December 2016

ROUNDTABLE: Where the power lies

Our panel discussed circuit breakers, index inclusion and the rise of the renminbi. Chaired by George Mitton and Alan Chalmers in Beijing. David Chao (special assistant to the chairman, CCB Principal Asset Management)
Chi Lo (senior Greater China economist, BNP Paribas Investment Partners)
Chen Wang (portfolio manager, client solutions group, CSOP Asset Management)
Tilman Fechter (global head of sales & relationship management, investment fund services & member of the executive board, Clearstream) Funds Global: China has enjoyed huge asset growth in recent years. However, asset management is a global industry. How do you see China fitting into this world? Chi Lo, BNP Paribas Investment Partners: International investors see China as part of the emerging markets universe, with the usual emerging market issues such as volatility. It is still not yet an asset class by itself, and that will remain the case in the medium term because China’s capital account is still not fully opened, which means there are no free capital flows with the outside world. That’s why we are keen to see MSCI and the likes include Chinese assets, such as A-shares, into their indices so that international fund managers have a benchmark for China along with the other emerging markets. Chen Wang, CSOP Asset Management: The Mutual Recognition of Funds (MRF) scheme between China and Hong Kong has seen an 8 billion renminbi outflow versus a 0.1 billion inflow. That is a clear trend that the Chinese people are willing to invest offshore – however, it suggests offshore investors are not that willing to invest in China. That’s partly because they expect the renminbi to depreciate, but it also suggests that foreign investors don’t know China that well. Another issue is that when Chinese people decide to invest offshore, they are still very interested in things like property, especially corporates and enterprises. These investors need specialists to help them to distinguish the other kinds of tools and products they could use. David Chao, CCB Principal Asset Management: Let me tell you some numbers. Until now, 2016, the whole asset management market is worth about 80 trillion renminbi. Banking investment is about 24 trillion, trust companies have 16 trillion, insurance asset managers have 10 trillion, securities houses have 12 trillion, public mutual funds have 8 trillion, and so on. If we want to talk about the asset management part, we need a definition. Which part must be globalised? The public mutual fund part is not the only way to globalisation of asset management. Some of the other routes are QFII vehicles and RQFII vehicles, the Stock Connect scheme and mutual fund recognition. For globalisation, a lot of people, maybe including the banks, have a different way to globalisation. So we didn’t detect the real number. I’ve just come back from Luxembourg. We have a lot of insurance companies registered in Luxembourg and a lot of major banks. A lot of Chinese insurance companies have already globalised. Tilman Fechter, Clearstream: I agree that we need to be careful with the numbers and how they are calculated. We are a big market infrastructure for funds and we never know exactly where the investments come from. A lot of assets can be held with, for example, a global custodian, and yet the underlying investor may be in China. You never know if you haven’t got the full picture. In terms of mutual recognition of funds, the numbers are a bit premature. The registration process is slow on both sides. We need to give it a year or two, maybe longer, to really get concrete numbers. Coming from Luxembourg, I have seen a lot of Chinese asset managers going west, setting up Ucits products and selling them in Europe. It is interesting because the Chinese asset managers face the same problems Western asset managers face in China. They are not known, they’ve got no history, no brand recognition and no distribution channels. The issue for both sides is that if you expect a sprint to success, forget it. It’s a marathon. Funds Global: China has created a number of conduits for investing in China and for China to invest externally. How do you see these initiatives working and how will they develop in the years ahead? Wang: For the MRF scheme, the numbers suggested that the inflow is much lower than the outflow. We also feel that many investors are not really using the scheme for investment but for cash-parking purposes – as a channel to get US dollars. Regarding the other schemes, the demand depends on the market. CSOP is the largest renminbi qualified foreign institutional investor (RQFII). Two years ago, before the Shanghai-Hong Kong Stock Connect launched, everyone was trying their best to get RQFII quota, and the quota was running out in Hong Kong at that time. Offshore investors had a great interest in China then, but now, after the Asian market crash last year, they are moving money out so they can wait and see. Now, everybody is trying to get qualified domestic institutional investor (QDII) quota. As well as these channels, there is now direct access into the onshore interbank market, and last