The UK’s biggest bank is exposed to Evergrande and the Chinese real estate market. It’s also trapped in the middle of an escalating economic war between the world’s two superpowers.
“I’d be naive to think that the turmoil in the market doesn’t have the potential to have second-order and third-order impact. Clearly with the changes that are taking place in the Evergrande situation, it’s concerning,” HSBC CEO Noel Quinn said on Wednesday at a Bank of America conference. In a webcast on HSBC’s website Quinn said he saw no reason to worry about HSBC’s loan exposure to Chinese commercial real estate, referring to a review of the bank’s provisions for distressed loans in the sector.
«You wouldn’t have seen anything in that, that indicated we were concerned about our CRE exposure in China».
HSBC’s asset management arm is among the largest foreign holders of Evergrande debt, with a little over $200 million of its dollar bonds, according to a fund analysis report by Morningstar. And dollar bondholders seem to be pretty low down in the pecking order of creditors. Today (Friday), Evergrande missed an interest deadline on a dollar-denominated bond worth $83.5 million without even issuing a public statement. The firm, now in uncharted waters, enters a 30-day grace period. If it doesn’t make the payment in that time, it will have defaulted.
Doubling Down
Interestingly, some banks, including HSBC, have been doubling down on Evergrande’s debt even as concerns about the company’s financial health grew, perhaps in the (seemingly mistaken) belief that when push came to shove Beijing would bail them out. Morningstar Direct data found that three Asian high-yield funds, belonging to UBS, HSBC and Blackrock, have been accumulating more units of Evergrande bonds over the past year. As the FT reported Thursday, the growing crisis at Evergrande is also sparking a sharp sell off of other high-risk Asian bonds, to which HSBC is also probably exposed. Real estate makes up 42% Asia’s high-yield bond market, with most of the borrowing coming from China.
Big developers such as Fantasia, R&F, Suna, China Aoyuan are already in big trouble. This is causing difficulties for some of the Chinese banks that have helped finance the sector’s last two decades of high-octane growth and unfettered speculation. Those banks, with some 50 trillion yuan ($7.7 trillion) of outstanding loans to developers and home buyers, have already been hit by a surge in defaults as authorities have escalated their curbs on the real estate sector, reports Bloomberg.
In late August ICBC said that its non-performing loans to real estate companies almost doubled in the first half of the year, while troubled loans to the sector at China Construction Bank jumped by 28 percent. China Merchants Bank recorded an almost four-fold jump in bad loans to real estate.
It’s hard to imagine that HSBC is totally immune to these developments. It clearly has exposure to China’s real estate market, including to buyers of uncompleted Evergrande residential projects. It is also probably no coincidence that HSBC’s shares have fallen 8% over the past four months, as Evergrande’s crisis has intensified.
But HSBC’s problems in China extend far beyond its exposure to Evergrande and the Chinese real estate market. HSBC’s biggest problem is arguably political, or to be more precise geopolitical.
Betting the Bank on China
Over the course of the last five or so years HSBC has bet the bank (pun intended) on China’s fast-growth economy while staging a strategic retreat from other markets. But China’s economy is beginning to look a bit fragile, as the Chinese government tries to stabilise the onshore property market, which is likely to be a long, slow, painful process. Also looking increasingly fragile is HSBC’s position in Hong Kong and mainland China
Despite being headquartered in the UK, HSBC is first and foremost an Asian bank — and always has been. Like its UK-based arch-rival Standard Chartered, it cut its teeth in Greater China in the 19th century (largely laundering the proceeds from the British East Indian company’s opium trade). And it remains a primarily Asian bank today. In 2020, its Mainland and Hong Kong operations accounted for 39% of its annual $50 billion in revenue, while the United Kingdom, its second largest market, brought in 28%.
The bank announced earlier this year plans to sell off its retail banking units in France and the United States and scale back its presence in some emerging markets in order to accelerate its eastward pivot. But there’s one big problem with this plan, as I reported for WOLF STREET in July: its success rests squarely on the bank’s ability to maintain good relations with the Chinese government, while also keeping the governments of the US and the UK on its side. In the middle of ratcheting tensions between China and the US (and by extension the UK), that is proving to be a tough proposition.
As geopolitical tensions have escalated between the US and China, HSBC has had to walk a tightrope in its relations with China on the one hand and Washington and London on the other. The lenders’ travails reveal a core challenge for multinational firms operating in China: the market is vital to their growth prospects, but Western firms doing business there increasingly risk being mired in the ratcheting tensions between Beijing and the West.
