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Asia-PacificJune 29 2021

China’s capital markets enter next phase

As China further opens up its capital markets, it comes with risk and reward for international investors. While the Ant Group IPO suspension came as a shock, there are plenty of other opportunities for investors looking to diversify their portfolios.
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China’s capital markets enter next phase

China’s capital markets are no longer hermetically sealed like when the country’s economy began to open up in 1978. After a slow start that saw decades of minimal progress, in recent years the government has begun tentatively opening its markets up to the rest of the investment world. 

In the latest development, at the end of 2020 foreign investors were permitted to access China’s futures markets. Prior to November 1, investors were restricted to the rules of the Qualified Foreign Institutional Investor (QFII) and the RMB Qualified Foreign Institutional Investor regime.

Under the new rules, investors can now more easily and quickly apply for licences, with approval time reduced from 20 days to 10 days. The eligibility criteria to become a QFII have been relaxed, and requirements such as minimum term of operation and the size of assets under management have been removed. 

The suspension of the Ant Group’s IPO was seen widely with concern

Sheng Songcheng, Anbound

During 2020, the futures market enjoyed a strong year, with the China Futures Association reporting that the total turnover of the market rose 50.56% to Rmb4.38tn ($680bn). The trend for growth has continued, with the cumulative trading volume from January to May 2021 reaching Rmb2.39tn, a 77.8% year-on-year increase. 

Despite the impression created by these huge numbers, China is not allowing the markets to grow unchecked — even if this risks causing an upset. 

Stock markets after Ant 

The markets were turned upside down, for example, when the highly anticipated Ant Group initial public offering (IPO) was put on ice at the end of 2020 after intervention from the Chinese regulators. An offshoot of the postponement has been the introduction of stricter regulations on China’s biggest digital payment companies. In recent years these companies have experienced exponential growth, while not being subjected to the same level of regulation as financial institutions. 

With these companies now experiencing stricter oversight, it has had a knock-on impact on how they are valued in the market. 

Alicia García-Herrero, chief economist for Asia-Pacific at Natixis, says: “The postponement of the Ant Group IPO fires the first shot on tighter regulations on tech players, and has changed the view of investors in terms of valuation and growth prospects in related firms. This has so far led to a weaker sentiment generally in China’s onshore markets and Hong Kong.”

The concern of the regulators has been to maintain financial stability. Xiao Yuanqi, chief risk officer at the China Banking and Insurance Regulatory Commission, has said the role of the regulator is to maintain a fair environment, and prevent companies from becoming too big to fail. 

Sheng Songcheng

Sheng Songcheng, Anbound

Fern Wang, director at S&P Global Ratings, says this is the key concern. “The incident is a wake-up call for the capital markets. While pro-innovation, market participants need to be aware that China regulators’ priority remains to be financial system stability. The withdrawal of Ant Group’s IPO underlines the uncertainties fintech companies face as Chinese regulators seek to rein in unfettered technological disruption in banking, protect consumers from excessive borrowing, and create a more level playing field by reducing regulatory arbitrage,” she says.  

The move had an impact on the valuation of Ant Group, and other companies like it. Yu Lingqu, deputy director of finance and modern industry department at the China Development Institute, says: “Under tighter national regulation, Ant Group’s valuation has become largely uncertain, hence the postponement being in line with public expectation. As to its impact on the capital markets, JD and Tencent and other platform businesses’ financial service sector IPO may face postponement as well. There is no clear schedule for this kind of companies’ IPO yet.”

The original Ant Group listing had generated considerable interest from retail investors, totalling $3tn from this segment alone, with prospective investors using personal funds from savings and loans to put in bids for shares. 

Sheng Songcheng, previously director-general of the department of statistics and research at the People’s Bank of China and currently a member of the expert advisory committee of China-based think tank Anbound, says the withdrawal of the listing helped to protect investors in the long term. 

“The suspension of the Ant Group’s IPO was seen widely with concern,” says Mr Sheng. “A change in regulation of internet lending in China has had a major effect on the business model and profitability of the Ant Group. Thus, in line with law and regulations, the stock exchange decided to avoid a hasty listing, playing a prudential role to ensure investor protection. In this sense, the operation of the domestic capital markets is becoming more and more standardised and legalised, which is a good thing for the long-term development of the capital market.” 

Stock Connect 

Within the moderated parameters of the Chinese stock markets, some innovations have been cultivated. The Stock Connect platform, which links up the mainland exchanges of Shanghai and Shenzhen with Hong Kong, has seen a period of good results. 

First launched in November 2014, Stock Connect allows international and mainland Chinese investors to trade more than 2000 securities. The exchange operates through two streams: the northbound stream is traded and settled in renminbi by Hong Kong and overseas investors, and has a daily investment quota of Rmb52bn. The southbound stream is traded by mainland investors in renminbi, with a daily quota of Rmb42bn. 

The quota indicates the upper limit for the difference between the buying values minus the selling values. When the value is met, no more transactions are allowed that day. This quota renews each day and unused quota cannot be rolled over to the following day. 

“By operating in a closed channel, capital is circulated between the stock markets, inhibiting uncontrolled capital flight,” explains Mr Yu.

The channel has proven to be very successful in supporting renminbi-denominated equity shares of China-based companies held in the Shanghai and Shenzhen Stock Exchanges, known as A-shares.

