If you had been waiting with bated breath for earth-shattering policy announcements from President Xi Jinping at this week’s Boao Forum, you have reason to be underwhelmed.
Xi was hardly going to get into details in his address but even after the central bank Governor Yi Gang fleshed out some of the bare bones of the much-touted financial sector reforms Xi laid out, it all failed to match the expectation the president’s right hand man Liu He built up just weeks before at the World Economic Forum in Davos.
Headlining the list of reforms is the restated promise of majority ownership and hence control by foreign capital across the financial intermediary space. Brokerage, banking and insurance, which have been restricted for decades, are to be opened up with foreign capital treated on equal terms as local capital. That sounds good on paper but few with China experience can expect that to play out in reality. Local brokers are simply too established and big to be challenged in any meaningful way by foreign firms for many years to come.
The most immediate change is the May 1 quadrupling of the HK China Connect daily trading quotas – an increase to 52 billion yuan (US$8 billion) for Northbound flows and 42 billion yuan for Southbound ones. That sounds great but in more than three years of operation the Northbound limit has been hit only once and the Southbound limit twice. On any given day, net flows use around only 10 to 20 per cent of the available quota. This specific move has been driven by the introduction of Chinese A shares into the MSCI index which will start in June of this year. Since the initial approval by the MSCI, both foreign banks and MSCI have lobbied and explained to the China Securities Regulatory Commission (CSRC) that there is a real concern that the daily limits would be unable to allow MSCI tracking managers to rebalance their portfolios without disruption, effectively causing China via the Connect scheme to lose face. To their credit the CSRC has taken this on-board and increased the limits and it will not lead to any immediate new inflows beyond what is already expected.
That Connect still covers only about 50 per cent of the listed shares on the Mainland remains a totally unaddressed issue. Connect was an inventive and useful scheme to give the appearance of opening up but it remains a secondary channel. The Qualified Foreign Institutional Investor scheme (QFII) is still the primary channel to properly access China and it is also the scheme that should be developed. Allowing QFII full access to onshore margin financing and borrowing markets would be a much more significant move than tinkering with Connect. Those who say China must move slowly should look at India by way of example. In the past 10 months, India’s foreign investor scheme has seen more than 1,200 institutions open accounts that give foreigners full access to onshore markets, full currency convertibility for stock related trades, access to local borrowing markets and all with clear accountability, transparency and control by the local regulator and central bank. You can have much greater foreign access and still keep control.
The announcement of a London Connect scheme is interesting but details are very patchy. An eight-hour time difference will mean it just won’t work in the same way as the current HK Connect and it is far from clear if there is even demand from local Chinese investors for London listed shares. It sounds impressive, but is a sideshow rather than a real opening up.
The futures markets also appear to be opening further with plans to increase limits on the CSI 300 index after the CSRC restricted trading and saw volumes fall by more than 99 per cent. The long awaited Shanghai Crude Oil contract is trading now and Dalian Iron Ore futures is also promised.
It is being presented as China’s opening but let’s not think this is some great upside surprise. Investors have been lobbying for decades for some of these developments and now they come at a time when China is interfering and exerting a level of micro control unseen in over 25 years of stock markets. As Xi made his address the exchanges were calling investors to tell them not to sell the market so the indices didn’t fall. That is hardly a sign that the market is the decisive factor.
Xi has promised a lot. He has consolidated power in his hands and can indeed make real changes if he desires but there is nothing to think that some great sea change is coming. Yi Gang spoke of gradual change, but that is what has happened for a decade. China can do a lot more than it has already done while still controlling foreign capital flows. A false comparison is forever made that change must be gradual or else it will be chaotic. That simply is not true yet it is a handy mantra to justify inaction.
China’s economic size continues to grow but its financial system remains immature and of limited interest to foreign capital. HK deposits of renminbi are unchanged over a five-year view, which seems incredible given the growing role of China in that time. The latest round of changes will help at the margins but Xi’s China is over promising and under delivering. He has the power to change that but it looks like he won’t.