Deutsche Bank Research China's financial markets March 16, 2009 a future global force? As the world struggles with the financial crisis and its repercussions on the global economy, questions inevitably arise as to what and wh will drive the financial markets in future years. China is likely to be one of the key players, given its dynamic development China's financial markets have enjoyed a period of strong growth E0E since the early 1990s, even though they are still relatively small compared to those of industrial countries and some other emerging markets Regulatory bodies have followed a careful and gradual reform path and will most probably continue with this approach. Given the current turmoil in global financial markets and the experience of successful gradual reforms, this approach is likely to provide a good basis for sustainable develop- ment in the future It would be unrealistic to expect China to emerge unscathed from the global recession. The weaknesses of less financially sound banks will be exposed during the downturn. A strengthening of provisioning and the capital base will be needed in light of a potential rise in credit losses management is a crucial determinant of winners and losers. It is rtant that Chinese banks continue to strive for prudent risk management research com In ten years, china is likely to account for 13% of the banking market, over 16% of the stock market and over 5% of the bond market worl Authors wide. Even under conservative assumptions, Chinas share in global financial 656423-8057 markets is set to grow syetarn.hansakul@db.com China's future role in global finance depends on its ability to open up. +4969910-31753 Granting greater market access to foreign financials will be a vital prerequisite for steffendyck@db.com sustained development, and greater integration and regulatory convergence efforts especially with the US and the EU should be key policy objectives +4969910-31889 steffenkern@db.com The"going global"drive of chinese financial institutions marks a Editor second wave of Chinese outward investments. While the increasing Steffen Kern internationalisation of Chinese financial institutions is not a totally new phenol Technical Assistant menon activity has increased markedly since 2006. In the near term, Chinese Sabine Kaiser banks' earnings and profit outlook for 2009 to 2010 as well as regulatory Deutsche Bank Research Frankfurt am Main considerations are likely to curb their global expansion. Over the medium and nger term much will depend on how the global economic system evolves from the crisis E-mailmarketingdbr@db.com Fax:+496991031877 The Chinese state is a global investor set to grow further In recent multilateral initiatives, China has contributed to the acceptability of sovereign Norbert wi investments. While advanced economies need to maintain liberal investment conditions, China is still at a starting point of opening up to foreign investments
Authors Syetarn Hansakul +65 6423-8057 syetarn.hansakul@db.com Steffen Dyck +49 69 910-31753 steffen.dyck@db.com Steffen Kern +49 69 910-31889 steffen.kern@db.com Editor Steffen Kern Technical Assistant Sabine Kaiser Deutsche Bank Research Frankfurt am Main Germany Internet:www.dbresearch.com E-mail marketing.dbr@db.com Fax: +49 69 910-31877 Managing Director Norbert Walter given its dynamic development. !!" even though they are still relatively small compared to those of industrial countries and some other emerging markets. # Given the current turmoil in global financial markets and the experience of successful gradual reforms, this approach is likely to provide a good basis for sustainable development in the future. $ The weaknesses of less financially sound banks will be exposed during the downturn. A strengthening of provisioning and the capital base will be needed in light of a potential rise in credit losses. # It is important that Chinese banks continue to strive for prudent risk management. %& '& (& ) Even under conservative assumptions, China’s share in global financial markets is set to grow. Granting greater market access to foreign financials will be a vital prerequisite for sustained development, and greater integration and regulatory convergence efforts especially with the US and the EU should be key policy objectives. * + , While the increasing internationalisation of Chinese financial institutions is not a totally new phenolmenon activity has increased markedly since 2006. In the near term, Chinese banks’ earnings and profit outlook for 2009 to 2010 as well as regulatory considerations are likely to curb their global expansion. Over the medium and longer term much will depend on how the global economic system evolves from the crisis. * In recent multilateral initiatives, China has contributed to the acceptability of sovereign investments. While advanced economies need to maintain liberal investment conditions, China is still at a starting point of opening up to foreign investments. - . March 16, 2009 /
