Asiamoney: the honeymoon’s over in Taiwan

Asiamoney, October 2010

Here are some titles of recent analyst reports on Taiwan. “Taking another step down.” “Fundamentals weakening.” “Increasing risk in H2.” One continues: “Late August has brought a gloomy feel to Taiwan.”

It’s an odd backdrop to what is meant to be a transformational, symbolic phase in Taiwan’s history. On Sunday September 12, the Economic Cooperation Framework Agreement between Taiwan and mainland China came into effect, 11 weeks after its June 29 signing. From now on, Taiwan is supposed to start reaping the benefits of the rapprochement with China that has characterised President Ma Jing-Yeou’s two-and-a-half-year administration. Among other things, tariffs on 539 Taiwanese products entering the Chinese market will be reduced or removed, representing about 16% of Taiwanese exports to the country; it’s a better deal than the Chinese have got in the other direction, where tariff reductions cover only 267 items representing 10.5% of that trade.

So why the long faces in Taipei? Partly it’s because, regardless of cross-Straits issues, Taiwan faces a lot of headwinds from other external issues. When Credit Suisse reduced its target for the TAIEX index from 8,500 to 7,300 (it was 8,157 at the time of writing) it was chiefly on the back of a weakening outlook for technology on the back of slowing demand. Credit Suisse has slashed its forecast too, from 7600 to 7200, for similar reasons.

But also, there’s a great sense of anticlimax in Taiwan, and it is most keenly felt in the financial services sector. “The signing of ECFA is of course a boost, but to other people it is a let-down,” says CY Huang, who is CEO of financial advisory group FCC Partners, chairman of the Taiwan M&A and Private Equity Council, and chief advisor to the investment bank Polaris Securities. Allen Wu, senior vice president and head of institutional investor relations at Yuanta Financial Holdings, adds: “The process seems too slow. [Taiwan/China] is open now in a sense. But has there been a practical effect yet? Not really.”

Hopes had been high. The financial sector is one of the areas that had suffered most when relations with China were coldest, because they have had to watch in isolation as others have benefited from exposure to China’s economic boom. They have been unable to serve corporate clients in their business in China, private banking clients who want to invest in China, or to offer individual mutual fund investors products within any Chinese exposure. All this was, and is, meant to change. “The financial sector had hoped the agreement would be equal to or better than CEPA,” says Daniel Wu, president of Chinatrust Financial Holding Company, referring to the Closer Economic Partnership Agreement signed between Hong Kong and China in 2003. That agreement, after several rounds, has involved more than 200 liberalization measures across 38 service sectors. “Unfortunately, the outcome from the first round of negotiation was a bit of a disappointment.”

So what has changed so far? A memorandum of understanding has been struck between Taiwan’s Financial Supervisory Commission and the China Banking Regulatory Commission to allow greater involvement of each country’s banks in the other’s territory, and this has been enshrined in this first round of ECFA. From the Taiwanese standpoint, banks will be permitted to upgrade their representative offices to branches one year after being set up (as opposed to two for most foreign rep offices). Perhaps more significantly, these branches will be permitted to offer RMB-denominated banking services after two years of operations, provided the second year was profitable; they can do so after one profitable year, but only to serve China-based Taiwanese businesses. This is a big difference to the norm: foreign banks generally must wait at least five years for this privilege, so on RMB lending Taiwan has leapfrogged from being banned to preferential treatment. These concessions are part of what is known as the “early harvest” list within ECFA.

Seven banks have received approval to upgrade their rep offices in China to branches, and are awaiting approval from the CBRC to do so, which it is hoped will happen later this year. Five are state-owned: Hua Nan Commercial Bank, First Commercial Bank, Taiwan Cooperative Bank, Chang Hwa Commercial Bank and Land Bank of Taiwan. Two private sector banks, first Cathay United Bank and then on September 16 Chinatrust, have FSC approval too.

Surely that’s good? Well, for Chinatrust, it is, but it’s less than expected. Chinatrust had hoped to set up a subsidiary, not a branch: it had planned to invest RMB3.2 billion into the subsidiary and to launch both retail and wholesale business there. Having a branch – if CBRC approves it – will certainly help, since it will allow more comprehensive corporate banking services. “In the first phase we will target our China-focused Taiwanese manufacturing clients,” Daniel Wu says. “It’s been a long time that we cannot serve them properly. We’ve been waiting eight to 10 years: now we can start serving them right away.” Wu plans to inject RMB800 million RMB into the branch, four times the minimum, in order to chase the business as aggressively as possible. “Based on our database there are 20,000 Taiwanese enterprises in China, but if you add up the upstream and downstream, the total could be 140,000, and that number will keep growing,” he says.

