HKEX’s China based Strategy: Fruitful Past, Uncertain Future

A key reason behind Hong Kong’s high rank in terms of capital market development, in spite of being the 37th largest economy in the world, is its vicinity to China. Hong Kong acts as a conduit between Chinese companies and international investors, helping Chinese companies access capital from the outside world as well as providing Chinese investors access to investment opportunities in the Asian region; around half of companies listed on the HKEx are from China. Consequently, since the mid-1990s, Hong Kong’s capital market growth has largely been driven by growth of the mainland economy. Hong Kong’s exchange operator, the HKEx group, has built its core business around the China growth story and came out relatively unscathed from the crisis of 2008. A dominant theme in the group’s recent strategy has been to move even closer to the mainland market by connecting to the mainland’s stock exchanges and providing members of two exchanges mutual access. In November, 2014, HKEx launched the Shanghai-Hong Kong Stock Connect program, enabling Chinese investors to trade shares listed and traded in Hong Kong and vice versa; Shenzhen HK connect is planned in the near future. In the last three years China has been opening up the Renminbi (RMB), and Hong Kong is positioning itself as China’s offshore RMB center by building RMB capability and developing diversified RMB products. HKEx is looking to capitalize on this opportunity as well. The mainland’s high demand for raw materials and international trades in commodities is another driver for the HKEx group. It recently acquired the London Metal Exchange (LME) Group to signal its intent to grow a commodity business. Leveraging on this acquisition it plans to build an “East Wing” of commodities clearing for the whole Asian region and during Asian time zone. HKEx’s future prospects, like its historic growth, are contingent on the mainland dynamics. While it has many upsides, too much reliance on China can have downside risks in case of slowing down of the Chinese economy or emergence of policy hurdles. Recent slowdown of Chinese economy has raised concerns about the prospects for its future growth and its potential adverse impact on the China-Hong Kong trading link. On the commodities front China seems uninterested at this point in taking help from other markets. Furthermore, commodities trading practices differ between China and Hong Kong as investors in China, unlike those in Hong Kong, want physical delivery. This requires significant warehouses that the HKEx is still in the process of developing. Lastly, neighboring Singapore will present competition in the OTC space as it also plans to be a major player in the region focusing on South East Asia and China.

Alipay Entering into South Korean Market

During the Lunar New Year, more than 100,000 Chinese visited South Korea. The way people shop in a duty free shop, or in a convenience store is quite different than before: They pay with the world’s well-known Chinese mobile payment, Alipay, the most successful case of Fintech in the world. In Seoul main streets and on Korean internet sites, we can easily find advertisements of Alipay. China UnionPay already entered into the South Korean market, and even a brand of my credit card issued in South Korea is UnionPay. They partner with BC Card, South Korea’s card issuer and they have been expanding their business in South Korea. China’s payment has entered into South Korean market in earnest and South Korean players have been getting into the game. T-money, the largest prepaid card player in South Korea and Hana Bank, the fourth largest bank in South Korea partnered with Alipay. As an example, Chinese tourists in South Korea can pay back to Alipay’s account after using T-money for foreigners if they have any remaining credits. T-money is available not only transportation including metro, bus and taxi but also for payments at convenience stores and other selected shops. Also, T-money has introduced a new service for domestic users, providing compensation system for Mobile T-money when a user loses a phone, providing a safer environment for T-money users. For Hana Bank, they haven’t started a service with Alipay but it will be launched soon. After launching a new service with Alipay, Chinese tourists will be able to pay with Alipay at merchants of Hana Bank. In other words, they can use Alipay in broader places like orthopaedics, nail salon and hair salon than what T-money service offers. The similar case has been seen in South Korea and Japan. Cashbee, South Korea’s mobile payment card partnered with Japan’s three major MNOs, NTT DoCoMo, KDDI and Softbank. Japanese tourists can now pay with their smartphone in South Korea after installing a dedicated application. A wave of Fintech has come to Korea. The country is attempting a different approach with the use of Fintech. Some players already recognized their current approach is not acceptable anymore hence it is the time to shift their strategy for future growth. Payments area has been getting global and more attractive for users. For example, Alipay gives 4.5% interest when a user deposits money. Yes, it’s attractive. However, players should evaluate what is important for their future growth without tapping into the current trend. Establishing an initiative for business growth should be the overriding concern now amid mounting attention to Fintech.

