China’s capital markets are experiencing a transformation, with global holdings of Chinese stocks and bonds having already jumped by about US$120bn in 2021 and still growing rapidly to cater to the demands for new asset allocation and diversification.¹ Population demographics and wealth creation in China have not only led to domestic advances in the financial instruments available, but have also had the knock-on effect of attracting more foreign investment to meet the needs of a growing and eager consumer base.

To discuss how these developments are impacting China’s capital markets, five industry experts came together in a Global Custodian panel titled ‘Chinese Capital Markets – paths to growth’. Each panelist offered their individual perspective on institutional investment, asset management, global custodian services and the domestic market.

Looking at the market from the inbound, outbound and domestic perspectives, the panellists all agreed on the impressive performance of China’s capital markets in recent years. The GDP growth has averaged almost 10% a year since 1978², when the country began to open up and reform its economy – and this is not expected to stop. Nicolas Aguzin, Chief Executive Officer of the Hong Kong Stock Exchange (HKEX), recently predicted that China’s capital markets will triple in size to US$100trn in the next decade.³ But what is the most significant contribution to that growth?

“It’s a combination of factors,” explained Tony Chao, Managing Director, Head of Securities Services, Greater China, Corporate Bank, Deutsche Bank. “For one, the size and scale of China’s market is enormous – it’s second only to the United States, in terms of economy size. The economic growth has meant that a lot of new wealth is being created and now more than 300 million Chinese households can be classified as middle class. So, with Chinese households looking to invest in more financial products, it’s not surprising that the market capital flows are experiencing a growth period.”

“What’s becoming apparent is the massive shift in interest from China’s traditional domestic saving method towards financial products such as public funds and mutual funds” 
Senan Yuen, Head of Investment, China, Fidelity International

Chinese markets are also experiencing a shift in consumer attitudes, towards financial instruments and away from holding individual stocks, real estate and bank deposits.

“For me, what’s becoming apparent is the massive shift in interest from China’s traditional domestic saving method towards financial products such as public funds and mutual funds – and with roughly 190 million investors participating in the Chinese capital market as of the end of July 2021, this is truly a domestic catalyst,” said Senan Yuen, Head of Investment, China, Fidelity International.

The growth in accessibility over the past decade, which has been driven by the extension of cross-border platforms such as Stock Connect,⁴ Bond Connect⁵ and China Interbank Bond Market (CIBM) Direct⁶, has proved to be a significant development. Together, these platforms have enabled foreign asset managers to access China’s financial markets without the need to incorporate a local entity in the country – leading to an increased number of international investments into the Chinese equity and fixed income markets. For instance, offshore investors increased their holdings of Chinese interbank market bonds by nearly 50% in 2020 to top US$500bn for the first time, according to Reuters data from 7 January 2021.⁷

“From my own experience, the accessibility of the market has really improved. When I first participated in the entry process back in 2007, it was quite difficult to get a local licence,” noted Yuen. “But now with the access process changing significantly, it is much more relaxed and easier for foreign institutional investors to enter the markets.”

Another key catalyst of China’s capital markets is the drive towards index inclusion for Chinese bonds as the country’s global footprint grows. “On a macroeconomic level, the index inclusion for Chinese bonds is a very interesting development,” commented Chao. “Chinese government bonds are also being added to some major indexes. This has led to a number of new index players, as well as fixed income players and, interestingly, sovereign investors coming into the market.”

For instance, in March it was announced that Chinese government bonds were to be added to the FTSE World Government Bond Index (WGBI) over three years from the end of October 2021.⁸ Chinese government bonds were previously included in index suites from JPMorgan and Bloomberg Barclays, but FTSE WGBI inclusion is expected to have a greater effect due to the size of passive flows tracking it.

China’s capital markets are experiencing a period of significant growth but, as Chao noted, “in terms of relative size, the international investor exposure in China is still relatively small. The overall international holding is low for the size of a market comparable to China – for example, for Chinese government bonds it is still less than 4%. So I think there’s still a lot of room to grow.”

As the Chinese capital market opens up and establishes itself as an international hub, investment structures are being created to meet the growing demand. “This is very much a continuing evolution,” noted Sam Xu, Chief Country Officer, Bank of New York Mellon China.

“At the moment in China, regulators are setting new policies very carefully and are making big strides towards opening up the capital markets,” explained Xu. “Specifically, we have seen the expansion of investment products from an inbound perspective. For example, the recent announcement by the cabinet will make commodities futures trading more accessible to foreign investors and provide a more attractive offering for hedge funds to expand into the Chinese market. These new structures will bring more benefits to international investors looking to invest in Chinese markets.”

Domestic players and international investors are both important players in China’s capital markets and, as the industry becomes more attractive to foreign investors, the investment structures need to be able to cater to both audiences.

