China's fast-emerging investment opportunities

As the Chinese Government steps up measures to internationalise the renminbi, it is creating opportunities for asset managers, willing to move early.

Mindful of China's huge economic potential, asset management firms of all types are eager to invest in this growing market. Gradually, the Chinese Government is making it easier for them to invest, while balancing this with a desire to retain control over its currency. Foreign investors that are quick to take advantage of emerging opportunities will gain first-mover advantage.

In spite of concerns about a possible slowing of economic growth, China still represents huge potential for investors. At a time when much of the global economy is stagnating, observers still view China optimistically. In the past 20 years, China has achieved a remarkable 20-fold increase in its GDP, and the International Monetary Fund has predicted that it will contribute to more than one-third of global growth by 2015.1

Vice Premier Li Keqiang made China's commitment to financial liberalisation clear when he visited Hong Kong in August 2011. In a speech outlining the Government's 12th Five-Year Plan (2011-2015), he announced 36 reforms. Notably, they included measures to help foreign direct investors by accelerating renminbi (RMB) exchange conversions, and an extension to the Qualified Foreign Institutional Investors (QFIIs) regime for investing in China securities.

While China's approach to liberalisation is cautious, the Vice Premier's speech confirmed the dedication to opening up the economy to foreign capital. For more forward-looking asset management firms, taking early advantage of the opportunities offered can earn considerable prestige, and can win the authorities' gratitude.

Growing RMB liquidity

As is natural in a country with foreign-exchange controls, RMB convertibility is at the core of the move towards financial liberalisation. Recently, partial liberalisation of RMB conversion has sparked the creation of a fast-expanding offshore RMB trading centre in Hong Kong. This enables asset managers to convert RMB-denominated profits and dividends back into their own currencies, while also leading to a proliferation of RMB hedging and investment products.

China's drive to internationalise the RMB started in July 2009, when it launched a pilot scheme in five Chinese cities to allow companies to settle import-export trades in RMB. A year later the Government extended the scheme across China, while also lifting restrictions on trade in the offshore RMB market, and allowing banks to manufacture and offer RMB products.

In the short time since then, RMB trading activity has mushroomed, with Hong Kong as its offshore centre. In just 12 months to the end of June 2011, RMB deposits in Hong Kong expanded more than fivefold, rising to over RMB550bn, up from RMB100bn at the end of July 2010. At the end of May 2011 , RMB deposits accounted for 18% of Hong Kong's foreign currency deposits and 9% of the total deposit base.2

This demonstrates that, in a bid to escalate the internationalisation of the RMB, the Chinese Government supports both Hong Kong as the leading offshore RMB centre and foreign investors' use of RMB for investing in the domestic market. Furthermore, to accommodate the expected surge in the use of RMB as the currency of choice for foreign investors, the Chinese Government has been very active in broadening RMB investment channels in order to make it easier for foreign investors to repatriate overseas RMB back to China.

Meanwhile, the number of QFIIs in China continues to increase. In September 2011, some 116 foreign groups had been granted permission to invest in the country's securities' markets3, with their investment quotas totalling more than US$20bn. The QFII scheme was launched eight years ago to allow foreign investors to gain greater access to China's domestic stocks without violating its exchange controls.

Steadily increasing opportunities

For private equity and venture capital firms, Vice Premier Li Keqiang's speech raised hopes by unveiling a new measure to ease foreign direct investment into China's businesses and assets. But, disappointingly, the subsequently issued notice giving more detail stated that private equity and venture capital firms would still have to apply to the Ministry of Commerce (MOC) for permission to make a local investment in RMB, rather than seeking permission at a local level.

Having to apply centrally to the MOC for permission on a case-by-case basis means that private equity and venture capital firms will have to wait longer for the necessary authorisation than other foreign direct investors. Among other things, the delay makes them vulnerable to foreign-exchange risk at a time when the RMB is appreciating against the dollar and other international currencies.

Even so, private equity and venture capital investing is getting easier. The earlier 2010 RMB reforms have significantly reduced the overall risk of making private equity and venture capital investments. Investors can now transfer RMB-denominated dividends or capital to banks in Hong Kong. The banks, in turn, can convert the RMB into any other currency. Furthermore, the time taken to get MOC permission to make an RMB investment in the first place is tending to shrink.

For mutual fund companies, too, there is gradual progress. The Vice Premier's speech brought news of an extension to the QFII scheme through a new "mini-QFII" scheme, which is officially called the RMB-QFII scheme. Hong Kong subsidiaries of mainland Chinese asset management or securities companies will probably be granted the first batch of these new licences. At the time of writing, it appears that about 10 licences will be granted, with a total quota of approximately RMB20bn (US$3.1bn). The Chinese government probably regards this as a pilot scheme, aiming to make it available to other participants in due course, although the relevant supervisory Chinese Government bodies and People's Bank of China are likely to want to limit the total funds flowing into China.

More broadly, gradual internationalisation of the RMB is leading to the creation of a wide range of investment and hedging products. The RMB (dim-sum) bond market is growing up fast — in 2010 some 16 issuers issued RMB36 billion-worth of bonds, while in the first seven months of 2011 alone, 43 issuers had issued bonds worth approximately RMB50bn.4 Exchange-traded hedging products include FX options and forward FX contracts. Additionally, investment banks are taking advantage of the growing liquidity of the offshore RMB market to offer synthetic hedging products to hedge funds investing in mainland China.

Navigating a way forward

For asset managers, the growing liquidity of Hong Kong's RMB market, and the proliferation of associated financial products, mean the currency-related risks of investing in China are falling. Every time the Chinese Government takes another step towards liberalisation of the RMB and its investment markets — taking care not to weaken foreign-exchange controls — financial market participants quickly seize the opportunities presented. While investing in China might still seem dauntingly bureaucratic to international investors, many participants are moving quickly to secure positions in this potentially vast market.

Taking early advantage of China's emerging investment opportunities requires knowledge and skilled navigation of the necessary permissions. But the Chinese Government's commitment to change is beyond question. Asset managers eager to gain an edge in China might find that spending the extra time and effort needed to access the market will bring worthwhile rewards.

1. Source: The Hong Kong Monetary Authority.
2. Source: The Hong Kong Monetary Authority.
3. Source: China Securities Regulatory Commission.
4. Source: The Hong Kong Monetary Authority.



Florence Yip

PwC Hong Kong
+852 2289 1833

If you have any questions, please contact the author or:

Cathy Kai Jiang

+852 2289 5659

or your local PwC representative.