Chinas Capital Markets-The changing landscape 9 Capital in, capital out: Sovereign Wealth Funds (SWFs In terms of the impact on Chinas domestic stock markets, two SWFs, namely the National Social Security Fund (NSSF)and China Investment Corporation (CIC)also The NSSF was set up in 2000 as a fund of last resort ' to help meet Chinas future pension challenge. It has been growing significantly in size, stature and influence since its inception with total assets rising from the initial RMB 20 billion (USD 3.1 billion)to RMB 857 billion(USD 131 billion) by the end of 2010. This makes it by far the biggest institutional investor in Chinas pension sector. In terms of investments, the nSsF must deploy no less than 50 percent in domestic bank deposits and government bonds via direct investment, but significantly it can also invest up to 30 percent of its total assets through appointed fund managers in domestic stock markets The NSSF also has fixed income holdings and investments in Pe funds and has ing a proportion (typically 10 eds of certain state-owned enterprise IPOs. Domestic holdings have increased significantly. especially after the gFC when most domestic equities were trading at historically low levels. This not only reflects the Fund's long-term investment objective, but also dicates an important role for the Fund- serving as a strong stabilising force in the iC has helped to diversify the country' s massive reserves and generate strong returns via long-term investments. With nearly two-thirds of its initial capital of USD 200 billion allocated domestically, ciC holds significant stakes in key national bank KPMG comment and financial institutions on behalf of the government. Such holdings include 49 9 QFlls serve as an intermediary cent of China Development Bank, 35 percent of Industrial and Commercial Bank subject to control and of China, 50 percent of Agricultural Bank of China, 68 percent of Bank of China and measurement of capital flows 57 percent of China Construction Bank. These holdings, combined with the profits nto and out of china. As the generated by its other domestic and overseas investments, brought the total asset capital account liberalises, OFlls size of CiC to almost USD 400 billion by the end of 2010 with the average return on will continue to be a major conduit for foreign investment, Capital outflow -QDII but we expect the quota syste will be relaxed in some ways While the Qfil scheme allows for international capital inflow into mainland financial markets, the Qualified Domestic Institutional Investor(QDiI) programme introduced in April 2006 sanctions five types of Chinese entities to invest abroad-banks trust companies, fund houses, securities firms and insurance companies. These entities can make investments in fixed income, equities and derivatives in approved verseas markets both for themselves and on behalf of retail or other clients Approval for both a licence and quota is required from the respective regulator and from SAFE respectively. As at end 2010, 95 Chinese institutions had been granted QDIl status, with a total quota of USD 68. 4 billion being allocated among 88 of The QDIl market provides more investment channels to Chinese retail and institutional investors. In doing so it helps domestic investors diversify market risk and, by reducing excessive internal liquidity eases the pressure on the RMb to appreciate. In these respects, the QDIl market has also impacted the capital market domestically, by providing alternative investment options and dampening currency Following the launch of a number of mega-funds in 2007, the QDIl market was elatively quiet in 2008 and 2009 before picking up again since December 2009 There are signs of a maturing of the domestic fund houses as many of them seek to develop their in-house QDIl research teams. Over time, international participants bridging role may diminish. It is no longer the case that the QDiI managers will Annual Report. These are not traded on the secondary mply look for special QDIl services that an international partner claims to offer CIC public disdosure reported by Chinese meda. more importantly, they are starting to eye the potential opportunities for their global expansion through partnerships with these international houses 0 2011 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG international"), a Swiss entity. All rights reserved
Capital in, capital out: Sovereign Wealth Funds (SWFs) In terms of the impact on China’s domestic stock markets, two SWFs, namely the National Social Security Fund (NSSF) and China Investment Corporation (CIC) also play a significant role. The NSSF was set up in 2000 as a ‘fund of last resort’ to help meet China’s future pension challenge. It has been growing significantly in size, stature and influence since its inception with total assets rising from the initial RMB 20 billion (USD 3.1 billion) to RMB 857 billion (USD 131 billion) by the end of 2010.8 This makes it by far the biggest institutional investor in China’s pension sector. In terms of investments, the NSSF must deploy no less than 50 percent in domestic bank deposits and government bonds via direct investment, but significantly it can also invest up to 30 percent of its total assets through appointed fund managers in domestic stock markets. The NSSF also has fixed income holdings and investments in PE funds and has benefitted by receiving a proportion (typically 10 percent) of the proceeds of certain state-owned enterprise IPOs. Domestic holdings have increased significantly, especially after the GFC when most domestic equities were trading at historically low levels. This not only reflects the Fund’s long-term investment objective, but also indicates an important role for the Fund – serving as a strong stabilising force in the domestic market. CIC has helped to diversify the country’s massive reserves and generate strong returns via long-term investments. With nearly two-thirds of its initial capital of USD 200 billion allocated domestically, CIC holds significant stakes in key national banks and financial institutions on behalf of