There are many China market access schemes available. How can foreign investors navigate them?
Chinese authorities have consolidated and harmonised older schemes such as QFII and RQFII. As a result, some of them may lose relevance for certain investor types. At the same time, we also expect more schemes to be introduced – such as London-Shanghai Stock Connect and ETF Connect.
Some schemes are tailored towards certain investor types (e.g. asset owners, asset managers, official institutions and/or sovereign wealth funds). Therefore, schemes will fit all overseas investors and decisions to use one scheme over another may be based on the decision criteria of the individual party.
Investors should re-evaluate their overall China access needs, rather than focusing solely on individual schemes. Thus, service providers must be scheme agnostic and assist their clients in selecting the solution that best suits their requirements.
BNP Paribas has experts in all local and international access schemes who can discuss the different options, the specific requirements and the benefits of each scheme.
What new China access schemes do you see in the future and what will be the drivers of any new scheme?
We are preparing for the possible implementation of the ETF Connect by the end of 2018. However, with the current market focus on the London-Shanghai Stock Connect, the launch of the ETF Connect is not likely to happen this year. We expect that discussions on the ETF Connect will restart in 2019.
The London-Shanghai Stock Connect is a welcome addition to the China market access landscape. It will mirror the existing depositary receipt (DR) model used for other overseas opportunities from London. This will attract small to medium-sized European and US investors, as well as financial institutions that currently do not have a presence in Asia.
As these investors are not generally active in existing China market access schemes, the London-Shanghai Stock Connect will not have a significant impact on the usage of those schemes by existing investors. In addition, each company wishing to list their DR must be approved individually which will add time into the process and have an impact on the scheme’s ability to attract a wide asset base. We anticipate that the scheme will therefore work best for investors targeting specific investment opportunities.
Aside from discussions over the ETF Connect, there are other Chinese asset classes that are not currently covered by existing schemes. Over time, we anticipate that international investors will show greater interest to invest in alternative asset classes and further solutions will be developed.
Similarly, it is possible that other jurisdictions will look to set up direct investment links to China. For example, Japan and China have announced that they are looking at mutual listing of ETFs. This is more likely to be on the basis of southbound rather than northbound (into China) investment pressure, although the interest could also be two-way.
From our perspective, the addition of further schemes should increase investment opportunities, increase efficiency for investors, and continue to build an international investment model for China that aligns with global best practice.
What other liberalisations to the Chinese financial markets do you expect?
China’s market authorities are highly engaged with investors and their intermediaries in a number of forums to seek guidance on which enhancements to the existing schemes will bring the most benefit for foreign investors.
Many market experts predict developments for the Bond Connect (such as repo solutions); securities lending for Stock Connect; increased onshore hedging solutions for all Connect schemes and continued relaxation of the admittance for the onshore schemes.
However, this level of engagement may not last forever. Investors are encouraged to clearly voice their views as soon as possible on additional enhancements that will generate further interest.
QFII and RQFII trading volumes are quite small. How much of this volume has gone to the Connect schemes?
It is arguable that QFII and RQFII did not attract the volumes that Chinese authorities were hoping for. Hence, they launched the Connect schemes to create solutions more like those international investors were used to, and to allow them to hold Chinese securities in their standard custodial models (i.e. global custody).
Since the launch of the Stock Connect in 2014, over 4,000 international investors have entered the market and invested into Chinese stock exchanges. This is approximately six times the number of investors active in the QFII and RQFII schemes and shows that the model has been accepted by international investors.
For the Bond Connect, over 400 investors registered within the first year of its launch. The monthly volume is still limited (trading volume for September 2018 was RMB 64.78bn (USD 9.3bn), with an average daily turnover of RMB 3.41bn). However, it was only in August-September 2018 that regulators enacted full Delivery versus Payment (DvP) settlement and block trading, and clarified tax rules.
Therefore, we expect that Bond Connect will continue to grow and, given the returns on offer from the Chinese bond market and the ability to settle on a T+1 or T+2 basis (compared to the T+0 requirement for Stock Connect), many observers believe that the rush to Bond Connect should exceed Stock Connect’s impressive figures.
Have improvements to access schemes affected the listing arbitrage opportunities that used to exist?
Recent improvements and simplifications have not had a large impact on listing opportunities. Rather, the relationships between market price, funding costs and hedging costs continue to have more of an impact on the opportunities available.
Consider fixed income securities. Currently, there are four types of bonds available in the market:
- onshore RMB
- onshore foreign exchange (FX)
- offshore RMB (known as Dim Sum bonds), and
- offshore USD (known as Kung Fu bonds)
Currently, capital flows into onshore RMB bonds and offshore USD bonds are flourishing, whilst investment into onshore FX and offshore RMB is decreasing.
Issuers and buyers are located in two different markets (onshore RMB and offshore USD, for example), and those two markets are not sufficiently connected an investment opportunity arises when there is a price discrepancy.
Price differentials continue to provide opportunities such as differences in FX hedging costs. When the USD-CNY forward curve is lower than USD-CNH, it is cheaper for overseas investors in the onshore RMB bond market to hedge FX onshore than offshore.
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