But a branch can’t take RMB deposits under RMB1 million, and that means no retail – which, for Chinatrust, is a key franchise. It also effectively means no wealth management offering, which again for Chinatrust is a mainstay in Taiwan. “We’ll have to bear with a branch for a while,” says Daniel Wu. “We believe in the second round of negotiations, which will start at the end of this year, we may be able to do that.”

But if Chinatrust is disappointed, that’s nothing on securities companies. This part of the market has been completely ignored by ECFA so far and for them, nothing at all has changed with this new agreement. “The banking sector feels excited but the securities sector feels it completely missed the boat,” Huang says.

Why not securities companies? Allen Wu says Taiwan’s security association approached the regulator from the start to ask for an opening into China, but notes that Taiwan’s regulator has “just opened a very tiny door for mainland Chinese financial institutions” in Taiwan and that the block on Taiwanese securities houses going into China is probably a quid pro quo. “It is too early for us to come in, and so far we are not even included.” Consequently cross-straits relations have been something of a damp squib for Yuanta, the only financial holding company in Taiwan to have concentrated its business on securities; “the opening of securities with a full licence or full ownership in China is most important to us,” he says.

Financial institutions beyond those with branch approval are approaching China in different ways. For years, the most closely watched was Fubon, which in 2008 bought a 19.9% stake in Xiamen City Commercial Bank in what was widely seen as a test case for Taiwanese engagement with the mainland. This bank, based in Fujian province, has applied for a branch licence in Chongqing and plans new outlets in Zhangzhou and Wenzhou, bolstered by Fubon’s money; in August the bank said it would inject RMB500 million this year and the same amount in 2011, through Fubon Bank (Hong Kong), which legally holds the Xiamen Bank stake.

More recently, SinoPac holdings and some of its subsidiaries have signed memoranda of understanding with China Huarong Asset Management Corporation on September 3, including personnel training, exchange of management experience and information, research, and product development. Taishin Financial Holding said on September 9 it plans to sign a cooperation agreement with Nanjing Zijin Investment (Taishin Bank also plans an office in Nanjing). Far Eastern International Bank is believed to be close to an agreement with Bank of Chongqing.

But, while there’s progress, there’s also a concern that political momentum behind cross-straits openness may be waning. On November 27 there will be municipal elections in five major cities: Taipei, Xinbei, Taichung, Tainan and Kaohsiung. They will tell us just how much Ma Ying-jeou’s support has dropped, which will have an impact on the pace of further engagement with China. Analysts are watching this closely. “An additional setback in sentiment for the KMT could limit their ability to push through new policies that open up to China in the run up to the elections and affect the balance of power post election,” says Randy Abrams at Credit Suisse. “If the DPP looks like it has a chance of recovering power, the assumptions made about cross-Strait relations may need to be adjusted.” There is still tension here: although ECFA was passed by Taiwan’s parliament without a single dissenting vote, that’s only because the opposition refused to take part in the vote. The DPP still wants formal independence from China and there’s nothing to say it won’t return to power sooner or later and unwind many of the measures that have taken the last two years to adopt.

The DPP is tapping into a fear about the converse of the ECFA arrangement: that, with improving access for Taiwanese institutions in China, there must come increasing opportunity for mainland groups in Taiwan. Many find this alarming, picturing ICBC coming in and either buying the nation’s finest institutions or beating them with their extraordinary scale and resources. It’s true that Chinese banks are getting involved – Bank of China and Bank of Communications applied on September 7 to set up representative offices in Taiwan, which under ECFA can subsequently apply for upgrade to branch status – but those on the ground say the fears are ill founded.

“There is a general fear that Chinese institutions are too big – that if ICBC or Bank of China takes a strategic stake in a financial institution they may swallow it or pose a significant threat to other institutions,” Huang says. “That is generally not true. It shows insecurity and a lack of confidence in Taiwanese institutions. It is not size that makes the difference: the fear is totally unnecessary.” For the moment Chinese institutions are heavily limited in the stakes they can take: 10% can be Chinese held, but each strategic investor is kept to a maximum of 5%. This limitation on Chinese access is hardly helping when the Taiwanese regulator seeks greater access on the mainland for Taiwanese institutions.

