China speeds up access to domestic markets


By Wouter Klijn

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China has taken a series of unprecedented steps to increase access to its domestic equities markets. theinstoreport finds out what this means for Australian institutional investors.

Only 17 years have passed since the death of Deng Xiaoping, the great architect of Chinese economic reform, but the speed at which China is opening up its domestic market to foreign investors seems to be moving faster than ever.

In April, China announced a major new strategy for its domestic equity market that would allow investors in Hong Kong to trade shares listed on the Shanghai stock exchange for the first time.

This so-called stock exchanges connectivity mechanism is set to start later this year, following a pilot program to test the electronic infrastructure.

Hong Kong-based investors will be able to buy up to 13 billion renminbi (RMB) ($2.2 billion) of Shanghai-listed stocks a day, while mainland Chinese investors will be allowed to trade up to HK$13.2 billion ($1.8 billion) of Hong Kong shares.

The overall investment volume is capped at RMB300 billion ($52 billion) for funds heading to Shanghai, and at RMB250 billion ($43 billion) for mainland investors trading Hong Kong shares.

Currently, foreign investment in the mainland Chinese stock exchanges of Shanghai and Shenzhen has been strictly controlled through the qualified foreign institutional investor (QFII) quota system, which allocates about $80 billion in quotas to foreign investors, and the renminbi-denominated qualified foreign institutional investor (RQFII) quota, which adds another $50 billion.

But the new connection between the exchanges could enable overseas investors to bypass these stringent quota systems and add almost another $50 billion of additional foreign money into China’s equity market.

In addition, the Chinese regulator, the China Securities Regulatory Commission, earlier this month said it would also expand the QFII quota from $80 billion to about $150 billion, while it would roll out its RQFII to London, Singapore, Taiwan and others exchanges, whereas now it is only available through select institutions in Hong Kong.

The number of approved institutions under the the QFII program has also increased by 22 this year to a total of 229 institutions.

Playing catch-up

Principal Global Investors (PGI) chief executive Grant Forster says the opening up of China has moved more quickly than people expected and investors would do well to make sure they are early adopters.

“The Chinese are putting a lot of effort and money into Shanghai and making that a financial hub –
develop the A-shares, extend the QFII allowance. They are really trying to get western investors into their shares markets,” Forster tells theinstoreport.

“If you look 15 years ago, very few people would have expected to be at this stage in terms of the China openness.

“They are looking for all sorts of ways to open up, the dim sum [corporate] bond market, but they are too sophisticated to let it happen overnight.

“It is going to happen in time, but you don’t want to be playing catch-up when it all converges.”

He also points to the recent review of the global emerging market index by MSCI, which assessed whether to allow China A-shares, those listed on the Shanghai and Shenzhen stock exchanges, to be part of the index, which would also result in the shares being included in MSCI’s China index and Asia index.

Although MSCI decided in June not to include the A-shares on the basis of a lack of accessibility to the market, it has given some strong signals to China about what it needs to do to get included, and many think the inclusion of Chinese A-shares is only a few years off.

Inclusion of A-shares would lead to a rapid take-up of weightings to Chinese equities, Forster says.

“[The weighting of] emerging markets in the All Country Index is still only 10 per cent,” he says.

“When China potentially comes in in 2016, you are going to see that go up.

“Currently, the A-shares are zero per cent [of the index], but the Hong Kong-shares are something like 1 or 2 per cent.

“If you get acceptance of A-shares into that benchmark, you could see [China] go as high as 4 or 5 per cent.”

Eyeing developments

More Australian institutional investors are realising the importance of China for their long-term returns.

AustralianSuper established a representative office in Beijing in 2012 and appointed former Economist Intelligence Unit director Stephen Joske, who also worked at the Australian embassy in Beijing, as senior manager of Asia, to help pave the way for greater investment in the region.

AMP Capital was one of the first Australian fund managers to obtain a QFII quota in 2006.

The investment manager’s head of greater China equities, Patrick Ho, says access is still a fickle point for index providers such as MSCI and more needs to be done for the inclusion of Chinese A-shares.

“In the recent review that MSCI has conducted they considered including the China A-share market into the index,” Ho tells theinstoreport.

“By liquidity, size and representation, the China A-share market is very qualified to be included, but one of the shortcomings that investors still have question marks about is the access, because there are only 200-odd QFII holders so far.

“So that is why China is trying to improve the access.”

He says he is cautious about expressing his expectations for the impact of the Shanghai-Hong Kong stock connectivity on the participation of foreign investors.

“With the Shanghai-Hong Kong connectivity, we would like to see how that will develop over the coming months,” he says.

“There is only a RMB300 billion quota for this scheme; it is not a limitless quota. You still have a quota to comply with.”

He says the connectivity will not necessarily lead to increased opportunities for the AMP Capital China Growth Fund.

“That depends on the investment mandate, but we are one of the largest buy-side QFII holders and have a long history of managing China A-shares, so for us it will not make a huge difference,” he says.

Nikko Asset Management head of global investment strategy John Vail says he expects further acceleration in economic reforms later this year.

“We think they are going to accelerate that a great deal in the second half [of the year],” Vail tells theinstoreport in a conference call.

“We expect them to do a lot of other reforms to create optimism.

“They are doing all the right things in China, and they need to do more of it.”

Yet the reforms have also impacted on confidence in the short term, which has added to the recent weakness of Chinese equity markets, he says.

“They are doing the right thing on reforms, but it is quite painful,” he says.

“The stock market in China has been quite weak and people are scared, as we are.”

Among the potential risks, he says he is particularly worried about the high prices in the Chinese property market, which could prove to be a tail risk.

“Most of us have gone through property bubbles and this has a lot of the same characteristics of that,” he says.

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