Like Standard Chartered, HSBC has thrown its support behind China’s imposition of security legislation on Hong Kong. It has frozen the assets of pro-democracy politicians and protesters, at the behest of Beijing. The bank has complied with just about everything Beijing has asked of it. But it’s still in Beijing’s bad books, partly no doubt due to the fact that it is, officially speaking, a UK-based bank, and the UK just signed a security pact with the US and Australia aimed at countering Chinese influence in the Asia Pacific.
Also, China still hasn’t fully forgiven HSBC for ratting out Chinese telecom giant Huawei to the U.S. Department of Justice for breaching U.S. sanctions on Iran. The information provided by HSBC led to the arrest of Meng Wanzhou, Huawei’s chief financial officer and daughter of the company’s founder, in Vancouver in 2018. Coincidentally, she was released just today and will be able to return to China after almost three years under house arrest. HSBC representatives claimed that they had little choice but to cooperate with the U.S. investigation — a legacy of the bank’s highly controversial deferred prosecution agreement with the DOJ in 2012, after being found guilty of breaching sanctions and laundering money for Mexican drug cartels.
In recent months Beijing has expressed its displeasure with the bank by allegedly ceasing one-on-one meetings with senior HSBC bankers as well as sidelining HSBC’s investment banking operations in China. In total, Reuters identified nine state-owned enterprises that have ended or cut back on their business with HSBC as a result of the bank’s falling out of favor with Beijing.
Anti-Sanctions Law
China has also introduced new anti-sanctions legislation aimed at counteracting what it perceives as Western economic bullying. The new law allows authorities to punish companies that comply with foreign sanctions. As The Diplomat notes, it is not the first to take such action. The EU has also enacted policies specifically aimed at circumventing certain sanctions regimes. The passage of China’s new laws, in June, does however suggest that life is going to get even more difficult for Western “companies that have a large market presence within China”:
Some of the potential responses spelled out in the new legislation are asset freezes, visa bans, business prohibitions, or deportations. One provision that has attracted particular attention is the ability for such measures to target not merely the entity complying with foreign sanctions or the policymakers that designed them, but family members of those parties or corporate leaders in their individual capacities as well. Further, those enforcing Western sanctions in China can be subject to lawsuits by Chinese companies that are harmed. In those instances, the pressure will be on top brass at multinational corporations with large scales of business in China to decide whether or not to comply with Western sanctions targeted at Chinese entities. In terms of the direct effects this may have on businesses, only time will tell. It is possible that the countermeasures may primarily target foreign politicians that hammer sanctions through legislative houses rather than corporate executives, but that is far from a certainty.
Given the flexibility of the policy and its discretionary implementation, it is quite possible that the overall level of enforcement may reflect the ebbs and flows of a given bilateral relationship. Additionally, it will be much tougher for enterprises that rely heavily on the Chinese market in driving revenue growth to avoid considering the potential impact of complying with sanctions against Chinese entities. The carrot of the Chinese marketplace may end up proving large and sweet enough to induce some businesses to either pressure their home states to relent on sanctions or elect not to enforce them in practice on Chinese soil. It is further possible we could see some large multinationals attempt to separate their China division from their other subgroups through complex corporate structures that might be able to weave around the sanctions. Of course, all of those seemingly crafty moves would run the risk of blowback back home and potential repercussions for noncompliance. All of this represents a delicate balancing act that must take into consideration the specific circumstances faced by an individual enterprise.
China’s anti-sanction legislation was first introduced on the mainland in June. It was scheduled to be extended to Hong Kong and Macau in August, sparking fears about the effects it would have on Hong Kong’s standing as a global business hub. In the end, Beijing put the plans on hold, apparently out of concern about the potential economic impact. But the reprieve is likely to be only temporary.
Just today, China’s Foreign Ministry released a fact sheet outlining 102 examples of US interference in China’s Hong Kong affairs since 2019, including imposing sanctions, smearing the Hong Kong government and police force and shielding and supporting anti-China forces that attempted to destabilize Hong Kong. According to Global Times, an outlet closely tied to the Chinese Communist Party, the fact sheet demonstrates the need for the anti-sanctions legislation: “since the US used legal means to interfere in Hong Kong affairs, Hong Kong needs to resort to the same means to protect itself and national security.”
Clearly relations between China and the US are not getting any better. If Evergrande does default on its US dollar bonds, leaving foreign investors including big banks holding the bag, they’re going to get even worse. And the worse they get, the harder it will become for HSBC (and other Western banks and companies with a large market presence in China) to keep both sides of the escalating economic war between Beijing and Washington happy.
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It couldn’t happen to a nicer bank.
My thoughts exactly when I read this article. HSBC doesn’t have the cleanest record in the banking business, does it?
