|The Rising Need for Chinese Wealth Management|
Over the last ten years, somebody on the Chinese mainland has become a US dollar millionaire every six minutes. In 2001, despite a decade of strong growth, China had only 124,000 individuals with a net worth of over ten million yuan. By May of this year, that number had risen to 960,000, after rocketing from 310,000 to 825,000 between 2006 and 2009. These numbers are both staggering and conservative: ten million yuan is, after all, a good deal more than one million dollars – but is the benchmark used by China’s most important rich list, the Hurun Report – and most of China’s wealthiest people hide at least some of their money, with Hurun estimating that only a third of the country’s roughly 4,000 renminbi billionaires are counted in the pages of its report.
The prosperity created at the top of China’s economy is as astonishing as the prosperity created at its bottom, which is routinely said to have lifted 500 hundred million people out of poverty. Reports vary, but experts reckon that as much as 41 percent of the country’s personal wealth is owned by 0.1 percent of the population, and according to a recent report from the Julius Baer Group, Chinese millionaires are expected to hold half of Asia’s total personal wealth by 2015. In the US, where the concentration of the nation’s wealth is more routinely analyzed, and lamented, the richest one percent of the population controls only a third of total wealth. China’s richest people are much more regionally concentrated too: two thirds of the country’s millionaires live in Beijing, Shanghai, Guangdong, Zhejiang or Jiangsu, along a narrow industrial belt in the country’s east.
Wealth in China is distinguished by more than just concentration. At an average age of only 39, the country’s millionaires are a full fifteen years younger than their counterparts in the developed world.
Fifty five percent of them are entrepreneurs while only 10 percent are executives. Real estate speculators (20 percent) and stock market millionaires (15 percent) make up the rest. These differences are a start at separating China’s rich from the rich elsewhere, but only a start. The new millionaires at the center of China’s explosive growth are also defined by the context in which they have made their money: a country that offers an unprecedented opportunity to get rich, but lacks the regulatory environment or fiscal maturity for both the secure investment and legal protection of that wealth, at least in comparison with other, more mature economies and the offshore financial centers that many of the country’s rich have turned to.
The dichotomy might help to explain why China’s high net-worth individuals like to work with a variety of different financial institutions. According to a report by Bain & Company, released in April of this year, 60 percent of the country’s millionaires do business with multiple wealth management institutions, and a surprising 85 percent channel at least some of their money into China’s state-owned domestic banks, which are only just beginning to grapple with the diverse needs of wealthy clients.
In 2007, the Bank of China was the first domestic operation to establish a private banking service for clients with deposits of over one million US dollars, and a number of other local banks now offer similar services. The high number of entrepreneurs among China’s millionaires goes some way towards explaining this trend. “The private banker's biggest competition for the Asian millionaire's share of wallet is not other private banks – it is the client's own business,” says Tan Su Shan, the Head of Wealth Management at DBS in Singapore. “With his fortunes so intricately linked to his business, the Asian high net-worth individual requires a holistic evaluation of his financial needs. A keen understanding of the industry his client operates in, as well as the ability to help him grow the business while managing financial risks, is crucial for the private banker.”
Chinese banks are better able to understand local conditions and have a wide service network, but most lack the experience and range of products offered by private banks that operate globally. Clients might also question how far they can trust a bank that is essentially an extension of the state, especially in the area of wealth and tax planning, services that are amongst the most important private banks typically offer. A 2008 report by the Boston Consulting Group highlights the importance of secrecy to China clients. “Chinese high net-worth individuals generally do not like to disclose their wealth,” it explains, “either for fear of investigation over the source of their wealth, or for concerns over attracting attention to their wealth. Consequently, in selecting their private banks, they can be quite careful about approaches to banking security and client privacy, from how they are introduced to their relationship managers to the reputation of their private banks, from the domicile of their private banking accounts to how they access their accounts.”
Foreign banks beat their domestic competitors into the high net-worth market. In 2005, AIG Private Bank opened an office in Shanghai, and some of the industry’s biggest players – including HSBC, Standard Chartered and Credit Suisse – either introduced private banking services to their existing retail offerings or opened branches in China soon afterwards. Despite initial optimism and the clear opportunity presented by so much new Chinese wealth, none have been very successful.
