Opinion: China Will Benefit From Easing Limits on Cross-Border Investments
Kai Keller is leading projects on the future of China's financial system with a focus on innovation, technology and economic growth at the World Economic Forum.
“The world is satisfied with words, few care to dive beneath the surface,” French mathematician Blaise Pascal observed some 400 years ago. His insight certainly still rings true today and fittingly describes China’s complex relationship with the rest of the world. As they tend to – or at least, should – financial markets have been leading the development of that relationship and there certainly hasn’t been a more exciting time in the integration process of China’s financial system into the global one.
Contrary to plenty of decoupling talk, much progress has been made to deepen that integration and the accelerated opening of markets to foreign players has gone a long way in facilitating transformation. And yet, substantially more work lies ahead, and this is certainly not the time to take the foot off the accelerator.
The past couple of weeks have produced enough concerning headlines to suggest the United States and China are already deeply engaged in financial warfare. A bill that could force major Chinese companies to delist their shares from U.S. stock exchanges passed the U.S. Senate in May. Around the same time the main U.S. federal government retirement fund halted a plan to track an index that includes shares of Chinese companies, a move that would have mirrored the inclusion of China A-shares into the MSCI index, one of the most popular global equity benchmarks.
Add to that the realistic threat of a further politicization of exchange rate policymaking and what is supposed to be a year of market opening and integration starts to look more like a year of alarming disconnect.
Even worse, these dynamics are unfolding at the worst possible time. The global economy is already grappling with a severe economic crisis caused by a still accelerating global health emergency and the uncertainty of an immensely consequential U.S. presidential election in November.
If we don’t want headlines to turn into a self-fulfilling prophecy, we must continue to distinguish noise from proven reality: Global financial integration and interdependence leads to win-win outcomes as it enhances prosperity and maintains international peace.
Case in point? The evolution of Asset Management in China. As the World Economic Forum highlights in an Insight Paper published today, China’s asset management industry is currently undergoing a substantial transformation process that, if shaped effectively, will bring much needed stability to domestic capital markets, allow individuals to access sophisticated means to save for retirement, their children’s’ education or unexpected expenditures, and in the process provides the domestic economy with much needed, professionally-managed capital to rebuild and expand post Covid-19.
Achieving these important policy goals requires the development of a mature industry to effectively allocate Chinese savings and pension money. The experience and portfolio and risk management capabilities of foreign firms can help Chinese players accelerate this maturation process and thus the whole asset management ecosystem will benefit from the removal of policies limiting the activity of foreign firms. The 200 trillion yuan, currently held in bank deposits and to be unlocked over time, will certainly present a tide sufficient to lift all boats – domestic or foreign.
Chinese and foreign asset management firms will co-exist, often partner and prosper. The more important challenge is whether Chinese capital markets are deep enough, or can grow fast enough, to absorb the floods of pension and savings money that over time will want to find their way into stock and bond markets. The answer at current market capitalizations is a clear no. Beyond purely practical limitations, the inability of Chinese money to invest overseas also carries important implications for the ability of investors to diversify and realize compelling, sustainable returns.
An important, well recognized piece of investment advice is to not put all ones’ eggs in one basket. Geographic diversification plays an important role in minimizing risk and overcoming home-country bias. Geographic diversification becomes even more important in a post-Covid-19 world as the current loose monetary policy environment – a legacy of the Global Financial Crisis – is here to stay for a very long time.
The additional accommodations made by central banks to cushion the economic shock of Covid-19 related lockdowns have led investors further into unchartered territory and asset price discovery recently has become more of a guessing game than a sophisticated exercise informed by tested principles. As the implications of long-lasting zero or negative interest rates and massive asset purchases by central banks have yet to crystalize, excess returns become increasingly difficult realize and the concept of safe assets no longer applies, investors must diversify in order to ensure they can meet future liabilities and aspirations. This includes diversifying out of cash and across geographies.
Zhou Xiaochuan has alluded to the considerations that will inform the expansion of investment mandates beyond domestic markets in the context of pension reform and everybody understands that the status quo will not change overnight. And yet all stakeholders must begin exploring how to redesign the global financial in a manner that reflects a range of interests and allows for Chinese money to flow more freely across borders.
One promising approach is to utilize the Greater Bay Area (GBA) as a sandbox for controlled experiments. The newly launched pilot program to allow cross-border investment in wealth management products (WMPs) by GBA residents is one good step to overcome current limitations.
The program builds on the success of the stock and bond connect programs between Hong Kong and Shenzhen and Shanghai and the continued appetite of policymakers to try and test new approaches is encouraging. Ultimately, these and similar programs may lead to more holistic approaches of the scale needed to effectively shape the ongoing transition out of savings and housing investments into broadly diversified investment portfolios.
The post-Covid-19 economic realities and positive feedback loops of the current experimentation will ensure progress continues to be made despite any geopolitical noise. Again, Blaise Pascal, knows why: “We are generally better persuaded by the reasons we discover ourselves than by those given to us by others.”
The views and opinions expressed in this opinion section are those of the authors and do not necessarily reflect the editorial positions of Caixin Media.
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