Huang believes that Taiwan’s rejection of the proposed sale of Nan Shan Life by AIG to Primus Financial Holdings in August reflects these same fears and objections. “That’s also a reflection of two things,” he says. “Firstly, that Taiwan has taken a very hostile attitude to private equity in general, and also the fact that because Primus is a Hong Kong-listed company, people assume Chinese money is behind it. That casts doubt in PRC institutions’ minds about whether they can participate in the Taiwan financial sector at all.”

All these things have led to a gradual dissipation of the excitement about Taiwan. Back in May 2009, Taiwan was trading at a 53% premium to the region, higher than any other Asian nation. By late August 2010, though, that premium had fallen to just 10%, and it’s still falling now. Net foreign selling in the four months to that time represented a cumulative 0.4% of national market cap, which, while not a damagingly large number, was second in the region only to politically uncertain Thailand.

Still, maybe it’s all about patience; for a visible sign that things are changing one only has to go to the airport and take one of the 370 direct flights per week between China and Taiwan after sixty years of no such connections. They serve a constituency of about one million Taiwanese who base themselves in the mainland, many near Shanghai; that weight of numbers is an unstoppable force in affecting change eventually. The first round of ECFA is not the finished article but a framework within which other things can be done; Allen Wu is still hopeful that the FSC will ask the China Securities Regulatory Commission to include securities in the next batch of ECFA talks, and Daniel Wu has the same hopes for subsidiary banks.

“ECFA is in line with everybody’s expectations,” says Allen Wu. “Maybe it just takes time. A lot of things need to be done. But it’s a good start.”

The Council for Economic Planning and Development said in September that Taiwan’s economy should grow at 5% a year through 2017 thanks to the China trade deal. It may prove that the events of the last year have underwritten Taiwan’s continuing economic success; it’s just that the financial services sector is getting increasingly impatient to enjoy a share of it.

BOX: TDRs

A lot is demanded of Taiwan Depositary Receipts. They are expected to coax Taiwanese capital that has left the country to come back home, and then to attract the Chinese growth story into Taiwanese investment markets. A big ask.

TDRs are listed vehicles much like an American Depositary Receipt, in that they represent a block of underlying shares on some other exchange. They have existed for more than a decade, but interest in them has been galvanized in the last two years as a method of helping the local capital markets benefit from warmer relations with China.

The first aim was to bring Taiwanese companies back home. Many companies have opted for listings in places like Hong Kong and Singapore, in large part because those markets bring with them no restrictions on investing the proceeds in mainland China. TDRs, it is argued, are a perfect way for those companies to seek a second listing now that those restrictions are largely gone: they can attract a loyal and hungry investor base, and support their country of origin too.

This began to happen in 2009, with TDRs from companies like Want Want China, a manufacturer of rice cakes and flavoured milks in China owned by the Taiwanese Want Want Holdings; and Yorkey Optical, a Taiwan-backed manufacturer of optical equipment which, because of its plant in Guangdong, had opted for Hong Kong rather than Taiwanese listing.

The greater hope, though, has always been that the TDR could start to attract Chinese companies in their own right – or at least the red chip companies that, while legally Hong Kong corporations, derive all their business from the mainland. There’s plenty to recommend it: Taiwanese investors are wealthy and have been starved of Chinese investment opportunities. They are a natural source of liquidity for a Chinese company (indeed, most TDRs trade at a considerable premium to their underlying shares – often over 20% – because of this scarcity value relative to demand. One, Solargiga, has traded as high as three times its Hong Kong price.)

A significant deal took place in August when Yangzijiang Shipbuilding Holdings raised NT$4.5 billion in a TDR issue. Yangzijiang is registered and listed in Singapore, but its main assets are in China. This has been billed the first mainland company to list its equity in Taiwan. “The first stage was Taiwanese companies listed in Hong Kong and Singapore,” says CY Huang at FCC Partners whose former employer and current client, Polaris, has been a leader in TDR issuance. “The second was foreign companies, such as Singaporeans, such as Oceanus [an abalone company from Singapore which launched a TDR in December]. Now we’ve moving to the third stage, which is PRC-background issuers.”

Huang expects to see many more. “It has tremendous potential,” he says. “The liquidity is very good, the price earning multiple is higher than they would get at home, and in certain sectors like high-tech Taiwan has an advantage in terms of investor understanding. Also it is perfect for small and medium sized issuers who would get lost in Hong Kong.”

Allen Wu at Yuanta says TDRs represent “another way to move capital freely in the cross-straits region. They create another option.” He doubts, though, whether market conditions will be favourable enough for as many TDRs to go through in 2010 as did in 2009.