Do Chinese UHNW need Western financial services?
China has seen the number of hedge funds based domestically almost double in 2016, as reported by Bloomberg with 1000 organisations registered reported to be worth $84 billion. Gaining wealthy Chinese UHNW clients has been a long-term target market for the private wealth industry globally, so we wondered what that meant for Western financial services? Will China leap frog Western players or is there lucrative investment work to be had? According to Eric Barnett, CEO of Kleinwort Hambros, life will not be as easy as many might think. Barnett says there is demand from Chinese investors for products such as hedge funds and there is a role for Western expertise in providing them but a lot depends on where the provision comes from. “It is hard for foreign institutions to establish mainland China-based operations and provide services on a level playing field to local competitors. It is an uneven fight,” says Barnett referring to traditional family relationships locally.
However, Patricia Woo, partner at Hong Kong law firm Squire Patton Boggs, says that whilst Chinese families are developing their own family hedge and private equity funds with specialised targets they will need Western players. “These families welcome more sophisticated financial products,” says Woo. “Most hedge funds used by wealthy families in China are long only or long/short equity funds. The value of European players would be to introduce or promote other types of hedge funds such as Managed Futures to broaden the horizon of underlying investments beyond equities.”
Chinese financial services trail Europe
Despite Chinese guanxi making entrenchment difficult, Eric Hu who is an associate at Squire Patton Boggs says there is first mover advantage for Western financial services: “The financial market in China, having a late start, mostly follow the development trails of the West. Overall, there are similar categories of financial products in both regions, although each category of financial product may be in a different stage of development and has different market share. Having said that, some financial products are structured in context of regulatory constraints. For example, as a special route under the controlled foreign exchange system in China, funds are set up under QDII which is the Qualified Domestic Institutional Investor regime to allow Chinese investors to invest in certain foreign securities markets.”
One size does not fit all
Woo adds that Chinese UHNW clients should not be considered a homogenous group. While the first generation is conservative and less used to sophisticated strategies, the younger generation, usually overseas educated, have had exposure to alternative asset and strategies and are more receptive to Western style financial products.
Chinese wealthy families have had a long history in investing in Chinese trusts which to some extent work like unit trusts but with explicit or implicit guaranteed return. “Therefore, from time to time, we come across Chinese investors with similar expectations when they explore financial products developed by non-Chinese players,” says Woo. “The guaranteed return expected by Chinese wealthy families would usually be higher than fixed income instruments offered by Western institutions. The key is to help them understand the differences in the dynamics and practices of different markets and therefore products,” concludes Woo.
“An IPO is one of the key methods to help Chinese families generate liquidity offshore and to extract private wealth from corporate wealth,” explains Woo. “For Western financial institutions, it helps to build a close working relationship between the investment banking department and the private banking department. Wealth planning such as succession and tax planning and even family office services help get the client on board and it lock them in,” she says.
London remains a safe-haven
Eric Barnett agrees and says: “Chinese investors are interested in utilising the services of institutions in London and elsewhere. Not just because of greater expertise. That may be a factor in some niches but it is patronising and wrong to assume they don’t have our sophistication. But they are interested in us for purposes of diversification of risk and the use of London or other jurisdictions as a safe haven for investments. This is likely to be the case for some time yet.”
Chinese wealth ‘grows up’
Although the alternative investment sector in China is still relatively young, Eric Hu sees some trends that favour Western methods. “Despite the overall higher risk tolerance, Chinese clients are increasingly asking for preservation of their wealth rather than more speculative strategies,” he says, “which means different service capabilities and service providers.”
Hu also thinks foreign investments will carry more weight in investments portfolios, as Chinese entrepreneurs expand overseas. “I suspect independent wealth management companies will benefit over banks,” says Hu. “Although, Chinese clients are increasingly becoming more sophisticated and interested in investment opportunities that are not traditional.”
However, long-term growth will ultimately depend on what direction the Chinese authorities take over the years to come. If President Xi Jinping keeps up his efforts to boost markets and service industries, the alternative investment sector should reap benefits for everyone. Which would seem to make China and its benefit for Western financial services, a watching brief.