A first look inside HSBC’s China JV

It has been along time coming – and that’s putting it mildly – but HSBC’s mainland investment banking joint venture is finally approaching the start line.

It’s still not quite done – there are China Securities Regulatory Commission inspections to be held, specific licences to be awarded, individual tests to be passed – but we can finally say with certainty that HSBC Qianhai Securities Limited will soon be open for business.

In his office in HSBC’s Hong Kong headquarters, Gordon French, head of global banking and markets for Asia Pacific, reflects on a process that has, one way or another, lasted rather a long time.

Setting up the venture “goes back 12 years,” he says, “and maybe even slightly longer than that.

“There were times along the way, including in recent years, when we did get close to setting up joint ventures but decided it wasn’t going to be the right structure, the right framework, the right partner or the right design, and pulled back.”

For a long time, all that was on the table was the less-than-ideal joint venture structure that has been employed by many foreign investment banks over the years: a minority stake in a JV alongside an established domestic partner.

There were quirky exceptions – both Goldman Sachs and UBS, among the first in, got either more licences than the others or a greater degree of management influence, in sometimes elaborate structures – but basically the only available option was to be the smaller partner in somebody else’s show.

None of the JVs, from Citi Orient to Deutsche’s Zhong De Securities, could really be said to have been a knockout success: all of them making a contribution but dwarfed in securities business by the big home-grown brokerages.

Their contribution to overall China investment banking profitability at those houses has, by and large, been negligible.

JPMorgan got fed up and sold out of its JV earlier this year.

Then, in 2013, the Mainland and Hong Kong Closer Economic Partnership (CEPA) came into being and, in particular, Supplement X, among whose sundry clauses was this: “Hong Kong-funded foreign-invested securities companies will be allowed to set up one full-licensed joint venture securities company each in Shanghai, Guangdong Province and Shenzhen… the maximum percentage of aggregate shareholding of the Hong Kong-funded institutions is 51%.”

It doesn’t look much, on paper, but for HSBC this was an enormously important shift. It meant two things: that, provided HSBC put it in the right place, it appeared to be permitted to launch a joint venture within which HSBC, not the local partner, would have control; and, better still, that among all the international peer group, only HSBC (and Standard Chartered, which has different priorities) appeared to fit the bill.

“When CEPA came into being, Stuart Gulliver and other senior people spotted the opportunity to aim higher,” says Irene Ho, CEO and general manager of the new venture, speaking in her first interview on the subject. When word of CEPA X’s likely concession started circulating in 2012, HSBC’s senior staff formed a task force to study it and set out to find a partner, starting dialogue with the Qianhai authorities, in a district of Shenzhen, in 2012.

Finding the right partner required a quite specific set of attributes. It needed to be a partner in one of the cities where these new JVs would be permitted, one with a decent track record but young enough to allow the JV to be basically a greenfield set-up, and , crucially, a willingness to let the foreign partner be in charge.

Qianhai Financial Holdings back then – and still today, to an extent – was little known outside of China or even Shenzhen. So why them?

“Best partner, best situation,” says French. “Qianhai is in the Pearl River Delta, so the location is ideal. The connectivity with Hong Kong is also attractive, but this JV will have national licences and will allow us to do business for global clients. It would have been very hard for any other partner in any other location, because this is the only partner to have given us all those things and ticked all those boxes.”

And a willingness to cede majority control of the venture?

“CEPA X gives us that optionality,” says French. “But yes, the willingness of our partner to do it for the first time in a partnership with HSBC was crucial.”

In that respect, it was perhaps helpful that Qianhai was not an established heavyweight but was finding its way in financial services. 

“We grew with the partner,” says Ho. “Qianhai Financial Holdings was at quite an early stage when we started talking, but they seized the opportunity to work with HSBC, and they themselves started delivering, promoting financial innovation in Shenzhen and Qianhai.” 

Since the two began talks, the Chinese partner has seeded other financial services companies, and led a consortium to buy ACR Capital Holdings, the owner of Singapore’s largest reinsurance firm. They issued bonds, including one through HSBC, a debut 2.5-year Rmb1 billion ($161 million) dim sum in April 2015, attracting an order book over Rmb13 billion.

“They don’t need the money,” says Ho, “but wanted to help develop the markets and promote their brand.”

French adds: “They developed their skills and experience along the way and built up their capital base. It feels like the right time for them to work with us.”

But finding the right partner, and striking terms with them, was only part of the process.

Getting the joint venture agreement done took “quite a long time,” says Ho, about three years from first discussions to formal application, but when the application was submitted to the CSRC in November 2015, it seemed like the rest was a formality.

On November 2 that year, HSBC proudly announced the deal, saying the agreement demonstrated the bank’s long-term commitment to China, its aim to build a business at scale in the Pearl River Delta, and its confidence in the development of China’s domestic capital markets.

