Written by Samuel Beatson.
Foreign investors were granted access to the tradable ‘A’ shares of Chinese listed companies from the introduction of the QFII scheme in February 2002, with practical instigation on 23 May, 2003, officially introducing foreign institutional investor ownership in the ‘A’ shares of domestically listed Chinese firms. One of the aims of QFII was to introduce foreign investors who could improve Chinese markets through their investment and management skills in addition to testing out relaxation of foreign exchange controls on the capital account.
The ‘Provisions on Issues Concerning the Implementation of “the Administrative Measures for Domestic Securities Investment by Qualified Foreign Institutional Investors”’ were issued on 27 July, 2012 by the CSRC. These new rules reduced the assets under management (AUM) requirement for QFII scheme applicants from $5 billion US to $50 million US for asset management, insurance and ‘other’ institutions, requiring them to have only two years of operating experience versus the five previously required, while commercial banks require only half the previous requirement of $10 billion US in AUM and no longer require to be global top 100 banks.
The aggregate holdings of 20% in a single Chinese company rose to a ceiling of 30% and holdings by a single QFII in a single company may be 10% rather than only 5% as previously (see this article). The applications process was streamlined at that time, no longer requiring a face-to-face meeting. These are provisions, i.e. have always been suggestive of flexibility in future.
Moreover, in 2005 a foreign strategic investor (FSI) scheme was promoted to enhance governance in banks and other SOEs. Through these schemes, themselves backed by a series of evolving Chinese policy initiatives, both foreign portfolio investment (FPI) and what could be classed as foreign direct investment (FDI), into the listed Chinese companies have therefore been stimulated.
FSI are encouraged to invest under the CSRC guideline ‘Measures for Strategic Investment by Foreign Investors upon Listed Companies’. They are attributed a role under this regulatory guideline as follows: ‘to bring in foreign advanced managerial experience, technology and capital, to improve the corporate governance standard of listed companies, and to protect the interests of listed companies and the shareholders’ (Article 1, CSRC, 2005b).
QFII accelerated rapidly, from 169 in number in 2012 to 237 at year-end 2013, according to this SCMP article. Their timing and performance in late 2008 and Q1-Q2 2009 were impressive, particularly their having skin in the game when domestic investors were not invested in Chinese equities (Z-Ben Advisors, 2011). The regulators have thus been steadily increasing QFII quotas and reducing approval requirements, continuing in their affirmative stance as regards the positive effect of their presence in addition to the potential for the Chinese stock market to attract foreign investors.
Since its implementation in 2002, the pilot for QFII arrangements have been enjoying sound and steady operation, playing a positive role in expanding institutional investor base and sources for long-term funds, introducing long-term investment and value investment concepts as well as further opening up capital markets (CSRC, 2013)
I interviewed a hedge fund manager face-to-face in Hong Kong last October and this was his position on Chinese A shares as he went on record:
My speciality being domestic China A shares, I think [A shares] are arguably the best value proposition in the entire world right now. The current index level of about 2100 [points] for the SH A share index down from about 6500 points, 65%. This index level is the same range we were trading in, say, 1998. How many things today can you buy the same price as 1998? Not US real estate, not the Euro, not the Dow, not the Yen. So historically this is the best, the cheapest global asset you can buy right now. It’s the cheapest market by many measures…we’re in the bottom 5% of all indices in the entire world over the past five years of performance, so, we’re talking about its peers. There are about 12,500 country indices. We’re in the bottom5% for the last five years… So, what that means is, we’re not sort of lagging in the middle of the pack, we’re basically the worst performing index in the world, with Greece, with us, we’re talking about typically, historically, when you’re punished this severely by the markets and you have been hit this hard, the bounce back can be pretty dramatic… up!
Earlier this week the Chinese government announced that Shanghai ‘A’ shares will be tradable for foreign investment via Hong Kong. This is a significant development for investors and an important part of the jigsaw in capital account opening. In particular there is an opportunity here to purchase Chinese stocks at a price that has not grown in line with the economy over the last eight years, at least the regulators and funds wish us to think so.
Why are foreign investors being encouraged beyond simply ‘economic stimulus’ – in this case, the buzzword for trying to get the stock market to move onwards and upwards through encouraging portfolio equity buying and resultant bullishness? 4 September, 2014 marks the day from which it appears foreign investors can now access Shanghai ‘A’ shares more readily than before, through Hong Kong. The problem in journalistic reporting thus far is that the term ‘economic stimulus’ does very little to gauge or explain why foreign investors are being allowed greater access to a Chinese domestic stock, or what impact they have had to warrant greater opening up.