“As a Chinese institution with a global outlook, we can clearly see that there are differences in what the two types of investors are interested in,” said Wilson Zhang, Managing Director, Regional Head of Equities, Head of QFII/WFOE Business, China International Capital Corporation Limited. “They pursue different investment goals and use different parameters and benchmarks to evaluate their performance. For instance, domestic bonds tend to be evaluated around once a quarter, while foreign investors run evaluations every three years or more.”

Deutsche Bank’s Chao added, “I have found that domestic investors are more adventurous in Chinese markets. They have more local knowledge and so they can take more risks. The local investors understand the Chinese companies better than the international investors operating remotely. With the growth of the market, having the local knowledge being fed back to the investors is increasingly important.”

Over the past year, China has been introducing strict regulations that affect many industries, including technology, real estate, education and capital markets. While many were surprised by the extreme nature of these regulations, it’s important for investors to understand the context behind the changes. Several policies were last updated more than 15 years ago – and with the amount of progress that has been made in that time, it’s no surprise that the frameworks in place failed to keep pace. With that in mind, what kind of services do inbound investors require to safely and securely carry out their business?

“First and foremost, we need to help investors interpret regulations and market changes which are fast evolving, and then analyse their impact on our clients in a timely manner,” explained Xu. “We also need to help them navigate the various access schemes and accounts of this complex landscape with advice and recommendations.”

With environmental, social and governance (ESG) investment now an unstoppable movement in the Asia-Pacific region, the panellists concurred on its major influence on the markets in the near-to- medium future. According to the MSCI 2021 Global Institutional Investor survey, around 79% of investors in Asia-Pacific increased their ESG investments ‘significantly’ or ‘moderately’ in response to Covid-19.⁹

“We are seeing a lot of demand for ESG initiatives on the ground,” reported Fidelity’s Yuen. “Our foreign institutional investors are asking us ‘how does it work?’. In China, there is definite growth in the number of instruments, with 141 ESG products now available and the market value increasing to RMB90bn [around US$14bn], as of June 2021.”

Yet although enthusiasm might be high, certain barriers in the region remain. With no consistent way of measuring ESG investments or disclosures, the industry is in desperate need of standardisation surrounding data and reporting.

“At the moment, there is a lot of self-monitoring, in terms of how companies and corporations are looking to impose their own ESG values”
Tony Chao, Managing Director, Head of Securities Services, Greater China, Deutsche Bank Corporate Bank

“While there is no “one size fits all” solution available, when it comes to ESG standardisation there is data available from some providers that you can use as a reference point,” Yuen explained. “In the absence of a market tool that evaluates a company’s ESG credentials, Fidelity have their own set of 200 questions that we use to assess each company and give them an internal rating. We use artificial intelligence in the form of Natural Processing Language (NPL) to sift through a vast amount of information of ESG trends from the media and internet and evaluate them.”¹⁰

Chao added that Deutsche Bank has an ESG Client Solutions team¹¹ that helps clients ensure that they are ESG compliant, so that they will be prepared when more formalised measures are put into place. “At the moment, there is a lot of self-monitoring, in terms of how companies and corporations are looking to impose their own ESG values,” he noted.

The past decade has been marked by many changes, in terms of shifting regulation, product diversifications and trends such as globalisation and ESG coming to the forefront. The global capital markets are seeing more and more institutional investors choosing to invest not only in China but also in various other APAC markets.

As market players begin to intermingle and complement each other, Yuen spoke of his enthusiasm for market collaboration in the future. “Now that local investors can invest in overseas products managed by offshore management companies, there are innovative synergies forming across programs, which is very encouraging for both investors and asset managers.”

With collaboration and international investment on the rise, there will likely be even more growth in China in the near future. “Watch this space,” concluded Xu. 

Chinese Capital Markets – paths to growth, part of the Global Custodian webinar series, was held on 10 November 2021

Sources

¹ See https://on.ft.com/3G61LnD at ft.com
² See https://bit.ly/3pig3Lb at worldbank.org
³ See https://bloom.bg/31e9ilT at bloomberg.com
⁴ See https://bit.ly/31pb82F at hkex.com.hk
⁵ See https://bit.ly/3diLLSR at chinabondconnect.com
⁶ See https://bit.ly/3dhlqVe at simmons-simmons.com
⁷ See 'China’s balancing act' at flow.db.com
⁸ See https://cnb.cx/3odghnG at cnbc.com
⁹ See https://bit.ly/3EjJdjl at msci.com
¹⁰ A point that came up at Sibos 2021. See the flow article ‘Green decision-making’ (28 October 2021)
¹¹ Contactable at esg.corporate-bank@db.com in addition to the Singapore-based ESG Centre of Excellence launched in May 2021