Business Financing and Capital Market Reforms

PECC-SINCPEC International Conference Competitiveness Enhancement: Business Financing and Capital Market Reforms in China STUART H. LECKIE, O.B.E., J.P., F.I.A., F.S.A. CHAIRMAN, STIRLING FINANCE LIMITED Co-author with RITA XIAO CONSULTANT, STIRLING FINANCE LIMITED 26 April 2012 1

Contents Capital Markets Financing i Channels Investor Landscape in China Institutional Investors Investment Fund Companies Insurance Companies Pension Funds Sovereign Wealth Funds Trust Companies and PE Firms Capital Market Reforms Note: the exchange rate used for the presentation is RMB6.30 = USD1, as at 31 December 2011, 2

Capital Markets - Equities Combined market capitalisation of Shanghai, Shenzhen and Hong Kong Exchanges together (USD5,670 billion) far surpassed that of Tokyo (USD3,325 billion) Launch of ChiNext China s NASDAQ Margin trading, short selling and index futures started Volatility remains high 2500 Market Capitalisation of Stock Exchanges (as at 31 December 2011, in USD billion) 2,357 2,258258 2000 1500 1000 1,055 500 0 SSE SZSE HKEx Source: Stirling Finance research, WFE 3

Capital Markets - Bond Recent decline in total issuance due to sharp decrease in central bank bills Unbalanced bond issuers: central bank bills, treasury bonds and policy bank bonds still account for 72% of the total issue, although this is down from 93% in 2007 corporate bonds - the market is dominated by state-owned entities High total issuance, but low liquidity, thus no market-oriented pricing mechanism Bond Issuance and Structure (2011) 10 9 8 7 6 5 4 3 2 1 0 9.51 60.0% 8.65 50.0% 7.98 7.06 40.0% 6.96 30.0% 5.71 20.0% 423 4.23 10.0% 0% 0.0% 2.73-10.0% -20.0% -30.0% -40.0% 0% 2004 2005 2006 2007 2008 2009 2010 2011 Total Issuance (RMB trillion) Annual Increase 19.43% 5.05% 3.57% 22.97% Central Bank Bill Government Bond Commercial Bank Bonds 20.30% 28.68% Policy Bank Bond Enterprise Bond Others Source: Annual Review of China s Bond Market, by China Government Securities Depository Trust & Clearing Co., Ltd. 4

Financing Channels Capital Markets: all about efficient asset allocation, and enhancing competitiveness Bank loans still dominate business financing for both SOEs and SMEs, with RMB110 trillion banking assets, more than 90% of all financial assets in China IPO is a common way to enhance competitiveness: Access to new funding; Build market awareness; Bring in large stakeholders, usually institutional investors; Eliminate agency problem; Broaden governance structure. Bond market: dominated by large companies Venture Capital (VC) & Private Equity (PE): now expanding in China, but usually very long-term investments involved Private lending on the rise: shadow banking system creating public attention, i.e. Wenzhou problem of run-away CEOs 5

Investor Landscape in China >80% trading volume comes from retail investors speculative activities But evolving towards a more even mix of investor classes Institutional investors progressively taking over from retail investors as the major force Assets continue to expand More interaction among institutional investors 8.0 7.0 6.0 5.0 4.0 30 3.0 2.0 1.0 0.0 22 2.2 Institutional Investors in China (RMB trillion) 6.0 1.9 70 7.0 Investment Funds Insurance Funds Pension Funds Sovereign Wealth Funds Source: CSRC, CIRC, MoHRSS, CBRC, SAFE, Stirling Finance Research * Pension Funds here represents accumulated balances in the State Urban Pension System. 4.8 Trust Funds 0.1 QFII 6

