Global reset – Monetary decoupling (Part 13: Intermediaries in the era of globalisation and decoupling)
Phuah Eng Chye (4 December 2021)
Intermediaries in the era of globalisation
During the era of colonialization, it was said that trade followed the flag and, by extension, that finance followed trade. Dutch and British banks ventured overseas to support their country’s vast overseas trading empires. Post-World War II marked the modern era of independent nations, financial liberalisation, globalisation and subsequent re-regulation. The growing economic power of the US was paralleled by the international expansion of its banks supporting their multinationals abroad. In the process, US banks played a key role in the global recycling of capital flows – mobilising rural US savings and petrodollars to finance corporate lending and treasury operations.
From 1970 onwards, the US and UK led the way in liberalising their financial sectors. This resulted in intense competition and severe industry consolidation. US banks such as Citibank and Chase Manhattan Bank pursued international expansion but due to costly domestic and international lending misadventures, they were bailed out on several occasions.
As more countries pursued financial deregulation, the differences between commercial, merchant and investment banking blurred as the leading banks sought to transform into universal banks to sustain their leadership. Japanese and European banks (Germany, France, Netherlands and Switzerland) went on an international acquisition spree to build global investment banking franchises to compete with their American rivals. By the late 1990s, the global investment banking industry had become quite concentrated and the top 10 global banks dominated financial markets, often accounting for more than 50% of market activities. In the aftermath of several crises, financial liberalisation ceded ground to global re-regulation as financial regulators adopted common standards to ensure orderly development and financial stability.
Internationalisation was a harrowing journey comprising a culmination of mishaps in managing talent, balance sheets, risks and relationships across countries. The challenge was to meld diverse nationalities and integrate the distinctly different cultures of consumer and corporate banking; corporate finance, product development and trading, asset management, compliance, risk management and technology. Though the leading intermediaries have globalised, nonetheless they have retained their home country identities. They cannot forget their roots as they rely on their home advantage of a dependable local deposit and client base and their local currency strengths.
The advantages of being global or regional financial centers – with exchanges as a focal point – has also ebbed. Decoupling has increased the geopolitical risks of becoming a global center. Information disruption (via technology, governance, information disclosure and analytics) diminished the uniqueness of traditional public markets and resulted in the fragmentation of venues. Traditional exchanges have reacted to new entrants and rising technological costs by demutualising, listing and merging; operating more as centres of governance rather than of liquidity. Liquidity is increasingly diverted into products (e.g. funds), private markets, technology-driven platforms (deposits, lending, investing) and digital assets. Nonetheless, growing ambitions are fuelling the competition to become a global center for cryptocurrencies and related technologies.
Transition of China’s intermediaries and financial system
The full impact of China’s rise as an economic power is yet to be felt because its intermediaries and financial system are lagging in many aspects. The evolution of China’s intermediaries and financial system will have an important bearing on the future outcomes for decoupling.
In this regard, domestic intermediaries operate at the frontline for countries seeking to project their financial power globally. Domestic intermediaries need to build the necessary intermediation capabilities to lead internationalisation of the country’s currency and capital markets. In this regard, the position of the two largest reserve currencies, the USD and Euro, is related to the strength of their intermediaries. Similarly, sterling’s decline is mirrored by the decline of UK’s leading intermediaries and their subsequent acquisition by foreign banks.
On the back of the country’s industrial-export growth, China’s commercial banks have powered their way to the top of global rankings. Based on S&P’s Global Market Intelligence’s bank rankings, David Feliba and Rehan Ahmad notes “China’s Big Four – Industrial & Commercial Bank of China Ltd., China Construction Bank Corp., Agricultural Bank of China Ltd. and Bank of China Ltd. – all held their top spots” reporting a combined asset value of $17.3 trillion, up 16.9% from the 2020 ranking. “Japanese Mitsubishi UFJ Financial Group Inc. remained at No. 5 with assets at $3.408 trillion. U.S.-based JPMorgan Chase & Co. was sixth with $3.386 trillion”. French BNP Paribas SA was No. 7 with assets of $3.080 trillion while HSBC Holdings PLC was No. 8 spot with assets of $2.984 trillion. “Driven by strong credit growth in 2020, the combined assets of all 19 Chinese banks on the top-100 list grew 17.66%” to $30.5 trillion. The U.S. banks were the next largest group with 12 institutions holding a combined asset size of $15.538 trillion.
