China's Financial Opening Is No Gold Rush
(Bloomberg) -- The guests are starting to arrive, but the house isn’t quite ready for this party. That’s the way to view a slew of recent measures to open China’s $40 trillion financial industry to outsiders.
This week, Beijing granted additional quotas for domestic funds to invest in overseas securities under the QDII plan, the first time it has done so in three years. At the same time, the government boosted permitted outbound institutional investment from Shanghai and Shenzhen. Meanwhile, Wall Street and other international banks are parsing draft rules on increasing stakes in securities joint ventures after China made good on a late 2017 pledge to ease restrictions.
If all this sounds promising, don’t get too excited.
Take the bank rules. The latest draft requires a controlling shareholder – in theory, the legal entity that holds the stake – to have a net asset value of 100 billion yuan ($16 billion). That’s a lot, even for bulge-bracket banks. While the rules are open to interpretation, several foreign partners are incorporated in Asia and wouldn’t make that bar.
It’s puzzling in any case that regulators have picked asset value as the yardstick, since broker-dealers typically run asset-light businesses. NAV is a measure that makes more sense for banks' wealth-management products in China. Regulations elsewhere in the world usually focus on net capital requirements, or capital cushions.
Beijing's use of a stricter measure may signal that foreign institutions are seen as potentially more than intermediaries, using their balance sheets to foster lending, and invest. Even domestically, there are only three Chinese securities companies that meet the NAV requirement.
A more cynical interpretation is that China is deliberately setting the bar too high, to the point that U.S. and European institutions will be unwilling to increase their stakes in ventures. Certainly, the closed market has helped domestic champions like Citic Securities Co. to emerge. Keeping them on top is important to Beijing as the broader financial system teeters. And even if foreign banks do gain control of their local units, they’re a long way from making boatloads of money in China.
The truth is probably somewhere between those extremes: Regulators are still getting their arms around a labyrinthine financial system. Its dark underbelly, in the form of shadow banking and deeply intertwined financial and non-bank financial institutions, has become clearer in the last year. So while individual companies like Citic and Guotai Junan Securities Co. will be hard to topple, smaller institutions may be at risk.
The bottom line is that China’s financial sector could use some fresh capital to address mispriced assets and misallocated resources.
Balancing capital is the other challenge. The granting of new quotas under the decade-old QDII system should help there. A stronger mutual-fund industry will help mop up funds currently chasing yields elsewhere, and potentially creating bubbles. The traditional funds industry, the biggest recipient of QDII approvals, competes at home not just with foreign institutions but with a wave of hedge-fund-like rivals. As of end-March, so-called “private securities funds,” mostly in equities and funds of funds, commanded 2.6 trillion yuan of assets, up from less than 1 trillion yuan three years ago.
The new rules would allow institutional investors like securities companies, insurance and asset managers to direct their capital – or cash raised domestically from third parties – overseas.
From fresh capital to healthy competition, new entrants help financial systems mature. They can also raise the effectiveness of risk management. At this stage, however, it’s hard to avoid the impression that China is mainly buying time to clean its house.
©2018 Bloomberg L.P.