On the cusp: regional integration in Asia

It’s 2015, the mid-point of the decade and a good time to start looking at major trends in Asian financial services over the next five to ten years. One of the major themes will be regional integration, which is another way of saying the development of cross-border markets. There are at least two important threads here: the ongoing internationalization of China’s currency, and the development of the ASEAN Economic Community (AEC) in Southeast Asia. RMB internalization is really about the loosening of China’s capital controls and its full-fledged integration into the world economy. And everyone seems to want a piece of this action, including near neighbors such as Singapore who are vying with Hong Kong to be the world’s financial gateway to China. The AEC is well on its way to becoming a reality in 2015, with far-reaching trade agreements designed to facilitate cross-border expansion of dozens of services industries, including financial sectors. While AEC is not grabbing global headlines the way China does, we see increasing interest in Southeast Asia among our FSI and technology vendor clients. From Celent’s point of view, both trends will open significant opportunities across financial services. In banking, common payments platforms and cross-border clearing. In capital markets, cross-border trading platforms for listed and even OTC products. In insurance, the continued development of regional markets. Financial institutions will be challenged to create new business models and technology strategies to extract the opportunities offered by regional integration. It’s the mid-point of the decade, and the beginning of something very big.

Challenges with China’s RMB Internationalization Process

Chinese authorities have been making concerted efforts of late to internationalize its currency (renminbi, RMB) by trying to increase its use in international trade settlement and investment. Their efforts are paying off as international RMB payments and trade settlement have grown rapidly since 2010. The whole process consists of three broad steps beginning with the use of RMB in trade settlement, then investment and then as a global reserve currency. The first step is well underway and has received the most traction of the three – around 10-15% of China’s international trade is settled in RMB at present. China has currency swap agreements with 24 central banks allowing them to directly settle international RMB trade. Use of RMB for investment purposes is still limited due to lack of development of the Chinese capital markets and strict controls imposed by the Chinese authorities. Use of RMB as a global reserve currency is the most ambitious step and likely to take the longest time. At present several central banks have expressed interest for increasing RMB holding as part of their reserve. However, the quantum of holding is small at present and primarily geared towards diversification of foreign assets.

In spite of these developments, there are challenges with China’s efforts to internationalize the RMB. Even though the Chinese currency recently broke into the list of top ten currencies globally, its share is still miniscule (~1%) in total global payments. At a broad level, RMB is mostly used to settle imports, but not exports – roughly a third of imports and less than 5% of exports are settled in RMB at present. Even in imports, invoicing is often done in US dollars while settlement happens in RMB.

A necessary requirement for RMB internationalization is to first make it fully convertible. China is planning to do this first through the offshore markets. Doing the same in the onshore market by opening capital account and liberalizing interest rate regime will be more challenging.

Then there are operational challenges for banks that need to be addressed. New systems and processes will be required to support clearing and settlement of payments in real time by domestic and international players. They also need to support different languages including Chinese, English and other regional ones and to accommodate working hours in different time zones to bring about a truly international system of operations.

These will also require strengthening of China’s anti-money laundering (AML) framework. AML practices in China have been in development for over 15 years, however, the AML regulations were largely inadequate until as late as 2006-07. As a result the internal control systems and company culture at banks in China tend to be inadequate, and they do not go beyond meeting basic regulatory requirements at present.

Given the rapid developments in the RMB internationalization process over the last three years, there has been a lot of enthusiasm and optimism expressed by several players regarding its potential to bring in major changes in the immediate future. However, it is safe to assume from past experiences that China will follow a planned, controlled, and slow but steady path in trying to raise the importance of its currency at a global level. True internationalization of RMB will require fundamental changes on many fronts including regulatory, market infrastructure, political and geopolitical aspects. An intermediate step in realizing the ultimate goal may be to first make RMB a dominant currency at a regional level (ASEAN/Asian). The extent of its adoption at a global level will however be long drawn and closely watched.

