Developing China's capital markets
(Kevan Watts)
2005-11-25 06:17

China is undergoing an extraordinary period in its economic development as it moves from a centrally planned economy to the vibrant marketplace we see today. Much of the reform has been done at a measured pace.

Two decades of economic growth and the consequent increased financial requirements of domestic companies have resulted in the need for more international participation as China moves to create open and transparent capital markets. Now is the time for China to allow a more dynamic rate of change.

Chinese regulators in the past few years have made encouraging progress in their efforts to open up the market and make China more competitive by steadily increasing the quotas for Qualified Foreign Institutional Investors (QFII); allowing more foreign participation in several financial services sectors; moving towards a more flexible currency policy; introducing stock market reforms; and reorganizing domestic financial institutions.

The China Securities Regulatory Commission (CSRC) is in the process of reforming non-tradable shares and this is a priority that is essential to the further development and improvement of the market. The regulator also recently proposed allowing companies to offer stock incentives to bolster corporate profitability and governance.

These are all changes in the right direction, but more needs to be done and needs to be done quickly. It is of the utmost importance for China to develop a larger domestic institutional investor base in order to create deeper, more mature equity and fixed-income markets. At the same time, to fund the expansion of domestic industries and maintain a healthy pace of economic growth, China needs to further open up its capital markets to international companies. This entails allowing foreign companies to take a controlling stake in domestic financial institutions and gain greater access to the domestic equity and fixed-income markets.

Take Merrill Lynch as an example. Merrill Lynch is one of the largest financial institutions globally with offices in 36 countries and territories, operating businesses spanning from investment banking and capital markets to fund management and private banking. In most developed countries Merrill Lynch is able to have a fully integrated financial services platform across its many businesses. In China, Merrill Lynch is currently only allowed to invest directly in renminbi-denominated shares and financial instruments through the QFII system. While our quota has recently been raised to US$300 million, it is still small compared to the US$420 billion capitalization of the market.

Merrill Lynch also operates an asset management joint venture with the Bank of China Group, BOC International Investment Managers. This is a long-term commitment and the bank has invested a great deal of resources into the venture, in which it currently holds a 16.5 percent stake.

Earlier in 2005, Merrill Lynch signed a memorandum of understanding with Anhui-based Huaan Securities to establish a securities joint venture. Merrill Lynch plans to take a 33 percent stake in the company.

While Merrill Lynch is eager to build these businesses so it can facilitate the growing demands of China's companies and individuals, the New York-based bank needs more latitude to do so. And Merrill Lynch is not alone most international banks are in a similar situation. It is difficult for global financial institutions to optimally leverage their capabilities in China unless they are allowed to own majority stakes.

If Chinese authorities were prepared to allow foreign investment banks to enter the market at a faster pace, more progress could be made more rapidly in the securities industry. One main reason this hasn't happened so far is the concern that foreign firms will dominate China's domestic securities industry. This isn't a likely scenario given China's particular culture, knowledge and language and it should not be the grounds for holding back market reform.

With greater freedom and access, international companies can bring much needed funding and expertise to their Chinese counterparts and the overall capital markets. It will take time for China to build up the infrastructure of its capital markets and this process represents an opportunity to reorganize the financial industry, inject new blood into the stagnant equity market and make China even more competitive as an economic powerhouse.

 
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