Investment Funds Companies Commenced in 1998, fast expansion until 2007, but shrank during last 5 years 69 Fund Management Companies (FMCs) authorized by the CSRC, with 914 registered investments funds in total as at 31 December 2011 Comparatively high openness to global players: 39 JVs out of 69 FMCs in total Active in both stock and bond markets, but do not always act as rational institutional investor. AUM of Fund Industry (RMB bn) FMCs and Fund Industry AUM of China 1997.5 1998.5 1999.5 2000.5 2001.5 2002.5 2003.5 2004.5 2005.5 2006.5 2007.5 2008.5 2009.5 2010.5 2011.5 3,500 3,276 80 3,000 70 2,676 2,519 60 2,500 2,192 2,000 1,939 50 40 1,500 30 1,000 856 20 471 500 325 57 85 81 119 170 10 11 0 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: China Galaxy Securities Research 7

Insurance Companies Rapid expansion: from RMB260 billion assets in 1999 to RMB6 trillion in 2011 Relatively low openness: foreign insurers still face regulatory barriers in geographic expansion and some important business lines, thus only 4% market share for foreign life insurers altogether, and only 1% market share for all foreign non-life insurers. Facing strict regulations on insurance investments Currently more than 50% insurance assets put into bonds Less than 2% holding of stock market capitalisation by insurers Not generally active in trading, but focus on long-term strategic investments. Total Assets of Insurance Industry (RMB billion) and Annual Growth 7,000 6,000 41% 47% 36% 40% 5,000 4,000 30% 30% 30% 28% 24% 3,000 2,000 22% 19% 15% 1,000 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: CIRC 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 8

Pension Funds Pension Assets: Cumulative balances in state urban pension system rose to RMB1.9 trillion in 2011, largely derived from individual accounts, with exponential growth in the last 2 decades Investment Scope: State pension assets are limited to bank deposits and government bonds, with only 2 percent p.a. returns in the past 10 years; National Social Security Fund will now manage RMB100 bn of Guangdong Province s individual account pension assets 2,000 Growth in State Urban Pension Total Assets (RMB bn) 1,500 1,000 500 0 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: Annual Reports of Ministry of Human Resources and Social Security 9

Sovereign Wealth Funds Top 10 SWFs account for almost 80 percent of the total assets of all SWFs China has 4 out of top 10 in the world (if we count HKMA) Ten Very Large Funds in the World (updated in December 2011) Country Fund Name Assets Inception Source of Funds (USD, billion) UAE - Abu Dhabi Abu Dhabi Investment Authority 627 1976 Commodities China SAFE Investment Company 568 1997 Non- commodities Norway Government Pension Fund Global 560 1990 Commodities Saudi Arabia Saudi Arabia Monetary Agency 473 N/A Commodities China China Investment Corporation 410 2007 Non- commodities Kuwait Kuwait Investment Authority 296 1953 Commodities China Hong Kong Hong Kong Monetary Authority Investment Portfolio 293 1993 Non- commodities Singapore Government Investment Corporation 248 1981 Non- commodities Singapore Temasek Holdings 157 1974 Non- commodities China National Social Security Fund 138 2000 Non- commodities Source: Sovereign Wealth Fund Institute; Stirling Finance Research 10

Sovereign Wealth Funds - NSSF Established in 2000 as pension fund of last resort, but acting like SWF USD138 billion assets: 58% direct investments and remaining 42% by appointed third parties: domestic FMCs and global managers including AllianceBernstein, BlackRock, Schroders, etc. Current asset allocation: 51% into fixed income, 32% in stocks, 16% in industrial investments and 0.6% in cash and cash equivalent NSSF international allocation: currently at 7%, with upper limit at 20% Very long-term institutional investor in the capital markets, and every move is watched closely by the market 160 140 120 100 80 60 40 20 0 138 130 114 82 60 36 10 15 16 21 26 2 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 0.5 0.4 0.3 0.2 0.1 0-0.1 Source: NSSF; Stirling Finance research Total Assets Annual Return on Investments 11

