- Politik
Lions and Dragons: Building New Financial Markets
In recent years, Luxembourg has become a key hub for China’s financial activity. Luxembourg’s international financial centre has attracted a great number of Chinese banks and become a revolving door between Chinese and European financial markets. A key factor in Luxembourg’s success is the pool of highly specialised human resources in its financial sector. Today, Chinese bank managers and experts in Chinese financial markets are an integral part of this pool of human capital. They all represent an emerging, strategic asset of Luxembourg’s financial centre.
In general, there is a lack of knowledge about Chinese banks’ way of doing business in Europe. Chinese banks not only are the world’s largest banks, but they seem to be safer and sometimes even more profitable than their Asian, European and American competitors. Multilateral financial organisations such as the Financial Stability Board (FSB) and the Bank for International Settlements (BIS) consider Chinese banks to be at the forefront of compliance with global regulatory standards, including reporting on international information sharing. Moreover, the Basel Committee on Banking Supervision (BCBS) recognises that China’s liquidity rules have a wider scope and set higher requirements in selected areas than those of its Western counterparts.
Chinese banks in Luxembourg
China’s banking presence in Luxembourg dates back to 1979, when the Bank of China established its first overseas branch after the Maoist revolution. Since then, the economic relations between Luxembourg and China have grown slowly but steadily. In recent years, China started following a renewed strategy of economic expansion with its concomitant launch of the Belt and Road Initiative (BRI). As a result, between 2013 and 2017, five more Chinese banks clustered in Luxembourg. This was a calculated choice; Luxembourg responds perfectly to China’s strategic needs, especially with regard to its unique expertise in cross-border investments. Today, there are seven Chinese banks in Luxembourg, which makes it one of the two Chinese banking headquarters in Europe, along with London.
Despite the fact that some Chinese banks have only just opened in Luxembourg, Chinese banking activity is well embedded into Luxembourg’s economy. For instance, the Bank of China was one of the seven banks that signed the agreement with Luxembourg’s Ministry of Finance to carry out eligibility checks for, and partly provide, loans to local companies in response to the Covid-19 crisis in April 2020. Chinese banks also employ Chinese second-generation expatriates in Luxembourg, who represent a valuable resource, especially in terms of their language skills, and Chinese bankers sit on the Board of Directors of the Luxembourg Bankers’ Association (ABBL). In addition, Chinese banks participate in start-ups and support cultural initiatives. More importantly, Chinese bankers in Luxembourg have established a Chinese Bankers Club to strengthen ties with local institutions and society. They also back the China-Luxembourg Chamber of Commerce (CHINALUX), a widely active initiative in Luxembourg for improving economic relations between the two countries.
Walking around Luxembourg City, one can easily recognise Chinese banks’ exotic logos against the backdrop of prestigious buildings. This is intentional. Indeed, Chinese banks have a locational strategy; they select highly visible venues close to key local institutions, such as central banks, ministries of economy and finance and stock exchanges. This is very clear in Luxembourg. Four banks are based on Boulevard Royal, the main artery of the city (once called Bankers Row), and the other three are close by. It is curious, however, that Luxembourg’s financial regulator, the Commission de Surveillance du Secteur Financier (CSSF), reports the presence of 14 Chinese banks on its website. In fact, Chinese banks in Luxembourg are all organised in a branch-subsidiary structure, that is, each of them is split into two different entities, even though they share the same building and staff.
The branch and subsidiary system
This organisation corresponds to two different regulatory frameworks. Branches are a direct extension of their parent banks in China, while subsidiaries are locally incorporated banks subject to local company law. By acting both as branches and subsidiaries, Chinese banks organise their financial operations in the most efficient way. On the one hand, they cover a wider range of activities and on the other, they manage their balance sheets strategically. Branches are part of a centralised network of branches, which are more or less free to move capital from one jurisdiction to another. However, they can only market their products within Luxembourg’s borders. Subsidiaries, instead, can operate beyond Luxembourg’s borders throughout the European Union thanks to their EU banking passports. Subsidiaries are more independent and capital movements between them and their parent banks are subject to more restrictions. Chinese subsidiaries in Luxembourg are governing bodies, which control their own networks of sub-branches in other EU member states. This organisation makes Luxembourg the headquarters of Chinese banking activity within the EU. However, not all Chinese subsidiaries have developed networks outside of Luxembourg yet.
Chinese banks that clustered in Luxembourg are organised in the same way as those in London. The main difference between these two banking headquarters lies in the fact that Chinese subsidiaries in London have expanded their networks within the UK only, with the exception of one sub-branch in Ireland. This territorial organisation makes Chinese banks very well positioned to deal with changes resulting from Brexit. However, the reasons why Chinese banks decided to keep the EU and the UK networks separate are mainly due to differences in British and continental law. Another important reason is the different functions that Luxembourg and London have within the international financial system. While London is a key hub for payments and foreign exchange transactions, Luxembourg is an international investment centre with a highly specialised cross-border investment fund industry.
