George Osborne is risking regulatory double standards as he seeks to court Chinese banks. The UK Chancellor of the Exchequer hopes that smoothing their path to Britain will in turn help London become the global centre for offshore trading in the renminbi. But the plan creates a worrying inconsistency.
Since the financial crisis, regulators have tried to restructure banks so regional operations function as separately capitalised subsidiaries. Osborne’s idea is to let Chinese wholesale banks operate only as branches in the UK. It’s an important technicality: branches rely on capital located elsewhere in their parent group. The failure of a systemically important foreign bank branch without a separate capital cushion could cause damage to the UK economy. Beijing could repatriate assets, leaving creditors with nothing.
This drive for so-called subsidiarisation originates from Lehman Brothers’ collapse, when funds leaked from London to the bank’s New York headquarters. While the Bank of England can’t force foreign banks to set up separately capitalised subsidiaries, most systemically significant institutions would find it hard to operate in the UK otherwise.
Fortunately, China’s five biggest state-owned banks – Agricultural Bank of China, Bank of Communications, Bank of China, China Construction Bank and ICBC —already all have UK subsidiaries. But although not all Chinese lenders are systemically risky, UK regulators need to remain vigilant. The few UK-based Chinese banks without separately capitalised subsidiaries may be smaller than the big five, but could grow. What’s more, Beijing’s oversight is notoriously opaque. The Prudential Regulation Authority, the Bank of England division that regulates wholesale banking, may only be able to make limited assessments of Chinese banks via its counterpart. The China Banking Regulatory Commission is unproven — it was only set up in 2003.
Osborne’s efforts to woo Chinese lenders look a lot like the light-touch regulation that undermined London’s reputation as the crisis broke. In the short-term, the renminbi trading pact may benefit London’s finance industry and boost Beijing’s share of foreign direct investment. But if a UK-based Chinese bank got into difficulties, and British regulators couldn’t stop a badly managed failure, the move would be a costly mistake.
- UK Chancellor George Osborne and Chinese counterpart Vice Premier Ma Kai agreed on October 15 to support trading of the renminbi in London.
- As part of the accord, Chinese banks can apply to operate wholesale branches in the UK, rather than separately capitalised subsidiaries.
- The agreement also seeks to increase foreign direct investment into China by allowing licensed London-based institutions to plough renminbi back into China.
Dominic Elliott is a London-based columnist covering investment banking. Prior to Breakingviews, he spent two years at moneydealer ICAP, where he brokered equity derivatives trades between investment banks, high-frequency trading firms and hedge funds. He has more than five years of financial journalism experience, including stints as news editor and investment banking editor at Financial News. He has also written for The Wall Street Journal Europe. Dominic holds an MA in Classics from Oxford University and an MSc in Development Management from the London School of Economics. Follow Dominic on Twitter @DominicElliott