the government. Such holdings include 49 percent of China Development Bank, 35 percent of Industrial and Commercial Bank of China, 50 percent of Agricultural Bank of China, 68 percent of Bank of China and 57 percent of China Construction Bank.9 These holdings, combined with the profits generated by its other domestic and overseas investments, brought the total asset size of CIC to almost USD 400 billion by the end of 2010 with the average return on assets over 12 percent per annum.10 Capital outflow — QDII While the QFII scheme allows for international capital inflow into mainland financial markets, the Qualified Domestic Institutional Investor (QDII) programme introduced in April 2006 sanctions five types of Chinese entities to invest abroad — banks, trust companies, fund houses, securities firms and insurance companies. These entities can make investments in fixed income, equities and derivatives in approved overseas markets, both for themselves and on behalf of retail or other clients. Approval for both a licence and quota is required from the respective regulator and from SAFE respectively. As at end 2010, 95 Chinese institutions had been granted QDII status, with a total quota of USD 68.4 billion being allocated among 88 of them.11 The QDII market provides more investment channels to Chinese retail and institutional investors. In doing so it helps domestic investors diversify market risk and, by reducing excessive internal liquidity, eases the pressure on the RMB to appreciate. In these respects, the QDII market has also impacted the capital market domestically, by providing alternative investment options and dampening currency speculation. Following the launch of a number of mega-funds in 2007, the QDII market was relatively quiet in 2008 and 2009 before picking up again since December 2009. There are signs of a maturing of the domestic fund houses as many of them seek to develop their in-house QDII research teams. Over time, international participants’ bridging role may diminish. It is no longer the case that the QDII managers will simply look for special QDII services that an international partner claims to offer; more importantly, they are starting to eye the potential opportunities for their global expansion through partnerships with these international houses. KPMG comment QFIIs serve as an intermediary subject to control and measurement of capital flows into and out of China. As the capital account liberalises, QFIIs will continue to be a major conduit for foreign investment, but we expect the quota system will be relaxed in some ways. 8 NSSF 2010 Annual Report 9 CIC 2009 Annual Report. These are not traded on the secondary market. 10 As per CIC public disclosure reported by Chinese media. 11 Source: SAFE. © 2011 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2011 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. China’s Capital Markets - The changing landscape | 9
10 Chinas Capital Markets-The changing landscape Recent innovations Three recent developments which have contributed to the development of a more mature equities environment are the secondary chiNext market in Shenzhen, the launch of stock exchange futures and the allowing of QFil investors to participate in futures trading. ChiNext for start-ups Established on the Shenzhen Stock Exchange(SzSE)in October 2009, ChiNext was set up to list companies in high growth sectors such as technology and pharmaceuticals. While requiring a far lower level of capital than the Main board the sme board, chinext has stricter thresholds in other areas (such as for business operations, information disclosure and limitations on stock sales) in place for transparency and risk management purposes ChiNext is considered an important capital market instrument to broaden Chinas dustrial structure and promote economic reform, especially given the difficulties some start-ups still face in securing bank financing. At the end of 2010, 153 companies had successfully listed on ChiNext, with a total market capitalisation of RMB 737 billion, including RMB 117 billion raised from the public. The average P/E ratio on ChiNext reached 60, signaling investors'enthusiasm for the new board. 2 Launch of long-awaited stock index futures China finally granted investors access to stock index futures in April 2010, subsequent to the official introduction of margin trading and short selling. Investors are now able to profit from both gains and declines in the market through more ophisticated investment instruments. Despite high levels of interest from retail nvestors and need for a relatively low capital entry requirement, a relatively stringent set of rules was imposed including a threshold of RMb 500, 000 as the minimum deposit for a single trading account and a margin requirement of 12 percent. Eligible retail investors must also have prior experience with commodities futures trading or mock trading of index futures, reflecting the regulators cautious attitude while gradually opening up the new channel for local investors. Equity funds, balanced funds and capital preservation funds are now allowed to participate s well, though bond funds or money market funds will need to wait for further notice 12 Wind, CMS China Research Department. ip and a member firm of the KPMG network of independent mt KPMG Internatior Miss entity. All rights reserved
