Chinese Inv Mgmt

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Investment Management

Entering the Chinese investmentmanagement industry*November 2006





China’s rapidly developing and increasingly liberalisedinvestment management sector presents a huge opportunityor international nancial services groups.

The economy is soaring, markets are maturing and thecountry’s increasingly afuent citizens have built uphousehold bank savings o $1.84 trillion. This represents asavings to Gross Domestic Product (GDP) ratio o 80%,a potential bonanza or investment managers.

Early oreign entrants into the investment managementsector have developed a head start through thedevelopment o joint ventures, local talent and businessrelationships. Yet, there is still considerable room orincomers to get in at the ground foor o what remains afedgling market. Looking ahead, greater reedom in bothwho can operate and how unds are invested is set to takethe sector to a whole new level.

• Rising prosperity and increasing pool o savings areopening up considerable opportunities or thedevelopment o the investment management sector.

• The proportion o household bank savings ($1.84 trillion)to GDP ($2.28 trillion in 2005) is 80%. Post oce savingsaccount or a urther $170 billion.

• Development o the investment management sector isprogressing hand in hand with ongoing pension reorm.Recent government initiatives include the licensing o new

Enterprise Annuity Plans (EAPs) and, in July 2006, theauthorisation o the rst enterprise pension plan.

• To date, the government has awarded contracts or nineund management companies (FMCs) to help manage thevast investment portolio o the National Social SecurityFund (NSSF). Such contracts are a prized source obusiness paving the way or managing institutional unds.

• Fund management investment was originally restricted toa limited pool o domestic securities. However, in April2006, the government took the rst step towards allowingFMCs to invest in overseas equities, which could greatly

increase und dierentiation, potential returns andconsumer demand.

• In the past, only domestic trust, investment companiesand securities companies were allowed to set up FMCs.While banks dominated distribution, they were preventedrom establishing investment management arms.However, the rules have been relaxed in recent years toallow banks to set up their own FMCs and insurers arelikely to ollow in time.

• Foreign nancial services institutions have set up jointventure (JV) FMCs since 2002 and have made signicantinroads in the investment management market. By August2006, Sino-oreign JV FMCs managed 30% o thetotal assets under management in the investmentmanagement market.

• The ceiling on oreign holdings has been graduallyincreased (now 49%) in the wake o WTO accession andmay eventually be eliminated.

• The early movers have gained a head start through accessto a wide choice o partners and distribution outlets.However, the rapid pace o development in the investmentmanagement market continues to open up resh openingsor oreign entrants, either through build or buy strategies.

• Relationships with local partners and understanding olocal language and consumer preerences are critical tosuccess. Foreign nancial services institutions will need torecruit and nurture local talent to succeed.

Introduction Overview

Entering the Chinese investment management industry • PricewaterhouseCoopers 1



All eyes are on China. The country has been transormedinto the ‘actory o the world’ since beginning its transitionto a ‘market economy with socialist characteristics’ at theend o the 1970s. Growth has averaged more than 9% perannum over the past 25 years and China is now the secondlargest economy in the world on the Purchasing PowerParity (PPP) basis1. At current growth rates, its GDP willhave overtaken the USA by 2050. Recent economicresearch carried out by PricewaterhouseCoopers suggestedthat China’s economy is currently 76% o the size o theUSA’s in PPP terms and, by 2050 it will be 40% larger thanthe USA’s. On the Market Exchange Rate (MER) basis,China’s GDP will reach 95% o the USA’s GDP in 2050.

Economic expansion has gone hand in hand with thedevelopment o an increasingly prosperous and aspirationalmiddle class that now numbers around 250 million citizens,almost equivalent to the entire US population.2 The double-digitannual rise in Chinese consumers’ disposable income oersa huge opportunity or und management companies(FMCs), both directly and through the investment o rapidly

accumulating bank deposits. According to the NationalBureau o Statistics, the bank savings to GDP ratio at theend o 2005 was a staggering 80%.

Yet while household savings had reached $1,838 billionby the end o 2005, only $58 billion was invested in mutualunds, clear evidence o the considerable room or growth inwhat is still a fedgling market. The potential to be tappedincludes the $25 billion NSSF, which is expected to reach$123 billion by 2010. There are also $123 billion in insuranceund assets, an increasing proportion o which can beinvested in domestic shares.

Pension reorm and the greying o the population areproviding urther catalysts or the development o the

investment management sector. Nearly a quarter o China’spopulation will be over 60 by 2030, according to the WorldBank. Yet, the state pension und in China is not sucient tosupport a greying population. The government is thereorekeen to open up urther opportunities or the developmento private pension unds and encourage more people to takeout private pensions to help make up or the potentialshortall in state pension provision.

