China
6. Financial Sector
Capital Markets and Portfolio Investment
China’s leadership has stated that it seeks to build a modern, highly-developed, and multi-tiered capital market. Since their founding over three decades ago, the Shanghai and Shenzhen Exchanges, combined, are ranked the second largest stock market in the world with over USD5 trillion in assets. China’s bond market has similarly expanded significantly to become the third largest worldwide, totaling approximately USD13 trillion. Direct investment by private equity and venture capital firms has increased significantly, but has faced setbacks due to China’s capital controls, which complicate the repatriation of returns. In December 2019, the State Council and China’s banking and securities regulatory authorities issued a set of measures that would remove in 2020 foreign ownership caps in select segments of China’s financial sector. Specifically, foreign investors can wholly own insurance and futures firms as of January 1, asset management companies as of April 1, and securities firms as of December 1, 2020.
China has been an IMF Article VIII member since 1996 and generally refrains from restrictions on payments and transfers for current international transactions. However, the government has used administrative and preferential policies to encourage credit allocation towards national priorities, such as infrastructure investments. As of 2019, over 40 sovereign entities and private sector firms, including Daimler and Standard Chartered HK, have since issued roughly USD48 billion in “Panda Bonds,” Chinese renminbi (RMB)-denominated debt issued by foreign entities in China. China’s private sector can also access credit via bank loans, bond issuance, and wealth management and trust products. However, the vast majority of bank credit is disbursed to state-owned firms, largely due to distortions in China’s banking sector that have incentivized lending to state-affiliated entities over their private sector counterparts.
The Monetary and Banking System
China’s monetary policy is run by the People’s Bank of China (PBOC), China’s central bank. The PBOC has traditionally deployed various policy tools, such as open market operations, reserve requirement ratios, benchmark rates and medium-term lending facilities, to control credit growth. The PBOC had previously also set quotas on how much banks could lend, but abandoned the practice in 1998. As part of its efforts to shift towards a more market-based system, the PBOC announced in 2019 that it will reform its one-year loan prime rate (LPR), which will serve as an anchor reference for Chinese lenders. The LPR is based on the interest rate for one-year loans that 18 banks offer their best customers. Despite these measures to move towards more market-based lending, China’s financial regulators still influence the volume and destination of Chinese bank loans through “window guidance” – unofficial directives delivered verbally – as well as through mandated lending targets for key economic groups, such as small and medium sized enterprises.
The China Banking and Insurance Regulatory Commission (CBIRC) oversees China’s roughly 4,000 lending institutions. At the end of the first quarter of 2019, Chinese banks’ total assets reached RMB 276 trillion (USD40 trillion). China’s “Big Five” – Agricultural Bank of China, Bank of China, Bank of Communications, China Construction Bank, and Industrial and Commercial Bank of China – dominate the sector and are largely stable, but over the past year, China has experienced regional pockets of banking stress, especially among smaller lenders. Reflecting the level of weakness among these banks, in November 2019, the PBOC announced that about one in 10 of China’s banks received a “fail” rating following an industry-wide review. The assessment deemed 420 firms, all rural financial institutions, “extremely risky.” The official rate of non-performing loans among China’s banks is relatively low: below two percent as of the end of 2019. However, analysts believe the actual figure may be significantly higher. Bank loans continue to provide the majority of credit options (reportedly around 66 percent in 2019) for Chinese companies, although other sources of capital, such as corporate bonds, equity financing, and private equity are quickly expanding their scope, reach, and sophistication in China. In December 2019, the Coronavirus (COVID-19) pandemic emerged in Wuhan, China. In response, the PBOC established a variety of programs to stimulate the economy, including a re-lending scheme of USD4.28 billion and a special credit line of USD50 billion for policy banks. In addition, the Ministry of Industry and Information Technologies established a list of companies vital to COVID-19 efforts, which would be eligible to receive additional loans and subsidies from the Ministry of Finance.
As part of a broad campaign to reduce debt and financial risk, Chinese regulators over the last several years have implemented measures to rein in the rapid growth of China’s “shadow banking” sector, which includes wealth management and trust products. These measures have achieved positive results: the share of trust loans, entrusted loans, and undiscounted bankers’ acceptances dropped a total of seven percent in 2019 as a share of total social financing (TSF) – a broad measure of available credit in China. TSF’s share of corporate bonds jumped from a negative 2.31 percent in 2017 to 12.7 percent in 2019. In October 2019, the CBIRC announced that foreign owned banks will be allowed to establish wholly-owned banks and branches in China. However, analysts noted there are often licenses and other procedures that can drag out the process in this sector, which is already dominated by local players. Nearly all of China’s major banks have correspondent banking relationships with foreign banks, including the Bank of China, which has correspondent banking relationships with more than 1,600 institutions in 179 countries and regions. Foreigners are eligible to open a bank account in China, but are required to present a passport and/or Chinese government issued identification.
