Banks’ China Dreams Turn Into Real Money
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The list of frustrations about China’s shortcomings as a base for foreign banks and investment firms is long. But many of those companies are increasingly enthusiastic about the profits they are making here.

China, excluding Hong Kong, was the fourth-most-profitable country last year for HSBC Holdings PLC’s unit that trades local currencies, bonds and derivatives for large corporate customers. That business churned out $353 million in pretax profits, up 137%, offsetting losses in consumer banking. HSBC hasn’t disclosed its first-quarter results in China.

At Citigroup Inc., net income in China jumped 95% in 2008 to the equivalent of $191 million, helped by a 20% rise in commercial foreign-exchange transactions. The surge was a sharp contrast to the New York bank’s overall net loss of $27.68 billion last year.

The results show that financial-sector profits in China aren’t just wishful thinking anymore. The banking industry’s woes in the U.S. and elsewhere accentuate the growing importance of developing markets like China and India, even though those countries generate small slices of the revenue and profits at the foreign banks doing business there.

In China, the growth also underscores how Beijing is offering foreign banks, fund managers and other firms more leeway to pursue business despite tight overall restrictions in the country’s financial system.

For example, China strongly controls its currency’s exchange rate and capital flows across its borders, which can crimp the role of foreigners. Still, J.P. Morgan Chase & Co. says it handles about 25% of China’s U.S.-bound dollar transfers, which is similar to its clearing volume elsewhere.

‘Having a controlled currency doesn’t mean there are no opportunities to make money,’ says Lisa Robins, head of China treasury services for J.P. Morgan in Beijing. ‘Our China business is growing and profitable.’

Foreigners also face limits on direct stock-market investment in China. Nevertheless, global money-management firms operated 32 joint ventures last year that controlled almost half the local mutual-fund industry’s $290 billion in assets, generating average management fees of $52 million each, according to Shanghai market-research firm Z-Ben Advisors Ltd.

And even though foreigners technically can’t trade commodity futures in China, some of the world’s biggest trading houses have found indirect ways to trade through local brokers. Non-Chinese firms are emerging as influential players on the country’s four exchanges, including in soybean futures. ‘They are trading large volumes,’ says one bank analyst who follows the sector.

In recent weeks, China has added vigor to a long-running effort to position Shanghai as a global finance and shipping hub. It has pledged pro-market rule changes, new products, technological advances and lower taxes. Despite the global recession, the moves reflect the belief that China’s growing economic might will translate into more money to manage in Shanghai.

The central government is determined to draw global banks, brokerages and other firms to Shanghai over the coming decade, promoting the city as a peer of Hong Kong, London and New York — and as preferable to Chinese cities like Beijing, Tianjin and Shenzhen. ‘It is of both long-term and strategic importance,’ said Liu Tienan, a vice chairman of the National Development and Reform Commission, China’s planning agency.

To reinforce that message, a who’s who of China’s financial-system architects will headline a Shanghai conference starting Friday called the Lujiazui Forum, named for the city’s financial district.

Few lists of top global financial centers spotlight Shanghai. In March, a City of London index ranked the Chinese city No. 35. Its drawbacks include government involvement in everything from who may issue, trade or underwrite stocks to interest rates on bonds. There also are misgivings about Shanghai’s legal, tax and media structures.

Finance represents about 7% of Shanghai’s gross domestic product, slightly less than the rate in New York City but far behind Hong Kong’s 12%.

China’s growth strategy is aimed at establishing a global financial center that retains Chinese characteristics. The government figures the allure of China gives it latitude to retain control of basic levers, including a thicket of regulations governing the yuan. But China’s nonconvertible currency makes it difficult for Beijing to offer foreigners unfettered access to its financial markets.

‘To be a truly global financial center, you need to have full convertibility of the currency,’ says Keith Noyes, Asia director for International Swaps & Derivatives Association Inc.

In derivatives, China’s restrictions may actually enlarge profits for banks since low levels of competition mean they can charge premium prices, which Mr. Noyes calls a ‘tax’ on users. He says the industry would benefit from more competition, higher volumes and lower fees. Even so, he says, ‘I get the sense that those who are involved in the derivatives business are making money.’

In the U.S., Washington has made it a priority in recent years to pry open China’s financial industry. The message was echoed this month by the U.S. Chamber of Commerce, which devoted a substantial section of an annual progress report to what it sees as the need for liberalization in financial services.

Changes in China’s financial industry can escape widespread notice because they often are highly technical, such as digitization of checks, electronic tracking of currency-derivative positions and the use of yuan to settle merchandise-trade transactions.

Some steps have been criticized as plain vanilla. For example, policy makers are touting plans for real-estate investment trusts, which have been around in the U.S. for 50 years. Others changes remain elusive, including China delivering on pledges to allow foreign companies to list and let locals trade stock-index futures.

London-based HSBC has sunk roots deeper into China than most foreign financial firms, and it was one of the first to incorporate subsidiaries here. Overall, HSBC recorded pretax profit of $1.605 billion in China last year, though 80% of that came from holdings in Chinese financial institutions.

For its direct subsidiaries, continued losses in Chinese consumer banking reflected operating hurdles. But HSBC’s banks also have scooped up deposits, giving the bank scope to offer fee-generating services to big companies, such as hedging contracts in the tightly regulated foreign-exchange market.

‘Even if it is regulated, there are movements,’ especially in currency forward contracts, as exchange-rate expectations adjust, says David Liao, HSBC’s Shanghai-based treasurer.

James T. Areddy

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