Aberdeen Asset Management is the latest firm to set up a wholly foreign-owned entity (WFOE) in China. George Mitton talks to TF Cheng of BNP Paribas Investment Partners, which set up its WFOE a year ago.
There was much interest when Aberdeen Asset Management said it had obtained a licence to set up a wholly foreign-owned entity (WFOE) in China. Though WFOEs have been around for some time, Aberdeen’s is being touted as the first of its kind that lets its holder operate in China as a private securities firm.
Although Aberdeen stressed a patient approach – “While we welcome China’s steady market opening and we’re thrilled to gain our WFOE licence, we will proceed slowly,” said Hugh Young, managing director of Aberdeen’s Asian business, in a statement – the news was noticed and discussed by Aberdeen’s rivals.
What is it that makes Aberdeen’s move significant?
According to TF Cheng, head of the Greater China business for BNP Paribas Investment Partners, “there’s a consensus developing of late that the WFOE is the way to go”. He should know. BNP Paribas Investment Partners set up its WFOE a year ago, and was among the first major foreign players to do so.
But what is a WFOE? A WFOE currently sits somewhere in between a representative office, which has limited powers, and a joint venture, which has a wide scope of operations.
Unlike a representative office, which is limited to vague ‘liaison’ and networking functions, a WFOE can sign contracts, collect revenues and employ a significant team. According to this summer’s US-China Strategic and Economic Dialogue, WFOEs can now manage money in China too, which they were not able to do beforehand: a big change, which Aberdeen’s licence seems to confirm.
Even with this new ability, WFOEs do not have as much freedom as joint ventures. A joint venture can potentially sell investment products to anyone in China, including retail investors, while WFOEs are at the moment limited to institutions and high-net-worth investors. However, WFOEs have one big advantage because, as the name states, they allow foreign companies to have 100% control. Until recently, joint ventures required a Chinese firm to have majority control.
Although some joint ventures have been successful, many have struggled, with firms such as BNY Mellon and Russell Investment having sold their stakes and exited their ventures.
It is the new power to manage money onshore in China that make WFOEs so attractive. The law around this is still a little ambiguous and is awaiting clarification, perhaps as a result of President Xi Jinping’s latest visit to the US (underway at the time of writing), but the potential is great. “It’s going to be a game-changer,” says Cheng. “I know a few of our key competitors are lining up to set up WFOEs, either hiring people or setting up an office. It would allow foreign firms to do stuff in China that they haven’t been able to before.”
As someone whose firm set up a WFOE some time ago, what would Cheng say are the first things to consider? After getting the right licence, it is recruitment, followed by brand building. The latter is important because foreign asset management brands are not typically known in China. The firm must bring on the right staff to promote the brand, initially to institutions such as pension funds and insurance companies, and ultimately to fund distributors and retail investors. The staff must understand the Chinese market, and yet, as employees of an international firm, they must be able to communicate with head office about their achievements.
“We need people with deep knowledge and access in China, who understand the local needs, and yet are able to translate that and operate in an international environment, by explaining the business to international colleagues. It’s not just about language. You need to be bilingual but also ‘bicultural’.”
Despite enthusiasm for WFOEs, Cheng says these are unlikely to become the sole route by which foreign firms access China. One reason is that the authorities are likely to keep several routes open. The Chinese government, says Cheng, “likes optionality”. This preference is clear in the way the government has opened up China’s capital markets in several stages, from the qualified foreign institutional investor (QFII) scheme to the Shanghai-Hong Kong Stock Connect. “It makes sense when a market is so big and diverse to have several different pathways,” he says.
Foreign firms themselves should be advised to keep their options open. Cheng says the regulatory landscape in China is developing fast, meaning it is difficult to keep track of everything. A strategy that gambles all on one access route risks faltering as a result of an unexpected change in regulation.
“If you’re managing the China business from headline to headline, you’re not going to make it,” he says. “You need to have a high conviction strategic vision and framework that can connect the new developments when they come. You don’t want to have to revisit your business case every time there’s a new announcement.”
As it stands, joint ventures still have a clear advantage over WFOEs in that they can potentially get all the different licences needed to do business with the various entities in China, be they retail clients or institutions. WFOEs, even with the new rules on private management, are limited and will not have access to the retail market. That may change in time, but it’s hard to know when.
Something else that may make joint ventures more appealing in future is that foreigners may be able to control them. Hong Kong-based Hang Seng Bank recently announced its aim of setting up the first majority foreign-owned joint venture in China, in the Qianhai economic zone.
“For foreign companies, where the concerns are control and governance, it might be enough to have control of a joint venture,” says Cheng.
The best strategy in China may be to keep all options open, which means having both a joint venture and a WFOE, not to mention quotas under the various capital markets access schemes such as the renminbi qualified foreign institutional investor (RQFII) scheme. BNP Paribas has four RQFII quotas.
“This is deliberate strategy,” says Cheng. “We believe in optionality and connectivity. I don’t think there will be a one-size-fits-all template that will fit.”
©2015 funds europe