China Opens Its Doors
We expect the harmonization of access schemes will continue, alongside the further relaxation of regulations that allow foreign investors to invest in onshore securities.
Clear moves towards harmonization can be seen – the most obvious examples being the proposed merger of the QFII and RQFII schemes, the removal of the QFII and RQFII investment quotas, the easing of market entry rules, and the liberalization of the FX market.
We expect the current access schemes to co-exist for the next few years, however, we feel there is a likelihood that onshore securities holdings will be fungible across various schemes. Already we are seeing this occurring: China bonds can now be transferred freely between the QFII, RQFII and CIBM direct schemes.
Additionally, we have seen an increased focus from market participants, collaborating to advocate for change to allow China bonds to serve as collateral within global transactions. Although a number of hurdles remain to be surmounted, clear progress has been made and will continue in 2020.
It is clear from all the proposed regulations issued by China in the past year that their road to market reform and opening continues, which may even be accelerated due to the US-China trade war.
China’s economic performance in recent decades has been exceptional. However, its growing economic clout on the international stage, where it is the world’s largest trading nation⁵, has not been matched by growth in the adoption of the RMB as a global payment currency. According to a SWIFT transactions report, the RMB accounted for a 1.46% share of global payments by value in 2017, putting it in seventh place internationally. Despite significant policy reforms by China’s regulators, this position has not changed dramatically in the past two years. In October 2019, the RMB moved up one notch to sixth position at 1.65%⁶.
As the world’s second-largest economy, the gap between China’s trading power and its currency share of world payments suggests there is huge potential for growth in the use of the RMB. China has been making rapid progress in internationalizing its currency, with trading in the onshore (CNY) market now available in Hong Kong through People’s Bank of China-licensed FX settlement banks. This allows foreign investors to trade CNY without the need to open accounts in Hong Kong and remit the USD equivalent into China. We expect to see greater cross-border transactions and RMB advancements from its role as a trade settlement currency to an investment currency and potentially a reserve currency.
With the recent inclusion of China’s securities in global indices, we have seen a greater diversity of investors with differing risk appetites increasing their allocations to China. Some of these include US and European pension funds, hedge funds, sovereign wealth funds and insurance companies. One of the benefits of broadening participation is that it is more likely to promote price discovery and make markets less susceptible to extreme volatility.
Although the opening up of China’s capital markets presents burgeoning opportunities, existing market challenges and new policy reforms being introduced at a rapid pace are making it challenging for investors, especially those new to the market. New inflows will need trusted global partners to help navigate the next phase of China’s deregulation. As global investors access the market, key factors to consider will be the choice of access schemes, FX optionality, ease of repatriation and counterparty risks.
Global investors are calling for regulators to introduce hedging tools as they scale their portfolios in China and seek to manage more complex risks. China’s regulators are heeding these calls and are expanding their investment scope in line with the government’s plan to integrate China’s capital markets with those of the rest of the world. New asset classes that will emerge in 2020 include:
While an expansion of asset classes is welcomed, immediate attention is needed regarding the ease of repatriation and the ability to efficiently trade in these instruments. For instance, clarity on hedging rules and legal agreements between global investors and FX counterparties can be improved. More reforms are necessary before we see growing demand for these new asset classes.
Generally, foreign investors appreciate China’s efforts to make its capital market more accessible, but some accessibility issues remain.
Among key upgrades, many investors would like to be given access to a listed futures market and other derivative products to enhance risk management as they scale their portfolios with higher inclusion ratios.
China A-Shares inclusion has important implications for investors, as many are currently under-weight in China equities.
Ultimately, however speedy China’s growth, the main challenge for global investors will continue to be charting the right path into unfamiliar territory. Choosing the right investment services partner to link the global with the local can be the answer to finding an approach that works.