Taiwan bouyant on China hopes

Euromoney, June 2008

For a sense of the buoyant mood sweeping Taiwan today, take a look at the stock market. In 2008 up to May 16, with China, India, Indonesia and Malaysia down by double digits and Hong Kong and Singapore not far short, Taiwan is a rare positive exception: amid the global credit crunch, it’s risen 7.7%.

The reason for the uncommon optimism is chiefly political. On March 22, the Taiwanese voted in a new president, Ma Ying-jeou. But the reason the markets have responded so favourably to the victory has nothing to do with Ma’s vision for domestic policy: it’s all about China.

Ma’s predecessor, Chen Shui-bian, was not a popular figure with China, and the feeling was mutual. Chen was a pro-independence figure who wanted statehood for Taiwan, rather than the curious halfway house it occupies today: a strong and successful democracy, but with no official standing as a world state, unable to participate under its own name anywhere from the Olympics to the United Nations. Chen’s stance certainly had a following among Taiwanese, but it came at a cost: relations with China were consistently difficult under his tenure and the impact on Taiwanese business has been drastic.

President Ma has come to power on a platform that promises much closer cooperation with China. The feeling is that, while in an ideal world many Taiwanese would like independent statehood, they don’t care strongly enough about it to accept the economic handicap that comes with it. Ma has had to tread a fine line politically, ensuring he doesn’t appear to be giving everything to China, but his message of closer engagement was enough to win the election.

“There ‘s a definite change of mood for the domestic economy here in Taiwan,” says Matthew Smith, a research analyst at Macquarie Research in Taipei. “A dead hand had been in place for longer than a decade with the restrictions on economic links with China. This dead hand is now being lifted, and the relief that’s being felt from that is driving a lot of optimism.”

While there are plenty of iconic measures that will demonstrate this newfound friendship – the one that will grab world headlines will be when direct flights commence between Taiwan and mainland China, which should happen from July, albeit only on weekends – one of the areas that stands to benefit most is the financial services industry. Taiwanese banks have not been permitted to acquire Chinese institutions, and have only been able to serve their clients’ activities on the mainland in a limited way, usually out of Hong Kong subsidiaries. Mutual funds managed from Taiwan have been unable to invest in Chinese securities. And this matters because Taiwanese businesses and individuals generally, not subject to such restrictions, have been highly active in China: it has been estimated Taiwanese have US$150 billion in investments in mainland China.

It has been a source of immense frustration to Taiwanese banks to watch their clients head into China but be unable to follow them. Everything ought to be in their favour: language, proximity, and to a lesser extent culture. Now, there’s a chance that Taiwanese banks will get a chance to compete. One of the first policy pledges that have been made is to remove a long-standing 40% cap on the amount of their net worth that Taiwanese companies can devote to China. In reverse, Chinese companies will be permitted to make strategic investments into Taiwanese listed companies. “Previously, they considered each other the enemy,” says CY Huang, president for greater China investment banking at Polaris. “Now it will be a two way flow. And of course these investment activities will need money, so there are going to be more financing activities, which is good for banks and securities companies.”

Huang adds: “How do you help a small Taiwanese company in China? There’s a severe credit tightening there and many Taiwanese companies will be affected; they may need creative solutions.” That’s now an opportunity for Taiwanese banks that can build Greater China offerings, whether for corporate finance, risk management  or treasury.

Also, a very significant transaction looks close to taking place. For years, Fubon Financial, one of the country’s biggest financial holding companies, has been sounding out a Chinese commercial bank based in Xiamen. The plan has been to acquire it through Fubon’s  Hong Kong subsidiary, and the Hong Kong Monetary Authority has been acting as a behind the scenes broker for the Taiwanese and Chinese authorities. It has been slow progress but in March Taiwan’s Financial Supervisory Commission announced it would allow Taiwanese banks to use their overseas subsidiaries to invest in mainland Chinese banks. All that remains is for China to approve it.

