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PECC-SINCPEC International Conference

Competitiveness Enhancement:

Competitiveness Enhancement:

Business Financing and Capital Market Reforms

in China

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

1

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Contents

Contents

Contents

Contents

Capital Markets

Fi

i Ch

l

Financing 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

2 Note: the exchange rate used for the presentation is RMB6.30 = USD1, as at 31 December 2011,

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Capital Markets

Capital Markets Equities

Equities

Capital Markets

Capital Markets -- Equities

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

 Volatility remains high

Market Capitalisation of Stock Exchanges

(as at 31 December 2011, in USD billion)

2,357 2 258 2500 0 2,258 1500 2000 1,055 500 1000 3

Source: Stirling Finance research, WFE

0

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Capital Markets

Capital Markets Bond

Bond

Capital Markets

Capital Markets -- Bond

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  corporate bonds the market is dominated by state owned entities

 High total issuance, but low liquidity, thus no market-oriented pricing mechanism 9.51 60.0%

10

Bond Issuance and Structure (2011)

4 23 5.71 7.98 7.06 8.65 6.96 10 0% 20.0% 30.0% 40.0% 50.0% 60.0% 5 6 7 8 9 10 20.30% 5.05% 19.43% 2.73 4.23 40 0% -30.0% -20.0% -10.0% 0.0% 10.0% 0 1 2 3 4 5 28.68% 22.97% 3.57% 4

Source: Annual Review of China’s Bond Market, by China Government Securities Depository Trust & Clearing Co., Ltd.

-40.0% 0

2004 2005 2006 2007 2008 2009 2010 2011 Total Issuance (RMB trillion) Annual Increase

Central Bank Bill Policy Bank Bond Government Bond Enterprise Bond Commercial Bank Bonds Others

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Financing Channels

Financing Channels

Financing Channels

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 g , g assets, more than 90% of all financial assets in China

IPO is a common way to enhance competitiveness:  Access to new funding;

 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

5

g g y g p ,

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Investor Landscape in China

Investor Landscape in China

Investor Landscape in China

Investor Landscape in China

 >80% trading volume comes from retail investors – speculative activities  But evolving towards a more even mix of investor classes

 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

7 0 8.0

Institutional Investors in China (RMB trillion)

2 2 6.0 7.0 4.8 3 0 4.0 5.0 6.0 7.0 8.0 2.2 1.9 0.1 0.0 1.0 2.0 3.0

Investment Funds Insurance Funds Pension Funds Sovereign Wealth Funds

Trust Funds QFII

6

Source: CSRC, CIRC, MoHRSS, CBRC, SAFE, Stirling Finance Research

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Investment Funds

Investment Funds Companies

Companies

Investment Funds

Investment Funds Companies

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  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.

FMCs and Fund Industry AUM of China

3,276 1 939 2,676 2,519 2,192 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 50 60 70 80 2,500 3,000 3,500 y (RMB bn)

y

325 471 856 1,939 10 20 30 40 50 500 1,000 1,500 2,000 o f Fund Industr y 7 11 57 85 81 119 170 325 0 10 0 500 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 AUM o

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Insurance

Insurance Companies

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

Insurance

Insurance Companies

Companies

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.

36% 41% 40% 47% 40% 45% 50% 5 000 6,000 7,000

Total Assets of Insurance Industry (RMB billion) and Annual Growth

30% 30% 28% 30% 15% 22% 24% 19% 10% 15% 20% 25% 30% 35% 2,000 3,000 4,000 5,000 8 0% 5% 10% 0 1,000 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: CIRC

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Pension Funds

Pension Funds

Pension Assets:

 Cumulative balances in state urban pension system rose to RMB1.9 trillion in 2011, largely derived

Pension Funds

Pension Funds

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  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

pension assets

Growth in State Urban Pension Total Assets (RMB bn)

2,000

500 1,000 1,500

9

Source: Annual Reports of Ministry of Human Resources and Social Security

0

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S

i

W lth F

d

S

i

W lth F

d

Sovereign Wealth Funds

Sovereign Wealth Funds

 Top 10 SWFs account for almost 80 percent of the total assets of all SWFs

Ten Very Large Funds in the World

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)

Country Fund Name Assets

(USD, billion) Inception Source of Funds UAE - Abu Dhabi Abu Dhabi Investment Authority 627 1976 Commodities

Ten Very Large Funds in the World

(updated in December 2011)

y

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 Corporationp 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

10

Singapore Temasek Holdings 157 1974 Non commodities

China National Social Security Fund 138 2000 Non- commodities Source: Sovereign Wealth Fund Institute; Stirling Finance Research

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Sovereign Wealth Funds

Sovereign Wealth Funds -- NSSF

NSSF

Sovereign Wealth Funds

Sovereign Wealth Funds -- NSSF

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 by t e a et 114 130 138 0.3 0.4 0.5 100 120 140 160 2 10 15 16 21 26 36 60 82 0 0.1 0.2 20 40 60 80 100 11

Source: NSSF; Stirling Finance research

2

-0.1 0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Total Assets Annual Return on Investments

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Sovereign Wealth Funds

Sovereign Wealth Funds -- CIC

CIC

Sovereign Wealth Funds

Sovereign Wealth Funds -- CIC

CIC

 CIC was established in September 2007

 Asset size increased from initial USD200bn to USD410bn as at 31 December 2010  Asset size increased from initial USD200bn to USD410bn as at 31 December 2010  59% of assets allocated through external appointments

 Domestic direct investments

b l

 USD67bn to acquire Central Huijin

 Major shareholder of largest banks in China

International direct investments

Morgan Stanley 6.8

Largest Overseas

Investments of CIC

(in USD billion)

1.6

1.9 3.0 4.2 AES Corp PT Bumi Resources Blackstone GDF Suez

(in USD billion)

0 9 0.9 1.0 1.5 Chesapeake Noble Group Russia-China Investment Fund Teck Resources

12

Source: Financial Times; Stirling Finance Research. 0.7

0.9 0.9 0 1 2 3 4 5 6 7 8 GCL-Poly JSC Kazmunaigas Exploration … Chesapeake

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Sovereign Wealth Funds

Sovereign Wealth Funds -- SAFE

SAFE

Sovereign Wealth Funds

Sovereign Wealth Funds -- SAFE

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 Reported in Financial Media

International Classification Board

Subsector Country Company

Cost (in USD Million)

Oil & Gas UK BP Global 2,000.0

S

O e seas

est e ts epo ted

a c a

ed a

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

13

Banks UK Barclays Plc 345.4

Banks UK Royal Bank of Scotland Group Plc 340.9

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Trust Companies and PE Firms

Trust Companies and PE Firms

Trust Companies and PE Firms

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

14

Long term capital commitment, usually for 5 8 years

 Quick expansion, but largely unregulated in China until December 2011

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Capital Market Reforms

Capital Market Reforms

p

p

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 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  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

k h ld l b d d bl h

 Large stakeholders can actively monitor business, and reduce agency problems to enhance competitiveness

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Capital Market Reforms

Capital Market Reforms

p

p

Prevailing Problem 2: IPO fever versus low dividend payoutsReforms: curb speculation and fine-tune market mechanismp

 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  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

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Capital Market Reforms

Capital Market Reforms

p

p

Prevailing Problem 4: financing difficulties for SMEs

 SMEs in China employ 80% of working population, account for 60% of China’s GDP, and contribute  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

f f d d ff l d h d b k l d

 SMEs face fund raising 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

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“This is not the End or the Beginning of the End

“This is not the End or the Beginning of the End,

but may be the End of the Beginning!”

Thank You!

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