China's opening of retail banking to foreign institutions in December may hasten another big shift in its financial sector: the rise of foreigners as major players in its booming money and bond markets.
Foreign banks expect a surge in their yuan assets when they offer yuan accounts and services to Chinese individuals, and they aim to make money from those assets by trading bonds.
Analysts estimate foreign banks could see their China bond business, which tripled in the first 10 months of 2006, more than double next year - and continue growing at such rates in subsequent years. "Currently, we mainly use the bond market to raise funds. But with increased yuan deposits, we will have enough funds to do bond business for investment purposes," said a treasury manager at an Asian bank in Shanghai.
"So we plan to apply to incorporate locally and be trading the bond market actively by mid-2007." Foreign banks in China now do business with Chinese firms in local and foreign currencies, but are limited to foreign currency services for Chinese individuals. Starting in December, they can offer yuan services to individuals if they incorporate locally.
They face tough competition against Chinese banks with much larger branch networks. But China's sheer size should help them win business - analysts believe foreign banks in Shanghai could attract a total 150 billion yuan ($19 billion) of personal savings in the first year, on top of their current yuan assets of slightly more than 100 billion yuan.
Forty-eight foreign banks traded 643 billion yuan of bond repurchase agreements on the interbank market in the first 10 months, four times the amount a year earlier.
Their spot bond trading more than doubled to 620 billion yuan, and total bond and bill holdings hit 36.09 billion yuan, nearly triple the amount at end-2005, official data shows.
Foreign banks are still pygmies in the market - they account for 3.4 percent of spot bond trade among banks, 1.5 percent of repo trading and 0.4 percent of bond holdings.
Their main obstacle is lack of access to yuan funds. They are net borrowers in the money market, with their lending to companies standing at roughly four times the amount of yuan deposits they attract from the firms.
By helping correct this imbalance, yuan retail banking will support several years of rapid growth that could make the biggest foreign banks significant, though far from dominant, players in the money and bond markets.
"We expect more trading in the Chinese Treasury market in the year to come," said Gilbert Tse, Asian head of Fixed Income Derivatives at Societe Generale
"To meet this trend, we have set up a yuan-denominated dealing room in Shanghai which will cooperate with our US dollar-denominated dealing room in Hong Kong. We plan to expand our Shanghai dealing room by adding more local staff next year."
Three foreign banks - Standard Chartered, HSBC and Citigroup - are already active bond traders. The first two have said they aim to incorporate locally in order to conduct yuan retail banking.
More trading by foreign banks could have large effects on China's bond market, which Goldman Sachs estimates could grow 20 percent annually in the next decade to become roughly as big as the US Treasury market by 2016.
Demand for the relatively small group of experienced interest rate traders may rise even faster, boosting salaries and fuelling the job-hopping which plagues much of China's financial industry.
A greater foreign role may pressure authorities to accelerate structural reform of the market. Government bond trade is divided between the stock exchange and the interbank market, the latter dominated by big state banks which control access to liquidity.
Authorities have been considering eventually unifying the two markets. This could for the first time allow the creation of an accurate yield curve, helping China introduce the sophisticated interest rate derivatives found in big overseas markets.
Foreign banks may take the lead in trading such derivatives. They are looking forward to the planned introduction of interest rate futures by Shanghai's new derivatives exchange, which could occur as soon as next year. "It will need several years for foreign banks to become key players in the bond market," said Su Zhenhua, money market analyst at Taikang Asset Management. "But their increased role in the domestic market will bring international expertise, which is important as China is now gradually launching new products not familiar to local traders, such as bond forwards, swaps and futures."
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