China’s road towards Currency Internationalization

China is the world’s second biggest economy, largest exporter and second largest importer. Yet China’s currency, the Renminbi (RMB), accounts for less than 1% of global FX turnover. The Chinese authorities have been making concerted efforts since late 2008 to internationalize the Renminbi by trying to increase its use in international trade and investments. Their efforts are paying off as RMB settled trade has grown since late 2010 and accounts for 8-10% of all international trades at present. The following highlights some major successes of their efforts: •    From October 2010 to June 2012 value of RMB payments grew by 17 times. Currently 91 countries are processing renminbi payments. •    Hong Kong is the dominant offshore centre for RMB trading accounting for around 80% of all renminbi payments; share of Singapore, Taiwan are also significant. UK is positioning itself as a major offshore trading centre for renminbi. •    RMB is among world’s top ten currencies traded. Three FX markets exist for RMB: onshore CNY market which is tightly controlled, offshore CNH market in Hong Kong which is relatively free, and USD denominated non-deliverable forward market. The currency sometimes trades at different rates in the CNY and CNH markets and many firms, especially large ones with subsidiaries outside borders, use it to conduct exchange rate arbitrage in these two markets. Given that China’s currency is not fully liberalized, this arbitrage sometimes is not settled by market forces and it creates pressure on the currency, as was evident late last year. Some therefore argue that significant proportion of RMB settlement comes from speculation in the two markets while imports are still invoiced and mostly settled in US dollar. Bank of China Hong Kong (BOCHK) and Bank of China, Macau, are the only two entities approved to clear offshore RMB transactions. Other banks can engage in offshore RMB business through agreement with BOCHK, or through relationship with other banks which have existing agreement with BOCHK. This presents an opportunity for many regional and international banks to tap into this burgeoning market of RMB clearing and trade related services. Moreover, two of the world’s biggest exchanges, the Hong Kong Exchange (HKEx) and the CME Group, recently announced plans to launch offshore yuan futures in Hong Kong by the end of 2012. This is likely to facilitate exporters and importers hedge their currency risks, especially now that the currency is showing some volatility. The forwards market at present is very efficient with tailor made contracts; therefore some think currency futures may not gain traction immediately among traders. However, along with importers and exporters who use currency futures and forwards to hedge exposure, this will also attract asset managers and other financial institutions as the contracts will be standardized and tradable at the exchanges. The outcome of these initiatives remains to be seen, but these moves are likely to further strengthen China’s efforts towards Renminbi internationalization. It must be mentioned that in spite of these developments, there are challenges with China’s efforts to internationalize the RMB. At a broad level, RMB is mostly used to settle imports, but not exports. Even in imports, invoicing is often done in US dollars while settlement happens in RMB. It is argued many Chinese corporations use the different currency markets (CNH-CNY) to engage in speculative activities and not that much for pure trade purposes. This effectively allows for interest rate speculation between the two markets as well. Many of these problems are intertwined as China has traditionally had very strict capital control, and the internationalization of renminbi is taking place before fully liberalizing its interest rate, exchange rate or capital account. Therefore how China attempts to internationalize its currency and manages its key rates at the same time will be closely watched.

Some insurance companies in China have started to invest in retirement communities

Insurance companies in China apply different business model in regard to retirement business. Some insurance companies focus on individual annuity, some are extending retirement business horizontally, selling corporate annuity, group pension, and individual annuity; and some companies are extending retirement business vertically, such as enter into retirement apartment business. In China, reverse mortgages face cultural opposition and will not be popular in the next five years. The main reasons are:
  • Old people want to leave their apartments to their children after death.
  • There is no legacy tax in China.
The target market for reverse mortgages is people who have more than one apartment or no child. There is no insurance company or bank that provides this kind of business yet.
  • The possibility of apartment prices going down is the main factor that worries financial institutions.
  • Banks do not have sufficient data for life expectancy.
  • Regulations are not complete: China land usage is limited to 70 years. If it is not renewed or does not get approval, then theoretically the land reverts to the state.
So the more acceptable method for old people is to sell their apartment and move to a cheaper one. Another way is living in retirement apartments and renting their own apartments out to provide income and cover the cost. The problem is that retirement apartment facilities are not good as of yet. For this reason, some insurance companies are extending retirement business value chain, have started to invest in retirement communities. For example, Taikang Life is building a retirement community in a suburb of Beijing. Union Life is building a retirement healthcare community in a suburb of Wuhan. For more, see my new report Pensions in China, Hong Kong and Singapore: Opportunities for Insurers.