Cathérine Casanova, Eugenio Cerutti and Swapan-Kumar Pradhan note “since 2016, Chinese banks have represented the largest banking system in the world. Their foreign claims are substantial, although those seem relatively small when compared to their domestic business…As of mid-2021, Chinese banks represent about 7.5% of global cross-border bank lending, and they reported claims on 175 out of 185 borrowing jurisdictions in the Bank for International Settlements (BIS) locational banking statistics. Their cross-border lending is particularly important for emerging markets and developing economies (EMDEs): Chinese banks report bank claims on 133 out of 143 EMDEs, with a market share of more than 26%…Similar to other banks from emerging markets, Chinese banks’ traditional business model and ownership structure distinguish them from typical advanced-economy banks. As of end-2019, loans constitute more than half of their assets, and they have a larger share of deposit funding than advanced-economy banks. While the differences are less pronounced for other measures such as return on assets and leverage ratio, the strong presence of publicly owned banks is another key characteristic that differentiates Chinese and other typical EMDE banks from advanced-economy competitors…The positive correlation between cross-border bank lending and bilateral trade of China with EMDE countries stands out. It is much stronger than the trade-lending relationship exhibited by Japanese and European banks, and it is more in line with patterns exhibited by US banks. Unlike all other banking systems, China’s past portfolio investment is negatively correlated with cross-border lending to EMDE borrowers. This seems linked to China’s capital outflow restrictions and the fact that Chinese portfolio investment is concentrated on few advanced-economy countries”.
For China’s global financial power to match that of the West, it needs to accelerate deepening and internationalisation of its financial system. This means its large financial intermediaries need to manage a transition from commercial banking to global capital markets. As a matter of comparison, China’s banks can be considered to be at the same stage of development as Japanese banks in the late 1980s – when they were among the world’s largest and when Japan’s share of the world economy was at its peak. But Japanese banks were complicit in their financial crisis and their balance sheets were fatally impaired when the equity and property price bubbles burst. Japanese banks, together with the economy, never fully recovered their vitality. Though the yen is widely used but attempts to internationalise usage through yen-denominated products (remember Samurai bonds) never took off. Despite foreign acquisitions, Japanese banks (and brokers) never seemed comfortable in an international setting. As a matter of comparison, European financial institutions fared better in terms of building their international franchise. However, the European intermediaries also suffered significant setbacks from credit and market fall-outs and do not currently seem well-positioned to cope with landscape disruption (competitive threats from negative interest rates, fintech and digital currencies). In addition, EU banks are disadvantaged because much of Europe’s capital market activities are still conducted in London.
The historical lesson is that it will be a challenging to manage the transition from banking to capital markets. The large Chinese state-owned banks face tremendous competition – from formidable foreign entrants as its domestic markets is liberalised, and from platforms and fintech (which are being brought under regulatory oversight). China’s state-owned banks are domestic and commercial banking-centric and, over time, their deficiencies could get exposed. It is not yet evident if they are up to the task of building the skills and cultures in products, investing, market-making, corporate advisory, risk management and technology; and developing their international networks and brand. The history of international and investment banking suggests it will be an accident-prone journey. In addition, it has become more difficult to build an international network as new licenses and acquisitions are harder to come by; especially given rising anti-China sentiment abroad.
A key aspect of China’s transition is to harness its huge domestic savings by developing its domestic fund management industry to support product development and liquidity in the domestic capital market. This is where US and Europe are so far ahead of the rest of the world. According to Willis Towers Watson research, conducted in conjunction with Pensions & Investments, assets under management (AuM) at the world’s 500 largest asset managers totalled US$104.4 trillion in 2019. The top 20 funds, accounting for 43% of total assets, are all from the West – with 15 from the US and 5 from Europe (Germany, France , UK and Switzerland). The two largest asset managers were Blackrock with US$7.4 trillion and the Vanguard Group with US$6.2 trillion. Chinese and Asian asset managers are noticeably absent from the top 20 – though they have large SWFs and pension funds.