Sovereign Wealth Funds - CIC CIC was established in September 2007 Asset size increased from initial USD200bn to USD410bn as at 31 December 2010 59% of assets allocated through external appointments Domestic direct investments USD67bn to acquire Central Huijin Major shareholder of largest banks in China International direct investments Morgan Stanley 6.8 GDF Suez Blackstone Largest Overseas Investments of CIC (in USD billion) PT Bumi Resources AES Corp 1.6 Teck Resources Russia-China Investment Fund Noble Group Chesapeake JSC Kazmunaigas Exploration Source: Financial Times; Stirling Finance Research. GCL-Poly 0.7 1.0 0.9 09 0.9 0.9 1.5 1.9 3.0 4.2 0 1 2 3 4 5 6 7 8 12

Sovereign Wealth Funds - SAFE China s FX reserves as of 31 December 2011: USD3.18 trillion Hong Kong subsidiary ( SAFE Investment Company Limited ) established in June 1997, with estimate assets of USD568bn as at 31 December 2011 Not active investor in domestic capital markets Quietly built up stakes in over 50 European companies, Australian banks and PE funds SAFE Overseas Investments e ts Reported in Financial a Media International Classification Board Cost (in USD Country Company Subsector Million) Oil & Gas UK BP Global 2,000.0 Oil & Gas UK Royal Dutch Shell Plc 1,166.5 Mining UK Rio Tinto Plc 550.9 Mining UK BHP Billiton Plc 371.7 Food & Drug Retailers UK Tesco Plc 444.8 Banks UK Barclays Plc 345.4 Banks UK Royal Bank of Scotland Group Plc 340.9 Utilities - Other UK National Grid Plc 332.7 13

Trust Companies and PE Firms Trust Companies: Exponential growth: from RMB150 billion in 2004 to RMB4.8 trillion in 2011 Most flexible type of institution in fundraising and investing Interaction of Trust Industry with Other Markets PE Firms: Long-term capital commitment, usually for 5-8 years Quick expansion, but largely unregulated in China until December 2011 National Development and Reform Commission (NDRC) will be the regulator for large PE 14

Capital Market Reforms Prevailing Problem 1: speculative trading activities and high volatility Reforms: encourage more institutional investors, such as pension funds, sovereign wealth funds, insurance companies, Qualified Foreign Institutional Investors (QFIIs), etc., for more long-term strategic investing Guangdong RMB100 billion pension mandates hands out to the NSSF Continuous relaxation on investment restrictions regarding stocks and bonds for insurance companies and Enterprise Annuities QFII & RQFII: just expanded to USD80 billion and RMB70 billion respectively Large stakeholders can actively monitor business, and reduce agency problems to enhance competitiveness 15

Capital Market Reforms Prevailing Problem 2: IPO fever versus low dividend payouts Reforms: curb speculation and fine-tune market mechanism Specific limits on daily price movements and transaction volume to curb excessive speculation on IPOs Develop rules on fair profit sharing and require dividend payout Prevailing Problem 3: lack of transparency Reforms: improve information disclosure, and investigate market irregularities Very large cases under investigation Regarding IPOs, information should be disclosed in a comprehensive, complete and accurate manner 16

Capital Market Reforms Prevailing Problem 4: financing difficulties for SMEs SMEs in China employ 80% of working population, account for 60% of China s GDP, and contribute 50% of government s tax revenue Big SOEs have more capital than they need, so they become lender through financial subsidiaries SMEs face fund raising dff difficulty and turn to shadow banking system at up to 30% p.a. lending rate Reforms: open more channels for business financing to serve the real economy (by Premier Wen Jiabao) Formalise private lending in Wenzhou, and allow direct overseas investments for individuals up to a cap of USD200 million in total p.a. Plan for new third board OTC equities market in China High yield bond market for small businesses Encourage PE and VC Funds to help small firms during pre-listing period 17

This is not the End or the Beginning of the End, but may be the End of the Beginning! Thank You! 18