Luxembourg is the largest cross-border investment centre globally and its fund industry ranks second in absolute numbers after the United States, with more than US$5 trillion of assets under management. Investors from the US and the UK have an exposure of over 980 and 800 billion euros respectively in Luxembourg’s fund industry. China does not rank as a major investor. However, China funnels over 40 % of its direct investments to Europe through Luxembourg. Therefore, China is not a key player in Luxembourg’s investment activities yet, but Luxembourg is a strategic location for Chinese banks’ international operations.
Chinese banks in Luxembourg are financial bridges between China and Europe. They provide services to European customers who want to enter Chinese markets and help Chinese customers to expand into Europe. Luxembourg is a perfect platform for Chinese banks thanks to its human capital. Luxembourg ranks fourth in the world for human capital in the financial sector, after New York, London and Hong Kong. The large pool of knowledge and expertise in Luxembourg helps banks, not only Chinese ones, to develop perfectly tailored investment vehicles for specific purposes. This is necessary to navigate the highly fragmented financial markets of the European Union, but also to direct investments towards non-European countries by benefitting from a highly sophisticated tax scheme. Chinese banks use these vehicles to manage merges and acquisitions in Europe, invest in infrastructure projects and reinvest into Chinese securities markets amongst others.
The renminbi
Within the scope of Chinese bank activities, the internationalisation of China’s currency, the renminbi (RMB), plays an important role. Chinese banks lend in RMB in Europe and offer a variety of services and products, including RMB investment funds and RMB bonds. Thanks to its specialisation in the cross-border investment fund industry and the presence of Chinese banks, Luxembourg has become a leading financial centre for the RMB business. Luxembourg’s specialisation attracts RMB deposits and related services. Today, Luxembourg hosts almost 80 % of European and more than 32 % of world funds with an exposure to China’s RMB denominated securities markets. The CSSF authorised the first EU’s fund to invest 100 % of its capital in Chinese securities in 2013. In 2014, the CSSF authorised the first Luxembourg-based fund to trade through the Shanghai-Hong Kong Stock Connect, which is one of the main channels for investing in China’s financial markets. Besides Chinese banks, few global banks act as intermediaries between foreign investors and Chinese securities markets and all of them have offices in Luxembourg.
It is curious that all the attention focuses on London when it comes to RMB international business. The reason, again, is London’s specialisation as a payment hub. In 2018, inbound and outbound payments through London totalled more than US$120 trillion. Transactions with the United States surpassed 50 % of the total and the US dollar covered 39 % of transactions. In 2019, RMB business in this market reached an equivalent of about US$98 billion, that is, more than 37 % of global RMB transactions outside Greater China. Luxembourg cannot compete with the pivotal role of London as a key hub of the global payment infrastructure. However, thanks to its specialisation as a cross-border investment centre, Luxembourg attracted an important share of the global RMB business. Asset managers from other jurisdictions, particularly from London, Hong Kong and Singapore, moved part of their RMB business to Luxembourg, thus increasing the local RMB pool.
In addition, the RMB bond market reflects the growing importance of Luxembourg in the international financial system. In 2011, the Luxembourg Stock Exchange (LuxSE) listed its first Dim Sum bond, that is, a RMB denominated bond. Since then, the LuxSE has experienced a fast-growing Dim Sum business. In 2018, Luxembourg became the first Dim Sum listing financial centre in the world, even before Hong Kong, with a global market share of about 26 %. Today, the LuxSE lists more than 250 RMB bonds. In comparison, the London Stock Exchange listed the first Dim Sum bond in 2014 and today its market counts for just over 100 bonds. Like the RMB investment fund industry, the RMB bond market in Luxembourg exceeds the one in London. Luxembourg and London have different functions in RMB global finance. London offers the “hidden” banking infrastructure for payments and foreign exchange trade, while Luxembourg represents the main “visible” market for investors.
Future relations between China and Luxembourg
In recent years, Luxembourg’s international financial centre has been in flux. In general, the number of banks in Luxembourg is decreasing, while assets under management are constantly increasing. New regulations have enhanced the investment fund industry and created new investment markets. Against this background, Chinese banks have established their largest European headquarters and become the second in number along with French and after German banks in Luxembourg. However, contrary to the widespread assumption that China is buying the world and debt-trapping other countries, Chinese financial activity in Europe is still limited, especially with regard to Chinese banks’ potential.
It is hard to predict the future of Luxembourg as a key element of China’s international financial activities. The world is facing structural changes in economic terms. China is set to become the largest consumer market on the planet soon, attracting more investments from abroad while progressively opening its financial markets to foreign investors. In all likelihood, the RMB will be the third most traded currency after the US dollar and the euro before the end of this decade. A gradual increase of outbound investments from China is expected. However, recent events such as the blacklisting of Chinese securities in the US and the Covid-19 pandemic have cast a shadow over the future of US/EU-China relations. A potential ray of hope is the recently signed Comprehensive Agreement on Investments (CAI) between China and the EU, which shows how a dialogue is still possible, especially when a huge new financial market is on the horizon. Against this background, Luxembourg’s international financial centre is very well positioned to attract more Chinese financial activity and influence the ongoing reshaping of global financial markets.
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