In this regard, China’s fund management industry appears to have reached take-off point. A joint World Economic Forum (WEF) and Oliver Wyman report highlights “the China asset management industry AuM reached RMB112 trillion (USD16 trillion) by the end of 2019, representing a tenfold increase over the past 10 years and an unprecedented growth compared to many other markets. At the same time, a significant portion of Chinese wealth remains held in RMB200 trillion (USD28 trillion) of bank deposits. These deposits are starting to be unlocked and will accelerate the growth and maturation of the asset management industry”. “We are at an inflection point that marks the beginning of multiple waves of transformation – characterized by the shift of funding from the retail to institutional segment, opening up of distribution channels, proliferation of active asset managers, transition from shadow banking to capital-markets driven financing, and growing cross-border connectivity between China and global markets – ushering in a new era of asset management amid a slowdown in the domestic economy and policymakers’ continued commitment to professionalize and liberalize the market”.
Though China is likely to close the fund industry gap, nevertheless China still operates at a disadvantage in other international areas. The West dominates multilateral institutions and standard setters; and lead in education and research on economics, finance and business. The custodian, research, ratings and indices segments are dominated by Western firms (mainly US) and international contracts are drawn up based on Western law. China therefore has a lot of ground to catch up on information intermediation such as ratings and research and building international confidence in its legal processes.
One area where China has an international advantage is in fintech and digital currencies. It is often overlooked but China facilitates information disruption. China allowed platforms to achieve dominance in their payment system but the government recently demonstrated that it has the ability and will to intervene decisively to tighten oversight over platforms. The contrasting attitudes between China and the West towards information disruption is evident with the central bank digital currency (CBDCs). China is pushing forward with the digital yuan while US and Europe seem bogged down by concerns over privacy and the impact on traditional intermediaries.
China can parlay its digital strengths to establish an alternative yuan eco-system that provides it with strong government oversight over gateways and fund movements. This will strengthen China’s confidence to liberalise its capital controls as it reduces the influence of the opaque offshore markets. The digital yuan will also strengthen connectivity between yuan-denominated currency, assets and intermediaries across borders and allow China to bypass Western-dominated custodial, clearing and settlement services. This will enhance cross-currency competitiveness which is critical for expanding the range and liquidity of yuan assets.
Intermediaries in the era of decoupling
After all the trouble they went through to globalise their operations, financial intermediaries now find decoupling is shifting the ground beneath them. Strategic conversations have changed as financial intermediaries find themselves having to choose between demonstrating their national loyalties or pursuing their global ambitions. At the moment, fund managers (including index providers) and exchanges are under pressure to align with decoupling policies. Global banks have to cope with the pressure from conflicting legal requirements. With the exception of US intermediaries eager to expand into China as the doors open, generally global ambitions are being put on the back-burner. For example, other exchanges are not rushing to woo China listings after the US fallout. In today’s mood, the fear is getting caught in the US-China cross-fire. Financial intermediaries have to navigate through several minefields in the era of decoupling.
- From governance to governments. Three decades ago, market forces were unleashed to drive globalisation. This elevated the role of intermediaries and entrepreneurs. The major challenge then was to raise governance standards to keep market forces in check. The situation has changed. Outcomes from globalisation – rising inequality and a changing world economic order – have triggered a fierce political backlash. Even as intermediaries moderate their roles in promoting globalisation, governments are intervening on many fronts – in trade, industrial development, technology innovation and competition and data security. In finance, governments are weaponizing sanctions, blocking foreign acquisitions and listings, and prohibiting investments in foreign companies. In addition, the role of financial intermediaries – already under threat by fintech – are being undermined by forbearance (due to the pandemic) while outsized central bank liquidity interventions is crowding out private sector intermediation. The shift from governance to governments imply a more passive role for intermediaries and markets and for the foreseeable future, government policies will be the sole driver of economic and market outcomes.
- Investment barriers. Typically, there is a backlash against export-surplus nations buying up assets in deficit countries; i.e. Japanese acquisitions in the 1980s. The backlash with Chinese purchases is more intense given the geopolitical tensions. While there is considerable Western pushback against Chinese purchases of foreign assets, the reverse – foreign purchases of Chinese assets – does not apply as China is still in the process of opening up. Hence, Chinese investments in US has dropped significantly but US investments into China seems to be holding up. The current government-markets dilemma over China listings in US is illustrative. The private sectors in both countries are aligned – Chinese entrepreneurs share a common interest with US intermediaries and investors to list in American markets. The US and China governments are curiously aligned on this issue. There is considerable US political pressure to cut off Chinese access to American US capital markets and US portfolio flows into China. On its part, China is taking the opportunity to crack down on entrepreneurs that circumvented its rules and to put pressure on them to list in China or Hong Kong which would aid the growth of its own exchanges. It also would not want to attract US capital inflows at this point as this would put pressure on its currency to appreciate.