Initial Public Oerings (IPOs) are helping to create a moredeveloped capital market (see Figure 2). However, equities

are still a relatively volatile investment. The retention o largegovernment stakes and the reservation o share quotas orhard currency oreign buyers (‘B shares’) also mean that theavailability o tradable equities or FMCs and other localinvestors (‘A shares’) has tended to be limited.

The restricted choice has been a particular issue or FMCsas their investments have so ar been conned to domesticsecurities. Now, in a strong boost or the investmentmanagement sector, a wave o fotations including theBank o China, China Construction Bank and Bank oCommunications, are increasing the range and volume otradable shares.

A urther capital injection is coming rom the introductiono ‘Qualied Foreign Institutional Investor’ (QFII) schemesthat enable oreign investors to invest in domestic A shares.The presence o the QFII is helping to make the domesticshare market more investor-oriented. It is also helpingto provide the impetus or the development o moremodern corporate governance structures including greaterprotection or minority shareholders. Other recentgovernment measures to help increase market liquidityinclude releasing some o its own holdings and beginning

1. China is the second largest economy in the world on a Purchasing Power Parity (PPP) basisand ourth on a Market Exchange Rates (MER) basis.

2. The Chinese Academy o Social Sciences denes ‘middle class’ as having amily assets obetween RMB150,000 and RMB300,000 (circa $18,750 and $37,500). There are around 250million such citizens.

Figure 1 - China: Key Facts (31.12.2005)

Population 1.3 billion

GDP in 2005 $2,279 billion (MER)

Growth 10.2%

GDP per capita $1753 (MER)

Bank deposits $3,752 billion (01.01.06)

Residential savings $1,838 billion (01.01.06)

Mutual und/GDP 2.7%

Mutual und/savings 3.1%

Investment environment

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Growth in number of listed companies ShenzhenShanghai

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Figure 2 - Growth in number o listed companies

Source: PricewaterhouseCoopers

Sources: PricewaterhouseCoopers and the National Bureau o Statistics o China

2 Entering the Chinese investment management industry • PricewaterhouseCoopers



Investment management development

Market capitalisation

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Figure 4 - Market capitalisation

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Figure 5 - Growth in und management companies As a relatively young industry, FMCs are generally leaner,more market-oriented and technologically-enabled than someo their counterparts in other nancial services sectors. Theregulations that govern them are also more uniorm,up-to-date and eective.

The development o commercial investment management inChina eectively began in 1998 with the launch o the rstretail closed-ended unds (CEFs), ollowed by open-endedunds (OEFs) in 2000. Growth since then has been rapid,with assets under management in retail unds nearly triplingbetween 2003 and 2005 (see Figure 3), despite a downturn inshare values on the Shanghai and Shenzhen Stock Exchanges(see Figure 4). There are now more than 50 FMCs managingover 200 unds that range in size rom $6 million to over $5billion (see Figure 5). Institutional asset management is alsodeveloping at pace, with assets under management in therecently launched EAPs having reached $12.5 billion.

Although entry into the investment management market wasoriginally restricted to domestic trust, investment companiesand securities companies, the rules have been relaxed inrecent years to allow any large ‘t and proper’ Chinese

institution to own a majority state in an FMC. Since 2002,oreign companies have been able to set up JVs with localFMCs, though their stakes are limited to 49%. In 2005,

Chinese banks were given the green light to establishtheir own investment management arms and insurancecompanies may ollow in time.

The government’s support or the development o FMCsrecognises the investment management sectors’ importance

in strengthening the institutional investor base (FMCs own46% o tradable shares) and helping to make up or theshortall in state pension provision. Government backingincludes tax incentives or investment management undinvestors. It is also hiring selected FMCs to help manage theNSSF, a prized mandate within the sector. Although themargins on the NSSF contract are limited, the prestige andexperience they coner will provide an important competitiveadvantage as the nascent institutional und managementsector develops and expands.

The accelerating liberalisation o the investment managementsector is highlighted by the recent go-ahead or the NSSF to

establish the country’s rst ‘Qualied Domestic InstitutionalInvestor’ (QDII) scheme. This groundbreaking move allowsthe NSSF to buy shares on the Stock Exchange o HongKong (SEHK), which could pave the way or other unds toinvest overseas – a number o FMCs are known to bepreparing applications to establish QDII unds. The widerchoice o investment and possibility o higher und yields thatwill result rom QDII schemes could attract an infux o newcustom or investment management businesses. Access tointernational markets would also enable Chinese FMCs todevelop derivative and other more eective hedgingstrategies than they are able to use at present.