Deutsche Bank Research Current Issues Editorial the financial markets in future years China has on many occasio The financial crisis has thrown the banking world into turmoil. As dust settles, questions inevitably arise as to what and who will dr been identified as one of the potential key players, given its size and share in the global economy and its vigorous pursuit of economic reform for several decades. Whether the country will be in a position to meet these expectations critically depends on how deeply it will be affected by the current crisis, how well it can emerge from the turmoil, and how its markets and regulators respond to the recent experiences. We set out to explore these questions, and assess China s prospect in a series of chapters in this report. We start by looking at the existing structure and recent develop ments of China s own domestic financial markets, assessing its capability and potential. We then take a critical look at the state of Chinas banking sector and how it will be impacted by the current global financial crisis. The potential of China's domestic banking sector is also examined. We try to gauge the current extent of China's integration into the global financial markets. The opening of China's markets to outside investors and the progress and pro- spects of regulatory liberalisation are also scrutinised. Finally, we look at China s own reach around the world through different angles china's financial institutions going abroad and Chinas role as a global investor. China's financial markets will continue to evolve as guided by its domestic dynamics and needs as well as external opportunities and circumstances. It is clear that China has global ambitions on top of the potential to be a key player in the world financial markets, and the country has made great strides in recent years. The journey is still in its early stages, and there will be many pitfalls ahead. As China continues to rise, it is difficult to imagine that its level of engagement or influence on the world stage will not grow. Syetarn Hansakul Steffen Dyck Steffen Kern arch16.2009
Current Issues 2 March 16, 2009 / The financial crisis has thrown the banking world into turmoil. As the dust settles, questions inevitably arise as to what and who will drive the financial markets in future years. China has on many occasions been identified as one of the potential key players, given its size and share in the global economy and its vigorous pursuit of economic reform for several decades. Whether the country will be in a position to meet these expectations critically depends on how deeply it will be affected by the current crisis, how well it can emerge from the turmoil, and how its markets and regulators respond to the recent experiences. We set out to explore these questions, and assess China’s prospect in a series of chapters in this report. We start by looking at the existing structure and recent developments of China’s own domestic financial markets, assessing its capability and potential. We then take a critical look at the state of China’s banking sector and how it will be impacted by the current global financial crisis. The potential of China’s domestic banking sector is also examined. We try to gauge the current extent of China’s integration into the global financial markets. The opening of China’s markets to outside investors and the progress and prospects of regulatory liberalisation are also scrutinised. Finally, we look at China’s own reach around the world through different angles: China’s financial institutions going abroad and China’s role as a global investor. China’s financial markets will continue to evolve as guided by its domestic dynamics and needs as well as external opportunities and circumstances. It is clear that China has global ambitions on top of the potential to be a key player in the world financial markets, and the country has made great strides in recent years. The journey is still in its early stages, and there will be many pitfalls ahead. As China continues to rise, it is difficult to imagine that its level of engagement or influence on the world stage will not grow. Syetarn Hansakul Steffen Dyck Steffen Kern
China's financial markets-a future global force? Deutsche Bank Research Table of contents Page China s capital markets- structure and market development Chinas banking sector to be tested by the downturn Chinese financial markets in the global context-much growth, little integration Opening up Chinas financial markets- progress and prospects of regulatory liberalisation Chinese financial institutions going global The Chinese state -a global investor March 16. 2009
China's financial markets – a future global force? March 16, 2009 3 ) Page China’s capital markets – structure and market development............................................................ 4 China’s banking sector to be tested by the downturn....................................................................... 12 Chinese financial markets in the global context – much growth, little integration ............................ 18 Opening up China’s financial markets – progress and prospects of regulatory liberalisation.......... 24 Chinese financial institutions going global........................................................................................ 33 The Chinese state – a global investor .............................................................................................. 37
