China - 6-Financial Sector China - 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. Bank loans continue to provide the majority of credit options (reportedly around 70 percent) for Chinese companies, although other sources of capital, such as corporate bonds, trust loans, equity financing, and private equity are quickly expanding their scope, reach, and sophistication. Chinese regulators regularly use administrative methods to control credit growth, although market-based tools such as interest rate policy play an increasingly important role.
The People’s Bank of China (PBOC), China’s central bank, has gradually increased flexibility for banks in setting interest rates, formally removing the floor on the lending rate in 2013 and the deposit rate cap in 2015—although it is understood to still influence bank’s interest rates through “window guidance”. Favored borrowers, particularly SOEs, benefit from greater access to capital and lower financing costs, as they can use political influence to secure bank loans, and lenders perceive these entities to have an implicit government guarantee. Small- and medium-sized enterprises, by contrast, have the most difficulty obtaining financing, often forced to rely on retained earnings or informal investment channels for financing.
In recent years, China’s “shadow banking” sector, which includes vehicles such as wealth management and trust products, has grown rapidly. Chinese authorities have taken steps to increase the transparency requirements and strengthen supervision of these banking activities, while also permitting these vehicles to continue to develop. These vehicles often provide private firms additional channels to obtain capital, though at higher than benchmark rates. In 2016, worried about increasingly interconnected leverage across China’s corporate sector, the government introduced a new macro prudential assessment tool to take a more comprehensive approach to managing financial risks. Regulators also issued informal “window guidance” to domestic and foreign banks to reduce lending and currency operations.
Direct financing has expanded over the last few years, including through public listings on stock exchanges, both inside and outside of China, and issuing more corporate and local government bonds. The majority of foreign portfolio investment in Chinese companies occurs on foreign exchanges, primarily in United States and Hong Kong. In addition, China has significantly expanded quotas for certain foreign institutional investors to invest in domestic stock markets; has opened up direct access for foreign investors into China’s interbank bond market; and has approved a two-way, cross-border equity direct investment scheme between Shanghai and Hong Kong that allows Chinese investors to trade designated Hong Kong-listed stocks through the Shanghai Exchange and vice versa. Direct investment by private equity and venture capital firms is also rising, although from a small base, and has faced setbacks due to China’s increased capital controls that complicate the repatriation of returns.
Money and Banking System
After several years of rapid credit growth, China’s banking sector faces asset quality concerns. For 2016, the China Banking Regulatory Commission reported a rise in the non-performing loans (NPL) ratio to 1.74 percent, up from 1.67 percent at the end of 2015. The outstanding balance of commercial bank NPLs in 2016 reached 1.5 trillion RMB (approximately U.S. $230 billion). China’s total banking assets surpassed 228 trillion RMB (approximately U.S. $35 trillion) in December 2016, a 14.4 percent year-on-year increase. Experts estimate Chinese banking assets account for over 20 percent of global banking assets. China’s credit and broad money supply continue to post low double-digit growth, outpacing GDP growth nearly two-to-one.
Foreign Exchange and Remittances
In 2016, several foreign companies complained about administrative delays in remitting large sums of money from China, even after completing all of the documentation requirements. Such incidents come amid announcements that SAFE had issued guidance to tighten scrutiny of foreign currency outflows due to China’s rapidly decreasing foreign currency exchange.
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. Foreign exchange transactions related to China’s capital account activities do not require review by SAFE, but designated foreign exchange banks review and directly conduct foreign exchange settlements. Chinese officials register all commercial foreign debt and will limit foreign firms’ accumulated medium- and long-term debt from abroad to the difference between total investment and registered capital. China issued guidelines in February 2015 that allow, on a pilot basis, a more flexible approach to foreign debt within several specific geographic areas, including the Shanghai Pilot FTZ. The main change under this new approach is to allow FIEs to expand their foreign debt above the difference between total investment and registered capital, so long as they have sufficient net assets.
Chinese foreign exchange rules cap the maximum amount of RMB individuals are allowed to convert into other currencies at approximately U.S. $50,000 each year and restrict them from directly transferring RMB abroad without prior approval from SAFE. While SAFE has not reduced this quota, banks are reportedly being instructed by SAFE to increase scrutiny over individuals’ request for foreign currency and to require additional paperwork clarifying the intended use of the funds.
In 2016, facing significant capital outflow pressure, the government tightened capital controls through informal guidance to banks and the introduction of reserve requirements for institutions conducting foreign currency transactions, among other measures. 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 facing challenges and delays in getting foreign currency transactions approved by sub-national regulatory branches.
China’s exchange rate regime is managed within a band that allows the currency to rise or fall by two percent per day from the “reference rate” set each morning. In August 2015, China announced that the reference rate would more closely reflect the previous day’s closing spot rate. Since that change, daily volatility of the RMB has at times been higher than in recent years, but for the most part, remains below what is typical for other currencies.
The following operations do not require SAFE approval: purchase and remittance of foreign exchange as a result of capital reduction, liquidation, or early repatriation of an investment in a foreign-owned enterprise, or as a result of the transfer of equity in an FIE to a Chinese domestic entity or individual where lawful income derived in China is reinvested.
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.
Remittance policies have not changed substantially since SAFE simplified some regulations in January 2014, devolving many review and approval procedures to banks. Firms that remit profits at or below U.S. $50,000 dollars can do so without submitting documents to the banks for review. For remittances above U.S. $50,000, the firm must submit tax documents, as well as the formal decision by its management to distribute profits. However, in 2016, some companies reported increased delays in receiving approval.
For remittance of interest and principle on private foreign debt, firms must submit an application form, a foreign debt agreement, and the notice on repayment of the principle and interest. Banks will then check if the repayment volume is within the repayable principle.
The remittance of financial lease payments falls under foreign debt management rules. There are no specific rules on the remittance of royalties and management fees. However, beginning in 2016, SAFE began requiring banks to hold 20 percent reserves against foreign currency transactions, significantly increasing the cost of foreign exchange operations.
The Financial Action Task Force has identified China as a country of primary concern. Global Financial Integrity (GFI) estimates that over U.S. $1 trillion of illicit money left China between 2003 and 2012, making China the world leader in illicit capital flows. In 2013, GFI estimates that another U.S. $260 billion left the country.
Sovereign Wealth Funds
China officially has only one sovereign wealth fund (SWF), the China Investment Corporation (CIC). Established in 2007, CIC manages an estimated U.S. $813.8 billion in assets (as of November 2016) and invests on a 10-year time horizon. China’s sovereign wealth is also invested by a subsidiary of SAFE, the government agency that manages China’s foreign currency reserves, and reports directly to the PBOC. The SAFE Administrator also serves concurrently as a PBOC Deputy Governor.
CIC publishes an annual report containing information on its structure, investments, and returns. CIC invests in diverse sectors like financial, consumer products, information technology, high-end manufacturing, healthcare, energy, telecommunication services, 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 U.S. $295 billion in assets; the China-Africa Development Fund (solely funded by the China Development Bank), with an estimated U.S. $5 billion; the SAFE Investment Company, with an estimated U.S. $474 billion; and China’s state-owned Silk Road Fund, established in December 2014 with $40 billion to foster investment in countries along the “One Belt, One Road.” Chinese SWFs do not report the percentage of their assets that are invested domestically.
Chinese SWFs follow the voluntary code of good practices known as the Santiago Principles and participates 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. The SWF generally adopts a “passive” role as a portfolio investor.