China's growing cluster of currency regulations and the development of regulations and financial markets and services related to currency management will be among the most important regulatory and market developments for Greater China in the coming years, according to Deloitte's latest white paper, presented at the Asian Financial Forum 2011 in Hong Kong.
Over the past few years, especially after the financial crisis, important steps have been taken to project the Renminbi (RMB) into an international role. In the process, three interrelated trends have emerged as both challenges and solutions to the overall future development of the Chinese Mainland's chains of capital. First is the surge in domestic equity investment funds, providing capital for pre-IPO investment in Mainland companies and likely seeking exits through A-share IPOs.
The paper reports the pace of RMB fund growth in the first half of 2010 was approximately three times that of 2009; by mid-2010, 23 foreign managed RMB fund applications were in various stages of processing and hundreds - possibly thousands - of purely domestic investment entities, generically called Equity Investment Funds (EIFs) were competing in the market place. In addition, according to Zero2IPO, 32 new private equity (PE) funds were set up during the first half of 2010, 26 of which were RMB denominated, with US$4.5 billion worth of capital raised.
Deloitte believes that the number of RMB funds will continue to grow at a fast pace. According to the PE survey from Deloitte, 96 percent of all foreign fund respondents reported considering setting up an RMB fund for equity investment in China a strategic priority.
The paper adds that exit challenges for investors will follow this surge of RMB funds. Usually, funds making investment in Mainland companies from RMB sources will want to recover RMB from their IPOs. However, there are market concerns about the capacity of A-share markets to support the IPOs implied by the surge in RMB funds. That is the second trend in the developments on the Chinese Mainland's chains of capital. Chris Lu, Deloitte China CEO, explains that market concerns about the capacity of the A-share market have been aggravated by the relatively volatile and somewhat weak performance of the A-share market in 2010. "While proven to be a popular option for PE and venture capital funds with RMB sources to exit, the ChiNext has rejected about 20 percent of applicants, leaving virtually no other on-shore exit available for RMB investment funds," says Lu.
The accumulation of RMB held outside the Chinese Mainland, encouraged and enabled by the policy to accelerate an international role for RMB, was cited as the third emerging trend. This RMB capital, largely held in low-yielding bank deposits, is seeking access to more investment instruments and better returns than presently available. In Hong Kong, RMB has already amassed at record paces. According to the Hong Kong Monetary Authority, RMB deposits soared 45.4 percent in the month of October 2010, resulting in a total of RMB 217.1 billion.
"However, options for getting better returns on RMB in Hong Kong are only increasing slowly. Regarded as an investment alterative, the RMB bond market had its first offering in early 2007, but it also exemplifies the low return problem. Accordingly, the Hong Kong bond market is consistently lower in interest rates than the Chinese Mainland market, by an average of 57 basis points," says Eric Tong, Leader of Global Financial Services Industry Group, Southern Region, Deloitte China.
Ken DeWoskin, Director, Deloitte China Research & Insight Centre, says these trends generate dynamic pressure that is reshaping the RMB landscape. First, there is pressure for RMB to recycle back into the Chinese Mainland market because of poor return outside the Chinese Mainland. Second, there is a need to support the rising number of RMB IPOs, which require more capacity on the part of both regulators and investors.
"We are seeing the early stages of two distinct paths to solutions - several reform initiatives that will open the Chinese Mainland market to outside investors and also establish RMB investment options outside the Chinese Mainland. RMB capital accounts and cross-border capital transactions have been controlled since the beginning of reform, the Chinese government will give careful consideration, with initiatives to be piloted in a gradual way to prevent any unanticipated shocks," notes DeWoskin.
MORE ARTICLES ON YUAN