The UBS experience must be heartening for the new arrivals, because what UBS has done, they can do too. Credit Suisse, inheriting legacy deals from its partner Founder Securities, has been particularly quick out of the blocks: it has already handled corporate bonds for Shaoxing Water Group, Founder Group and Linan City Construction Development. “We believe the underwriting business is quite significant in China, so that’s the area we are going to be focused on,” says Neil Ge, chief executive officer of Credit Suisse Founder. Zhang Liping, who heads Credit Suisse’s overall China business, adds: “This year the market will be mainly dominated by the bond offerings. We expect our revenues will mainly be from bond underwriting.” Deutsche is not yet set up, but as a leading debt house globally it can be expected to follow the same track. “Deutsche Bank has been very successful in these businesses [underwriting] globally and we are also confident of replicating that success in China,” says Lee Zhang, Deutsche’s global banking head for Asia Pacific and chairman for China.
But now let’s look at Goldman Sachs. If one only looked at capital markets, one would think the venture had vanished in 2008. It was involved in no A-share or domestic bond issues tracked by Dealogic at all, all year. It didn’t used to be like this: in 2007 the JV advised on deals including a US$5 billion-equivalent A-share deal for Ping An, the Bank of Ningbo IPO and a landmark $2.7 billion-equivalent corporate bond for Sinopec. But last year it all went away.
There’s no doubt Goldman had a disappointing year in debt in 2008 but Jin-Yong Cai, CEO of Goldman Sachs Gao Hua Securities, says the business has not flagged. “I would not characterise it in that way. We have about 50 people (in investment banking) and that means we can’t do everything. We are trying to focus on the most impactful transactions. What is impactful for our clients might not necessarily be impactful for our league table position.”
He adds: “Globally, underwriting has increasingly become a commoditized business. Fee pressure is everywhere and in China it is particularly acute but it nevertheless remains core to our business.” If “impactful” means M&A advisory, Goldman can demonstrate success: it is representing China Huiyuan Juice Group, China’s largest juice supplier, in its mooted takeover by Coca-Cola for $2.4 billion; it is advising on the tie-up between China Unicom and China Mobile; and represented ICBC in its $5.6 billion investment into South Africa’s Standard Bank.
Does Cai’s assertion about underwriting margins hold up? Underwriting margins are commoditised for sure, particularly on IPOs, but not really all that bad on a world scale. Ge at Credit Suisse Founder says that while equity underwriting fees are lower than the global norm at 2 to 2.5%, bond market fees, from 0.5 to 1.5%, are probably higher. Partnow says on corporate and enterprise bonds, where the bulk of the dealflow is, margins are from 0.8% to a little over 1%, though much lower for financial bonds. And Zhang at Deutsche adds: “China’s securities market is competitive for a reason – namely that a great opportunity exists, and that the growth potential remains very high.”
But what’s really interesting about the Goldman experience is that it seems to have made most of its money far from underwriting. “As we have developed the secondary business we have become dependent much less on underwriting and much more on secondary trading and commissions,” says Chris Keogh, senior advisor to the chairman at Gao Hua Securities (the side with those secondary businesses in it). It’s tricky to get an exact steer on the business since not everything done through the ventures is reflected in their own revenue lines, but the 2007 accounts are revealing: out of a combined RMB3.05 billion in operating income between the two entities, RMB2.84 billion was in commission income, of which only RMB593.19 million was from underwriting – and that was in a much better year for A-share issues. In short, its revenue split is the opposite of UBS’s.
Why? Well, just as the UBS model in its early days has hitched its colours to the emergence of China’s debt markets, the Goldman model appears to be anchored to the emergence of China’s institutional investor base. This is, after all, a very potent target market. “Historically people have been focused on international clients getting QFII quota [qualified foreign institutional investors, who have set allocations to invest in A-share markets] and access to the market,” says Keogh. “That’s business we want to do and aggressively pitch for, but the entire quota of QFII is $30 to $40 billion. That’s much smaller than the $350 billion that’s in the mutual fund industry domestically.” The 40 or so mutual funds that make up this figure are probably also responsible for the bulk of non-retail domestic turnover. While the mutual funds are the most visible part of this picture, there is also great potential in corporate and trust accounts which can do asset management products, and the insurance companies who are steadily being permitted more and more of a free rein to invest funds in A-shares.