According to a Hong Kong Stock Exchange spokesperson: “At the end of 2020, total cumulative turnover on southbound and northbound trading was over HK$14tn ($1.8tn) and Rmb40tn respectively. The success of the programme is also reflected by the significant increase in the value of cross-border holdings. As of December 31, 2020, Hong Kong and international investors held a total of Rmb2.3tn-worth of A-shares, from Rmb86.5bn in 2014. In the first quarter of this year, the average daily turnover of Southbound Stock Connect and Northbound Stock Connect reached HK$60.8bn and Rmb126.8bn respectively, both setting new quarterly highs.” 

The Stock Connect channel has allowed China to gain experience of operating with international investors within its own parameters. Mr Sheng says: “Mutual connection between China’s mainland exchanges and international finance centres are a good thing to foster two-way flow of capital. A lot of experience for the gradual opening of China’s capital account has also been accumulated in this way.” 

Stock Connect has allowed foreign investors to include Chinese shares in their portfolios. Ms García-Herrero says: “Stock Connect is a successful initiative as it has become one of the milestones of China’s financial opening and a major reason for global indexes to include Chinese A-shares into the coverage. Since the launch of Stock Connect, the foreign ownership of A-shares has increased from 1.5% in 2014 to 4.3% in March 2021.” 

The future could bring more ambitious collaborations between the bourses. Mr Yu believes that, in the future, China will possibly apply the Stock Connect model to collaborations with the major exchanges in New York, Tokyo and London, before completely opening up its capital markets. 

By the end of 2020, the total amount of domestic bonds and stocks held by foreign capital was $1.1tn, which was 4.7 times the figure at the end of 2015

Yu Lingqu, China Development Institute

Using the model of Stock Connect, Bond Connect was launched in July 2017 to provide cross-border bond trading and settlement between the China Central Depository & Clearing and Shanghai Clearing House, and the Central Moneymarkets Unit in Hong Kong.

Steps are now being taken to draw up draft rules for a cross-border connection of wealth management businesses between the Guangdong-Hong Kong-Macao Greater Bay Area. The operation has a daily quota of Rmb150bn of net capital inflows and outflows for either the north or south moving streams respectively. 

“A net management actually allows greater amounts of total capital flows while controlling the risk of volatility,” Mr Sheng says. “We can see the opening up of the capital account is conducted in a positive but prudential way. It will also encourage cross-border use of renminbi and is good for capital account opening up and a gradual internationalisation of our currency.” 

Even with these developments, Mr Sheng wants to see more progress. “I have been calling for a two-way opening up of China’s capital account since the second half of 2020. Not only should we embrace international investors, but we also need to go outside to invest in business and improve our capital allocation,” he says. “To sum up, such practice should be valued, because it enables mainland investors to invest in overseas assets, and financial support for the real economy also has a richer source of funds.” 

Foreign investors 

China’s decision to open up to international investors is not unfounded, as foreign money has poured into the country. There is clear evidence that, even with the stringent operation model, investing in China is an attractive option for foreign investors. 

“The data says it all,” says Mr Yu, as he outlines figures from the State Administration of Foreign Exchange statistics. These show that foreign capital’s net buy of stocks and bonds in China’s mainland was $615bn, within which net purchase of A-shares was $150.7bn via Stock Connect, and net purchase of bonds was $464.3bn via Bond Connect and interbank bond market direct investment. 

“By the end of 2020, the total amount of domestic bonds and stocks held by foreign capital was $1.1tn, which was 4.7 times the figure at the end of 2015,” Mr Yu adds. “When it comes to foreign investors, bonds are preferred — the net buy value is three times that of the amount for stocks. As for stock shares, investors seem to focus more on China’s advantage in market scale and prefer key players in consumer products.” 

The appetite of investors for China’s offerings is split between the public and private. Ms García-Herrero says: “International investors are increasingly interested in China’s capital markets but there is a divergence between bonds and equities. For bonds, foreign investors are only interested in government and policy bank bonds, which forms 85% of their holdings. In equities, foreign investors are generally interested in the new economy and names that cannot be found in Hong Kong, which is a proxy for investing in China-related assets.” 

Significantly, the use of renminbi is growing. Mr Sheng says: “So far, renminbi has appreciated by 8.2% since the second half of last year. In 2020, foreign investors increased their holdings of renminbi bonds by $186.1bn. In addition, the inflow of foreign direct investment to China reached $212bn, up by 14%, in a context of shrinking international direct investment. There are lots of good investment opportunities in China.” 

For example, he points to the Shanghai municipal government’s decision to speed up development of a global asset management centre by 2025. Qualified foreign investors will be able to set up securities, funds, pension management institutions in Shanghai, or establish wealth management firms as co-founders. These foreign institutions are being encouraged to set up renminbi funds to invest in domestic non-listed companies, private placement of listed companies and mezzanine funds, special assets, private equity and venture capital funds. 

While China is making progress, there is still much to be learned about operating in the international marketplace. Jinny Yan, chief China economist at ICBC Standard Bank, says investors should enter the market with their eyes open to the risks as well as the rewards.

“There are still a lot of conservative investment decisions being made in the Chinese bond market and equities because there is not enough in-depth knowledge about corporate credits. Foreign investors know there is a huge amount of risk in investing in credits with limited information,” she says. “However, investors who are able to navigate the Chinese credit market well are often rewarded with higher yields compared to sovereign government bonds.” 

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Kimberley Long is the Asia editor at The Banker. She joined from Euromoney, where she spent four years as transaction services editor. She has a BA in English Language and Literature from the University of Liverpool, and an MA in Print Journalism from the University of Sheffield. Between degrees she spent a year teaching English in Japan as part of the JET Programme.
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