Deutsche Bank Research Current Issues Chinas capital markets-structure and market devel。 pment The development of China's capital markets can be divided into three phases. Between early 1978 and 1992 full-scale economic reform took place, with capital markets emerging in response to the beginning incorporation process of Chinese enterprises as the concept of privatisation took off following the introduction of the Open Door policy. In the second phase(1993-1998), the focus shifted to strengthening the capital markets in terms of institutional Financial markets in framework as well as supervisory framework. Supervision of capital son markets was consolidated, leading to the formation of the China of GDP, 2008 (latest available data) Securities Regulatory Commission(CSRC)in its current form China Regional pilot programmes were expanded nationwide. The pro- mulgation of the Securities Law marked a milestone in the third Brazil phase between 1999 and 2007, resulting in formalisation and strengthening of the legal status of China's capital markets. The India emphasis rested on refinement of the legal and regulatory system to Russia create a more transparent and efficient market. Concepts such as corporate governance and market discipline were introduced Further, a series of reforms were implemented to facilitate future development of national capital markets in terms of product Japan While substantial progress has been made and reforms are generally heading in the right direction, several areas are still subject to further work. These include, among others, corporate overnance as well as capital market infrastructure and rating 00 agencies. In order to make China s financial markets really world- class they have to become freer, more transparent and better a Private sector credit regulated. Aside from increasing the share of institutional investors a Stock market capitalisation especially in the stock market, it is necessary to raise the general level of financial literacy. By successfully implementing these reforms, China s financial markets will be in better shape to serve investors' and fund raisers needs at the same time and thus support China' s long-term growth in a more efficient manner. Non-FIs heavily on banks Structure of Chinas capital markets of total extemal financing, 2006 Compared to industrial countries, Chinas financial markets are still Bonds relatively shallow as measured in relation to nominal GDP (see 10.1 Stocks chart 1). Bank loans to the private sector account for the lion,s share ABS not least due to the recent steep decline in the stock market. However, in a BRIC comparison, China leads in terms of combined Bank financial market depth The comparatively large share of private sector credit shows that the Chinese economy remains heavily dependent on bank finance. Bank loans account for more than 80% of total financing to the non- financial sector, while equity and bond issuance plays a sub ordinated role(see chart 2 ). Aside from financial risk concentration Source: CSRC in the banking system this signals that capital markets are still derdeveloped See CSRC (2008). China Capital Markets Development Report. China Securities Regulatory Commission. March 2008 People's Bank of China(2008a). Financial Stability Report 2007 March 2008 p.28. arch16.2009
Current Issues 4 March 16, 2009 - The development of China’s capital markets can be divided into three phases1 . Between early 1978 and 1992 full-scale economic reform took place, with capital markets emerging in response to the beginning incorporation process of Chinese enterprises as the concept of privatisation took off following the introduction of the Open Door policy. In the second phase (1993-1998), the focus shifted to strengthening the capital markets in terms of institutional framework as well as supervisory framework. Supervision of capital markets was consolidated, leading to the formation of the China Securities Regulatory Commission (CSRC) in its current form. Regional pilot programmes were expanded nationwide. The promulgation of the Securities Law marked a milestone in the third phase between 1999 and 2007, resulting in formalisation and strengthening of the legal status of China’s capital markets. The emphasis rested on refinement of the legal and regulatory system to create a more transparent and efficient market. Concepts such as corporate governance and market discipline were introduced. Further, a series of reforms were implemented to facilitate future development of national capital markets in terms of product diversification. While substantial progress has been made and reforms are generally heading in the right direction, several areas are still subject to further work. These include, among others, corporate governance as well as capital market infrastructure and rating agencies. In order to make China’s financial markets really worldclass they have to become freer, more transparent and better regulated. Aside from increasing