Grand Duchy grows in importance as hub for Chinese banks in Europe.
When China Investment Corp bought European warehouse firm Logicor last year in an eye-watering €12.25-billion deal, the sovereign wealth fund reportedly turned to Bank of China and China Construction Bank for a €6.8-billion loan.
As Chinese companies shop for targets in Europe, the firepower of the country’s banks is helping to support their expansion.
Chinese banks have, as a result, sought a foothold in Europe through which to run their business. Tiny Luxembourg, whose entire capital city’s population is smaller than the number of employees globally at some of the huge state-owned banks, has become a key hub.
The Grand Duchy is now home to seven Chinese banks. Bank of China arrived in the late 1970s, followed by the Industrial and Commercial Bank of China (ICBC) in 1999.
Since 2013, the growth has accelerated, with China Construction Bank, Agricultural Bank of China, China Merchants Bank and Bank of Communications all setting up shop. The latest to arrive, China Everbright Bank, established a European headquarters only six months ago in August last year.
Luxembourg has also not been immune to M&A deals itself – with Chinese conglomerate Legend Holdings snapping up a 90% stake in Banque Internationale à Luxembourg in September last year.
For Luxembourg, the increasing presence of Chinese banks represents a rare growth area in a bank market that is otherwise contracting. The banks also bring new business, including big-ticket lending, which has traditionally not been a mainstay of Luxembourg’s financial market. Yet their expansion is not without its risks.
Belt and Road
The jump in the number of Chinese banks in Luxembourg coincides with a state-backed overseas acquisition drive over the last decade.
“After the financial crisis in 2008, when the global economy turned down, China started to expand and encouraged the ‘going out’ policy,” says Amanda Yeung, vice-president and treasurer at the China-Luxembourg Chamber of Commerce and director of EMEIA Chinese business services at audit firm EY.
“The government encouraged the banks to grab the opportunity to go out with and assist the Chinese companies for their global expansion.”
The banks are also moving in lockstep with president Xi Jinping’s One Belt, One Road initiative, which was written into the Chinese party constitution in October last year. This initiative intends to create a modern-day ‘Silk Road’.
“If you compare before 2009, the number of overseas branches of the Chinese banks all over the world is far less than it is right now,” Yeung adds.
A crackdown in China on capital outflows and some companies’ ‘trophy’ or debt-fuelled deals – in addition to nervousness from European governments about relinquishing control of sensitive technology – led to a drop in Chinese outbound M&A activity last year in Europe and the US to $52.5 billion (€42.6 billion) from $149.7 billion in 2016, according to Mergermarket figures.
However, after the October party congress, Chinese companies are expected to push on in 2018, with acquisitions more directly linked to the new Silk Road, such as infrastructure, natural resources and energy deals.
Chinese companies still have an appetite for takeovers but perhaps “in a more refined direction”, Yeung explains.
The choice of Luxembourg as a hub for Chinese banks through which to orchestrate European operations is partly down to business strengths but also to political considerations.
As Britain prepares to leave the European Union, London has become less attractive as a European hub, while Luxembourg is viewed as a more neutral choice than say France or Germany.
“Luxembourg was certainly a place that offered more stability to use the European passport than London,” says Pit Reckinger, partner at Luxembourg law firm Elvinger Hoss Prussen.
“Luxembourg is, by definition – and for almost a century now – an international hub focusing on cross-border business, moreso than France or Germany, with their large internal markets And because of our size, people view us more neutrally.”
“The core business is definitely the bilateral and syndicated loans – these are huge amounts and very large deals”
Chinese banks in Luxembourg operate a dual presence – with the exception of China Merchants Bank – establishing both a branch of the Chinese parent bank, which brings lending firepower, and a subsidiary, which has a European passport to sell services cross-border.
The main business of many of the Chinese banks remains lending, or corporate banking, with large syndicated loans provided at the branch, which can use the balance sheet and credit rating of its Chinese parent.
“The core business is definitely the bilateral and syndicated loans – these are huge amounts and very large deals,” says Denis Costermans, executive director at EY, who advised China Everbright on its move to Luxembourg last year.
