Source: www.asiaecon.org |

China Sets New Rules on Overseas Investments

Within the past few months, China has been taking a number of measures to curb its appetite for amassing huge export surpluses and foreign exchange reserves. China has been pressured with criticisms that they are manipulating their depressed currency and that their economy is overheating

Within the past few months, China has been taking a number of measures to curb its appetite for amassing huge export surpluses and foreign exchange reserves. China has been pressured with criticisms that they are manipulating their depressed currency and that their economy is overheating. Much of the problem is the fact that there is more money floating around than investment opportunities in China. Last year, China began a pilot program under which one fund management firm, Hua-an, along with 18 banks and three large insurers, were allowed to invest overseas in an effort to reduce the ever-increasing foreign exchange reserves and afford citizens the opportunity of alternative investments. China took another step in that direction by allowing, for the first time ever, all of China’s securities brokerages and fund managers to invest client funds in overseas stocks and bonds beginning July 5.

In order to invest overseas, the 110 securities firms and 57 fund management companies that call China home will need to submit an application for qualified domestic institutional investor (QWDII) quotas to invest in offshore securities. They can invest in the full gamut of financial products - bonds, real estate investment trusts, futures, shares, bank bills, bank deposits, government and corporate bonds, convertible bonds, financial derivatives, and asset-backed securities - that are listed on the 33 markets worldwide that have agreements with China.

Many view this policy adjustment as a breakthrough for China, not only because of the opening of capital controls but to the extent at which it was done. Fund managers and brokers have unlimited freedom to invest as much as they want overseas. However, the drawback is the high entrance point – participants must have a net asset value of at least CNY 200 million (USD 26 million) and have client capital of at least CNY 20 billion (USD 2.6 billion) whereas securities brokers need at least CNY 800 million (USD 104 million) in capital and a ratio of net capital to net assets of at least 70 percent. (1)

Such a policy was long overdue. On top of the massive foreign exchange reserves and their undervalued currency, shares of Chinese companies have not only quadrupled over the past two years but currently trade at twice the price on the mainland than in Hong Kong. The arbitrage between Hong Kong and mainland listed shares exemplifies the zeal, albeit irrational, of mainland investors and shows the detrimental effect of China’s rigid capital controls. Allowing investments to go overseas permits mainland investors to diversify and hedge the risk involved with the Chinese stock market, which has been volatile of late and, according to some, is due for a correction.

This policy adjustment shows that China is getting serious about opening up its closed capital account and reducing foreign exchange reserves, which should appease the WTO and the developed nations of the world. It has yet to be seen whether this new allowance will affect fund manager and securities brokerage decisions. Nearly USD 19 billion of QDII quotas were doled out last year through the pilot program, but only a small fraction had been used because China’s undervalued currency makes overseas investment unappealing to Chinese investors.(2) 
However, under the rule change brokerages and fund managers can raise yuan-denominated funds overseas, rather than just foreign currency denominated funds as it was under the pilot program. For mainland investors who believe the yuan will continue to appreciate, allowing yuan-denominated funds overseas could be a huge boon for overseas investment. Even if only 10 percent of the CNY 1 trillion (USD 131 billion) that is currently under fund management is invested overseas, this would still amount to USD 13.1 billion. (3) Furthermore, the rule change should encourage the movement of excess liquidity from mainland China to Hong Kong, closing the valuation gap that currently exists and holding up asset prices in Hong Kong. The rule change should reap China huge benefits, although some analysts believe that large investment outflows should not be expected until early next year because of the need to create administrative procedures.

Source: www.asiaecon.org |