by 2020, and suddenly there’s real global asset clients who then get burned. This is going to disrupt the market, and allocation for domestic Chinese investors, you’ll find yourself comyou see this already now. The regulators are extremely tight on sales peting with the likes of UBS and Morgan Stanley? and risk profiling. The key about China is social stability, and if you I think that they will come eventually – I don’t know when – but we have a lot of people getting burned by wealth managers, the only reac- never think that we can be the only leading firm in China. If you look at the US, as a mature wealth market, you have there a mix of firms. tion from the regulators will be “shut it down”.

But I believe that there will be a few Chinese private wealth manageWhat will be the aftermath of this latest Ponzi scheme fiasco? Will ment firms that will become prominent globally. One of them could be Noah. investors have short memories?

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DISCRETIONARY PORTFOLIO MANAGEMENT PEER-TO-PEER CONNECT 2016 June 21, 2016 | 9:00am - 12:45pm | JW Marriott, Hong Kong

The DPM Peer-to-Peer Connect is designed for leaders of discretionary allocations at the private banks. For the 20 selected leaders, the morning will encourage sharing and learning, and foster connection between the heads of DPM allocations at the private banks.

This dialogue between peers is held in an intimate, off-the-record and collegial style, hosted

by Asian Private Banker and its editorial team.

To submit an application for participation, please email: koye.sun@asianprivatebanker.com.

For more information, visit apb.news/dpmphk2016

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