Recent innovations Three recent developments which have contributed to the development of a more mature equities environment are the secondary ChiNext market in Shenzhen, the launch of stock exchange futures and the allowing of QFII investors to participate in futures trading. ChiNext for start-ups Established on the Shenzhen Stock Exchange (SZSE) in October 2009, ChiNext was set up to list companies in high growth sectors such as technology and pharmaceuticals. While requiring a far lower level of capital than the Main Board or the SME Board, ChiNext has stricter thresholds in other areas (such as for business operations, information disclosure and limitations on stock sales) in place for transparency and risk management purposes. ChiNext is considered an important capital market instrument to broaden China’s industrial structure and promote economic reform, especially given the difficulties some start-ups still face in securing bank financing. At the end of 2010, 153 companies had successfully listed on ChiNext, with a total market capitalisation of RMB 737 billion, including RMB 117 billion raised from the public. The average P/E ratio on ChiNext reached 60, signaling investors’ enthusiasm for the new board.12 Launch of long-awaited stock index futures China finally granted investors access to stock index futures in April 2010, subsequent to the official introduction of margin trading and short selling. Investors are now able to profit from both gains and declines in the market through more sophisticated investment instruments. Despite high levels of interest from retail investors and need for a relatively low capital entry requirement, a relatively stringent set of rules was imposed including a threshold of RMB 500,000 as the minimum deposit for a single trading account and a margin requirement of 12 percent. Eligible retail investors must also have prior experience with commodities futures trading or mock trading of index futures, reflecting the regulators’ cautious attitude while gradually opening up the new channel for local investors. Equity funds, balanced funds and capital preservation funds are now allowed to participate as well, though bond funds or money market funds will need to wait for further notice. 12 Wind, CMS China Research Department. © 2011 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2011 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 10 | China’s Capital Markets - The changing landscape
Chinas Capital Markets-The changing landscape 11 The first and the only stock index future is based on the csI 300 Index, which covers about one-sixth of all stocks listed in China and accounts for about 60 percent of ket capitalisation. There are currently four active contracts for the front month ne month behind the front month and then the next two months in the march June, September, December cycle. The future is also subject to a +/-10 percent price band based on the previous close. At the end of 2010, 46 million contracts had been traded, and average daily volumes had stablised at around 250,000 spot contracts(with approximately USD 38 billion notional equivalent) The index futures market has generated huge interest from retail investors. by the third day of trading, the traded value of stock index futures already exceeded the value of stocks traded on the ssE. Though the CSrc has imposed strict instructions for proper regulation of the market, it is clear that the market is highly influenced y speculation, which has heightened volatility and limited its ability to truly reflect he direction of the underlying stock market. Further developments are taking place towards a mature index futures market, and liquidity should continue to increase QFlls allowed to participate in stock index futures trading As part of the governments efforts to further open up Chinas financial markets, the ecently unveiled"Rules on Index Futures Trading for Qualified Foreign Institutional Investors(QFlls)"allow for QFlls' participation in the domestic stock index futures KPMG comment market by offering them a new hedging tool, a further investment option and a level playing field with domestic investors tock index futures are a sign of the maturation of capital markets Stringent limits set out in the Rules, however, are indicative of the government's although some stringent rules are caution regarding the nascent financial derivatives market. As retail investors have attached OFlls will be allowed always regarded investments by QFlls as an indicator of sensible diversification to trade stock index futures for the a-share market, QFlls' participation in the stock index futures market could hedging, but not for speculative prove influential. With their index trading experience gained in the international purposes, in a similar manner markets, QFlls could help broaden the investor base of Chinas financial markets to their domestic counterparts QFlls are also prohibited from Regulatory change issuing financial derivative Chinas regulatory bodies(most notably the CSRC) are playing a critical role in the products in offshore markets with changing composition of the investor base and in allowing specific production index futures as an instrument nnovations. With so much pent-up demand for new financial products, when the are limited in the daily value of government and regulators act, the market can often respond extremely quickly tures contracts they can hold and can only open accounts with Prospects for a new Fund Law one bank for custodian services In order to improve market transparency, China is moving closer to revising the and no more than three futures brokerages for futures trading current law governing the fund management business by circulating a consultation paper within the industry. a new Fund Law may involve several amendments to the current legislation which was promulgated in 2003. This may include allowing fund managers to trade equities and derivatives for personal accounts, something whic currently prohibited in China The government continues to explore how deregulation can enhance the market without increasing the risk of insider trading The csrc has indicated that it may expand the supervision of fund managers and include on-site investigation of fund Other significant developments include proposed regulation of non-public funds by the CSRC, granting non-public funds access to the public retail fund market. By registering with the CSRC, non-public fund managers may offer public funds subject to approval. This may lead to further market competition with public fund managers due to the expertise and service non-public fund managers can offer, especially in wealth management business. 0 2011 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG international"), a Swiss entity. All rights reserved
