Expect little to change in China’s securities industry in 2007, the year in which the National Congress of the Communist Party is held. For when that highest body convenes at the Great Hall of the People in Beijing once every five years, the over-riding concern is security and stability.
“Any new initiatives in the financial markets will be undertaken with extreme caution,” says Robert Lawrence Kuhn, senior advisor, Citigroup (Investment Banking) and editor-in-chief of a recently-published book entitled China’s Banking and Financial Markets: The Internal Research Report of the Chinese Government.
“So no-one should look to see a great liberalisation of the markets this year. If anything, there will be a tightening in virtually every area, including new investment products.”
Given the desire for stability, Mr Kuhn says the near 9 per cent fall in the Shanghai Composite Index on 27 February was “very disturbing to a government which is going out of its way to avoid any sudden lurches in the domestic stock market”.
The Chinese government, he adds, is worried about the possible social consequences of people losing money.
“Investors are not that sophisticated so if they lose money, they blame the brokerage company or the government.”
At time of writing, China’s main share index had reached a record high less than one month after suffering its biggest one-day decline for a decade. Nevertheless, Mr Kuhn believes further corrections are likely as an expensive an over-valued market “finds its proper level”.
But with so much liquidity in personal savings accounts earning a low rate of interest, he asks: where else do people put their money?
“I don’t think there will be much diversification away from equity funds because there are no alternatives that will be acceptable to many people in the mid-term.”
At present, fixed income funds are largely investing in central bank bills and government bonds as corporate debt issuance is limited. Efforts are being made to develop a corporate bond market but it has relatively little depth or liquidity. This situation is unlikely to change much in the near future. Corporate bonds, while increasing in issuance, still represent a very low percentage of all issued debt. That said, corporates more than doubled in 2005 to 65.4bn yuan (€6.29bn) (face value).
In 2005, according to research for Mr Kuhn’s book (co-authored by Li Yang), total bond issuance in China amounted to 4379.1bn yuan, a rise of 1589.7bn yuan (57 per cent) over the previous year. This huge growth was due to the issuance of central bank bills, which accounted for 77.3 per cent of the increased bond volume as a whole.
Boosting bonds
Mr Kuhn points to two potential reforms which could boost the government bond market in the future.
“These are the function allocation of government departments in foreign reserve management and the issuance of local government bonds. If the Ministry of Finance instead of the People’s Bank of China is endowed with the responsibility of control of the excess liquidity caused by foreign reserve accumulation, and if local governments are allowed to issue bonds, government bonds will play a much more important role in the bond market of China.”
In line with government policy to diversify the markets, the Chinese securities regulator is reported to be encouraging asset managers looking to launch new fixed income funds.
Mr Kuhn also believes the regulator will gradually open up the Qualified Foreign Institutional Investor (QFII) market which was introduced in 2002. At the end of last year, 46 foreign institutions had been granted a QFII quota with a total investment of $9.54bn (€7.1bn), compared with 31 QFIIs with a total investment of $5.87bn at the end of 2005.
“This year, I see a maintenance of the QFII restriction followed by a loosening up after the government elections in March 2008. This is assuming that the economy is in good shape and that political progress is smooth in terms of the new appointees.”
Pointing out that in this year of the Communist Party Congress, one cannot ask any question related to finance without putting it in the context of the political situation, he says that left-leaning scholars in China are currently protesting that the country is being “over-run” by foreign capital.
Mr Kuhn’s co-authored book reveals that the annual average rate of return of the National Social Security Fund (NSSF) is a paltry 3 per cent, much lower than the 13.66 per cent cumulative return on five-year treasury bonds. Established in September 2000 as the long-term strategic reserve fund to cover national social security payments, the 280bn renminbi scheme has an allocation of 82 per cent to low-risk assets including bank deposits (39 per cent of total assets) and bonds (43 per cent). This low return is one of the factors that will drive the expansion of the NSSF investment scope. Mr Kuhn says the authorities are considering allocating a small percentage of the portfolio to alternative investments. Again, no radical change to asset allocation is expected in this politically-sensitive year.
Twelve foreign asset managers have been awarded NSSF investment mandates to date. These include: Hong Kong equity - Allianz Global Investors; Invesco and a joint team from UBS and China International Capital Corporation; Global (excluding US) equity - AllianceBernstein, Axa Rosenberg and State Street Global Advisors; US equity - Janus Intech and T Rowe Price; Global bonds – Pimco; BlackRock and AllianceBernstein; FX cash mandates - BlackRock.
The Chinese securities regulator reportedly plans to approve the development of a futures and options market early next year. But caution is the watchword.
“The fragmentation of domestic commodities futures markets coupled with the lack of professionalism of many of the firms involved makes the authorities reluctant to open these markets up to foreign investment. On the other hand, pressure is growing internally to draw in foreign participation into the futures market.”