Indeed, a lack of clear rationale for the liberalization rhetoric has caused an embarrassment for China as it has attracted academic and journalistic criticism, the opposite of what the new leadership wants. For example, Professor Minxin Pei (2013) warns that the centre-endorsed document composed by planning heavyweight the NDRC (National Development and Reform Commission -國家發展和改革委員) and issued during the first half of 2013, contained ‘vague and general announcements of principles and aspirations but lacks specifics’.
More recently, China’s seven-strong Communist Party Standing Committee of the Politburo (中國共產黨中央政治局常務委員會), elected by the 2012 National People’s Congress pledged in the official communiqué released to state media outlet Xinhua (新話) that ‘the government will push two-way opening up of capital markets and speed up yuan convertibility under the capital account’ say Market News International.
There is substantial evidence that foreign share ownership in other economies can go well beyond limited abnormality of returns in the window after ‘liberalization’ – defined by Peter Blair Henry (2000) as ‘a decision by a country’s government to allow foreigners to purchase shares in that country’s stock market’.
As institutional investors, foreign investors around the world are reported to push for improvements to company corporate governance (Gillan & Starks, 2003). Moreover, Charles Kwong noted that Chinese listed companies are desirous of foreign investors’ input in terms of intangible capital, such as product knowledge, human resources and managerial expertise, in addition to technical assistance. The present and future provision of finance by outside investors without the return (interest and principal repayment) obligations the company faces with debt (bond) issuance is a staple goal in equity (stock) issuance.
Investors had high hopes of foreign investor’s contribution. And as the following World Bank researchers opined at the instigation of the QFII scheme:
…weak corporate governance in listed companies would lead to limited foreign portfolio investment to the PRC capital markets over the short term. However, the introduction of QFII program will likely have a positive impact on the development of [the] PRC capital market over the medium to long-term, and eventually on the method by which PRC listed companies handle corporate governance issues. Kim, Ho & St. Giles, (2003: 43)
A key objective thus has been for western governance practices to be introduced into the domestically Chinese listed companies, beyond that minority of firms which had already achieved concurrent offshore/overseas listings. Foreign investors and institutions have therefore been expected to bring with them a myriad of benefits to Chinese capital markets and their constituent companies, especially in augmenting corporate governance and thence, performance.
To introduce managerial experience from foreign investors, the China Banking Regulatory Commission (CBRC) has established five standards for foreign strategic investors (FSI). First, foreign shareholdings should be not less than 5 percent. Second, foreign strategic investors should hold their shares for at least 3 years. Third, foreign strategic investors should appoint directors and senior managers to help the invested banks. Fourth, foreign strategic investors should possess a strong financial position, management experience and willingness to cooperate. Fifth, a single foreign strategic investor should not invest in more than 2 Chinese banks. FSI into local banks (i.e. non-listed banks) has been previously capped at 15% and later revised to 25% Shen, Lu & Wu (2009). The minimum 10% stake for FSI, effectively, the taking on of previously state-owned shares, has an uncapped maximum in stock market listed firms.
FSI has facilitated corporate governance and performance improvements in the Chinese banks. For example, (Shen et al, 2009, Tan, (2013) and Luo, et al., (2014 – forthcoming) all document foreign investor contributions to governance and efficiency in Chinese banks.
The problem with QFII, FSI and other modes of foreign investment in the non-financial Chinese A shares of companies is that little has been done quantitatively to assess the impact empirically. Tan (2013) concludes that the impact has been limited, however his assessment was based on a small sample of telephone interviews in 2009. Moreover, he concedes that some mechanisms for engagement with Chinese companies, such as workshops with management were carried out.
Moreover, I have found evidence of positive Chinese managerial responses to the demands, e.g. for transparency, even by the smallest of institutional investors, suggesting that foreign investors can have a leveraged form of ownership power, beyond their commensurate voting rights in the Chinese companies.
What can be gleaned from the recent announcement goes beyond mere stimulus. It seems reasonable to infer that the Chinese regulators want to transliterate the benefits of FSI and bring into line the benefits QFII could bring as incentivized owners, monitors and even strategic assistants in the Chinese listed companies. This therefore forms part of a broader strategy in the development of Chinese capital markets and in particular raising the standards, competitiveness and financing capabilities of Chinese listed firms.
Samuel Beatson is a PhD Candidate in the School of Contemporary Chinese Studies, University of Nottingham.