Indeed, the Pearl River Delta business was one of HSBC’s 10 strategic priorities it had outlined in its investor update in June that year.

“The establishment of the joint venture securities company will be subject to regulatory review and approval,” the release added. And that turned out to be quite the waiting game.

In the months that followed, the market and media (Euromoney included) became more and more puzzled by the time it was taking to get that approval.

It had appeared, when HSBC announced the venture, that they must have been very confident of getting CSRC approval, and the assumption in the industry was that it was a done deal.

But as one month led to another, and into a second year, murmuring began in the industry. What was going on? Was there a significant problem with the structure? Had changing Chinese policy, and the enormous domestic stock market crash that came in the meantime, nixed the deal?

In the end, HSBC waited 20 months before approval came in June 2017.

HSBC refuses to comment on CSRC or the time taken to secure its approval, except to say that the scale of HSBC’s new endeavour clearly warranted scrutiny.

“This is unprecedented,” French says. “You’re opening up your market to a very large institution who’s going to come in and genuinely compete on some type of level playing field – more so than ever before, anyway. From a prudential perspective, if I was the regulator, I would be treading carefully and kicking the tyres too.”

One can infer, though, that the fact that HSBC dealt with three different chairs of the CSRC must have had something to do with the delay.

Those changes and, in particular, the shift from Xiao Gang to Liu Shiyu in February 2016, also involved a change in most of the key staff.

On top of that, the time between HSBC’s application and approval included a period of enormous market instability in Chinese domestic equities, market interventions, policy changes, a shifting attitude towards outbound movement of the currency, and senior personnel changes across the Chinese state landscape, not just the CSRC.

Publicly, HSBC had very little to say about the delay while it was underway, and one suspects they genuinely didn’t know what was happening behind the scenes at the CSRC. Few who deal with it do: an application could be lost in minutiae at a low level or escalated to the Politburo for all that anyone on the outside is aware.

The venture is, though, a big deal. In every other joint venture to date, the foreign partner is the minority, and few licences typically sit within that venture.

In Citi Orient, for example, which is considered one of the most successful Sino-foreign JVs to date, Orient Securities is the principle enterprise and continues to hold most of the licences; the JV contains a licence with a structure built around it, and there is no overall net creation of new licences.

“In our case,” says Ho, “our partner has no licence and we have no licence, so we are seeking new licences through HSBC Qianhai Securities. The implications are much bigger in our venture, with the foreign partner taking control.”

From Ho’s point of view, this was a structure worth waiting for. “My own opinion was that we shouldn’t go for a minority stake, period,” she says. “I think it’s better for us to be greenfield than brownfield. Although we know a greenfield JV will be difficult at the beginning because you have to start from scratch, it means you can build from a good foundation with the right corporate governance.”

Ho herself was a smart hire to run the thing. She rejoined HSBC in November 2014 after five years at Ping An Securities, a spell that included roles as CFO, COO and eventually president.

Before that, she had been with HSBC since 1997, starting in debt origination, spending a stint in Beijing on secondment to the World Bank, and ultimately being the head of strategy for HSBC Bank (China).

“Irene has been in this industry for as long as anybody, and we wanted her back,” says French. “So, in addition to having all the right qualities and having run a securities company for a Chinese firm, she knew all the right people to approach and was able to hire very good people who had worked in the biggest existing JVs.” 

Ho says almost all the key roles for the venture have been filled with a combination of internal hires from HSBC and those from elsewhere.

“We haven’t been trying to hire superstars,” says Ho. “But collectively we are a good team.”

At the time of the interview in September, the last key hire – the JV’s head of financial crime compliance – was due to start the following week, and many had been in place for a year already, almost three years in Ho’s case.

Finally, she is going to have to get new business cards in which the word “Designate”, in brackets, after “CEO and general manager”, can be ditched.

“We handpicked people internally who would move into this from day one, and we went and sourced from the outside,” says French. “We wanted people who had done those jobs in other firms so we could learn from their experience, both mistakes and successes.”

In the recruitment drive, priority was given to roles such as the CFO, COO, CRO, legal and compliance.

“Why did we do that? Because this is all about risk management,” says French. “You don’t get a second chance on whether it’s a sustainable franchise and whether the control functions can run your risk management to HSBC standards. So, it’s no accident that the first big hires were in those areas.”

From now on, “there is a pretty compressed timeline,” Ho says, starting with the CSRC conducting an on-site inspection.

All of the venture’s senior staff and specific board members have to undergo tests for senior managers on market rules and regulations, specific practices, risk and various other things to demonstrate their experience before they will be granted the necessary qualification for formal appointment.