the share of institutional investors, especially in the stock market, it is necessary to raise the general level of financial literacy. By successfully implementing these reforms, China’s financial markets will be in better shape to serve investors’ and fund raisers’ needs at the same time, and thus support China’s long-term growth in a more efficient manner. Structure of China’s capital markets Compared to industrial countries, China’s financial markets are still relatively shallow as measured in relation to nominal GDP (see chart 1). Bank loans to the private sector account for the lion’s share – not least due to the recent steep decline in the stock market. However, in a BRIC comparison, China leads in terms of combined financial market depth. The comparatively large share of private sector credit shows that the Chinese economy remains heavily dependent on bank finance. Bank loans account for more than 80% of total financing to the nonfinancial sector, while equity and bond issuance plays a subordinated role (see chart 2). Aside from financial risk concentration in the banking system2 this signals that capital markets are still underdeveloped. 1 See CSRC (2008). China Capital Markets Development Report. China Securities Regulatory Commission. March 2008. 2 People’s Bank of China (2008a). Financial Stability Report 2007. March 2008, p. 28. Bank loans, 84.9 Bonds, 10.1 Stocks, 3.9 ABS, 1.1 0(1 % of total external financing, 2006 Source: CSRC ' 0 100 200 300 400 500 US Germany Japan UK Russia India Brazil China Bonds outstanding Private sector credit Stock market capitalisation 1 % of GDP*, 2008 (latest available data) Sources: BIS, Bloomberg, IMF IFS, DB Research *As shares of 2008 est. GDP
China's financial markets-a future global force? Deutsche Bank Research Brief history of Chinas bond market Bond market While some kind of financing instruments Market structure resembling bonds can be traced back to Chinas "Spring Autumn" and"Warring Although total annual issuance has surged since the early 2000s States"periods(770 B. C to 256 B.C. ) bonds in from less than RMB 1 tr to RMB 8 tr as of end-2007-China's bond modern sense became more widely used during the late 19th/early 20th century to market is still relatively small as a share of nominal GDP (35%in finance government spending and larg 2007)especially when compared to mature economies. Public infrastructure projects. Having vanished ector issuance continues to dominate People' s Bank of China following the foundation of the PRC in 1949 (PBC) and treasury bonds accounted for almost 80%of total the bond market came back to life in the early issuance in 2007 and more than 75% until September 2008. In the 1980s as economic reforms kicked off and categories "financial bonds" and " corporate bonds, entities that are enterprises had to diversify their funding sources. Treasury bonds were relaunched in linked to the state play the most important role. Policy bank bonds constitute more than 90% of total issuance of financial bonds Accordingly, commercial bank bonds make up only roughly 10% of defaults started in 1993 leading to a period of the total issuance volume Among corporate bonds, those from decline in corporate issuance. Financial bond state-owned enterprises account for more than 70% of the total until banks from 1984 on. Starting from April 1988, September 2008, almost unchanged from their 2007 share trading of treasury bonds by retail investors was permitted in seven cities and by the end of that year it had spread across the country. The Strong growth until 2008 interbank segment was established by the Total annual issuance PBC in 1997-open only for domestic in- stitutional investors. After 2000, the range of 70730 market participants was broadened to also include domestic non-financial institutions 4.22 Intemational institutions were also given per mission to issue so-called Panda bonds 050 bonds denominated in RMB. In exchange- based trading, net price bond trading was 10210620 44044058099 5 introduced in 2002 and the following years witnessed a number of new products, includin asset-backed securities by non-FIs OTC 99719981999200020012002200320042005200620072008 ading was also established in 2002 in order to RMB tr(left) 96 of GDP (right) service retail investors and SMEs Source: Chinabond The higher treasury share in 2007 can be attributed to the issuance So far no major shifts in of so-called"special T-bonds"which were used to buy USD 200 bn term structure RMB tr in foreign exchange as capital funds of China Investment (CIC) Frequency and issuance volume of PBC bonds also in creased again starting in 2007 as the effect of monetary policy tightening. However, due to a policy change towards monetary easing PBC issuance declined in late 2008 The share of bonds with maturities of less than one year has 4 traditionally been high in China's bond market. It rose from 30% in 2002 to more than 75%in 2006, but in 2007 declined sharply to less than 45%. However, in the same year the share of bonds in the one to three year range rose to 22%, which means that the term structure of the chinese bond market remains skewed towards the short end. Longer-term issuances could gain some ground in 2007, but issuance data for 2008 suggest that shares of bonds maturing up to 1Y 1-3Y within seven to ten years or after ten years are back to single-digit 3-5Y territory again 7-10Y amore than 10Y The Chinese bond market can be separated into two sections: the Source: Chinabond OTC section -which can be sub-divided into an interbank and the commercial banks'OTC market-and so-called exchange-based 3 Policy banks are: China Development Bank(CDB), Export-Import Bank of China (Eximbank), and Agricultural Development Bank of China(ADBC) China Government Securities Depository Trust Clearing Co Ltd (2008). China Bond Market Review 2007 January 2008, p 21 March 16. 2009
