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Foreign Investors and Chinese ‘A’ Shares

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.

Bull Run in China’s Equity Markets: Some reflections

中国沪深股市By Samuel Beatson.

After offering weak returns to investors for a long time, the Shanghai stock exchange index for all shares has seen a dramatic rise of almost 15% in the last forty five days. This seems to indicate that investors in the stocks of Chinese companies have keen expectations for mainland companies and following global equity portfolio flows to both Japan and Hong Kong, the Chinese stock market has offered its own short terms gains.

Hong Kong’s Hang Seng index has been climbing for three months which seems to support the phrase that “Hong Kong was, and continues to be at the centre of Chinese-led capitalism.” The short-term bullishness here demonstrates the institutional and local confidence in the Hong Kong market. The steadfast rise in Hong Kong stocks may also indirectly reflect the renewed global interest in the shares of Chinese mainland companies amongst foreign investors in addition to that of Chinese investors in Hong Kong and the mainland who possess Hong Kong stock trading accounts.

Moreover, in 2012, the Chinese regulatory authorities approved a record 72 new QFIIs (Qualified Foreign Institutional Investors) to be able to invest directly in the mainland, more than in 2009, 2010 and 2011 put together, taking the closed capital account another notch towards the optimistic vision of openness outside investors wish for. In addition to satisfying the foreign institutional hunger to be a “China player”, it may also signal that regulators have some confidence in the market offering stable returns in the mid-term.

The moves upwards in the Hong Kong and mainland Chinese equity markets reflect an internal investor confidence in China’s economy and an expectation that the valuation of its listed firms should move in line with those on the exchanges of developed financial markets in the region.

Another positive sign for the development of capital markets and the evolution of what were large, unprofitable listed firms are the 2011/12 global portfolio flows into China. These have finally surpassed cumulative portfolio investment inflows into the other BRICS economies apart from India, overtaking Brazil for the first time. Again this signals investor confidence that the new Chinese leadership might take a more pragmatic approach to financial markets and the performance of companies could improve mid-long term both in terms of productivity and standards of reporting and managerial integrity.

The evidence seems to send a clear message to the new Chinese political line up that further financial markets development is required in China to facilitate China’s competitiveness and attractiveness for outside capital in addition to the expectations of internal investors. The latter is necessary to curb investment outflows from within China, which have risen from US68 billion in 2008 to US190 billion in 2011. It also shows confidence in the contemporary image of the Party.

China can remain optimistic with the latest economic figures, but should not ignore the very real political risk of leaving financial markets under-developed. The issue of developing China’s capital markets should no longer remain a side-line issue– an opportunity cost of FDI that sits on the margin– let alone an opportunity cost of ideological rhetoric. Neither should it be left to internal investors to “follow” the developed economies in regions around mainland China and prop up China’s stocks. Focusing on continuing reform and development of China’s enterprise and financial markets could help solve the challenges and opportunities China faces and promote stable growth in these most exciting of times for China.

Samuel Beatson is a PhD candidate in the School of Contemporary Chinese Studies, University of Nottingham.

Opinions expressed in the CPI blog do not represent the views of the China Policy Institute or the School of Contemporary Chinese Studies at the University of Nottingham. They are the personal views of the bloggers/authors

What role can university students play in fostering the integration of the Chinese and local communities? Observations from an Open Space Workshop held 1st November 2012

By Samuel Beatson.

The Grand Circular Seating Arrangement

As a PhD student focusing on the Chinese financial markets, I was curious and attended an Open-Space Workshop last Thursday 1st November with the theme: Promoting and practising global citizenship in Chinese society. I guess a majority of more than 100 student attendants shared a similar feeling to me.

They had been asked to attend as a part of a Career Skills module and most of them are master degree students in the School of Contemporary Chinese Studies at the University of Nottingham who have majored in finance, banking or accounting.

I was even more surprised to find that more than 20 resource people had been invited by Dr Bin Wu, the convenor of this Module and organiser of this event, when I arrived at the workshop venue in the very heart of the University’s Main Campus, the Trent Great Hall.

These guests represented organisations outside of the University, including the International Organisation for Migration (IOM) from London, Nottingham City Council, Broxtowe Borough Council, the Nottinghamshire Chinese Welfare Association and Nottingham Chinese School.

There were also the senior managers and staff of relevant departments such as Student Services, Community Partnerships and the Chaplaincy in attendance. Unlike students, these resource people knew precisely the purposes and objectives of the workshop.

The circular arrangement of chairs at the venue gave students a feeling of equality with the staff and stakeholders. A freedom or large space was created allowing students, in particular Chinese students, to stand up and express their ideas and proposals in front of such a large number of strangers.

Butterfly or Bumblebee? Participants could stick with one project or mingle between groups.

Although having known nothing about global citizenship or the open-space technology/methodology before, I easily understood the rationale, theme and also the rules of this event. This was partly due to a clear opening address by Dr Jackie Sheehan, Deputy Head of the School, and an introduction by Dr Wu, and partly due to the skill of two professional facilitators.

In spite of unpreparedness, as if by magic, a lot of students including myself could not stop ourselves from expressing ideas for group discussions. The workshop received 15+ topics/ideas for two rounds of discussions, the majority posed by students.

Topics ranged from social help for the elderly to providing recovery support for compulsive gamblers in the Chinese community; from creating a bi-lingual entertainments newsletter to going into schools to raise awareness about Chinese Studies; from House Partying to how to make friends.

Resource persons played an important role in fostering innovative thinking and group discussion and inducing students to develop a realistic project proposal that would make use of internal and external resources by engaging relevant stakeholders.

To develop an in-depth understanding, I asked Dr Andreas Fulda, an expert in open-space workshop methodology who introduced this method to the School three years ago, to explain why he had proposed the topic: how to make friends studying abroad. Here is an edit of his response:

”If Chinese students… are unable to make friends with other international students it is also fairly unlikely that they will exercise their citizenship, for example by volunteering for charities or engaging in environmental groups… Students who attended our group discussion agreed to the individual goal of making at least one new friend. I consider this a most useful exercise in relationship building, a key skill in an increasingly inter-connected world.”

Discussion group “hosted” by Dr Andreas Fulda

I asked Dr Wu to assess the outcomes of this workshop. He replied that the event had successfully tackled the three objectives set-up in advance, including: raising awareness about global citizenship and the open-space workshop methodology; creating opportunities for students to volunteer in local communities and enhancing partnership and cooperation with the local community and stakeholders.

Having witnessed the smiling faces of student participants, I can understand Dr Wu’s satisfaction.

Sam Beatson is a PhD candidate in the School of Contemporary Chinese Studies

Opinions expressed in the CPI blog do not represent the views of the China Policy Institute or the School of Contemporary Chinese Studies at the University of Nottingham. They are the personal views of the bloggers/authors.

NB Click an image to enlarge.

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