The toughest problem private banks in China face is regulation, which severely limits the range of products they can offer. To invest in offshore markets on behalf of clients, banks must apply for a QDII quota, clearly defining the amount of renminbi they can convert and move out of the country. Domestic banks get the lion’s share of these quotas, which are in themselves restrictive, limiting the kind of securities a financial institution can buy. Foreign banks have an even tougher time lending money. By law they can only lend out three-quarters of total deposits, a much higher loan-to-deposit ratio than is typical in developed economies and an obstacle to the holistic wealth management solutions clients might expect. By 2007, foreign banks had only managed to capture 2.7 percent of total banking assets in China. By 2010, their total share had actually shrunk, to 1.83 percent, after the Chinese government channeled its huge stimulus program solely through domestic banks.
Understandably, China’s wealthy still prefer domestic investments, particularly in real estate and stocks. The 2010 Asia-Pacific Wealth Report compiled by Cap Gemini and Merrill Lynch put the home-region allocation of investment by Chinese high-net worth individuals at 85 percent, but private banks, both foreign and domestic, again find it difficult to differentiate their products, because China still has a relatively small range of financial instruments. Bonds, for example, are still in their infancy and the trading of futures, within a limited regulatory framework, was only introduced last year.
The Chinese government is gradually reducing the obstacles that prevent more nuanced investment, both on and offshore. It allowed foreign banks to incorporate locally and provide renminbi services in 2007, for example, and is constantly tinkering with its exchange controls, a process that is expected to culminate in the de facto internationalization of the renminbi before too long. The financial crisis provided the government with the impetus to develop the country’s financial markets more quickly, particularly where it sees opportunities to reduce volatility, and the crisis, along with its lingering consequences, has also affected the investment profile of China’s wealthy. Many high net-worth individuals sustained heavy losses in the dark days of 2008 and 2009, because after years of enjoying high returns their portfolios were over-leveraged. The sting they felt has increased the demand for better financial advice, which is in short supply on the mainland, as well as for more balanced portfolios that are insulated against both global and domestic shocks.
All of this indicates that there is good reason to be optimistic about the future of private banking on the mainland, but in the short-term, many of China’s private banks operate more like representative offices, helping clients to put together sophisticated offshore structures that are less affected by domestic regulations, and high net-worth individuals often find that their needs are better served by travelling to offshore financial centers like Hong Kong and Singapore for wealth management. “I think that what is happening,” says Mike Grover, an offshore tax specialist, “is that private banking and independent financial advisors create the ‘solutions’ for their clients with offshore locations such as Labuan IBFC providing the enabling structures. It is a ‘collaborative’ relationship between the high net-worth individual, the advisor and the jurisdiction selected to domicile the activities.”
Eight percent of China’s total personal wealth was invested offshore in 2007, according to another Boston Consulting Group report, but that figure could be much higher by now, partly because recent estimates suggest that as much as 9.3 trillion renminbi might be ‘hidden’ from the state, but also because Chinese businesses are investing more in foreign markets and making more profits overseas as a result.
Offshore wealth management is underpinned by double taxation agreements, which prevent individuals as well as companies from paying tax on the same income, asset or transaction in more than one jurisdiction. China’s first tax treaty was only signed in 1983, but since then it has worked hard to grow its network of tax treaties and the country now has tax agreements with almost 180 countries, including almost all of the world’s offshore financial centers. Although the government has generally pursued these treaties to improve trade relations, wealthy individuals are among the beneficiaries, because offshore financial centers offer a much better regulatory environment for asset protection and tax planning. “Centralizing wealth management in an international finance center is an efficient and effective way for people to handle both their personal and business planning,” explains Jenner Davis, CEO of the Cook Islands Financial Services Development Authority. “Many wealthy Chinese have children being educated in other countries, they might own real estate overseas, and chances are they have business interests worldwide. All of these things create a more complicated financial and legal picture for them. Relying on service providers in places like the Cook Islands can actually make life easier for the wealthy Chinese. The Cook Islands lie halfway between China and North America therefore they are able to carry out business across multiple time zones in a single day. Legislation protecting assets gives Chinese clients comfort when dealing with assets in multiple jurisdictions with different legal systems.”