China's financial markets – a future global force? March 16, 2009 5 Brief history of China’s bond market While some kind of financing instruments resembling bonds can be traced back to China’s “Spring & Autumn” and “Warring States” periods (770 B.C to 256 B.C.), bonds in a modern sense became more widely used during the late 19th / early 20th century to finance government spending and large infrastructure projects. Having vanished following the foundation of the PRC in 1949, the bond market came back to life in the early 1980s as economic reforms kicked off and enterprises had to diversify their funding sources. Treasury bonds were relaunched in July 1981 and, from 1982 onwards, corporate bonds re-emerged. A wave of corporate defaults started in 1993 leading to a period of decline in corporate issuance. Financial bonds became a regular financing instrument for banks from 1984 on. Starting from April 1988, trading of treasury bonds by retail investors was permitted in seven cities and by the end of that year it had spread across the country. The interbank segment was established by the PBC in 1997 – open only for domestic institutional investors. After 2000, the range of market participants was broadened to also include domestic non-financial institutions. International institutions were also given permission to issue so-called Panda bonds – bonds denominated in RMB. In exchangebased trading, net price bond trading was introduced in 2002 and the following years witnessed a number of new products, including asset-backed securities by non-FIs. OTC trading was also established in 2002 in order to service retail investors and SMEs. Bond market Market structure Although total annual issuance has surged since the early 2000s – from less than RMB 1 tr to RMB 8 tr as of end-2007 – China’s bond market is still relatively small as a share of nominal GDP (35% in 2007) especially when compared to mature economies. Public sector issuance continues to dominate. People’s Bank of China (PBC) and treasury bonds accounted for almost 80% of total issuance in 2007 and more than 75% until September 2008. In the categories “financial bonds” and “corporate bonds”, entities that are linked to the state play the most important role. Policy bank3 bonds constitute more than 90% of total issuance of financial bonds. Accordingly, commercial bank bonds make up only roughly 10% of the total issuance volume. Among corporate bonds, those from state-owned enterprises account for more than 70% of the total until September 2008, almost unchanged from their 2007 share. The higher treasury share in 2007 can be attributed to the issuance of so-called “special T-bonds” which were used to buy USD 200 bn in foreign exchange as capital funds of China Investment Company (CIC)4 . Frequency and issuance volume of PBC bonds also increased again starting in 2007 as the effect of monetary policy tightening. However, due to a policy change towards monetary easing PBC issuance declined in late 2008. The share of bonds with maturities of less than one year has traditionally been high in China’s bond market. It rose from 30% in 2002 to more than 75% in 2006, but in 2007 declined sharply to less than 45%. However, in the same year the share of bonds in the one to three year range rose to 22%, which means that the term structure of the Chinese bond market remains skewed towards the short end. Longer-term issuances could gain some ground in 2007, but issuance data for 2008 suggest that shares of bonds maturing within seven to ten years or after ten years are back to single-digit territory again. The Chinese bond market can be separated into two sections: the OTC section – which can be sub-divided into an interbank and the commercial banks’ OTC market – and so-called exchange-based 3 Policy banks are: China Development Bank (CDB), Export-Import Bank of China (Eximbank), and Agricultural Development Bank of China (ADBC). 4 China Government Securities Depository Trust & Clearing Co. Ltd (2008). China Bond Market Review 2007. January 2008, p. 21. 0.21 0.62 0.44 0.44 0.58 0.99 1.76 2.73 4.22 5.71 7.98 7.07 0 5 10 15 20 25 30 35 0 1 2 3 4 5 6 7 8 9 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 RMB tr (left) % of GDP (right) 2 '""3 Total annual issuance Source: Chinabond 4 0 1 2 3 4 5 6 7 8 9 00 01 02 03 04 05 06 07 08 up to 1Y 1-3Y 3-5Y 5-7Y 7-10Y more than 10Y 2 RMB tr Source: Chinabond 5