“We hope that we can close the transaction around the end of June or early July,” says Victor Kung, president of Fubon Financial. “We would like to see the same kind of banking services that we offer here in Taiwan offered in China as well.”

The progress of the Fubon deal will be closely watched. If it goes well, other deals are likely to be allowed; if not, that will clearly have consequences too. Those close to the deal say it is important not to get too carried away, though. Under the latest rules, banks will only be allowed to hold 20% of a Chinese bank. Besides, the approval is only for Hong Kong subsidiaries with $6 billion in assets. And at the moment, Fubon’s the only one with the muscle in Hong Kong to do it.

“It is significant, but there are not many Taiwanese enterprises that have the financial muscle, the recognition and the international savvy to go abroad,” says Huang. “Apart from Fubon, there are a few like Cathay Financial Holdings, but maybe only four financial institutions have the capacity and motivation to do that.” Sinopec has been rumoured to be looking at purchasing a bank in Hong Kong, and has been linked with the banking assets of Ping An there. “But you shouldn’t expect a lot of Taiwanese financial institutions rushing to do this,” he says.

It’s not especially practical, either, to do things through the subsidiary. “It probably makes a lot more sense for them [regulators] to hammer out an agreement whereby banks can operate directly,” says Smith. “Buying an institution of this size [a sufficiently large Hong Kong subsidiary] is a fairly significant investment and there aren’t that many banks in Hong Kong that are up for grabs. If all you’re trying to do is get into China, it doesn’t make a lot of sense to go to Hong Kong first.”

Nevertheless, it’s a landmark, and will provide more benefits than the bottom line contribution of a Chinese stake would initially suggest. Clients that might not deal with a Taiwanese institution at all might bring a whole book of business over once they know there’s going to be representation for them on the mainland.

Certainly, the banking system needs a fillip. It used to rely on unsecured consumer credit for margins and profits; that market crashed two years ago and the industry is only now recovering from the debt burden.  Instead, two areas tend to sustain the banking sector today: wealth management, and small to medium enterprises.

The wealth management story rests on the increasing wealth of Taiwanese people – it’s a prosperous economy known for its entrepreneurial zest – and their growing willingness to diversify assets out of the most mainstream asset classes.

It does face headwinds because of the global economy. “Wealth management is contingent upon global capital markets,” says Smith. “Most of this is about getting money offshore and so far this year it’s been pretty tough, the markets don’t look great. Most products that are being sold are along the lines of fixed income, which carries lower profit for the institutions that are selling them.” That said, “if things turn around, and eventually they are going to, it will be a good source of wealth management income for those who are able to do it.”

Lucrative as these sectors are, there are an awful lot of banks chasing them. Even after a round of consolidation, Taiwan boasts almost 40 banks for a population of 23 million.

Nevertheless, plenty of foreign institutions see the attraction in buying Taiwanese institutions, particularly the flagging ones that the FSC has taken over and then sold off. Among the multinationals, HSBC took over Chinese Bank, Standard Chartered bought Hsinchu International Bank, Citigroup bought Bank of Overseas Chinese, ABN Amro bought Taitung Business Bank (and was actually paid to do so, such was the state of its loan book), and DBS acquired some assets of Dowa Bank. Then there are the private equity deals, with Carlyle, GE Consumer Finance and Longreach among the names to have bought. According to the FSC, the foreign share of Taiwan’s banking sector was 15.8% in March, up from 4% a few years ago, and it’s likely to continue to climb. Private equity funds are now being linked with another small bank, Suny CHECK.

One reversal of this trend came recently when Temasek, the Singaporean state-backed investment company, said it would pull out of its own investment in a Taiwanese institution, called E-Sun. That said, few are particularly concerned about it, noting that two other institutions in which Temasek has stakes, DBS and Standard Chartered, also own Taiwanese banks, so that E-Sun may have presented an overlap in the portfolio.