The first and the only stock index future is based on the CSI 300 Index, which covers about one-sixth of all stocks listed in China and accounts for about 60 percent of market capitalisation. There are currently four active contracts for the front month, one month behind the front month, and then the next two months in the March, June, September, December cycle. The future is also subject to a +/- 10 percent price band based on the previous close. At the end of 2010, 46 million contracts had been traded, and average daily volumes had stablised at around 250,000 spot contracts (with approximately USD 38 billion notional equivalent). The index futures market has generated huge interest from retail investors. By the third day of trading, the traded value of stock index futures already exceeded the value of stocks traded on the SSE. Though the CSRC has imposed strict instructions for proper regulation of the market, it is clear that the market is highly influenced by speculation, which has heightened volatility and limited its ability to truly reflect the direction of the underlying stock market. Further developments are taking place towards a mature index futures market, and liquidity should continue to increase. QFIIs allowed to participate in stock index futures trading As part of the government’s efforts to further open up China’s financial markets, the recently unveiled “Rules on Index Futures Trading for Qualified Foreign Institutional Investors (QFIIs)” allow for QFIIs’ participation in the domestic stock index futures market by offering them a new hedging tool, a further investment option and a level playing field with domestic investors. Stringent limits set out in the Rules, however, are indicative of the government’s caution regarding the nascent financial derivatives market. As retail investors have always regarded investments by QFIIs as an indicator of sensible diversification in the A-Share market, QFIIs’ participation in the stock index futures market could prove influential. With their index trading experience gained in the international markets, QFIIs could help broaden the investor base of China’s financial markets. Regulatory changes China’s regulatory bodies (most notably the CSRC) are playing a critical role in the changing composition of the investor base and in allowing specific production innovations. With so much pent-up demand for new financial products, when the government and regulators act, the market can often respond extremely quickly. Prospects for a new Fund Law In order to improve market transparency, China is moving closer to revising the current law governing the fund management business by circulating a consultation paper within the industry. A new Fund Law may involve several amendments to the current legislation which was promulgated in 2003. This may include allowing fund managers to trade equities and derivatives for personal accounts, something which is currently prohibited in China. The government continues to explore how deregulation can enhance the market without increasing the risk of insider trading. The CSRC has indicated that it may expand the supervision of fund managers and include on-site investigation of fund managers. Other significant developments include proposed regulation of non-public funds by the CSRC, granting non-public funds access to the public retail fund market. By registering with the CSRC, non-public fund managers may offer public funds subject to approval. This may lead to further market competition with public fund managers due to the expertise and service non-public fund managers can offer, especially in wealth management business. KPMG comment Stock index futures are a sign of the maturation of capital markets although some stringent rules are attached. QFIIs will be allowed to trade stock index futures for hedging, but not for speculative purposes, in a similar manner to their domestic counterparts. QFIIs are also prohibited from issuing financial derivative products in offshore markets with index futures as an instrument, are limited in the daily value of futures contracts they can hold, and can only open accounts with one bank for custodian services and no more than three futures brokerages for futures trading. © 2011 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2011 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. China’s Capital Markets - The changing landscape | 11
12 Chinas Capital Markets-The changing landscape Investment rules relaxed for insurers In August 2010, a set of new investment guidelines was promulgated by the cirC, aiming to broaden the investment scope for the insurance industry in the country he asset-liability matching ability of the insu The new rules took effect on 31 August 2010 with key highlights including a minimum requirement of 5 percent of total assets for bank deposits, government bonds/securities and money market funds and a maximum holding of 20 percent for quities and equity funds (instead of mutual funds only as in previous regulations) Policy relaxations were also granted for investment in other asset classes such private equity, infrastructure and real estate. In general, the new guidelines are widely considered as a positive development for the insurers as more investment channels are now open The insurance industry had total assets of RMB 4. 