Charles Li Direct 

Charles Li Direct

The Paths to China's Full Liberalisation


I wrote last week about Hong Kong's potential opportunities as the Mainland continues to evolve, and this week I want to elaborate with a few details of what we can do to benefit from China's growth and facilitate its further opening.  I spoke at the 2015 Lujiazui Forum in Shanghai yesterday and the pace of China's internationalisation and opening was a hot topic.  Shanghai-Hong Kong Stock Connect has created unprecedented new opportunities for investors, and the RMB's march towards internationalisation is gaining speed.  But we're also at a point where China will be making some important decisions about how to proceed into the next phase of its development.

The liberalisation of China's financial markets is inevitable

A robust financial market can only truly be realised once it is open and transparent.  Open financial markets have more breadth and depth, with more accurate and representative price signals.  China is at a point in its development where opening up is the logical next step in order to promote innovation, help Chinese enterprises acquire assets with greater efficiency on a global scale, and assist retail and institutional investors to diversify their asset allocation globally.  In our view, China's integration with global financial markets is inevitable, but how it happens is not.

A truly international market must also have a truly international currency, and the RMB's internationalisation is gaining momentum in that direction.  But the RMB will not reach its full potential unless there is a diverse RMB ecosystem, both onshore and offshore.  A new suite of RMB investment products will help drive the currency's internationalisation, including making it a candidate as a global reserve currency.

What are the different ways China could open?

There are two key ways China could open up: the first involves allowing investors and funds to come in and go out from China in a direct path.  The second option is an assisted path that removes some of the stress and confusion of a new environment but still provides the benefits of access.

The first path, "coming in and going out", involves welcoming foreign liquidity and foreign investors directly into China, thus bringing them into China’s legal and regulatory scope, while also opening the gates to allow Chinese investors, liquidity and products to go abroad and participate in foreign markets.  China is already experimenting with this path via the QFII, RQFII, QDII schemes and even the upcoming QDII2, as well as initiatives like the new trading platforms in the Shanghai Free Trade Zone.  While this could be considered the ultimate model of opening without compromising China's regulatory control, the downside is it will take some time for China to reach scale because foreign investors are largely unfamiliar with China's legal and regulatory regime.

The "going out" leg of this path allows Mainland investors and liquidity to go abroad, making them completely subject to the rules of the game in overseas markets.  This not only means China would lose regulatory influence over Chinese liquidity and products, but also means institutions and individuals will need to have sufficient knowledge and risk tolerance to venture into foreign markets.  It's not for everyone.

Whether coming in or going out, the philosophical differences between the Chinese market and international markets are so vast, and the legal environments so different, that it will take a long time to bridge the gap.

The second path is an assisted path in and out.  This is epitomised by the Stock Connect model, which allows Mainland investors and products to tap foreign markets without leaving the comfort of their home market's legal and regulatory regime.  Conversely, it allows international investors and issuers to tap opportunities in China without being subject to a completely unfamiliar system.

The Connect programme allows mutual access to each other's secondary markets, or companies already listed in Hong Kong or Shanghai.  The next step is to expand the link to include Shenzhen.  After that, the programme will, over time, be extended to include equity derivatives, possible primary offerings, commodity futures and fixed income and currency products.
Using this model, China's opening could achieve considerable scale within a short period of time, as the structural and rule changes required would be minimal.  For Chinese intermediaries, the model would also allow the expansion of their businesses and client bases internationally.

This path started with Shanghai-Hong Kong Stock Connect and will evolve into other asset classes under our Mutual Market model, supported by a strong offshore RMB ecosystem.  The RMB ecosystem in Hong Kong makes it easier for Chinese issuers and investors to "go out" from Mainland China, and also puts Hong Kong and Shanghai in complementary roles as joint promoters of RMB internationalisation.  Furthermore, with more openness and efficiency, this path would be able to support the next phase of China's economic growth and transformation with little change to the Mainland's current structure.

China's capital market has been opening up at various levels and in multiple dimensions.  The two different paths to full liberalisation can be coordinated and implemented in parallel to suit the needs of different types of investors while also jointly promoting the internationalisation of the RMB.  We believe that with appropriate risk control, a higher degree of market openness will lead to more market players and more efficient capital markets.  This will help drive a new round of economic growth.

How can Hong Kong contribute?

So what can Hong Kong do to contribute?  We can be a buffer between the vibrant global marketplace and China's insulated domestic market.  This is already working well under Stock Connect, as international investors can buy and sell A shares in Shanghai via their Hong Kong broker, and have the trades cleared here in Hong Kong.  It provides the best of both worlds.

We can also provide value by acting as a testing ground for the Mainland's interest rate reform, which continues to progress.  As exchange and interest rate reform can have repercussions on the rest of China's financial system, it's important that they are done cautiously.  In this context, the offshore RMB market in Hong Kong is even more important.  Experimentation in Hong Kong would support the continued steady progress in the reform of interest rates and the RMB exchange rate, assist the Mainland as it takes its next important steps towards full liberalisation, and develop Hong Kong into a premier RMB wealth management centre.



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