When China opened up its A-share markets to foreign investors in 2003 through the Qualified Foreign Institutional Investor (QFII) scheme, UBS was the first bank to receive approval. Its current QFII quota of US$800 million is the largest. Despite foreign participation in the markets, performances have been weak, with the A-share market losing half its value over the last five years, during which time the economy has expanded 50%. The China Securities and Regulatory Commission (CSRC) suspended share listings last May so companies could convert their state-held shares into tradable shares and hopefully breathe life into the markets. Nicole Yuen, head of China equities at UBS and the first foreign member of the CSRC listing committee, told CHINA ECONOMIC REVIEW why the bank is prepared to wait for its rewards in the long term.
Q: What needs to happen once domestic share listings resume?
A: The introduction of good quality, well managed companies into the A-share market is what is required now. We need new blood and of course this has to be very good blood – then there will be a future for the A-share market.
Q: With this in mind, what do you think is in store for the markets in 2006?
A: The fact that the equities market has deflated is a great thing because the bubble of 2001 could not have sustained itself – it was always going to burst. It took five years to decline to a level, which I think is very reasonable. It is comparable to that of open markets like Hong Kong. The fact that this bubble has burst, coupled with an economy that is going strong – not just for the last three or four years, but the forecasts for the next five to 10 years are without exception robust – gives us huge expectations for the market. I would not expect 2006 to be a phenomenal year in which things take a sharp upturn and I don't want to see that. What I would like to see is a gradual rebound in the market.
Q: What can be done to improve corporate governance in listed companies?
A: This is exactly what the non-tradable reform is aimed at. Previously, big shareholders were invariably the state – provincial government, quasi-government – and they paid no attention to the share price because it didn't concern them. They couldn't sell the shares. But now the reform of non-tradable shares provides the opportunity to align the interests of the major state shareholders with the share price. They appreciate that if the company does well, earnings will go up; they can sell their shareholdings at a higher price and there is the possibility of turning their work into cash.
Q: But couldn't the A-share compensation scheme that forms part of the reform process be described as unfair?
A: It's a very Chinese phenomenon because the compensation given for the A-shares is not as much founded on legal grounds as more a legacy from the past. When these A-share holders bought into the company at the time of IPO or subsequently, they did not expect there would be such a large free float – they assumed most of the shares would be kept as state shares and not sold on the market. But no one ever said these shares would never become freely tradable so, legally speaking, there has been no breach of commitment. It is just how the market has developed. Whether we should pin the responsibility on the company management, shareholders or big state shareholders to compensate these people for the reversal, is more a practical matter than a legal matter. There is no right or wrong – if it works, it works.
Q: How much longer is the QFII scheme going to run and what has it achieved?
A: In Taiwan the QFII regime ran for about 10 years and I think it will take less time for it to reach its natural end in China. This end will come when there is no more foreign restriction on investment or currency conversion has been substantially reduced or eliminated. Ultimately, we don't want to be classified as QFII, we want to enjoy the same rights and opportunities as local investors. I think there has been a significant improvement since QFII entered the market. Local fund managers' investment approaches have become much more like ours, with greater emphasis on fundamentals rather than on speculation. The managements of A-share companies are now more willing to talk to investors like ourselves and the quality of their financial reports has improved. We are coming from a very low starting point so even a dramatic improvement doesn't get you to the same standard as a developed market, but we are seeing the trends emerge.
Q: Does holding portions of the QFII quota in cash form undermine the system, and to what extent does the government pressure you to invest more in A-shares?
A: You cannot force an investor to put 100% of their investment into A-shares or any other kind of instrument – fund managers want to have discretion in constructing their investment portfolios. Having said that, given the objectives of the QFII regime, we should expect QFIIs to put the bulk of their money into the market rather than hold it in cash. We welcome government calls for more money to be spent on A-shares and we say to them: "If you see a QFII that is performing well – like us – then encourage them, extend their quota. If you see a QFII that is parking it in cash all the time, don't extend their quota." They need to pick out the good ones from the bad, it's not a matter of balancing quotas and we are very much against this. Ever since we placed our first order in 2003 as the first QFII, the bulk of our money has been invested in the market. We have 60-70% of our quota in A-shares and the rest is mostly in convertible bonds and equity funds.
Q: What are the major challenges facing the CSRC in the years ahead and how can it deal with them?
A: Decision-making in China on policy issues is a process of consensus and a number of different authorities have to support a proposal before it can be implemented. While the CSRC may see the way forward in terms of developing equity markets, other ministries may or may not be at the same place at the same time. In addition, the CSRC's enforcement powers are relatively weak vis-?-vis companies' management. Invariably, it lacks the ability to bring lawsuits against offenders. Changing the CSRC's mandate and augmenting its enforcement powers would help. A higher degree of understanding is also required from other government authorities as to how the equity market operates and how it can be improved. A lot has been done to fix up the banking system, now something similar needs to be done about the equity market.
Q: Why have China's brokerages performed so badly and when will they turn the corner?
A: There are a number of issues. Over the past decade supervision has been insufficient – that is a fact. These brokerages have undertaken activities that are manifestly illegal and yet they were allowed to continue and the problems festered until they got so big they couldn't be reversed. This happened due to a lack of experience on the part of the regulators and investors as well as the "good-time feeling" that existed when the markets were going up and up. It is difficult to say when things will improve as they are only at the very beginning of the reform. At the end of 2004, securities firms were required to start disclosing their proprietary investments, and this revealed just how big the black hole is. They have taken the first step by confronting the problem and are now thinking about how to fix it. It is a long process.
Q: What does UBS stand to gain from the acquisition of a stake in Beijing Securities?
A: We want to actively participate in the local markets so that we can contribute tangibly to their wellbeing. We are not looking at huge business opportunities yet – we just want to help make the system more conducive to doing business. Our view is a long-term view: once the capital market in China has grown to a significant size we would like to be in there doing business and would expect a good return. But right now we are just looking at ways in which we can help build the market.
Q: There has been talk of limitations being placed on the services foreign brokers can offer. What is UBS allowed to do according to the investment agreement?
A: A number of aspects relating to the transaction are still subject to final CSRC approval, although we have received State Council approval. We are allowed to get involved in the restructuring of the firm – basically putting an end to Beijing Securities and establishing a new company in which we will have a direct shareholding. We can then use that as a platform for us in China to provide primary and secondary market investment banking and wealth management.
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