9 trillion as at the end of 2010. which means a maximum of almost rmb 1 trillion can be allocated to equities. This equates to 4 percent of total stock market capitalisation at present. Offshore developments The deregulation of offshore RMB business since mid-2010 has led to fast-paced development of an offshore RMB market in Hong Kong The launch of the first RMB fund and RMB-denominated insurance policies granted foreign investors new investment channels to access rmB-denominated assets It also served as an example of further promotion and internationalisation of the Chinese currency in offshore markets While Hong Kong remains the leading centre for large Chinese initial public offerings, the continued growth of the shanghai Stock Exchange(SSE)in the st five years means that by the end of 2010, the total market capitalisations of Shanghai and Hong Kong were very evenly matched. With effect from December 2010, the HKEx has allowed Chinese companies to submit their accounts using Chinese accounting standards. While the HKEx has presented the move as a way to help reduce compliance costs for mainland companies and improve market efficiency the new PRC accounting standards, which were released on 1 January 2007, are already quite closely aligned to International Financial Reporting Standards (IFRS) Shanghai's plans for an International board will certainly be well received by foreign companies and local investors alike upon its formal introduction. In the meantime Chinese companies will also benefit from expanded listing choices. The first RMB- denominated share has just been listed on HKEx. Such dual/cross-listings should eventually help raise the overall quality of listed companies in both Shanghai and Hong Kong and effectively expand the breadth and depth of both markets Further capital inflow: Mini-QFIl The forthcoming Mini-QFll programme looks set to serve as an additional inward capital channel. As a variation on the original QFll scheme, Mini-QFll will allo qualified Hong Kong subsidiaries of both Chinese securities firms and fund management companies to channel rmb deposits in Hong Kong into the mainland financial markets via investment products. The programme will also be supervised by the CSrC and will distinguish itself from the original QFl in terms of currency and possibly investment scope. It will be subject to separate licence and quota approvals as indicated in Table 2 With a number of Chinese firms' Hong Kong subsidiaries actively preparing licence applications, market expectations point towards a high probability that the mini-QFIl ssets will be initially invested in fixed income products, with equity investment The market generally expects the initial size of the programme to be rmB 3 billion, which would equate to about 10 percent of the total QFll quota pledged. This 0 2011 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG international"), a Swiss entity. All rights reserved
Investment rules relaxed for insurers In August 2010, a set of new investment guidelines was promulgated by the CIRC, aiming to broaden the investment scope for the insurance industry in the country and help improve the asset-liability matching ability of the insurance companies. The new rules took effect on 31 August 2010 with key highlights including a minimum requirement of 5 percent of total assets for bank deposits, government bonds/securities and money market funds and a maximum holding of 20 percent for equities and equity funds (instead of mutual funds only as in previous regulations). Policy relaxations were also granted for investment in other asset classes such as private equity, infrastructure and real estate. In general, the new guidelines are widely considered as a positive development for the insurers as more investment channels are now open. The insurance industry had total assets of RMB 4.9 trillion as at the end of 2010, which means a maximum of almost RMB 1 trillion can be allocated to equities. This equates to 4 percent of total stock market capitalisation at present. Offshore developments The deregulation of offshore RMB business since mid-2010 has led to fast-paced development of an offshore RMB market in Hong Kong. The launch of the first RMB fund and RMB-denominated insurance policies granted foreign investors new investment channels to access RMB-denominated assets. It also served as an example of further promotion and internationalisation of the Chinese currency in offshore markets. While Hong Kong remains the leading centre for large Chinese initial public offerings, the continued growth of the Shanghai Stock Exchange (SSE) in the past five years means that by the end of 2010, the total market capitalisations of Shanghai and Hong Kong were very evenly matched. With effect from December 2010, the HKEx has allowed Chinese companies to submit their accounts using Chinese accounting standards. While the HKEx has presented the move as a way to help reduce compliance costs for mainland companies and improve market efficiency, the new PRC accounting standards, which were released on 1 January 2007, are already quite closely aligned to International Financial Reporting Standards (IFRS). Shanghai’s plans for an International Board will certainly be well received by foreign companies and local investors alike upon its formal introduction. In the meantime, Chinese companies will also benefit from expanded listing choices. The first RMBdenominated share has just been listed on HKEx. Such dual/cross-listings should eventually help raise the overall quality of listed companies in both Shanghai and Hong Kong and effectively expand the breadth and depth of both markets. Further capital inflow: Mini-QFII The forthcoming Mini-QFII programme looks set to serve as an additional inward capital channel. As a variation on the original QFII scheme, Mini-QFII will allow qualified Hong Kong subsidiaries of both Chinese securities firms and fund management companies to channel RMB deposits in Hong Kong into the mainland financial markets via investment products. The programme will also be supervised by the CSRC and will distinguish itself from the original QFII in terms of currency and possibly investment scope. It will be subject to separate licence and quota approvals as indicated in Table 2. With a number of Chinese firms’ Hong Kong subsidiaries actively preparing licence applications, market expectations point towards a high probability that the mini-QFII assets will be initially invested in fixed income products, with equity investment exposure being relaxed on a gradual basis. The market generally expects the initial size of the programme to be RMB 3 billion, which would equate to about 10 percent of the total QFII quota pledged. This © 2011 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2011 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 12 | China’s Capital Markets - The changing landscape