Investing into and out of China
Despite the global economic slowdown, foreign investors are still eager to invest in China’s capital markets, and domestic investors are showing increasing interest in overseas securities. Capital and currency controls remain obstacles in both directions, but are being gradually relaxed, writes Andy Ng, Head of HSBC Securities Services China.
19 Sep 2012
Andy Ng, Head of HSBC Securities Services, China
China's economic story over the past 30 years has been nothing less than astounding and according to a report we, at HSBC, published in January, The World in 2050, it will eventually become the world's biggest economy.
Despite the travails of the global economy, we forecast that China's GDP will increase 8.4% this year and 8.8% next. This growth is driving large flows of investment - direct and portfolio - into and out of the country.
However, portfolio investment - shares, bonds, mutual funds and other securities - in both directions is still restricted by capital and currency controls. Though there is still a long way to go before the securities markets are fully open, controls have been relaxed in recent years, thanks to policies adopted by the China Securities Regulatory Commission (CSRC) and state leaders.
Guo Shuqing, Chairman of the CSRC China Securities Regulatory Commission is one of many who recognise the need for more liberalisation. "China's capital markets have the potential to become world-class markets," he said in a speech in June. "But achieving that cannot be an easy task. Stiff efforts are still needed to push forward the process."
Mr Guo said that China needs to accelerate the building of multi-level capital markets - equities, bonds, derivatives and other instruments - with a variety of funds and products available to foreign as well as domestic investors. Shanghai cannot turn into an international financial centre unless it develops its capital markets.
Since China's first securities investment fund was created in 1998 the investment management sector has flourished. By the end of 2011, the net combined value of securities investment funds was RMB 2.19tr, according to the CSRC. The sector has matured to the extent that June saw the creation of the China Securities Investment Fund Association (CFA) and the staging of the country's First Fund Industry Annual Conference.
However, only a small proportion of funds and other securities in China are held by foreign investors. That is because they must apply to the CSRC to be Qualified Foreign Institutional Investors (QFII) if investing in foreign currency, or renminbi QFII (RQFII) if investing in local currency. There are 181 QFIIs as of 12 September 2012 - banks, securities houses, asset managers and insurance companies - but they are small and the market capitalisation of the shares they hold accounts for only 1.1% of the free float market cap of A-shares.
The combined total that QFIIs are allowed to invest was first set at $4bn, later increased to $30bn, and increased again in April this year to $80bn as part of the CSRC's programme to encourage overseas institutional investors. The RQFII regime, which came into effect last December, imposed an initial quota of RMB 20bn ($3.2bn) but that too was raised in April, to RMB 70bn ($11.2bn).
China's capital markets have the potential to become world-class markets, but achieving that cannot be an easy task. Stiff efforts are still needed to push forward the process.
21 RQFIIs have been approved so far, including firms such as ChinaAMC, CSOP Asset Management, CICC, Citic Securities and Haitong.
In July this year the CSRC officially released a revised circular announcing further relaxations of the QFII rules. According to the CSRC the aim is to further facilitate the development of the QFII system, attract more long-term foreign funds and promote the steady development and opening-up of China's capital markets.
For instance, asset management firms, insurance companies, and sovereign wealth funds - the so-called long-term investors - will only be required to have been in the business for two years (reduced from the current requirement of five years) and have managed assets of at least $500m in the preceding financial year (reduced from the current requirement of $5bn).
On top of the above, the range of products QFIIs can invest in now includes futures and bonds traded on the China Inter-bank Bond Market (CIBM). Another relaxation is to increase the limit on the aggregate amount of A-shares held by all foreign investors in a single listed company from 20% to 30%.
Investments in overseas securities and funds can only be made through the Qualified Domestic Institutional Investors (QDII) scheme, which came into effect in 2007. At the end of 2011, the total quota for QDII products, set by the State Administration of Foreign Exchange (SAFE), was $74.95bn, although it is not known how much of the quota had been used. The QDIIs are a mixture of China-headquartered institutions, and subsidiaries and branches of foreign institutions such as HSBC Bank (China), investing mainly in the Asia Pacific region (in particular Hong Kong and Singapore) as well as the US.
The first QDII products were US mutual funds. In the first year interest from retail investors was overwhelming, with $15bn being invested in only four Collective Investment Scheme (CIS) products. However, the average return was minus 40%. In the second year, 2008, another five CISs were issued, but they attracted only $625m. In 2009 there was no issuance. Total QDII CIS issuance between 2007 and 2012 has amounted to $20.3bn, three-quarters of it coming in the first year, with an average return of minus 10%.
There are several reasons for these disappointing results in QDII funds. Stock markets around the world have performed poorly since the 2008 financial crisis. Most investment managers in QDII funds initially had little knowledge and experience of trading in overseas markets. And the renminbi has appreciated against other currencies.
China's securities markets present excellent opportunities for foreign investors. At the same time, securities markets in other parts of the world provide exciting growth potential for Chinese SWFs, institutions, companies and individuals.
Yet the future looks bright. To improve performance, more QDIIs are partnering with overseas firms to handle the discretionary investing, though investments still have to be approved by Chinese regulators. The CSRC continues to encourage this form of outbound investment, and more Chinese securities houses and fund management companies have been setting up overseas branches to build up their knowledge and experience. Furthermore, forecasts for renminbi appreciation have been scaled back, thus reducing the foreign exchange risk of investing abroad.
The role of securities and fund services providers
Investors into and out of China use a range of securities services providers for their post-trade needs: custody, fund administration, fund accounting, net asset value calculations, corporate actions and transfer agency services.
Custodians, for example, help their clients understand the inbound and outbound markets, how they work, and provide an interface with the Chinese regulators. When a firm applies for QFII status, the custodian will check its application form and related documentation, and confirm to the regulator that the applicant is qualified according to the rules. Once the QFII starts investing, the custodian will monitor its activities to ensure it follows the investment plan, sticks to the quotas, adheres to the committed asset mix, and follows all other applicable rules.
HSBC Securities Services is by far the dominant custodian in the QFII sector. We are the custodian for 33% of the 181 QFIIs, capturing a market share of 33% in terms of QFII quota.
HSBC has several advantages over its rivals in the inward investment market. First, it has the longest track record in China. In 1992 it became the first foreign sub-custodian for B-share custody. In 2005 it was the only custodian bank to obtain special approval to perform custody services to the Pan-Asia Index Fund in the CIBM. In 2012 it was the first and only foreign bank to help foreign insurers enter the CIBM.
Second, HSBC has an experienced and well-connected custody management team onshore in Shanghai and Beijing that works seamlessly across front, middle and back offices. The benefit for clients is that they can talk to professionals who speak the same language, have the same service mind-set that they enjoy in their home country, and are their eyes and ears in this exciting market.
Third, we work closely with regulators and industry bodies, participating in market initiatives designed to standardise and improve China's securities sector. For most, if not all, consultative meetings called by regulators to discuss cross-border investment, HSBC has been invited and in many cases was the only foreign bank present.
In summary, China's securities markets present excellent opportunities for foreign investors. At the same time, securities markets in other parts of the world provide exciting growth potential for Chinese SWFs, institutions, companies and individuals.
Yes, inward and outward flows are subject to significant restrictions, but the authorities are committed to easing them, gradually. Within the current restrictions there is still great potential, potential that a first-rate securities services provider can help investors unlock.