week during the UK-China Economic and Financial Dialogue, we have seen good potential for a Shanghai-London Stock Connect and for what are called panda bonds. This shows that despite the market fluctuation, the capital market opening up hasn’t been stopped. Lo: The various schemes to allow investors to invest into China, and for Chinese investors to invest outside of China, are the regulatory backdrop for opening up. But if you look at the development from a structural perspective, there’s something else behind it. Essentially, this is capital account liberalisation with Chinese characteristics. The quotas will get bigger and bigger, various schemes such as Stock Connect and mutual fund recognition will go beyond Hong Kong, but the government doesn’t want to completely let go of control in the medium term. As to Chinese investors and whether they are ready to participate, my view is that, financially, many of them are. We’ve got a big cohort of high-net-worth individuals in China. These people want to start diversifying investment and spreading their risk. But, in terms of their investment behaviour, China is still in a catch-up phase. Even the institutional investors in China have a mentality like retail investors. The concept of diversification and international asset allocation is not here yet for Chinese investors. Chao: As a company, when we look at the overseas market, we think about how to leverage the resources of our shareholders first. We see that the Chinese government’s open policy is growing but not too fast. But they will come to open. The mutual funds industry has a lot of initiatives such as QDII. Renminbi clearing centres are another initiative. There are clearing centres in the UK, Europe, the Americas. Our government’s open policy is not just for one part, it is for overall. RQFII quotas are also important. In the Hong Kong market, the RQFII quota is used up already, but a lot of countries still have a quota, like Luxembourg. We see a lot of opportunity to do business because it doesn’t have to be just through the mutual fund vehicle. My view is that if you want to go external, you should think about what kinds of vehicle are still open. What kind of countries are still open? The countries that still have a lot of quota available. Fechter: There are multiple channels. If a high-net-worth individual wants to get some money invested into offshore assets, there are enough quotas. They will find a way if there’s a demand. Also, often it takes a bit of time to get all of the regulatory things worked out. We remember that it took Luxembourg some time to approve the Hong Kong-Shanghai Stock Connect as a way for funds to invest. The regulator wanted to tick a couple of boxes. It’s gratifying as well that the Commission de Surveillance du Secteur Financier (CSSF) has granted access for Ucits managers in Luxembourg to access Chinese interbank bond market and invest into Chinese fixed income instruments without recourse to their QFII and RQFII licences and quotas, under the simplified scheme released by the People’s Bank of China this summer. This provides far easier access to Chinese bonds than was previously the case. On the other side, the institutional investor or distributor bank also wants to make sure that the assets are safe. For a German investor to get that comfort that a local Chinese fund is as secure and trustable as one that is domiciled in Germany takes a bit of time. But there is a serious demand in investing into China as a country. As a company, institutions are approaching us to get educated, to find out which ways they can invest or what are the options. If you see the assets we hold on behalf of our customers, which are A-shares or other instruments with Chinese underlyings, it’s growing. This is probably the beginning of a wave. You can’t yet quantify it in numbers which are impressive, but it will come. Funds Global: How significant is the recognition of the renminbi as an international reserve currency by the International Monetary Fund (IMF)? Lo: For investment side, in the short to medium term, the inclusion of the renminbi in the special drawing rights (SDR) by the IMF will not have much material impact on international asset allocation. But its symbolic effect is important for China. The inclusion of the renminbi in the SDR is an acknowledgement by the international community of China’s progress in financial liberalisation. That will improve the confidence of the Chinese authorities to keep going with opening up and liberalisation and structural reform. The issue is that, even for official institutions, allocations to renminbi assets after the SDR inclusion are very small. The SDR, as of today, is worth about $280 billion in total foreign exchange reserves in the world. The renminbi’s weighting in the SDR is less than 11%. If you assume the central banks and other official institutions benchmark their foreign exchange reserve portfolios to the renminbi’s weighting in the SDR, we are looking at an additional demand for renminbi assets from the central banks and sovereign funds of about $31 billion. That is a drop in the bucket of the $42 trillion of world