The branch, which is not a standalone legal entity, is still primarily regulated in China by the China Banking Regulatory Commission as an arm of the parent. It is also subject to supervision from the Commission de Surveillance du Secteur Financier (CSSF).
Only in 2013 did the UK relax its rules and allow Chinese banks to set up branches instead of capitalised subsidiaries in London. As a result, most of the Chinese banks in Luxembourg also have a London branch, and some will have similar set-ups in other European capitals.
In Luxembourg, many of the banks also have a subsidiary, which is a legal entity with its own capital and through which the bank then runs other European branches. The CSSF is the ‘home regulator’ for the subsidiary, as well as for any branches.
“To complete the picture, [the Chinese banks] also need in a second stage to develop internationally, to follow their clients who establish in Germany, in France, in Spain, for instance,” says Costermans. “This is where they need the subsidiaries to go along internationally in Europe.”
Luxembourg veterans like Bank of China and ICBC have been expanding the services offered through the Grand Duchy by creating a network of “sub-branches” from their Luxembourg subsidiary. Bank of China, for instance, now has branches in Rotterdam, Brussels, Warsaw, Stockholm and Lisbon.
Chinese banks operated 17 branches across Europe from a Luxembourg HQ at the end of 2016, according to a PwC analysis. They also employed 656 people in the Grand Duchy.
The PwC report found that 38.5% of Chinese banks’ business in Luxembourg was lending – taking in trade and project financing and syndicated loans.
The subsidiaries also act as a “service centre” for the European branch network, as well as the branch of the parent in Luxembourg – accounting for 30.8% of the banks’ Luxembourg business.
However, the supervision of Chinese banks’ blossoming European networks also brings challenges for Luxembourg’s regulator.
ICBC, for instance, was fined €3.7 million by the CSSF for misconduct in March last year, while in September it emerged that the bank’s Madrid branch is under investigation for money laundering.
Marc Feider, senior partner of law firm Allen & Overy, said the CSSF, which has steadily increased its staff levels to around 800 civil servants, has the expertise and manpower to regulate the Chinese banks’ expansion.
“We have come from a time in Luxembourg when we had 220 banks to a time now when the number of banks has shrunk to around 140,” he says.
“The regulatory context has become more complex, but, at the same time, some of the responsibilities of the CSSF have shifted to EU regulatory bodies.
“So the capacity and resources are here, and the expertise to deal with third-country investors and banks, including Chinese investors and banks, is also here.”
“The service offering may not be very similar to that of their peers”
There can, nevertheless, be “cultural differences” with the Chinese banks, he acknowledges.
“Cultural differences matter and are real,” Feider says. “They need to be bridged to close the gap. This requires that both sides make efforts to understand their respective viewpoints.”
Corporate services, especially large syndicated loans, are also by their nature distinct from the regional, back-office, retail or private banking operations traditionally found in Luxembourg.
“The service offering may not be very similar to those of their peers,” concedes Yeung. For instance, there are not many Chinese banks running large fund operations like depository banking, although some are looking at moving into this area.
Yeung says Chinese banks are keen to diversify their services in Luxembourg, most recently demonstrated by a move into green bonds.
While corporate lending remains key, the banks are adding more strings to their bow, including some institutional services, their own funds and more private and retail banking.
Luxembourg is also already the second-largest global domicile of investment funds investing into mainland China, after Hong Kong, and the largest European listing centre for renminbi, or dim sum, bonds.
More Chinese banks could be on their way. Luxembourg’s finance minister Pierre Gramegna, who has led government trade missions to China to court business, said in January two banks were in discussions with the government. Shanghai Pudong Development Bank’s board previously voted to set up a branch in Luxembourg.
There are also increasing expectations fintech companies will follow suit. Alipay – ‘China’s Paypal’, owned by billionaire Jack Ma – already announced its intention to come to the Grand Duchy in 2014, which is still rumoured to be in the works.
Luxembourg, which would fit more than 3,700 times into China, has successfully fashioned itself as a entry point into the European market for Chinese financial firms.
Chinese banks’ rise and expansion in Europe, however, is now increasingly linked to Luxembourg – and with that comes responsibility.