At the same time, the government recognises the importanceo strengthening consumer condence and bringing rules andregulations up to international standards. This includes newrequirements on governance, disclosure and risk management.


Growth in total AUM (US$ Billion)

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Figure 3 - Growth in total AUM (US$ billion)






Products, customers and distribution

Relatively low rates o return rom bank deposits areencouraging more and more savers to switch some otheir assets to investment unds. Many banks are alsothemselves investing in unds or the same reason. Otherkey investors include the NSSF and the country’s industrialconglomerates, many o whom have been actively investingin both unds and the FMCs that manage them.

The products on oer rom the mainstream FMCs are mostly

vanilla and long unds. Insurance unds and various types ocompanies products are operated by trust companies andsecurities companies, though the reputation o some othese institutions is not always good.

A sign o the rapid evolution o the investment managementsector is the take-o o OEFs over the past two years (seeFigure 6). Their popularity has dampened demand or CEFs,which are now traded at an average discount o 27%. TheChinese government has no plans to promote CEFs or allowconsolidation o OEFs into CEFs or vice-versa. CEFs willlikely be gone once they have reached their maturities.

However, certain aspects o demand do refect what is still ayoung and or many consumers an unamiliar market. A lacko understanding o equities and collective investments may,in particular, push consumers towards what they mayperceive as ‘saer’ money market unds. Such unds areparticularly large and popular in China, as they are in manyemerging markets.

Distribution o OEFs is dominated by banks, many o whomhave also taken on the role o independent custodianrequired by regulation. Some ear that the recent launch oproprietary unds by a number o banks may reduce theaccess to market or independent FMCs. However, in

February 2006 the regulatory authorities introduced newrules to prevent banks rom discriminating against otherunds they sell and there has been no sign that competitionrom banks has led to a slowdown in und launches byindependent FMCs. The entry o insurers could open up animportant new sales channel to both retail and institutionalinvestors. Other as yet untapped outlets include suchinstitutions as the postal savings.

Management ees are generally competitive, ranging rom0.5% to 1.5%. However, returns are oten low by

international standards. Analysis o 100 share unds in theShanghai and Shenzhen markets ound that the averagereturn in 2005 was only 3.8%. While one did manage toachieve a return o 17%, around two-thirds were below 5%.In Hong Kong, by comparison, the highest return was morethan 100% and many unds achieve 30% or more. Theperormance o the Chinese unds refects the decline inshare values and limited availability o tradable equities,though share prices have rallied in 2006 and a number onew issues are in the pipeline.

Up until now it has also been dicult to dierentiatebetween unds and management styles, though this maychange as the investment management market opens upand international rms begin to establish a strongerpresence. The launch o new benchmark indexes and otherdedicated market inormation services are also making iteasier or consumers to compare perormance.

Leading players

As Figure 7 highlights, the investment managementindustry continues to be dominated by the subsidiaries andassociates o trust and investment companies. Huaan, oneo the largest players, is a typical example. It was ormed in1998 under the sponsorship o Shanghai International Trust

Growth in number of

authorised investment funds

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Open-ended funds

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Figure 6 - Growth in number o authorised investment unds


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Figure 7 - Top ten und management companies

(As at 31 August 2006 – ranked by AUM US$ billion)


Source: Z-Ben Advisors



and Investment and our securities companies. Huaan hasconsistently been at the oreront o the market, launchingChina’s rst OEF in 2000.

Although Sino-oreign JVs are beginning to challengethe leading players (see Figure 7), the local FMCs havecontinued to play a leading role in the market thus ar.Merger and acquisition has so ar been inhibited by a ‘oneplus one’ rule that means that a company can only own onemajority and one minority stake in an FMC. However,

the rst sign o what some expect to be wider consolidationhas come with CITIC Trust’s acquisition o a 41% stake inChina Asset Management, the country’s third largest FMC.CITIC also owns part o a JV FMC with Prudential.

Access to the market

Another great advantage o Chinese investment managementbeing a relatively young industry is that the investmentneeded to gain a oothold in the market tends to be arsmaller than banking or insurance. As little as $12 millionto $15 million has enabled oreign investors to establish asizeable stake in a greeneld JV and play a signicant rolein its management and development.

There were 20 authorised Sino-oreign JV FMCs in operation

at the end o August 2006’ (see Figure 8). A number o otherJVs are in the pipeline (see Figure 9).

Figure 8 - Partnerships in operation

Sino-oreign joint venture und management companies (operational) as at August 2006

FMC Foreign partner Local partner Foreign Main FundsEquity Loc.