In essence, offshore financial centers offer two different structures for the protection of individual wealth: trusts and private foundations. Trusts evolved out of British common law, and have antecedents going as far back as the Crusades in the twelfth and thirteenth centuries. Private foundations appeared much more recently, in Lichtenstein, where they were first introduced into the civil law code in 1926. Both allow for the transfer of wealth into a legal structure that can protect against a wide range of claims, from bankruptcy to inheritance disputes and divorce. The use of these structures is popular in offshore financial centers partly because legal protections are generally much stronger, but also because taxes are almost always significantly lower, allowing individuals to reduce the costs of both investing their wealth and passing it on.
Although the two structures are generally used for the same purposes today, the fact that they emerged from different legal traditions continues to affect how they are perceived by high net-worth individuals from China. “In general, foundations are more familiar to clients of civil law jurisdictions, like China,” says Mr. Davis. “While the Chinese are becoming more comfortable with trusts as they learn more about them and ways in which they can retain flexibility, foundations are still often preferred as they give more control to the client in most circumstances.”
In a bid to attract more investment from civil law jurisdictions – and China in particular – the Cook Islands are now in the process of passing legislation that will allow foundations to be established there. This is part of a wider trend: like private banks, offshore financial centers have noticed the explosion of wealth in China, and are working hard to educate the country’s high net-worth individuals about tax exemptions, asset protection and succession planning in their jurisdictions. There is still a lot of work to be done. “Many Chinese clients are not familiar with the structures typically offered in many international finance centers,” says Mr Davis. As a result, “service providers must generally be more hands-on and involved with the transactions of their Chinese clients. They require a more intense level of service and higher level of advice, whereas clients from other markets just want the entity required for their particular needs.”
China’s new millionaires might not be well versed in the intricacies of offshore finance, but they are transforming the industry all the same. The 2011 Global Private Banking and Wealth Management Survey, conducted by PricewaterhouseCoopers, tips Singapore to become the world’s next wealth management hub, soon. To get there, it will have to oust both London and Switzerland, where wealth management began. The survey does not mention the rise of high net-worth individuals in China as a specific cause for this sea change. It refers only to the “globalization of wealth,” in which China plays a major part.
Wealth is indeed globalizing, but at the same time China’s wealthy are also going global – at an incredible pace. Twenty seven percent of Chinese people with fortunes exceeding 100 million yuan have already emigrated, and another 47 percent are thinking hard about trading in their passports. The reasons for their departure are numerous, and include fundamental social issues like the quality of education and healthcare, along with the inconveniences of travelling as a citizen of the People’s Republic, but offshore finance plays its part, and some offshore centers – like St Kitts and Nevis in the Caribbean – are even targeting high net-worth individuals from China with economic citizenship programs.
“Current tax anti-avoidance rules make it difficult for Chinese corporations to move money offshore to minimize Chinese taxation,” explains Mike Grover, “but these same rules do not apply to Chinese individuals. A Chinese individual that either relinquishes Chinese citizenship or is a permanent resident of another country shifts from a worldwide basis of taxation to being taxed as though he or she is an expat, meaning that they will be taxed on Chinese source income only. This is highly advantageous, because it allows for an increase in the amount that can be transferred offshore under Chinese foreign exchange rules, as well as the ability to remit funds offshore for start-up purposes in the new location and the receipt of inherited assets without restriction to non-residents. As a result, there are more avenues to send funds offshore. If the remitted funds are put into a trust or foundation, which has always made good sense from an asset protection and for succession planning purposes, it also means that the funds may be professionally managed for the beneficiaries and benefit from being lowly taxed in locations such as Labuan IBFC.”
The wholesale emigration of its richest people must concern the Chinese government. It will almost inevitably adjust the regulations that make giving up Chinese citizenship so attractive, but these, like other changes, are likely to follow in the same general direction that Chinese economic policy has taken from the earliest days of reform and opening: a gradual opening up backed up by a steady effort to strengthen financial markets. China’s wealthy will probably find it easier, not more difficult; to manage their money in the way that they decide is best. The institutions that help them make these decisions, be they offshore financial centers or private banks, both domestic and foreign, will have to be nimble, but will have shaping the evolution of the wealth management industry for at least the next decade, and probably much longer, as their reward.
The opinions expressed do not constitute investment advice and specialist advice should be sought about your specific circumstances.
Published on our website on May 15, 2013