Foreigners like the idea of getting a branch network very cheaply, and a platform to build on, for areas such as wealth and asset management, and also to assist with China business. Some of them are finding other ways to exploit the market’s growth potential too. In May, Citi launched three Taiwan index-linked exchange traded certificates to be listed in Hong Kong, part of a new family of tracker products called C-Tracks. “We see increased interest from our clients to invest in Taiwan,” says Dickson Cheung, managing director, Asia Pacific Structured Products and Head of Greater China Sales at Citi.

Another possibility for increased activity is Taiwanese real estate. Huang reckons openness with China will boost Taiwanese property on three fronts: overseas Taiwanese working in China, who haven’t previously considered purchasing property back home because of the inconvenience of travel but who will now find themselves an 80 minute flight from Shanghai to Taipei; multinational managers who service China and are sick of paying Hong Kong rents; and mainland Chinese, whether tycoons or ordinary individuals. “Taiwan for them is a symbol, a mystery land: they can go anywhere else in the world but not Taiwan,” he says. The lifting of that veil should prompt investment, Huang says, and that’s also good for the financial services industry.

While all the attention is focused on China, some analysts believe there are reasons for optimism domestically too. “While waiting for cross-strait ties to develop, we believe investors should, in the meantime, focus on domestic policies – the low-hanging fruit,” says Credit Suisse analyst Ernest Fong in an April report. In particular, a NT$3.99 trillion infrastructure project, called i-Taiwan 12, is “the most ambitious infrastructure program to be undertaken in Taiwan in decades,” Fong says. “Conversely, we believe expectations of short-term benefits to airlines and hotels, from improving cross-straits ties, may be overstated. While warmer ties between China and Taiwan are likely, they require time.”

BOX: Revamping the stock market

Stock market reform has come to Taiwan. The Taiwan Stock Exchange has launched a plan to merge the country’s various exchanges and platforms, and to list them next year.

“We don’t have a concrete plan on the amount of capital to be raised: we’re at the pre-IPO stage,” says Rong I-Wu, chairman of the Taiwan Stock Exchange. But it is clear that the float will involve the merger of the stock exchange, the Gre Tai Securities Market second board, the Taiwan Futures Exchange, and the Taiwan Depository & Clearing Corporation into subsidiaries of a single new holding company.

Why? “One reason is it will be more efficient and cost-effective if we merge the cash and the futures,” says Wu. “Secondly we can push forward consolidation to promote our strategic direction for the future development of the exchange. We understand we cannot isolate our exchange only in Taiwan: we need to extend our market, to talk about finding a strategic alliance with an exchange in the US or Europe. The ultimate aim is that enterprises of all shapes and sizes can raise capital in Taiwan’s capital market.”

In other measures, the TSE is introducing a lower trading cost for the securities borrowing and lending market; faster execution on short selling; and easier off-exchange transactions;

Foreign institutional interest is growing in Taiwan’s market. The total trading value of securities was US$274 billion in the first quarter of 2008. Stock exchange representatives have roadshowed to New York, London, Hong Kong, Singapore and the Middle East recently in an attempt to attract capital and to tell the Taiwan story, apparently with some success: in the first four months of this year foreign investors accounted for 24% of trading volume compared to 20% last year, and for 31% of overall shareholdings. Foreigners like not only the valuations (though they’re climbing) but the liquidity: an over US$700 billion market cap, combining the approximately 700 TSE companies with the 550 on GreTai, and US$1.2 trillion in trading volumes between the two markets in 2007. Regulation and transparency are considered good by regional standards.

Bankers in the country like what they see. “It’s good for Taiwan,” says CY Huang. “All international stock exchanges are consolidating with each other. The Taiwan market cannot afford to be too fragmented.”

“Ultimately what it [the TSE] should do is open its venue to other regional companies,” Huang adds. “If you look at Hong Kong and Singapore, they are successful because they have not limited themselves to Hong Kong and Singapore companies. They’re open to all across the region.”