Regional Head of Securities Services for Greater China and Northeast Asia
China: A core priority
The newly released 2017 Standard Chartered RMB Investors Forum Survey, which comprised of 900 global market participants, found that 60% of respondents indicated investing in China was one of their top three priorities, while 69% planned to increase their exposures over the next 12 months. Strong GDP growth, more settled market conditions, diminished concerns about capital controls, credit market maturity, regulatory clarity and a stabilized RMB were all significant impetuses for this positive investor sentiment.
Government and sovereign entities have been increasing their investments into China, since the inclusion of the RMB into the International Monetary Fund’s Special Drawing Right (SDR) basket in 2016, in order to manage their RMB liquidity.
Liberalized FX hedging rules have attracted insurers to the domestic fixed income market. Regulatory guidelines oblige insurers to lengthen the duration of their bond holdings, forcing them to identify highly liquid, long-dated instruments which generate returns and can be hedged in the same currency. Chinese bonds fit these criteria.
Identifying the correct access channel
Accessing China is not a science but an artistic skill in navigating a wide range of channels available to international institutions. In 2016, Standard Chartered predicted that Stock Connect would overtake QFII (Qualified Foreign Institutional Investor) as the most commonly used scheme for equity managers to access China.1
Stock Connect reforms – namely the inclusion of Shenzhen and the removal of the aggregate quota limits – have also helped drive investor interest with 40.4% of organizations saying they would grow their China investments through the scheme.
Foreign exposure to Chinese fixed income is low but this is changing under the China Interbank Bond Market reforms (CIBM). At the time of our survey in March 2017, some 12.3% of respondents said that the CIBM was their preferred access channel and over a third were evaluating CIBM as a means by which to grow their China investments. This has been enabled through FX hedging rule changes, with a number of institutions in Korea, Hong Kong and Taiwan all expressing bullish sentiment that these amendments will prompt greater flows into the CIBM market either directly or via the Bond Connect.
The emergence of new channels begs the question as to what will happen to the traditional China access routes such as QFII and RMB Qualified Foreign Institutional Investor (RQFII). Both schemes remain popular, but the survey found that just 1.9% of respondents would use QFII as an access channel moving forward, while only 50% of the quotas on average are being used by foreign investors. As the pool of foreign investors in China grows, it is likely these newer allocators will increasingly pivot towards Stock Connect and CIBM at the expense of QFII and RQFII.
What is left to address?
We still need to make structural and operational reforms in anticipation of the impact that MSCI and subsequent bond index inclusions will have over the next 12 to 24 months. Stock Connect has a daily quota of Rmb13 billion, prompting one fund manager at the RMB Forum in Hong Kong to warn that trading freezes and repatriation risks made it hard for passive funds to enter the market. This is also a problem for daily-dealing Undertakings for Collective Investment in Transferable Securities (UCITS).
Uncertainty over trade settlement has only been partially resolved through the establishment of the Special Segregated Account (SPSA) structure although key UCITS’ regulators point out it does not offer true Delivery Versus Payment (DVP). “In place of real-time DVP, the market creates a 4.5 hour window of potential exposure for investors, which was originally deemed to run counter to the intent and spirit of UCITS V,” said one regional market specialist.
Equally, RQFII and QFII have long been beset by issues around taxation. The handling of withholding tax for QFII and RQFII managers has been an issue which has only increased in importance since the launch of Stock Connect. Stock Connect is currently temporarily exempted from withholding tax. However, QFII and RQFII investors are increasingly unsure about whether to continue accruing for withholding tax, or if they need to prepare for an unwinding of their previous accruals.
On the horizon
The reformist agenda is continuing at an incredible pace with the launch of Bond Connect at the beginning of July, which provides international investors with simplified access to CIBM bonds directly from Hong Kong, removing the need to open custody and bank accounts in China.
The scheme has begun to attract interest from investors who are new to China or are exploring the market, but do not want to commit to having a direct relationship onshore. Relatedly, the survey found that 27.4% of respondents said they were likely to use Bond Connect in the next 12 to 24 months.
All of these reforms help to increase our readiness ahead of the massive asset transitions that we are about to see going into China. With around $16-18 billion of assets expected to enter into Chinese equities through the MSCI inclusion and a further $225 billion likely to flow into domestic bonds following various bond index inclusions, the hardest work is yet to come.
About the Author
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