How Beijing Can Regain Trust of Global Institutional Investors

Original Article Published on Caixin Global

Fang Xinghai, a vice chairman of the China Securities Regulatory Commission (CSRC), hosted an online meeting attended by executives from more than a dozen foreign financial institutions on Jan. 25. The meeting revealed that Beijing and Washington were making progress on coordinating regulation of U.S.-listed Chinese companies, Reuters reported.

Shen Bing, director of the CSRC’s Department of International Affairs, told CNBC on Jan. 28 that Chinese companies’ overseas listings will resume with the introduction of new regulations.

On the afternoon of the same day, the Cyberspace Administration of China (CAC), alongside the National Development and Reform Commission, the Ministry of Industry and Information Technology, and the State Administration for Market Regulation, convened a meeting. The meeting stated that the Communist Party of China’s Central Committee places great importance on — and shows sincere concerns for — the healthy and sustainable development of internet companies. The statement has set the tone for encouraging the industry’s development.

The regulators’ frequent release of favorable news is intended to stabilize the internet and technology industry as well as calm global institutional investors.

However, many investors remain cautious, waiting to see how the policies will shake out.

The recent tragic slump of U.S.-listed China concept stocks has fundamentally changed global investors’ expectations about China. If China wishes to win back their trust, words will not be enough. Investors need to see tangible policy implementation and effects.

Investor expectations

Three recent regulatory documents constitute the basic framework for Chinese companies to list overseas. That said, detailed rules have yet to be released.

For example, listing in the U.S. requires the approval of relevant industry authorities and the CAC, but details remain unclear regarding the submission of materials, government agencies which accept the materials, approval standards, the time frame and the feedback mechanism.

At the moment, overseas institutional investors have three main concerns: First, when will the detailed rules be introduced? Second, will there be a batch of companies, rather than just a few selected by the authorities, that can go through the approval process, which would show the authorities’ true attitude toward listing in the U.S.? And, third, will special service windows be set up, just like in local civic centers, to efficiently help with the approval process for companies?

Investors want to know the boundaries of regulation and the meaning of rules, and from policy implementation, they want to get a sense of the government’s real attitude toward private sector companies as well as the internet and technology industry. That will not just reflect China’s actual will to continue opening up, but also serve as the basis for global institutional investors to rebuild expectations about Chinese companies.

For institutional investors, regulators need to strictly implement Beijing’s requirements for building a service-oriented government and efficiently solve issues related to the variable interest entity structure and Chinese companies’ U.S. IPOs. Meanwhile, they should also issue, and most importantly, fulfill favorable policies, which will help rebuild investor expectations.

During the IPO process, a company’s valuation can be determined based on its past and expected future cash flow, with the assumption being that future growth is predictable. Without this premise, it is impossible to calculate its valuation.

The current issue is that with global institutional investors’ expectations disrupted, U.S.-listed Chinese stocks can’t be properly priced, so their prices are falling almost across the board.

Liu Guoqiang, a deputy governor of the People’s Bank of China, said on Jan. 18 that the government should respond to market concerns in a timely manner, as delaying the response would make it more difficult to solve the problem. Liu’s remarks strongly resonated with the market, because they tackled the concerns of both companies and institutional investors.

Can mainland capital replace global investors?

Some U.S.-listed Chinese companies have conducted a secondary or dual primary listing in Hong Kong. Many people hope that the southbound capital flow — the Chinese mainland’s capital flow into the Hong Kong market through the stock connect program — can replenish the liquidity in the market and even replace global institutional investors to be the leading force. But they may not be aware that Hong Kong would be competing with Shanghai and Shenzhen for the mainland’s liquidity.

Southbound funds are part of the mainland’s liquidity that is worth about 1 trillion yuan ($157.2 billion) a day. If the Hong Kong market is highly dependent on the funds, it would surely divert a considerable portion of that liquidity. Once this happens, the Hong Kong market would essentially become part of the mainland market, just like the stock markets in Shanghai and Shenzhen. This would lead to Hong Kong losing its status as a global financial center.

Regulators are very clear on this issue: Hong Kong’s status as an international financial center must be guaranteed. Thus, institutional investors using U.S. dollars should continue to dominate the Hong Kong market.

For Hong Kong to be still considered an international financial center, it requires the support and recognition of global institutional investors. How can such support and recognition be strengthened? 

Global investors are China’s friends 

As an offshore market, Hong Kong doesn’t have a strong local economy or enough influential local fund managers, resulting in the absence of a local anchor. In the global capital market, Hong Kong is dependent on major U.S.-dollar institutional investors, who are regarded as an anchor for the city.

In the last two decades, institutional investors around the world have invested more than $1 trillion in China’s overseas-listed companies through equity and debt financing. Through investment, business expansion, employment and other activities of China’s top listed companies, those funds have boosted the country’s employment, social insurance funds, tax revenue and consumption, contributing to its economic development and technological progress, as well as the betterment of its people’s livelihoods.

Many overseas institutional investors have helped China’s national-level funds make asset allocation plans and guided Chinese capital to enter the global market. They remain resolute in investing in China, and continue to obtain licenses to do business in the country, while recognizing and supporting its development.

These investors may not speak Chinese, but their deeds demonstrate that they are China’s friends, rather than outsiders. Therefore, China should treat them as friends. In that case, Beijing will have to be more thoughtful when issuing new policies that may affect them.

Institutional investors engage in long-term asset allocation, which won’t be easily adjusted unless the market changes dramatically or expectations deteriorate. Last year, China’s policy and non-policy factors caused a shock to certain industries and companies, weakening their long-term growth prospects. Meanwhile, institutional investors attempting to navigate the policy “minefields” simply abandoned their plans, once they decided they couldn’t screen the terrain properly. As a result, many of their basic assumptions about Chinese companies and the Chinese market became invalid, contributing to the major change in their expectations and making it nearly impossible to make long-term investments in China.

To put it simply, the future is too unpredictable.

Political economy

In China, any economic issue is essentially a policy or political one. Top leaders have advocated building a service-based government, and avoiding campaign-style governance.

The top leadership has recently mentioned the term “fallacy of composition,” which can refer to last year’s successive issuance of several industry policies within a short time frame, including those for real estate, after-school tutoring, and carbon emission reduction. That onslaught has generated a devastating result. The leadership mentioned the term, meaning that China will do its best to avoid similar cases happening in the future.

There are also some statements from the leadership that can help stabilize institutional investors’ expectations, such as “don’t treat long-term goals as short-term ones,” “don’t treat systematic goals as fragmented ones,” and “don’t treat protracted battles as blitzkriegs.”

To sum up, the recent news regarding Chinese companies’ listings in the U.S. released by domestic authorities has given the market a glimmer of hope. However, the final result will depend on policy implementation.