How a Chinese spin-off would ring-fence bank’s golden goose

Last month, HSBC Holdings reported a 28 per cent year-on-year drop in its first-quarter profits, mainly due to troubled loans in its Russian and Chinese businesses. Since then, there have been calls for the bank to split into two – one focused on Asia and one on its global business.

First, The Wall Street Journal reported an unnamed investor had made the demand via a public relations firm. Then Bloomberg and the Financial Times reported Ping An Insurance (Group), China’s largest insurer and the bank’s biggest shareholder, was pushing the demand with the board. HSBC swiftly dismissed the idea.

However, we believe a split is worthy of further consideration.

Last June, when China rolled out its antisanctions law in response to what it calls the “long-arm jurisdiction” of the West, we proposed multinational companies caught in the geopolitical cross hairs, such as Nike, HSBC and Huawei Technologies, consider spinning off their Chinaand US-centred businesses.

While picking sides is an option, a better choice is to have two separate firms with separate boards and different brands serving two different markets.

The geopolitical tensions between China and the United States show little sign of subsiding. In Hong Kong, the next chief executive is unlikely to take it lightly if HSBC continues to deny the city’s leader its banking services. This will further shrink HSBC’s breathing space in Hong Kong and on the mainland.

Beyond geopolitical considerations, there are business management reasons for HSBC to consider splitting into two.

Though headquartered in London, HSBC derives most of its revenue and profit from

Hong Kong and the mainland. Given the bank’s hierarchical organisational structure, its senior managers of the Hong Kong and mainland businesses are possibly several layers removed from the top brass.

Management theory predicts they would have less motivation because they bear the brunt of the workload but have limited autonomy. A shorter distance between the top of the bank and its Asian business would solve this problem.

HSBC seems to be moving in this direction already, given its decision to relocate four top executives from London to Hong Kong last year. Even better would be to move its headquarters back to Hong Kong, though this brings further political complications.

Another drawback of HSBC’s global structure is the pressure to invest internationally. This drove its efforts in North America – with poor results.

In 2002, HSBC bought consumer lender Household International for US$16.15 billion.

After a mere six-year stint, it retreated from the US consumer finance business by writing off most of its investment in Household. Last May, it said it was selling most of its US retail banking business.

There are many reasons for HSBC’s underperformance in the US market, but one stands out: its desire to justify the bank’s global status by investing internationally, even though Hong Kong and the mainland generate most of its revenue and profit.

With HSBC spun off into two separate companies, the entity serving the global market is likely to be more disciplined in its investment decisions. Meanwhile, the Chinese entity can focus on growing its business, perhaps with dual headquarters in Shanghai and Hong Kong.

One common argument against spin-offs is they scale down companies. No doubt managers want to grow their companies, but investors care more about the value of and return on investments. Moreover, management theories suggest that with better incentive alignments offered by the spin-off, both the Chinese and global entities will become more successful in the long run.

In shifting HSBC’s strategy towards China and other emerging markets, chairman Mark Tucker is using the playbook that he successfully deployed at AIA in 2012. But he now needs an organisational structure that supports the chosen strategy.

In its current form, HSBC is predominantly focused on the Chinese market, but also burdened by regulations set up for sprawling global banks. Indeed, Tucker’s success at AIA stemmed not only from the insurer’s focus on Asia, but also its separate listing in Hong Kong and the managerial autonomy obtained when parent AIG unloaded its shareholdings completely.

For HSBC, a spin-off rather than a carve-out of the Hong Kong and mainland business (as in the case of AIA from AIG) would offer the right incentive structure for the bank’s Chinese business right away. And it would allow HSBC to continue its global banking business with fewer regulatory burdens and political pressures. For investors such as Ping An, this creates two golden geese, one perhaps much more profitable than the other. Let’s hope Tucker repeats his success at AIA for HSBC.

Benjamin Poon studied business administration and law at the University of Hong Kong and is soon to commence work as a trainee lawyer in Hong Kong. Zhigang Tao has joined Cheung Kong Graduate School of Business as professor of strategy and economics after taking leave from the University of Hong Kong