Foreign Exchange and Remittances
Foreign Exchange
While the central bank’s official position is that companies with proper documentation should be able to freely conduct business, in practice, companies have reported challenges and delays in obtaining approvals for foreign currency transactions by sub-national regulatory branches. Chinese authorities instituted strict capital control measures in 2016, when China recorded a surge in capital flight that reduced its foreign currency reserves by about USD1 trillion, stabilizing to around USD3 trillion today. China has since announced that it will gradually reduce those controls, but market analysts expect they would be re-imposed if capital outflows accelerate again. Chinese foreign exchange rules cap the maximum amount of RMB individuals are allowed to convert into other currencies at approximately USD50,000 each year and restrict them from directly transferring RMB abroad without prior approval from the State Administration of Foreign Exchange (SAFE). In 2017, authorities further restricted overseas currency withdrawals by banning sales of life insurance products and capping credit card withdrawals at USD5,000 per transaction. SAFE has not reduced the USD50,000 quota, but during periods of higher than normal capital outflows, banks are reportedly instructed by SAFE to increase scrutiny over individuals’ requests for foreign currency and to require additional paperwork clarifying the intended use of the funds, with the express intent of slowing capital outflows.
China’s exchange rate regime is managed within a band that allows the currency to rise or fall by 2 percent per day from the “reference rate” set each morning. In August 2019, the U.S. Treasury Department designated China a “currency manipulator,” given China’s large-scale interventions in the foreign exchange market. Treasury removed this designation in January 2020.
Remittance Policies
According to China’s FIL, as of January 1, 2020, funds associated with any forms of investment, including investment, profits, capital gains, returns from asset disposal, IPR loyalties, compensation, and liquidation proceeds, may be freely converted into any world currency for remittance. Under Chinese law, FIEs do not need pre-approval to open foreign exchange accounts and are allowed to retain income as foreign exchange or to convert it into RMB without quota requirements. The remittance of profits and dividends by FIEs is not subject to time limitations, but FIEs need to submit a series of documents to designated banks for review and approval. The review period is not fixed and is frequently completed within one or two working days of the submission of complete documents. For remittance of interest and principal on private foreign debt, firms must submit an application form, a foreign debt agreement, and the notice on repayment of the principal and interest. Banks will then check if the repayment volume is within the repayable principal. There are no specific rules on the remittance of royalties and management fees. In August 2018, SAFE raised the reserve requirement for foreign currency transactions from zero to 20 percent, significantly increasing the cost of foreign currency transactions.
Sovereign Wealth Funds
China officially has only one sovereign wealth fund (SWF), the China Investment Corporation (CIC), which was launched to help diversify China’s foreign exchange reserves. Established in 2007 with USD200 billion in initial registered capital, CIC currently manages over USD940 billion in assets as of the close of 2018 and invests on a 10-year time horizon. CIC has since evolved into three subsidiaries:
- CIC International was established in September 2011 with a mandate to invest in and manage overseas assets. It conducts public market equity and bond investments, hedge fund, multi-asset and real estate investments, private equity (including private credit) fund investments, co-investments, and minority investments as a financial investor.
- CIC Capital was incorporated in January 2015 with a mandate to specialize in making direct investments to enhance CIC’s investment in long-term assets.
- Central Huijin makes equity investments in Chinese state-owned financial institutions.
CIC publishes an annual report containing information on its structure, investments, and returns. CIC invests in diverse sectors, including financial services, consumer products, information technology, high-end manufacturing, healthcare, energy, telecommunications, and utilities. China also operates other funds that function in part like sovereign wealth funds, including: China’s National Social Security Fund, with an estimated USD325 billion in assets; the China-Africa Development Fund (solely funded by the China Development Bank), with an estimated USD10 billion in assets; the SAFE Investment Company, with an estimated USD417.8 billion in assets; and China’s state-owned Silk Road Fund, established in December 2014 with USD40 billion in assets to foster investment in OBOR partner countries. Chinese state-run funds do not report the percentage of their assets that are invested domestically. However, Chinese state-run funds follow the voluntary code of good practices known as the Santiago Principles and participate in the IMF-hosted International Working Group on SWFs. The Chinese government does not have any formal policies specifying that CIC invest funds consistent with industrial policies or in government-designated projects, although CIC is expected to pursue government objectives. CIC generally adopts a “passive” role as a portfolio investor.