foreign exchange reserves. The material impact in the short to medium term is not there. Chao: I agree that including the renminbi into the basket is going to be good for the capital markets. It will open gradually. But it is not just the capital market but maybe the interest rate liberalisation that is important. Wang: I agree that there won’t be any big effect from the renminbi inclusion at the moment, but I do think in the next four to five years that this is a great opportunity for the renminbi to become a reserve currency. If you look at the US election, Donald Trump plans to apply new trade policies that may result in the US dollar having less impact on the global economy. That’s really the opportunity for the renminbi to catch up and become one of the more important currencies globally. On China’s side, the government is pushing the One Belt One Road policy and trying to have more influence in trade. China is one of the largest trade partners for many of the countries in the One Belt One Road scheme. China wants to have the trade settled in renminbi and have minor commodities priced in renminbi. There’s a huge opportunity for that. Also, if you look at the history of the US, the size of the US economy actually became larger than the UK’s economy decades ago, but it was not until after World War Two that the US dollar became a more important reserve currency than sterling. It takes decades for a country’s currency to catch up to the size of its economy. China has the second-largest economy and its currency has got to be stronger and more important in global trade in future. It takes some time, but given the favourable external and internal environment, this is
a good opportunity to speed up the process. Fechter: I agree, it’s symbolic, at least in the short term. The inclusions are not going to make a big difference. How is it going to help our business? As a market infrastructure, we are a bit different than the asset managers who are interested to sell the products. Our role is to make sure routes are opened. For example, if an institution in Europe or in the Americas or wherever can hold A-shares, via Stock Connect or whatever programme, we need to make sure they are available. That’s what we are working on and we believe so much in that story that we often are the first ones who are opening the routes. We have even set up a stock exchange in Frankfurt, in cooperation with Shanghai, called Ceinex, and there also there are ETFs and bonds listed, which have underlying assets of Chinese equities or bonds. Funds Global: Chinese mainland assets are still not included in major indices such as the MSCI Emerging Markets index. What will it mean for you if these assets are included? Fechter: This is more than symbolic, because all of the passive strategies would need to be adapted, and that automatically triggers a lot of inflow at the beginning, and then continuously. After that, you would expect inflows from active strategies too. Wang: We thought MSCI would add China into the emerging markets index this year, but it didn’t happen. We think it’s very important, though. We manage ETFs and we talk to many institutional investors, and to them, index inclusion is a must for them to consider China. The major concerns are fluctuations in Asia and worries about the inconsistency of policies. That’s something that China is really working on right now. The regulation is getting much, much better. The legal structure is – I won’t say it’s good or wrong – it’s just different. The CSRC made big efforts at the beginning of this year to meet the MSCI chairman mostly every week, to discuss this. They really, really want this to happen. But after MSCI decided not to include, the tone has slightly changed. They said it’s their commercial decision. We have seen the regulators made reasonably good and sincere efforts to make this happen, but it’s MSCI’s decision in the end. I think it will eventually happen. Before that, we need to get prepared for anything we can. Many of the asset management companies and also custodian banks are testing their systems this year before June to get ready. We’re much more prepared if they get included next year. Lo: If you look at the IMF decision to include renminbi into the SDR basket, they had more than 40 conditions that China had to tick off. China ticked off all the conditions. But if you look at the details of the conditions, basically they are talking about liquidity flows in and out of China for IMF members under the SDR framework. These are basically the official institutions. Now, these institutions, since last year, have had no serious restrictions on coming in and out of China, so that satisfied the IMF conditions. But when you look at the MSCI type of private sector considerations, there are all these crosses. The bottom line is, as an international investor, I’m concerned about my money. When the money goes in, I cannot get it out any time as I want. In terms of fund withdrawal, you still have all these restrictions of a week, a month, a quarter or whatever, that haven’t been resolved. This liquidity issue is the biggest obstacle facing the foreign private-sector