Foreign investors wary of China onshore risks
The preferred method for playing Chinese credit markets remains the dim sum bond market, say analysts, as China’s expansion of access to its onshore market is met with a cool reception by foreign investors.
China increased the qualified foreign institutional investor (QFII) and renminbi qualified foreign institutional investor (RQFII) quotas over the summer, raising the QFII ceiling – which allows offshore buyers to use US dollars to purchase securities in the onshore market – from $80 billion to $150 billion, on July 12.
It also announced two new RMB business regions, adding London and Singapore to the list of financial centres authorized to issue RMB-denominated financial products directly to international buyers.
While the move indicates that Beijing is pro-actively edging along the RMB internationalization curve and incrementally opening its capital account to foreign participation, in fact international investors remain wary about shifting large amounts of capital onshore.
Indeed, the QFII increase belies the fact investors had only taken up about half of the old quota before the increase, according to data released by the China Securities Regulatory Commission (CSRC) in Beijing.
It is no secret that China’s domestic stock market has suffered poor performance during the past few years, with the Shanghai Shenzhen CSI Index down 14.33% and the Shanghai Composite Index down 14.07% since September 2011.
Moreover, allegations of corruption and securities fraud perpetrated by companies and brokers alike have overwhelmed the Chinese regulators’ ability to maintain a functional market by international standards. This led the CSRC to shut down the Chinese IPO market to new launches last October, leaving around 900 companies who had applied for listing in regulatory limbo.
Although Chinese officials hope that increased bandwidth in the international investment quotas will attract new money to stimulate flagging equity markets, investors are not rushing to commit new funds.
According to Hong Kong-based market sources, most of the $43 billion of committed capital has come from the special administrative region, as international investors wait for a more concrete market-reform road map and implementation timeline to emerge.
“International investors realize that the Chinese stock market has been one of the worst performers in the region, in fact the world, over the past few years,” says one market source. “Chinese stocks are still dead in the water and there is not nearly enough international participation.
“The authorities are very aware of this lack of demand and are looking for sources of new money to support the market. However, investors are unlikely to respond until the government acts on market reforms.”
While the Rmb4 trillion domestic Chinese bond market, especially high-yield issuers, benefited from QFII inflows after the government opened the quota to fixed-income investors, that flow has since slowed as Beijing has moved to drain what it saw as excessive capital inflows in the first quarter.
Moreover, the effect of Fed tapering on emerging market bond yields has compounded negative investor sentiment toward Chinese economic prospects.
Indeed, the government struggled to sell all the bonds in a June auction, raising just Rmb500 million after initial plans to raise Rmb15 billion, even after increasing the yield from 3.14% to 3.76%.
“It is not a favourable environment for bonds in the onshore market right now and foreign investors are holding back,” a source says.
The preferred method for playing Chinese credit markets, therefore, remains the dim sum bond market, which continues to attract new interest, although returns and volumes have moderated after the exuberance of the market’s first few years.
Documented under international law and subject to the same legal and market discipline as any other international bond market, the dim sum sector is set to grow this year to around Rmb280 billion to Rmb360 billion, up from Rmb275 billion in 2012.
“The dim sum yield is market driven, unlike onshore bonds where rates are effectively determined by official, and not so official, interventions,” says a Chinese investment strategist.
“Investors therefore find dim sum yields as a more reliable gauge for Chinese credit risk, although the market is not even a 10th of the size of the domestic market and not really representative in that sense.”
With the appointment of former Bank of China chairman Xiao Gang to the helm of the CSRC, Beijing appears to have grasped the need for a more explicitly pro-market approach to financial reform and Xiao has been quick to set his targets on challenges posed by IPO and shadow banking issues.
It remains to be seen if China can offer the transparency on reform that international investors are waiting for.