Thought Magazine

Perspectives on China’s Financial System Reforms

For decades, China’s financial system effectively mobilized savings to satisfy the nation’s investment requirements. However, since the country’s transition to a more sustainable growth trajectory will depend on higher consumer spending and the development of the nation’s service industries, a more balanced system will be needed to improve capital allocation.

The most conspicuous imbalance in China’s financial system is the prominent role played by bank intermediation in growth, with bank credit accounting for close to 80 to 90 percent of funds raised by the corporate sector. This bank-centric model of finance was effective in mobilizing savings to satisfy investment needs during China’s earlier stages of development but has placed the private sector and smaller firms at a disadvantage.

China’s equity and bond markets remain relatively small but have developed imbalances of their own. Although the private sector now accounts for more than 60 percent of gross domestic product (GDP), state-owned enterprises have benefited disproportionately from initial public offering (IPO) fundraising and account for approximately 80 percent of stock market capitalization.

When comparing the depth of China’s financial system to those of more developed market economies, the most notable differences are the relatively small size of outstanding debt securities and a near-absence of securitized loans. A pilot program allowing major banks to securitize credit assets was launched in 2005 but scrapped in the wake of the subprime mortgage crisis. The government has recently reintroduced a bank loan securitization program with a quota of RMB50 billion.

One of the main aims of the current round of reforms is to increase the proportion of direct financing as a share of total social financing—a measure that includes items such as entrusted loans, trust loans, bankers acceptance bills, corporate bond financing and equity raising by non-financial enterprises, in addition to regular bank loans. According to data from the People’s Bank of China (PBOC), bond and equity fundraising (by non-financial companies) together accounted for only 16.1 percent of total social financing between January and November 2012, although this represented an increase from 14.1 percent in 2011. As part of plans to build Shanghai into an international financial center, direct financing has been targeted to reach 22 percent of total social finance in Shanghai’s financial market by the end of the 12th five-year plan.

Financial Market Depth Comparison, Year-End 2012 (% of GDP)




China’s equity markets do not reflect the broader economy

Due to the prominence of large SOEs within the listed universe, China’s equity markets are not representative of the broader economy. The banking sector is especially overrepresented, since nearly all major Chinese banks are now listed. There are also disparities between market capitalization and earnings, with banks’ share of earnings nearly double that of the sector’s share of market capitalization. Sectors associated with the consumer economy are especially underrepresented in the equity market in terms of both earnings and market capitalization. The composition of China’s listed company earnings will evolve in the coming years, especially as more consumer-related companies become listed and if interest rate reforms temper the earnings growth of China’s banks.

The securities regulator’s reform agenda

In early 2012, the newly-appointed China Securities Regulatory Commission (CSRC) Chairman Guo Shuqing renewed the regulator’s commitment to market reforms and set out the following priorities:

INCREASING THE ROLE OF DOMESTIC INSTITUTIONS—The CSRC will encourage long-term institutional investors, including state and corporate pension funds, insurance companies, national endowment insurance fund, as well as housing funds to increase the proportion of capital markets investments in their portfolios. China’s provincial pension funds (with approximately RMB2 trillion in assets) and housing funds (with approximately RMB2.1 trillion in assets) will also be encouraged to invest in A shares. State media has reported that pension funds may be allowed to invest up to 30 percent of assets in the domestic market.

REFORM OF LISTING/DELISTING MECHANISM—The CSRC will pursue reforms in the IPO pricing mechanism and underwriting process to prevent excessively high IPO prices and subsequent speculation and market manipulation. Moreover, the administrative approval process for IPOs will be streamlined by reducing 32 percent of the approval criteria. The regulator has also pledged to revise delisting rules to allow for swifter removal of companies that fall short on minimum criteria (e.g., positive net assets, minimum annual revenue or trading volume).

IMPROVING CORPORATE DIVIDEND PAYOUTS—The CSRC has pledged tighter regulation of listed companies that have not distributed promised dividends or that have long refused to declare a dividend. In May 2012 policymakers further pledged to increase SOE dividend payout ratios.

STRENGTHEN CHINA’S PRICESETTING ABILITY FOR KEY COMMODITIES—The regulator has allowed the launch of silver futures on the Shanghai Futures Exchange and will explore the introduction of other new products such as a market for crude oil and other major commodities.

EXPANSION IN OTC MARKET— A CSRC official indicated last May that small and medium-sized non-public companies will be allowed to have their securities traded on a national over-thecounter market in an expansion of a pilot program that started in 2006 in Beijing’s Zhongguancun technology hub.

Lower entry barriers for foreign investors

In recent months, Chinese regulators have also shown a greater inclination to reduce entry barriers to the domestic capital markets for foreign investors.

QFII: ACCELERATED QUOTA APPROVAL—The CSRC announced in April 2012 that it would raise the total quota for the Qualified Foreign Institutional Investor (QFII) program from USD30 billion to USD80 billion. China last increased the ceiling to USD30 billion from USD10 billion in 2007. In the downbeat market environment, regulators have accelerated the review and approval of QFII investors and awarded higher investment quotas to licensees (Qatar Holding LLC was awarded a USD1 billion investment quota on November 21). A total of 64 foreign institutions have been granted QFII licenses this year compared to 29 institutions in 2011 and 13 in 2010, with total investment quota of USD11.9 billion granted during the year-through-October, compared to USD1.92 billion in 2011. Shanghai is also said to be planning to introduce the QFII program in local futures, gold and derivatives markets during the period from 2011 to 2015. The move has been outlined in the latest plan for Shanghai’s foreign investment published on the Shanghai Municipal Development and Reform Commission website.