investors. No matter what the China Securities Regulatory Commission (CSRC) or what the Chinese government does on the other conditions, the bottom line for international private investors is that they are concerned about getting their money back when they want it. Chao: Let’s say that the first step is to include 5% of A-shares into the MSCI index. Now, 5% will bring about $16.5 billion into A-shares. If it was 100% inclusion, it would have been $273 billion. You may look at $16.5 billion and say this is a small number, but it is only the beginning. The market will open later, when it is ripe. Lo: David is right. The point is that the MSCI inclusion of Asia, whenever it happens, is not going to be one shock. It will be a phased-in process. How long is it going to take? Nobody knows, but if I remember correctly, when Taiwan and South Korea were included in the MSCI emerging markets index, it took them between ten to 15 years to go from zero to full inclusion. Probably China will take longer because there’re more structural changes that China needs to do in the economy, in the corporate sector, in banking, finance, accounting and so on, to get the international confidence in Chinese assets to be included in a market index like MSCI’s. Funds Global: Global investors have been wary of investing in Chinese mainland assets recently because of the volatility in the stock market and concerns about regulatory intervention such as circuit breakers. Are these concerns justified? Wang: From the investor perceptive, it’s normal and justified to be concerned about all of this. However, our ETF investors can repatriate on a daily basis. We have supported billions of repatriations on one single trading day. If you invest through a segregated account, however, that might be tougher because you’ve got to clear up the taxes to close down the account. The capital gains tax has been waived, it has been clarified, but you still have to do tax reporting with the tax officers and it may take some time. Normally it takes three months, but in real case practice it can take much longer than that. The liquidity issue last year was a big problem. We modified our fair valuation system, because we have products in the US and products in Europe and in Hong Kong. It’s a tough process. We had to explain to the Luxembourg regulator, the Ireland regulator and to the US regulator why we had to modify fair valuation and then it had to be consistent because we’re the manager and we have to be consistent for our products across regions. A good sign is that if the regulators realise a policy is not having the expected impact on the market, they stop it pretty quickly (i.e. the circuit breakers). As the capital market opens up, you do make mistakes and you correct them. I think that’s a good attitude. Lo: Concerns about the Chinese market, the interventions and the circuit breakers, are justified. But thanks to a lot of the media reports, there has been a lot of exaggeration. The Chinese market is an emerging market, and China has its share of developing market issues such as transparency, intervention, and so on. But there is intervention all over the world. The European Central Bank, the Bank of Japan are doing it too. China is doing its own bit. When the Chinese authorities see things getting out of hand, they come in. That’s a natural reaction. Chao: I agree, we are a developing market. All investor schemes are on a retail basis. The government in a way is protector for the individual investor. If we see that investors are protected, that is good. Remember that high return means high volatility. That is the way the market works. If you want to make a high return, you need to expect high volatility in this market. I usually tell our investors, institutional investors, that that’s the market situation. We are a developing market. So our government, our regulator is still learning a lot of things. Fechter: The problem is this unpredictability. For example, the ETF repatriation works much better than if you have got direct accounts. The problem is many foreign investors are not aware of that. People wouldn’t know the difference between one or the other. But I’m of the opinion it’s a continuous process. And because everything is exaggerated, people are losing track of the fundamentals. Fundamental data long-term is good. Sophistication is coming in. You see deregulation gradually. Yes, not to the pace, maybe, everyone wishes or hopes for, but we are getting there. I would make the hypothesis that it always depends on the investor time horizon. Three months and I would probably be hesitant, but 30 years, for my retirement, I’m optimistic. Funds Global: A number of major sovereign wealth funds have established offices in Hong Kong as an Asian base and a gateway into China. Is this the start of international institutional investors focusing on the region at a grassroots level? Lo: Official institutions are showing a trend that they want on-the-ground personnel in Asia to prepare for the eventual rise or further rise of China’s economic power. But this trend is not quite there with the private sector yet. China will need to open up to the