Despite geopolitical tensions and COVID-19, China continued to open up its capital markets and financial industry to international investors throughout 2020
China is on the brink of dramatic growth and intense investor interest. It continues to build its momentum in its finance industry and is increasingly opening up its markets through inbound schemes such as qualified foreign institutional investors (QFIIs) and Renminbi QFIIs (RQFIIs), CIBM Direct, Stock Connect, Bond Connect, and outbound schemes like Qualified Domestic Institutional Investor (QDII) and the Qualified Domestic Investment Partnership (QDLP).
“Since the 1980s, China has gradually been opening up its markets and this has only accelerated, particularly in the last 10 years, as China’s economy has grown and become more interconnected with the global economy and international capital markets,” affirms Florence Lee, head of china business Development for Europe, Middle East and Africa (EMEA), securities services, HSBC.
Amid the recent geopolitical tensions, volatility and disruption of COVID-19, China continued to open up its capital markets and financial industry to international investors throughout 2020. Last year saw significant growth for China with total foreign holdings of Chinese at a record high, due to the indices inclusion effect, CNY appreciation and market movements.
Last year also saw the approval of public mutual funds licenses granted to global fund houses’ wholly foreign-owned enterprises (WFOEs) in China, approvals of foreign majority owned joint ventures between global fund houses and Chinese bank wealth management subsidiaries. Approvals of local funds custody licenses were also granted to more foreign banks operating in China.
Meanwhile, from an outbound perspective, market participants observed changes to China’s outbound investment quota expansion last year.
According to industry experts, from Q4 2020, Chinese regulators will add an additional $10 billion QDII quota every year which will be announced at the beginning of each quarter.
Cross-border flows are also expected to accelerate in 2021 as China steadily recovers from the pandemic. With all of this in mind, China’s market is beginning to break away from its title as an emerging market.
Engaging with global markets and lowering the barriers to entry
China is continuing to engage with global markets and in line with this China scrapped the quota system on inbound investment schemes QFII and RQFII in May 2020.
Effective 1 November 2020, Chinese regulators published new rules to merge the QFII and RQFII schemes into one allowing for a streamlined the application process, shortened licence approval time, and greatly expanded the scope of permissible investments such as futures trading, options, bond repo transactions, margin trading and securities financing on stock exchanges, securities lending, and initial public offerings.
HSBC’s Lee says: “Since then, we have seen investors’ growing interest in the new products launched under the new regulation, particularly securities lending, investment in private securities investment funds, margin financing and short-selling.”
A lot of institutional sophisticated investors are not just content in trading Chinese cash equities, Lee suggests they want more diversified securities and instruments to trade as part of their investment strategy, so it’s no longer like it was in the past when it was about being merely long-term buy-and-hold investors in China.
“There are now a lot more opportunities for them as set out in the regulation – for example, commodity futures, exchange-traded funds options, and bond futures, and we’re waiting for further detail to be released from Chinese regulators,” says Lee.
Similarly, John Sin, head of asset servicing, Greater China, BNY Mellon, highlights that all these amendments work towards making the Chinese markets more attractive to foreign investors, such as improved ability to hedge, which allows investors to execute their strategies more effectively.
“Also, fuelled by indices inclusion, assets under custody in Chinese securities held on behalf of foreign investors have grown significantly at the end of 2020 compared to a year ago which shows the growing interests of foreign investors in the Chinese markets,” says Sin.
As well as engaging with global markets, China is working on lowering the barriers for global investors, and compared to few years ago, a lot of barriers have been removed and it’s now easier for international investors to hedge their China market risk.
“Similar to other regulated markets, what’s important is that international investors are financially strong, have proper governance in place and the origin of their funds is transparent,” comments Lee.
Meanwhile, there has been a notable rise in adoption of international practices in various investment schemes such as simplified account opening and operational process set up, removal of initial approvals and quota, more friendly repatriation process, expansion of investment scope and use of hedging tools.
Sam Xu, country executive, China, BNY Mellon, explains that transparency challenges resulting from corporate governance and information declaration deficiencies are being acknowledged and addressed.
“Many investors have moved analysts onshore in China,” says Xu.
Expansion in China’s onshore capital markets over the next few years is another factor that is set to help attract foreign investors.
Xu suggests this space will expand due to continued GDP growth, a continued push for RMB internationalisation, and a determination to reform China’s financing structure as well as the use of capital markets direct financing 17 per cent at the time of writing) to replace overly weighted bank lending.
Chinese assets
Chinese assets are being used for collateral more regularly than in previous years, partly due to the Chinese government’s continuous effort to promote the use of RMB-denominated assets as collateral in the international financial markets.
BNY Mellon’s Xu says the Chinese regulators’ vision is to make RMB assets eligible for expanded scope of use, launch RMB pricing mechanism for rates, valuation of financial products, commodities, etc, and promote RMB to be used between non-Chinese parties.
Another important and key factor in this respect is index inclusion. On the fixed income side, two major indices — Bloomberg Barclays Global Aggregate Bond Index and JPMorgan Government Bond Index Emerging Markets — have already completed the inclusion of Chinese bonds.
Last autumn the FTSE Russell announced they would include Chinese governments bonds, subject to a review in March, in the FTSE World Government Bond Index
“Index inclusion of Chinese securities will act as that catalyst for asset managers and owners to buy China assets, while also encouraging them to have more confidence to invest their capital in China, as we have seen in other emerging markets,” says Lee.
Another factor here is the yield and growth story in China. Lee affirms: “Even with market volatility and uncertainty at the start of the pandemic, we continued to see capital going into China. The China A-shares market is performing well while Chinese bonds are providing a much better yield compared to a lot of other developed markets.”
RMB’s appreciation has also enhanced the return of an international fund manager’s China portfolio.
All of these factors together are contributing to Chinese assets being increasingly used as collateral in market transactions.
Trends for 2021
For 2021 and onwards, China’s market is expected to continue its growth momentum. This year has already seen the likes of HSBC and Standard Chartered taking advantage of QFII. For example, Standard Chartered Bank (China) has taken on the role of the custodian in assisting a large overseas institutional investor to complete a stock borrowing deal in the A-share market, and HSBC has enabled short selling transactions under the QFII/RQFII scheme.
The themes from 2020 are expected to continue into this year but with increased acceleration. BNY Mellon’s Xu believes there will be continued inflow from global investors into China’s capital markets, more global fund houses approved for market entry via public mutual fund WFOE and bank wealth management joint ventures, and start launching products.
Over at HSBC, Lee notes there has been “a surge in enquiries” from clients about how to apply for a QFII license, or how to invest in China fixed income.
In addition, China’s landscape for 2021 is also expected to see sovereigns and central banks accelerating their exposures to RMB. The efforts China has made over the past few years have encouraged international investors to engage in China with more welcoming market access.
Chinese regulators are also simplifying and streamlining the processes to further welcome international investors. These factors will place China in good stead for 2021 and accelerate the trend in attracting investors.
“I think the China story will still be the yield-seeking story, because a lot of international investors are thinking post-Covid: ‘What shall we do, where should our capital go?’ China will continue to be a focus for asset managers and owners, given its post-Covid recovery performance and strong export-led market characteristic,” says Lee.
Lee concludes: “If you look at China at the moment, they have to a certain extent returned to a sense of normality compared to a lot of other countries and, consequently, many clients are thinking that because of China’s yield and growth story, it will be one of the engines leading the world economic recovery in 2021 and 2022.”