Bancassurance, Next Only to Agent Distribution Channel in Asian Insurance Market

While my earlier article discussed in general on how Bancassurance channel is shaping up in various regions in Asia Pacific. This write-up sheds some light in terms of market share and growth of Bancassurance in various regions in A Pac. It is evident that this channel is picking up in most of Asia Pacific region. However the channel is still next only to the dominent Agent channel. In Mainland China, Bancassurance accounted for 27 percent market share of total insurance sales, agent channel dominated the market (37 percent market share) in 2009. Insurance market in China is undergoing structural changes with in the market and this is expected to boost the premium income of insurers via banking channel. In Hong Kong, Banks have become an important distribution channel for life, health and mandatory provident funds, supplying up to 40 percent of the market’s new business. HSBC and Hang Seng Bank together held 40 percent of the Mandatory Provident Fund (MPF) market. In Taiwan, the concept of “One Stop Shop” has become a common philosophy for banks. Premium income for individual life insurance new business from bancassurance accounted for 68 percent in 2009. Banks contributed 88 percent to new individual annuities, 66 percent to new investment-linked businesses, and 51 percent to new life insurance businesses. While P&C market is dominated by agents and brokers (67 percent of the market share). Personal accident/ health Insurance is mostly under taken by Insurance companies themselves, thus accounting for 91 percent of this line of business. In Singapore, insurance agents make up the main sales channel for life insurance. The market share however has declined from 66 percent from 2004 to 61 percent in 2009. Bancassurance accounted for 22 percent of the total weighted new business premium income Bancassurance market share in Malaysia has grown from 45 percent in 2005 to 51 percent in 2008. The agency network had traditionally been the main distribution method but has gradually lost some ground to bancassurance. Agency network accounted for 47 percent market share in 2004 which has come down to 44 percent in 2008. Domestic insurers account for over 80 percent of Bancassurance market. In South Korea, solicitors and internal employees make up the main sales channel for the life insurance industry. In 2008, the bank channel grew to 37 percent next only to solicitors and internal employees of the insurance companies with 54 percent. Indian life insurance market is dominated by tied agents, more so with the state owned Life Insurance Corporation of India (LIC). Over 75 percent of new business premium is generated by individual agents. However, individual agents in private companies account for less than 50 percent of total sales, while more than 40 percent is attributed to the bank and direct selling channel. Banks and brokerage firms have 30 percent and 20 percent respectively of the P&C insurance market. Markets such as Thailand, Malaysia and China have better acceptance of bancassurance channel as opposed to India and Singapore as brokers and agents are still major insurance carriers in these region. It is also noteworthy that all developing and accelerating markets are evidencing high potential for growth in Bancassurance.

Insurance agents equiped with new tools to realize policy issue in real time in China

Ping An insurance company in China produced e-policy for new insurance application from Oct.1st 2010. Now insurance agents from Ping An insurance company could do bunisness in a brand-new way: -generate insurance proposal on laptop computer; -discuss with customer and make adjustments, send the final proposal to headquarter by wireless network for underwriting; -receive short message about underwriting result in about 1 minute later; -customer pay premium by useing mobile POS device (insurance sales agents bring mobile POS device); -e-policy go effective; customers are able to check their policy information from Ping An website; This kind of technology platform is innovative in China. Many insurance companies like to follow Ping An model, we can expect more insurance companies will adopt e-policy in new business, and streamline the sales process to be more efficient.

Distribution strategy in China’s diverse market conditions

I talked with a reporter recently about Asia distribution channels. She asked me question about in emerging markets like China, what the challenges are, and issues facing by insurers to build up a cost effective distribution channel, and what being important for a successful distribution strategy in China’s diverse market conditions. China is a big and diverse market. Most places in China are emerging markets. It is not common for people to initiate the purchase of insurance products. This is due to the limited knowledge they have of life insurance. Insurance is mainly sold in a face-to-face setting with an individual agent of an insurance firm, where the agent would provide a detailed introduction of the product; hard selling may be involved as well. Hence, the main sales channel for life insurance in these emerging markets is individual agents. But in many big cities in China, insurance markets are maturing. People are more aware of insurance product; they’ll purchase insurance through banks, car dealers, travel agencies, telephone, and internet. Individual agents are still an important distribution channel in these big cities, but in the face of stiff competition with other distribution channels, as well as the increase in diversity of financial products, some insurance companies are investing in more training to equip agents to become financial advisers, and establishing online and mobile support system. The biggest challenge by insurers to build up a cost effective distribution channel in China is the market diversification. Multi-channel distribution is very important. Any single distribution channel, any single distribution strategy can’t meet all market conditions. The important thing for a successful distribution strategy in China’s diverse market conditions is the alignment of product and distribution channel. Design of product should be aligned with target customer and designated distribution channels.

Welcome to Celent’s Asia Blog

Celent is continually looking for ways to better connect and interact with the financial and technology communities. Continuing in the tradition of Celent’s industry-specific banking and insurance blogs, we are now launching a blog focused on issues in business and technology strategy in the Asian financial services. Welcome to Celent’s new Asia blog. From the beginning, a differentiator at Celent has been our coverage of financial and technology issues from a global perspective. As part of this commitment, over the past few years, we have been ramping up our research on Asia and India. We have now built up quite a substantial library of research on these regions, which we think is pretty unique. Building on this, we have recently also launched two new research services, one focused on India, the other focused on the rest of Asia. These services essentially bundle reports from our banking, securities & investments, and insurance services into regionally-focused services aimed at firms seeking cross-vertical competitive information on Asia and India specifically. And now the Asia blog. We have a baker’s dozen of analysts ready to lob commentary on what we see developing in the region, as well as on Celent’s activities. We think you will find our essays informative and stimulating. And we encourage you our readers to participate in the feedback loop by sending us your comments and questions. The goal is to create an active dialogue on the evolving financial services and technology markets in India and Asia.