private sector more as it has opened up to the official institutional sector. The private sector is still quite restricted through the quota system. Wang: Globally, China is under-allocated and the situation will improve in the following few years. In the long term, these sovereign funds have to build up trust with Chinese market participants. We have investors who are concerned that the Chinese are not going to honour contracts. They really need to get to know China more before they can trust the people. The way of doing business is a little bit different. Also, even though they’re building offices in Hong Kong or maybe in China in the future, local expertise is crucial to succeed in the China market. The Chinese interbank bond market has been opened up to foreign institutions for some months now, but to trade on the interbank market you’ve got to speak the language and you’ve got to get to know other participants, otherwise you can’t find partners to trade with. Chao: I’ve met the some sovereign wealth funds people before. I told them two concerns. What kind of business do they want to develop, and what kind of stage? Now, if you are just beginning and if you want to deal with the regulator, you need a representative in Beijing. If you are not set up in Beijing, if you just travel from Hong Kong to Beijing, it’s not advantageous. Fechter: It’s not very adventurous to go to Hong Kong, but it really depends. If it’s the first time you’ve put up an office in Asia, to serve the entire region, Hong Kong is probably not a bad choice because it has the connection to China but also to the rest of the region. If you’ve already got regional offices and you want to do business in China, then Hong Kong is probably not the way to do it. If you want to do China business, you should be in Beijing or Shanghai. Funds Global: Where do you see China in five years? Lo: For growth, China will still be growing at between 6% and 7%, which will remain one of the highest growth rates in the world. That is a fundamental underpinning for opening up and structural reforms and also for foreign investors to keep their attention on China. In terms of investment, we are going to see more expansion of the quota system, mutual recognition schemes, and so on, extending beyond Hong Kong. As I mentioned in the beginning, this is the way that China opens up the capital account without completely losing control. In terms of investment products, there will be more products available to offshore investors than onshore. It really depends on how comfortable Beijing is at allowing local money to invest overseas. The government understands the need for diversification, but when it comes down to capital outflow, seeing all these Chinese investors going overseas, it does have a concern on the stability of the local system. For foreign investors going into China, in five years’ time, the landscape of competition will be totally different from what we are experiencing today. The key here is distribution. China is moving very fast into e-commerce and online distribution., However, the big players such as the banks will remain the key players in terms of distributing products in the Chinese market for now. Foreign asset managers will have to find a way to work with these big players onshore. In five years’ time, maybe foreign investors like us will be free to distribute our products. If so, the competitive environment will be quite different and, I think, a lot will focus on digital e-commerce. But the fundamentals still the same. We would need to work with the key players onshore. Wang: I’ve been talking to many private fund managers in China and the feedback from them is that the economy is not as bad as people think. Of course, we’re going through a difficult time, but if you go to the street you will see that people are leading a pretty good life. You also see that well-educated young people work really hard. The good thing is that China has figured out its problems and is heading in the right direction to make improvements. I believe it’s going to be a really promising economy, and one that’s too big to ignore, of course. Chao: I am optimistic for the Chinese government because the government is stable. It will not change every five or ten years like in other countries. Why didn’t I come back to my home town in Taiwan? If in four years they change another government, there will be another party, I will need to meet a lot of new people. That takes more time to do business. It is easy to live here in China. If I want to eat, I can order food from my mobile app and they send good meals. There’s a lot of e-commerce. You can even order a full massage to your home, or have someone clean your house. Fechter: I hope the Chinese economy is not as hyped as at the moment. It needs to become normal to report on China in a balanced way and not like football teams, where one week you have a star and the next you have a disaster. In China, things will pick up and change rapidly. In five years, we will have a more healthy, more robust and hopefully more predictable system. ©2016 funds global asia

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