RMB QUALIFIED FOREIGN INSTITUTIONAL INVESTORS (RQFII)—First introduced in December 2011, the RQFII program is the only channel through which institutional investors may channel offshore Renminbi toward the Mainland Chinese capital markets. During 1H2012, investor reaction to the first wave of RQFII products was subdued, considering that the scheme’s rules required a minimum 80 percent allocation to fixed income and capped the amount of equities held in a fund at 20 percent, meaning at a lower total expense ratio. In response to the positive reception by investors, approvals of RQFII quotas have been fast-tracked since July, and at the request of authorities in Hong Kong, the quota for the RQFII program has recently been expanded to RMB270 billion from the previous ceiling of RMB70 billion. By the end of October, 21 financial institutions had been allocated a total RQFII investment quota of RMB48 billion. The CSRC is considering Taiwan as a second destination for the RQFII program.

License Approval & Quota Allocation for China

The gradual lowering of entry barriers to foreign investment should support market development by boosting competition and increasing the presence of longer-term investors (from just over 1 percent of trading at present). Regulators are also reportedly considering further liberalizations, such as allowing foreign hedge funds to participate in the QFII program and creating a new mechanism to allow foreign pension funds to invest without going through the QFII channel.

China’s bond market

Another priority for policymakers is to develop a well-functioning bond market with a broader base of both issuers and investors. Commercial banks are currently the largest investors in the market, while the central bank, the Ministry of Finance and the various policy banks account for the lion’s share of bond issuance. A more streamlined regulatory framework could spur the development of the corporate bond market while a broader base of investors could generate demand for high-yield bonds and create a more viable channel for private firms to raise funds. In these two regards, the following recent developments are noteworthy:

RISING CORPORATE BOND ISSUANCE—The Chinese corporate bond market has experienced a surge in fundraising in the last couple of years, mainly due to new regulations that shortened the approval process to one month in cases where issuers satisfied at least one of four criteria:

  • AAA-rating
  • bond issuance of less than three-year tenor where the issuer is AA-rated
  • net asset value of at least RMB10 billion
  • net assets of over RMB200 million and have applied for access to the electronic fixed income trading platform at either the Shanghai or Shenzhen exchange

The three regulators of the corporate bond market (PBOC, NDRC and CSRC) have decided this year to establish an inter-ministry coordination mechanism to improve consistency. With central government encouragement, more small and mid-sized companies opted to raise funds from the domestic bond market in 2012—the net corporate bond financing component of China’s total social financing increased by 68 percent in the January to November 2012 period.

PRIVATE PLACEMENT OF HIGH-YIELD SME BONDS—The Shanghai and Shenzhen Exchanges have announced a pilot program that will allow non-property and finance-related SMEs to list high-yield bonds through private placement. Bonds issued under the pilot must have maturities of no less than one year and interest rates not higher than three times the PBOC benchmark lending rate.

FOREIGN INVESTMENT IN THE INTERBANK BOND MARKET—In August 2010, foreign central banks, HK/Macau settlement banks and foreign banks involved in RMB settlement were allowed to invest in China’s interbank bond market. Starting in March 2012, the PBOC allowed foreign participants to use RMB as the investment currency. However, the trading volume by foreign entities remains very thin relative to overall transaction volumes.

China Bond Investors (2011)


Strong fundraising momentum in the offshore market

A second way in which China’s bond market is evolving is in terms of increasing RMB bond issuance in the offshore market, primarily in Hong Kong. The market for so-called "dim sum" bonds grew rapidly in the past two years, but momentum slowed in 2012 as expectations for RMB appreciation have become more modest and the interest rate on CNH (offshore Renminbi) that an issuer must pay has risen to about 3 percent compared to 1.5 percent last year.

DIM SUM BONDS—The total value of dim sum bonds issued in Hong Kong amounted to RMB99.8 billion in the January to August period of 2012, an increase of 34.8 percent over the same period in 2011.

CDs—CDs have emerged as a core component of the dim sum product suite, accounting for 14.3 percent and 43.8 percent of total outstanding dim sum products in 2010 and 2011, respectively. In 2012, CDs accounted for the majority of the increased value of outstanding dim sum products—or 61.7 percent of all dim sum products issued in 1H2012. Chinese banks’ Hong Kong subsidiaries issued approximately 80 percent of all offshore RMB CDs, with the rest issued by Hong Kong and multinational institutions.

Maturity of Outstanding Dim Sum Products (RMB bn)



We see the current period of leadership transition as marking a new wave of policy experimentation aimed at addressing structural imbalances within the financial system, the most conspicuous of which is the prominent role played by bank intermediation in growth. The current system has put China’s small and medium-sized enterprises at a particular disadvantage. According to government estimates, SMEs generate about 65 percent of GDP and 80 percent of the country’s jobs but have received only about one-fifth of bank loans.

In March 2012 the State Council designated Wenzhou as a pilot region for sweeping financial reforms, at the center of which are measures to lower entry barriers for private capital in the financial sector, reduce funding costs for SMEs and encourage qualified informal lending companies to develop into legitimate village and township banks. The Wenzhou financial reform is the most ambitious to date, but notable initiatives are also underway in other regions of the country. Although they are regional in nature, these experimental reforms may pioneer the establishment of a financial system that can better cater to China’s conception of a more balanced economy.

Thought, 1Q 2013

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Video overview
of More Growth, Less Fear featuring Bruce Kasman, chief economist for J.P. Morgan Investment Bank


Jing Ulrich

Jing Ulrich
Chairman of Global Markets, China
J.P. Morgan Investment Bank


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