Only after that can the formal process of licence application begin, with supporting documentation on corporate governance, general staff qualification, policies and procedures, infrastructure readiness and so on.

HSBC has publicly stated it is going for three of the six available licences – anything more than that in one go would be considered absurdly ambitious – and they will be brokerage, a sponsoring and underwriting licence, and an investment advisory licence (which covers research).

They are known informally in the industry as a golden triangle of licences – one really needs all three to build a sustainable business.

The idea is that as HSBC Qianhai proves itself, further licences might be added in time. And in the long run, it might look like HSBC itself.

“It’s potentially a version of what we have in Hong Kong, because we’ll be able to do everything in the capital markets and securities arena, and therefore the only difference will be the design and architecture,” French says.

“Essentially it allows us to do so many more things domestically, as well as bringing global investors – with whom we have very strong traction – into the A-share market and other local markets. As other licences come along, we will start to look more and more like a full service player. And business begets business.”

HSBC is, of course, up against some extraordinary powerful forces in the domestic industry. Names like Citic Securities, China Securities and Guotai Junan Securities boast eye-watering league table numbers that HSBC Qianhai can’t realistically hope to match, and in practice probably doesn’t want to.

The idea in the early days appears to be to harvest the work that comes from HSBC’s existing client base and let the big names in domestic securities go hunting for everything else. Seeing how aggressive HSBC becomes in seeking truly new business will be interesting to watch.

Opinion within the industry has been sanguine, with competitors seeing it as an option that simply isn’t open to them.

“HSBC have done what you would expect them to do with CEPA, but their position is unique because of their Hong Kong funding base,” says one banker with an existing JV. “It’s annoying for us, but I suppose in a longer view it could be good for everyone. If they do this well and don’t stuff it up then you might hope the demonstration effect kicks in and others are allowed to do the same structure.

“Today, though, I’m not holding my breath.”

Another in China says: “Good luck to them. But Shenzhen isn’t where the business is. It’s in Shanghai.”

A third says: “They got their approval, but that’s just the start. Now they have to make it work. And even with management control, I can tell you that is not going to be easy.

“But I kind of hope it works, because they must be being viewed as a test case.”

Then there’s remuneration. The domestic industry operates on a model based almost entirely in commission, with base salaries extremely low by investment banking standards anywhere in the world. When it’s all about the commission, bankers are incentivized to chase new business no matter what it looks like, which clearly isn’t going to fly with HSBC’s own stance on due diligence and client relationships.

HSBC itself says remuneration in the JV will follow the standard HSBC approaches rather than the commission-heavy practices common in mainland institutions.

“We will follow the HSBC international best practices,” Ho says.

This, HSBC hopes, is in line with what China wants anyway: in late August, the CSRC called chairmen, chief executives and compliance officers of mainland securities houses into a town-hall meeting specifically to warn them that living on commission-based remuneration is unsustainable.

The point of JVs ever since the earliest days has not just been about handling domestic IPOs and the like. It has been about providing another channel to a much bigger suite of services.

It helps Goldman’s bigger business in China that it is in a position to assist with domestic securities, even if the Gao Hua structures don’t make any practical difference to the overall bottom line.

Citi has another string to its bow when serving a client active in China that it can point to Citi Orient as an avenue for domestic investment banking work.

This will be a crucial point for HSBC Qianhai.

“We see phenomenal opportunity to deepen the wallet and add more value,” says French. “If we’re right about this, if we have done good things for institutions on investment advisory, brokerage, capital markets and M&A, it would be strange if they didn’t come to us when their custody or cash management mandate comes up, because they will view us as an institution that they can now invite in for those mandates.

“But if we make it too hard for them, and if they feel they are dealing with a different institution, then that will be diminished.”

Making HSBC Qianhai look and feel like HSBC itself will be a challenge, rendered easier by effectively building it from the ground up.

It has been helped in this respect by the fact that the whole of HSBC has wanted this venture to work for a long time.

French argues that the 10 most-senior people who have been involved in the venture at HSBC must have a combined 250 years in the firm: “Senior management at HSBC is completely committed to China. It’s a top priority for all of us.”

Ho agrees.

“I’ve seen lots of the joint ventures come into being, and commitment is key,” she says. “At HSBC, I can name maybe 30 people in senior management who are closely involved in this, and I think that’s essential to making it a success.”

Asked what he learned from the process, French says: “Stay calm. There will be lots of opportunities along the way, but be very clear on what is important to you. Everybody wants to do more business in China, but you have to take the long view and know what your non-negotiables are.”

When the approval finally came through in June, a group of the people involved celebrated in their offices with champagne.

Even as they did so, French was stressing to them that it would be back to work in the morning with a hell of a lot more to do.

That work really kicks off now.