Rapid Growth of Chinese Investment Companies Is Building Risks, Says Fitch

Chinese investment companies (ICs) have grown rapidly over the last five years due to loose monetary policy and government support for investment that diversifies the economy and helps local companies to expand overseas, according to Fitch Ratings.

Strong growth is likely to be maintained over the long term, notwithstanding constraints that recent restrictions on capital outflows may have created.

However, rapid growth and increasing operational complexity might not have been matched by investment in risk management, and the solid performance of most ICs is yet to be tested through a full economic cycle.

The assets of Chinese ICs grew by a compound annual growth rate (CAGR) of 67% in the five years to end-2016, which was fast even by the standards of China's rapidly growing 'shadow banking' sector.

IC assets had reached an estimated CNY10.6 trillion (US$1.5 trillion) at end-2016, which was equivalent to 7% of Chinese bank assets or around 13% of GDP.

Fitch expects assets to rise by more than 25% per year over the next five years.

Increasingly visible on the international stage

Chinese ICs have become increasingly visible on the international stage, reflecting the importance of overseas expansion in their overall strategy.

Fitch estimates that overseas investments account for around 30%-40% of their total assets.

Many ICs have reached a scale where foreign acquisitions have become necessary for portfolio diversification, but the strategy has also been in line with the government's long-term "going out" policy, which has pushed companies to invest and operate abroad.

IC strategies are often aligned with the government's economic policies, supporting, for example, the One Belt, One Road initiative and economic rebalancing toward tertiary industries. Some state-owned ICs prioritize government policies over profit.

Short-term headwind to overseas expansion

The government's recent efforts to contain capital outflows, which include greater scrutiny of outward FDI, could act as a short-term headwind to the overseas expansion.

However, ICs generally keep much of their foreign-currency liquidity offshore and have expanded access to offshore capital markets, which should support foreign acquisitions without adding to capital outflows. Moreover, their outward direct investments tend to be of a long-term strategic nature that the government is likely to favor over investments in real estate or prestige assets, such as sports clubs, for example.

Chinese ICs have gained a competitive edge in making overseas acquisitions, with shareholders of targeted businesses often attracted to the opportunities offered by Chinese ICs' strategic portfolios and access to the Chinese market. For example, Fosun's focus on the Chinese middle class meant it was able to offer potential synergies and cross-selling opportunities to existing shareholders when it made investments in Club Med and Cirque du Soleil.

Most ICs have so far been able to meet performance targets, but Fitch believes that is mainly a reflection of favorable market conditions. Their strategies and risk controls have not been tested by significant market volatility or an economic downturn.

Moreover, risk-reporting tools and frameworks are less sophisticated than those of developed market peers, and are not institutionalized, with founders able to influence risk decisions.

One vulnerability is a reliance on divestment proceeds and bank loans to meet cash outflows, which creates a risk that ICs could be pushed into fire-sales in the event of liquidity stress.

The state-owned ICs are in a stronger position than individually owned ICs in this respect, as they have better banking relationships and lower leverage.

 

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