- Rising compliance costs. Andrew Sheng points out “intense geopolitical rivalry is a further minefield in the financial landscape. If global supply chains and technology standards are going to decouple, how should finance respond? As the US applies pressure on Chinese companies and individuals through sanctions and legislation, financial institutions are struggling to deal with shifting goalposts”. The compliance costs of globalisation have risen sharply and financial intermediaries dread getting caught in the middle of jurisdictional cross-fire. The strategic challenge for financial intermediaries is whether to pursue globalisation – as US intermediaries seem to be doing in China – or to withdraw to reduce their risks – as HSBC did selling off its US operations?
- Information disruption and ecosystem decoupling. Traditional intermediaries face increasing competition from fintech and digital currencies to be the gatekeepers of financial connectivity. In tandem with this, the loyalties of intermediaries will be tested as decoupling tensions spill over into currency usage and as distinct networks for USD and yuan emerge that are based on different rules and standards for data and technologies. Ecosystem decoupling would reduce interoperability and insert additional roadblocks to cross-border flows.
- Weakening global policy cooperation. Andrew Sheng suggests “the global financial system has grown faster and is too complex and entangled for any single nation to manage on its own. If the largest financial systems are caught up in acrimonious geopolitical rivalry, what are the risks of financial accidents that can easily escalate into financial crises? In the 2008 global financial crisis, the Group of 20 stood together to execute a range of responses. This time around, there is no unity”. In addition, “central bank assets have grown faster – at 8.4 per cent per annum on average in 2013-2018 – than banks (3.8 per cent) or non-bank financial intermediaries (NBFIs) (5.9 per cent) to corner 7.5 per cent of global financial assets. Can financial markets assume that central banks will continue to underwrite their prosperity? As inflation rears its head, central banks will have to reverse their loose monetary stance, putting the global financial system under stress. This system has structural and regulatory cracks, but they can only be fixed through some political understanding among the big players. Without this, expect a messy outcome”.
The future global landscape for intermediaries will be shaped by decoupling policies and information disruption. Financial intermediaries need to bear with the unwinding of earlier hard-earned globalisation gains and are likely to adopt the wiser strategy of keeping their head down and capital intact. As global financial intermediaries retreat into their shell, this creates difficulties for central banks. Central banks have over-committed on QE and the problem is there isn’t enough private intermediation capacity to take up the slack if central banks were to exit QE. As it stands, QE liquidity is increasing being congested within domestic markets while global intermediation activities reflect de-leveraging is impeding global recycling of capital. In the meantime, the most active intermediation modes such as fintech (which are not capitalised to withstand financial shocks) and asset managers are vulnerable to sharp interest rate rises, sudden large liquidity withdrawals and forced selling. At a time when it is needed most, the ability of national policy-makers to cooperate to address these critical challenges has been damaged by decoupling and diverging policies.
Andrew Sheng (16 July 2021) “Why the global financial landscape is undergoing a seismic shift”. SCMP. https://www.scmp.com/comment/opinion/article/3141334/why-global-financial-landscape-undergoing-seismic-shift
Cathérine Casanova, Eugenio Cerutti, Swapan-Kumar Pradhan (24 November 2021) “The global footprint of Chinese banks”. Voxeu. https://voxeu.org/article/global-footprint-chinese-banks
David Feliba, Rehan Ahmad (23 April 2021) “The world’s 100 largest banks, 2021”. S&P Global Market Intelligence. https://www.spglobal.com/marketintelligence/en/news-insights/research/the-worlds-100-largest-banks-2021
Global Times (6 July 2021) “China to tighten rules for firms listed overseas to enhance data protection”. https://www.globaltimes.cn/page/202107/1227993.shtml