Harvest Deutsche Asset Zhongcheng Trust 19.50% BJ 12Fullgoal Bank o Montreal Fullgoal 27.78% SH 10

ABN AMRO Xiangcai ABN AMRO Northern Investment Trust 49% BJ 7

China Merchants ING China Merchants 30% SZ 7

Fortune SGAM SGAM Fortune Trust 33% SH 7

INVESCO Great Wall INVESCO Great Wall 49% SZ 7

Fortis Haitong Fortis Haitong 49% SH 5

Guotai Jun’an Allianz Allianz GTJA 33% SH 4

SW BNP Paribas BNP Paribas SW 33% SH 4

China International J P Morgan Fleming Shanghai ITIC 49% SH 4UBS SDIC Hongtai UBS SDIC 49% SZ 4

Everbright-Pramerica Pramerica Everbright 33% SH 3

BOC International Merrill Lynch BOCI 16.50% SH 3

Franklin Templeton Sealand Franklin Templeton Sealand 49% SH 2

AIG Huatai AIG Huatai 49% SH 2

BoComm Schroders Schroders BoComm 30% SH 3

CCB Principal Principal CCB 25% BJ 2

ICBC Credit Suisse Credit Suisse ICBC 25% BJ 3

CITIC Prudential Prudential plc CITIC Trust 33% SH 1HSBC Jintrust HSBC Shanxi Trust 49% SH 1





As Figure 10 outlines, potential entrants can choosebetween setting up a greeneld JV or buying into an existingFMC. The regulator would appear to avour purchase overstart-up at present, though this may change as marketconditions evolve. Possibly mindul o some o the setbacksexperienced in other emerging markets, a number ooreign nancial services institutions have establishedrepresentative oces as a precursor to ull market entry.This patient approach enables the investor to developrelationships, gain rst-hand experience o the market and

then target suitable partners.

The early movers such as ABN AMRO, ING, SGAM andFortis, have gained a signicant head start. Early entryenabled them to have rst or at least a wide choice o talent,JV partners and distribution channels. They have since beenable to nurture this talent and develop the relationships thatare so important in Chinese business.

Figure 9 - Sino-oreign JV FMC (in preparation or negotiation)

Banca Lombarda Guodu Securities

Lord Abbett Yangtze Securities

Alliance Capital Pingan Group

AGF South China Securities

AXA Investment Shanghai PudongDevelopment Bank

Credit Agricole Agricultural Bank Asset Management o China

DBS Asset Management Changsheng Fund

United Overseas Bank Beijing Securities

KBC Asset Management Jinyuan Securities

Nikko Asset Management Rongtong FundManagement

Royal Bank o Canada Minsheng Bank

Figure 10 - Choices between setting up a greenfeld JV or buying an existing FMC

Representative office

Incorporate JV FMC Launch funds

Partner search

Greenfield JV FMC

CSRC authorisation forJV FM & fund launch

Target search

Buy into an

existing FMC

Negotiate & invest Incorporate JV FMC Launch funds

Partner search

Greenfield JV FMC

CSRC authorisation forJV FM & fund launch

Target search

Buy into an

existing FMC

Negotiate & invest

Market research

Strategic decision

Entry options






However, new opportunities are opening up or companieswishing to make their move. For example, the green light orbanks to enter the investment management market in 2005has considerably widened the choice o potential partners,as will the eventual go-ahead or insurance companies toset up their own FMCs. While the leading national banksoer the broadest access to customers, partnership with acity or provincial bank could prove an equally attractiveoption. Unlike the market leaders, many o which havealready established their own FMCs, the smaller institutionsmay not have the resources or expertise to set up theirown investment management operations and may thereore

especially welcome outside support. It is also worthbearing in mind that several o the ‘regional’ banks servepopulations larger than western Europe’s. Moreover, aregional ocus may be more practical in seeking to establishan initial oothold in such a vast, complex and diverse country.

The development o the corporate pension market isopening up urther opportunities. O the 29 companiesgranted licences to set up EAPs in 2005, our arepart-owned by oreign institutions. Other oreign rms haveorged partnerships with state-owned industrial corporations.This includes Societe Generale, which ormed the FortuneTrust and a subsidiary FMC with the backing o Baosteel,

China’s largest steelmaker. Such partnership can oer bothconsiderable capital and a patient long-term approach toseeking return on investment.

Regulation is clearly a key consideration. Although Chinahas been gradually opening up the investment managementsector to oreign investment since its accession to theWTO in 2001, oreign rms are still only allowed to hold amaximum share o 49% in a JV. Although the regulatorycapital requirement is a relatively modest $12.5 million,proposed JVs must undergo stringent vetting by theChina Securities Regulatory Commission (CSRC). Whetherto move now or wait until regulation permits oreigncompanies to control wholly owned subsidiaries is very

much an individual decision, which is likely to be based on anumber o actors, including local opportunities, the group’soverall China strategy and its risk appetite or enteringemerging markets.

