A look at the paradox and opportunities in China's capital markets

Updated: 2013-06-15 07:45

By David Wilkinson(China Daily)

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With the global economy still facing a period of uncertainty and lackluster growth, multinational companies are scouring the globe looking for growth economies with above-average return on investment. China is the second largest economy in the world behind only the United States and, with over 1.3 billion people, has the largest population of any country globally.

The boom of the Chinese economy and its emergence as a global powerhouse is somewhat of a paradox given that China, in many ways, remains an enigmatic force with a fairly unique set of economic drivers. It's clear for all to see that the Chinese economy is growing strongly, but what is more impressive is when you look at it in the context of other world economies such as the United States. With a projected 8 percent growth rate in 2013, which is about 6 percent above the US and even higher when compared to Europe, China represents one of the biggest economic opportunities today, and most likely of the future. To many companies around the world, China is inevitably one of the economies that cannot be ignored. As China's economy has expanded, the financial industry has continued to grow both in terms of size and importance. The industry however is tightly regulated especially with respect to international financial institutions market participation options. Having said this, as part of China's continued integration into the global economy and its commitments to the World Trade Organization, the industry as a whole is opening up.

An ever-evolving force, reform in China's financial services industry is also playing a critical role in opening up the market. Currently, financial futures, margin trading and several other products and reforms are changing the industry. From a political and regulatory standpoint, these changes are revealing unique opportunities for capital markets firms - both in terms of trading and providing services to the industry - though they may only be short lived.

Despite its economic might on the world stage and reform in progress, China remains a developing country where half of its population is rural and agriculture still accounts for nearly half of rural employment.

Unlike other markets, where a large percentage of the investors are institutional, retail investment activity accounts for about 40 percent of total turnover in Shanghai as compared to 30 percent in Hong Kong or even 20 percent in New York.

Whilst the domestic markets are developing quickly and investment options are increasing, the range and number of investment options in China are still relatively limited; this situation is one of the key drivers in the increase in asset prices leading to the asset bubble that many believe the Chinese economy is facing as too much money chases too few investment options.

Another challenge in China is that the renminbi is a capital-controlled currency. What this means is that any conversion of the renminbi to another currency needs to happen through official channels and be approved by China's State Administration of Foreign Exchange. Corporations and individuals can convert a certain limited amount of currency every year, but this amount is typically very limited and not very useful if the person or company intends to invest significant amounts outside of China.

Often, Chinese mainland companies will either belong to, or have a Hong Kong entity. If trade or services transactions are then completed in US dollars, the company can decide to keep that money offshore and that they can use for non-renminbi transactions or investments (typically US dollar). If they have been paid or received renminbi however, and unless they use grey-market channels, domestic companies could invest very little of said monies abroad.

Similarly, in addition to domestic investors looking for alternatives to the local markets and investment vehicles, foreign investors, seeing the growth of the domestic markets, have been increasingly looking for ways to invest in, and take advantage of, the domestic Chinese market.

Moving into China's capital markets as an institutional or individual investor, broker, fund manager, technology provider or any company can be daunting amidst so many variables. There are numerous regulations and policies that need to be followed for any segment of the industry and often the entrenched domestic competition are hard to displace. For companies coming into the Chinese market it is a move that requires a great deal of research and insight into the machinations of the economy - how it operates - and a keen eye for the paradoxical.

According to financial consulting firm KapronAsia, the companies that have successfully navigated the China paradox share the following attributes:

Patience: The pursuit of Chinese traction is a long-term investment. This is not a get-rich-quick opportunity but a seasoned approach. Chinese companies and their leaders demand commitment to the market. It may take years to develop a business in China; patience is key as it takes commitment to the cause and developing relationships to make that happen.

Realism: You may have a great service or product but competition is rife. Stop thinking in terms of - 'imagine getting just 1 percent of the market'. The market is flooding with domestic and international competition and new firms are unlikely to gain a significant amount of market share easily.

Pragmatism: A pragmatic approach is essential. Drop the idea that what was tried and true in the Western markets will translate effectively in the China market. A thorough understanding of the market is required first, followed by the development of a very clear and cohesive strategy to entry.

Partnership building: Aligning with local companies is critical. Entry to China is a collaborative endeavor. From practical and administrative matters to gaining valuable insights, partnering is essential. Working with partners to truly understand the market can help you avoid the same mistakes others have made in the past.

China is a big market and one that firms cannot ignore. As the country grows in terms of economic and political influence, it will, and indeed has already, had a large effect on countries, markets and economies around the world.

Needless to say, reform in China's financial services industry and the country as a whole is far from over and will likely continue for many more years to come.

The author is a senior director of financial services at Equinix APAC.

(China Daily 06/15/2013 page4)