Lianhe Zaobao (8 Jul 2021) “Didi COO and family called traitors: Chinese tech entrepreneurs now public enemies on social media?” ThinkChina. https://www.thinkchina.sg/didi-family-called-traitors-chinese-tech-entrepreneurs-now-public-enemies-social-media
Phuah Eng Chye (2015) Policy paradigms for the anorexic and financialised economy: Managing the transition to an information society. http://www.amazon.com/dp/B01AWRAKJG
Phuah Eng Chye (5 June 2021) “Global reset – Two whales in a pond”. http://economicsofinformationsociety.com/global-reset-two-whales-in-a-pond/
Phuah Eng Chye (19 June 2021) “Global reset – Monetary decoupling (Part 1: Sterilisation and QE)”. http://economicsofinformationsociety.com/global-reset-monetary-decoupling-part-1-sterilisation-and-qe/
Phuah Eng Chye (3 July 2021) “Global reset – Monetary decoupling (Part 2: Economics of large central bank balance sheets)”. http://economicsofinformationsociety.com/global-reset-monetary-decoupling-part-2-economics-of-large-central-bank-balance-sheets/
Phuah Eng Chye (17 July 2021) “Global reset – Monetary decoupling (Part 3: Consequences of diverging policies)”. http://economicsofinformationsociety.com/global-reset-monetary-decoupling-part-3-consequences-of-diverging-policies/
Phuah Eng Chye (31 July 2021) “Global reset – Monetary decoupling (Part 4: Lessons from Plaza Accord)”. http://economicsofinformationsociety.com/global-reset-monetary-decoupling-part-4-lessons-from-plaza-accord/
Phuah Eng Chye (14 August 2021) “Global reset – Monetary decoupling (Part 5: The end of USD supremacy – Will it be different this time?)” http://economicsofinformationsociety.com/global-reset-monetary-decoupling-part-5-the-end-of-usd-supremacy-will-it-be-different-this-time/
Phuah Eng Chye (28 August 2021) “Global reset – Monetary decoupling (Part 6: The forthcoming currency war)”. http://economicsofinformationsociety.com/global-reset-monetary-decoupling-part-6-the-forthcoming-currency-war/
Phuah Eng Chye (11 September 2021) “Global reset – Monetary decoupling (Part 7: Currency wargame scenarios)”. http://economicsofinformationsociety.com/global-reset-monetary-decoupling-part-7-currency-wargame-scenarios/
Phuah Eng Chye (25 September 2021) “Global reset – Monetary decoupling (Part 8: Sovereign digital currencies and networks in the currency war)”. http://economicsofinformationsociety.com/global-reset-monetary-decoupling-part-8-sovereign-digital-currencies-and-networks-in-the-currency-war/
Phuah Eng Chye (9 October 2021) “Global reset – Monetary decoupling (Part 9: Information perspectives on digital currencies)”. http://economicsofinformationsociety.com/global-reset-monetary-decoupling-part-9-information-perspectives-on-digital-currencies/
Phuah Eng Chye (23 October 2021) “Global reset – Monetary decoupling (Part 10: CBDC implementation)”. http://economicsofinformationsociety.com/global-reset-monetary-decoupling-part-10-cbdc-implementation/
Phuah Eng Chye (6 November 2021) “Global reset – Monetary decoupling (Part 11: The future of cryptocurrencies)”. http://economicsofinformationsociety.com/global-reset-monetary-decoupling-part-11-the-future-of-cryptocurrencies/
Phuah Eng Chye (20 November 2021) “Global reset – Monetary decoupling (Part 12: Role of intermediaries – Disintermediation and fintech regulation)”.
Robert N McCauley, Patrick McGuire, Philip Wooldridge (20 September 2021) “Seven decades of international banking”. Bank of International Settlements. BIS Quarterly Review. https://www.bis.org/publ/qtrpdf/r_qt2109e.htm
Willis Towers Watson (12 October 2020) “Global asset manager AuM tops US$100 trillion for the first time”. Thinking Ahead Institute.
World Economic Forum (WEF) (July 2020) “China asset management at an inflection point”. In collaboration with Oliver Wyman. https://www.oliverwyman.com/content/dam/oliver-wyman/v2/publications/2020/jul/china-asset-management-at-an-inflection-point.pdf
 See Robert N McCauley, Patrick McGuire and Philip Wooldridge for a review of international banking.
 Currently, cross-currency spreads are high because the convention is that non-USD currencies need to be converted into USD before it is converted into the other currency. Non-USD currency trading is costly thus because it involves two spreads rather than one (as is the case for USD).
 Chinese entrepreneurs want to keep some assets outside China as well as to build a base for international expansion. US financiers find the business opportunities lucerative and the listing were taken based on a work-around Chinese rules. See Lianhe Zaobao for insight on the Chinese perspective on Didi.
 See Global Times.