The Chinese character for finance, 才华 (Cái), is rich in meaning. It consists of two words: On the left is the character for sea shell, which in the ancient past was a medium of exchange used in trading. The character on the right means talent or wisdom. Combined, they mean the accumulation of wealth using talent.

With this slight diversion in linguistics as an introduction, I would like to outline the types of investment securities available in China to overseas investors.

China has risen to become the second-largest economy in the world in 2010. The International Monetary Fund (IMF) has forecast that China’s economic growth will continue, with the Chinese GDP projected to reach US$11.78 trillion in 2016, doubling from the 2010 GDP level of $5.88 trillion.¹ In order to implement this substantial scale of development, China is dependent to a certain extent on the expandability of its current infrastructure and resources. Some of the research topics that investment analysts should explore include: (1) how China’s growing need for investment products is likely to be met, and (2) what the capital market activities required to support its new and increasing economic activities will be.

INVESTMENTS IN CHINA

Onshore investments

The China Securities Regulatory Commission is responsible for the regulation and supervision of the securities and futures markets. In China, there are two stock exchanges (Shanghai Stock Exchange and Shenzhen Stock Exchange) and four futures exchanges (Shanghai Futures Exchange, Zhengzhou Commodity Futures Exchange, Dailian Commodity Futures Exchange and China Financial Futures Exchange).² Futures contracts traded include financial futures contracts (equity index futures, Treasury bond futures) and commodity futures contracts (agricultural and industrial products).

Table 1 summarizes the most recent official statistics available on the size of the securities market in China. Appendix Table A shows the comparative market capitalization of listings on the world’s largest stock exchanges.³

Through the government approved Qualified Foreign Institutional Investor (QFII) program, foreign institutional investors are allowed to make direct investments in A-shares listed on the Chinese Exchanges. In December 2010, there were 106 approved institutions with holdings amounting to Rmb297 billion (about US$45 billion). Approved institutional investors through the pilot program for Renminbi QFII (RQFII) were allowed to conduct currency conversions of their investments in the Chinese securities market. At the end of 2011, there were 21 institutional investors under the RQFII program, for a total maximum investment amount of Rmb20 billion⁴ (about US$3.2 billion).

To allow foreign or overseas-listed Chinese companies greater flexibility to raise capital in Renminbi (Rmb), the Shanghai Stock Exchange announced in 2011 a plan to prepare for launching a pilot program on the International Board.⁵ The investments will be made available to retail and institutional investors in China.

Investment instruments

(I) Chinese equity investments on exchanges:

A-shares: common shares issued by Chinese companies, denominated in Renminbi. Trading is for local retail and institutional investors only.

B-shares: common shares issued by Chinese companies, denominated in Renminbi but traded in U.S. dollars (on the Shanghai Exchange) or in HK dollars (on the Shenzhen Exchange). These investments are for local investors only, as well. They allow domestic companies to raise foreign currencies. Appendix Table B summarizes the industry sector weighting of the Shanghai Stock Exchange Index.⁶

(II) Fixed income investments:

Outstanding bond issues amounted to US$3 trillion at December 2010 (Table 1). These comprised central bank bills; commercial paper; finance, enterprise and corporate bonds. The government has indicated its strong commitment to supporting development of the corporate bond sector as a diversified funding source from traditional bank loans.

OFFSHORE INVESTMENTS

Overseas equity investment

For foreign investors, there are opportunities to invest in Chinese companies through H-shares. These are shares issued by companies incorporated in China with listings primarily on the Hong Kong Stock Exchange. H-share listings are also made in Singapore, London and New York. As of year-end 2010², there were 166 H-shares and issuers with total capital raised amounting to US$163 billion. In January 2012⁷, the Hong Kong Stock Exchange Hang Seng China Enterprise Index (H-share Index), which measures the return on the top 40 H-share issues traded in HK dollars, had a weighting for the financial sector of 57 percent of the index, followed by the energy sector at 25 percent. Table 2a outlines the top 5 constituents.

Foreign investors can also invest in so-called Red Chip shares, i.e., shares in mainland China companies incorporated outside mainland China and listed in Hong Kong. The actual business of these companies is based in mainland China and controlled directly or indirectly by central, provincial, or municipal governments in China. The return of the top-25 Red Chip issues traded in Hong Kong is measured by the Hong Kong Stock Exchange Hang Seng China-Affiliated Corporations Index (Red Chips index).⁸ Key industry group weightings include properties & construction (20 percent); telecommunications (18 percent), energy (16 percent) and conglomerates (15 percent). Table 2b shows the top five index constituents.

Overseas bond investment

Foreign investors can participate in offshore Rmb bond issues directly in Rmb in the Hong Kong market. These issues are generally referred to as “dim-sum” bonds. In 2011, there were 289 dim-sum bond issues totalling Rmb151 billion (about US$23 billion) with almost a four-fold increase from the Rmb36 billion issue in 2010.⁹

FUTURE DEVELOPMENTS

To scale up to meet its economic growth targets, China is expected to address a number of important topics.

It is reported² that individual investor securities accounts represent more than 99 percent of total securities accounts in the country. In 2010, holdings of individual investors accounted for 30 percent of total free-float market capitalization of the equities market. It is important therefore for the government to emphasize investor protection and education as product distributions are broadened over time. The World Bank Development Research Centre¹⁰ has proposed a deposit insurance scheme to be set up for small depositors.

To achieve a desirable standardization and streamlining of financial accounting and reporting, it is important for China to continue to broaden application of international accounting principles (IFRS).¹¹ This will provide strategic benefits to issuers in the form of better access to overseas capital markets for funding of investment and greater flexibility to explore overseas business opportunities.

To further expand and broaden primary and secondary fixed income markets, there is a need for more market statistics, independent rating assessments, and other due diligence information. Statistical information is particularly important for product pricing, asset valuation, and risk management functions.

The government’s commitment to further expand economic activity from coastal cities may require additional infrastructure to allow broad distribution of financial services to rural and remote areas. There may also be a need to consider specific programs for rural banking and for the currently underserved business and consumer sectors.

References:
1. “China 2030: Building a Modern, Harmonious, and Creative High Income Society,” February 27, 2012, prepared by The World Bank and The Development Research Center of China’s State Council.
2. IMF Sustainability Report – study international currency framework implicit limitations & promote diversification of central bank reserve currency

Footnotes:
¹ IMF World Economic Statistics.
² China Securities Regulatory Commission Annual Reports, 2007, 2008, and 2009.
³ The World Federation Exchanges statistics, www.world-exchanges.org.
⁴ China Daily, March 3, 2012.
⁵ China Daily, April 23, 2011.
⁶ Bloomberg data, March 9, 2012.
⁷ Hong Kong Stock Exchange Hang Seng China Enterprise Index Factsheet, January 2012. The Index is
free-float adjusted with 10 percent capped maximum size per issue.
⁸ Hang Seng China Affiliated Corporations Index Factsheet, January 2012. “Red chips” refers to a company with minimum 30 percent holdings held by the Chinese entities and at least 50 percent of revenue or profit or assets derived from China, www.hsi.com.hk.
⁹ Bloomberg data, <LEAG636>.
¹⁰ “China 2030: building a modern, harmonious and creative high income society,” February 27, 2012.
¹¹ “An overview of new PRC GAAP: differences between old and new PRC GAAP and its convergence with IFRS,” KPMG, September 2011, www.kpmg.com/cn.