No, it doesn’t. This is a bank that began business in the opium trade 155 years ago and which was fined $1.9 billion in 2012, 147 years later, for serving as a middleman for Mexican drug cartels. Notoriously deemed too big to jail, HSBC entered into a deferred prosecution agreement with the Justice Department under the condition that it must clean up its act, which obviously hasn’t happened:
https://www.icij.org/investigations/fincen-files/hsbc-moved-vast-sums-of-dirty-money-after-paying-record-laundering-fine/
And which was never even intended to happen, actually.
The details on their money laundering in Mexico City were hilarious. Imagine designing a special “deposit window” to precisely fit their money boxes of your cartel clients. Of course it was much more efficient. Staff didnt have to open the boxes in the front of the bank.
Beat me to it, first thought on seeing the headline.
If only there’s a way through Patreon to get the Chinese government to twist the knife a bit harder on HSBC, I’d donate money for sure.
Make these guys bleed!!!
it takes 20 seconds to check who the principal bankers are on Evergrande’s website. And HSBC is not one of them.
please do some basic research…
Please study up on basic roles in finance before making dubious allegations. A “banker” is either an investment banker (underwrites stock and bond issuance, performs M&A advisory) or a lender. Specifically, the need to hold licenses to operate as securities dealers and/or depositaries.
Asset management is a completely different role and to the extent the asset manager has assets of third parties (as opposed to, say, public pension funds like CalPERS) is subject to a completely different regulatory regime. HSBC’s asset management operationgs, like those of Goldman and J. P. Morgan. are completely separate from its banking side and no one who understood the industry would confuse one with the other.
Being an investor in a company’s securities require NO business relationship with the management of the company, witness how activists often hoover up shares and then pressure management. If the securities are liquid, an asset manager can quickly go from being a large holder to a non-holder; how fast depends on the size of their position and their willingness to risk having their sale(s) depress the market price.
Now when an asset manager loses money, it does not hurt the management company unless it loses so much that investors flee and it can’t fund its expenses. But Nick also points out that HSBC (as in its other operations) has tremendous exposure to China and Chinese real estate, and could be caught in a downdraft if the Evergrande unwind goes badly.
I trust you will find your happiness on the web elsewhere.
I think “John doe” accidentally left the “p” out of his last name.
There has been a movement the past few years by the west to cut off China diplomatically, militarily, financially, etc. in order to weaken it and retard its growth. So what we have is a growing chasm between China and western countries and it looks like HSBC is going to be dropped into it. China will see no need to bail them out. Not with a British carrier sailing around the Pacific. But what China is doing is the right thing. True, they totally stuffed up by letting this problem grow so large instead of nipping it in the bud years ago so they will be in for a lot of pain in the next few years. And HSBC will be merely collateral damage but considering their record, I will shed no tear for them.
Dim sum fortune cookie saying:
‘You will do well to avoid going to jail for life in the PRC, in bed.’
Unlucky numbers of stock price falls:
-14%, -26%, -7%, -22%, -19%, -8%
It’s a Dim some misfortune cookie.
‘Kiss and make up with PRC or else’
Thank you, Nick.
Spot on.
I worked at HSBC from 1999 – 2006, including the integration of CCF / HSBC France, including the elegant second empire building on the Champs-Elysees, and Republic. Colleagues worked on Household, where our doubts about the wisdom of that acquisition were ignored and it was better to say nothing and move on.
HSBC has cross shareholdings with Communications Bank and Ping An and each way distribution agreements with both. HSBC’s clients like Ashmore asset management are also caught up.
Some years ago, UK regulators warned of UK bank exposure to China via Hong Kong and Singapore branches. Some of these loans are long term and no longer easy to sell down in the secondary market.
Some loans may be made by banks to affiliates, often in tax havens, and an intra-group loan made to the parent in China. The ultimate exposure to China may not be recorded as such. Such conduct is not limited to China. Whatever suits the bankster to minimise capital and AML risks goes.
The political pressure on HSBC to show its commitment to China goes back to when the bank bought Midland and relocated its HQ to London, after an attempt in the early 1980s was rebuffed by the Bank of England. For example, when company announcements are made, the CEO will be in London and the chairman in HK or vice versa.
The descendants of the drug dealers whose fortunes built HSBC and Standard Chartered are still prominent in public, business and social lives. In the UK, they are the Cameron, as in David, Swire, Keswick, Rothschild and Sassoon families. In the US, they include the Forbes, as in Kerry, and Delano, as in Roosevelt, families. The banks always rate a mention, but not the individuals.
There is a team, including former diplomats and spooks, at London HQ dedicated to managing the relationship with China.
Thanks for all those extra nuggets, Colonel. Most appreciated.
Wow a reference to Household Finance. I had forgotten about those consumer finance snakes, er, lenders; now I can vaguely recall the news when HSBC acquired them.
There is much that has been written previously concerning subprime mortgage finance. Household is one of the older names out of that cesspool (I believe unless that is inaccurate).