China's yuan-denominated A-share market has been sliding for months – from January to mid-August, the key index has gone from 490 to 355 – and local securities firms are reporting huge trading losses. Yet foreign institutions are still queuing up to join the QFII scheme, allowing them to buy shares in the same market. What's going on?
For one thing, there is a difference between joining a club and actually using the facilities. Many QFIIs (Qualified Foreign Institutional Investors) are hardly touching their investment quotas because they see few stocks worth investing in. And while their cash sits in the bank, there is always the hope of a currency revaluation.
Indeed, there have been complaints that the QFII scheme has become a parking lot for currency speculators instead of a channel for pumping cash into the stock market. But Jason Huang at Beijing market intelligence firm Fangzhou Bo Xun argues that the QFIIs are just being cautious. "Serious QFIIs are committed to the long-term [and] confident things will get better," he told China Economic Review.
Hopeful might be the better word. The A-Share market is awash with F-Grade performers – clapped-out state-owned enterprises (SOEs) and brokers who don't play by the rules – and the risk of government intervention, direct or indirect, continues to skew the market. The state routinely acts to save companies that free markets would leave to fail, like Southern Securities, whose debts were recently largely written off by the state banks. China Securities is another broker that has recently sought help from the government, in this case, Beijing's municipal government. A fresh run of IPOs this year has begun to shift the balance of the market in a more healthy direction. But BNP Paribas chief economist Xing Dong Chen contends the newcomers won't be enough to pull the market out of its hole – and that liquidity is still moving away. "The new IPOs are not very aggressive," Chen said. "Listing companies want to list at a high price but investors worry about their IPO price holding."
But he dismissed talk of QFIIs simply being in the game for exchange rate speculation opportunities. "[QFIIs] are here for the long-term," he said. The problem is that there are so few attractive shares to buy right now. UBS, the first foreign institution to qualify for QFII status in July 2003, almost qualifies as a unique member of the QFII Club in other ways. It has not only actively invested – in about 80 companies so far – but in February it applied to bring its allotment up to the maximum permitted US$800 million – after getting its original quota doubled to US$600 million in October 2003.
According to Nicole Yuen, head of UBS Securities China, UBS alone probably accounts for up to 5% of daily transactions on Shanghai and Shenzhen A-Share boards. Speaking to the China Daily in July, she said the bank's portfolio included Baoshan Iron & Steel, Shanghai Port Containers, Sinotrans Air, ZTE Corp and other solid, sustainable performers that met key tests on corporate governance and disclosure.
The single biggest problem holding back markets is still the high ratio of non-tradable to tradable shares – an average of around 70 percent or more for all listed companies. "Shares are artificially priced high, so instead of going up, they can only go down," said Chen. If the companies do not expand the size of their floats, downward pressure on share prices will continue. But if the non-tradable shares ARE floated, the extra liquidity will push prices down as well. That is a major dilemma for the government, which would just love to see a bull market.
The overall price slide tends to hide the good performers, of which there are some. Chemicals and infrastructure companies are considered to be good bets, and China's export economy also makes good logistics firms sustainable winners.
But the market remains crowded with losers. In July, rating company Xinhua Far East downgraded long-term credit ratings on monosodium glutamate (MSG) maker Henan Lianhua Gourmet Powder (LHGP) because controlling shareholder state-owned Henan Lianhua Gourmet Powder Group failed to repay massive loans it owed LHGP.
Variations on this theme – basically state-owned parent companies milking their publicly traded subsidiaries by borrowing and then reneging – are common.
Foreign companies can sometimes help from the sidelines. TV tube maker Shenzhen SEG Samsung Glass Co Ltd (SSG) recently received a higher credit rating from Xinhua Far East thanks to its affiliation with a joint venture between Korea's Samsung Corp and US-based Corning Inc. The two companies became major shareholders in April 2004, a move that led to new management, a new board and better valuations. Only one problem for Shenzhen-listed SSG: Cash owed by parent SEG holds it back from getting an even higher credit rating.
Tougher regulation is needed and slowly it is happening. A 20-page State Council document issued in July promised the government would pull back from investment activities and leave the markets more room to decide prices. The China Securities Regulatory Commission also issued a new policy which allows swaps of debt and shares within companies and a few companies are piloting this. Writing debt off through issuance of shares is a way to tidy up messy SOEs, but substantial reform of the markets – including de-listing the worst of the listed SOEs – will still take years.
Corporate governance also has to be made real. Too many listed firms have a single majority state-owned shareholder, which often feels it can shift money in and out of the listed vehicle at its convenience. Valuations are also too high. But any fundamental changes impact on powerful interest groups, and no sudden reforms can be expected.
Software billionaire Bill Gates brought some cheer recently when the Bill and Melinda Gates Foundation became the seventeenth institution to join the QFII club. The foundation immediately invested in printing and pharmaceutical A-Shares. Divine intervention, meanwhile, could be at hand. The Highland Drive Baptist Church has also put its money into Mainland stocks under the QFII scheme, according to a report on Beijing's Easy FM.