Foreign investors should not under-estimate their localcompetitors. Although the local players may not have theexpertise o their international counterparts, a combinationo established relationships and cultural and linguisticunderstanding has given them a valuable head start. As Figure 7 on page 4 highlights, there are as yet noSino-oreign JV FMCs in the top ve FMCs.

Indeed, the quality o relationships is critical, rom JV

partners through to distributors, customers and regulators.Several JVs are the ruit o ties built up over many years.

Domestic partners can clearly benet rom the research,market experience and access to technology o outsiderms, especially now FMCs are about to begin investingoverseas. In turn, local partners oer the relationships andcustomer understanding that are vital or success. As theFMC develops, it will be critical to attract, nurture and retainlocal talent, rather than relying on expatriate expertise.

Ultimately, patience is likely to be the watchword orsuccess in what remains a fedgling market. While there areclearly advantages or companies able to establish an earlyoothold, urther liberalisation and the development ogreater consumer awareness may be required beore theinvestment can come to ruition. Indeed, it may provenecessary to exploit short-term tactical opportunities inorder to develop longer term strategies.




Contacts

I you would like to discuss any o the issues raised in this paper in more detail, please speak with your usual contact at

PricewaterhouseCoopers or call one o the ollowing:

Nick Page, Partner

PricewaterhouseCoopers LLP1 Embankment Place, London WC2N 6RH, United Kingdom.

Tel: + 44 (0) 207 213 1442

Fax: + 44 (0) 207 804 4907

Mobile: + 44 (0) 7808 633 248

[email protected]

Yangchew Ooi, Associate Director

PricewaterhouseCoopers Zhong Tian CPAsLimited Company11th Floor, PricewaterhouseCoopers Center,202 Hu Bin Road, Shanghai 200021, P.R. China

Tel: + 86 (0) 21 6123 2977

Fax: + 86 (0) 21 6123 8800

Mobile: + 86 (0) 1381 787 2897

[email protected]

Andrew Cann, Senior Manager

PricewaterhouseCoopers LLP1 Embankment Place, London WC2N 6RH, United Kingdom.

Tel: + 44 (0) 207 804 2814

Fax: + 44 (0) 207 804 4907

Mobile: + 44 (0) 7900 498 499

[email protected]

Matthew Phillips, Partner

PricewaterhouseCoopers Zhong Tian CPAsLimited Company11th Floor, PricewaterhouseCoopers Center,202 Hu Bin Road, Shanghai 200021, P.R. China

Tel: + 86 (0) 21 6123 2303

Fax: + 86 (0) 21 6123 8800

Mobile: + 86 (0) 1381 611 8614

[email protected]

Subjects covered in the Financial ServicesM&A yer series

1. Russian nancial services M&A

2. Innovative nancing: Lie insurance securitisation

3. European banking consolidation

Recent fnancial services M&A relatedpublications

• Going or growth: the outlook or M&A in the nancialservices sector in Asia (2006)

• Financial services M&A: review and outlook or mergersand acquisitions in the European nancial services market (2006)

• The new deal: FS M&A in an IFRS environment (2005)

• Focus on growth: Striking the right value balance withinnancial services (2005)

• Focus on restructuring: the drivers shaping the nancialservices sector (2004)

Nick Page and Andrew Cann are senior members o PricewaterhouseCoopers Financial Services Transaction Services team.

Matthew Phillips and Yangchew Ooi are senior members o the China Financial Services Advisory (FSA) Services team. Theteam is dedicated exclusively to advising banks, insurers, und managers, private equity houses and other nancial servicescompanies on market entries, acquisitions, disposals and IPOs. Services provided include strategy reviews, commercial duediligence, nancial and tax due diligence, structuring, synergy reviews, operational due diligence, post-deal integration, vendorservices and regulatory authorisation.




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The PricewaterhouseCoopers Financial Services M&A suite o collateral is produced by experts in their particular eld at PricewaterhouseCoopers, toreview important issues aecting the nancial services industry. It has been prepared or general guidance on matters o interest only, and is notintended to provide specic advice on any matter nor is it intended to be comprehensive. No representation or warranty (express or implied) is givenas to the accuracy or completeness o the inormation contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopersrms do not accept or assume any liability, responsibility or duty o care or any consequences o you or anyone else acting, or reraining to act, inreliance on the inormation contained in this publication or or any decision based on it.

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