A recent article written by Thomas Hale and Tabby Kinder, published in the Financial Times on 5th July 2021 brought to light some of the tentative steps taken by Chinese authorities at liberalization of their capital markets and the effects of the strengthening of the renminbi. (For the full article, click here)

Key points from the article are included and summarized in the following:

China has long enforced strict capital controls over its household wealth in order to retain it within its borders however, there are hints that the liberalization of the Chinese capital market is forthcoming, albeit slowly.

Chinese citizens are currently permitted an annual allowance of $50,000, which has remained unchanged since 2007. Ye Haisheng, a Chinese official at the State Administration of Foreign Exchange (Safe) has said that the government is exploring the possibility of broadening the scope of this allowance to include the purchase of insurance and securities in foreign markets.

In June, record amounts of money were approved by the government to flow out of the country through an official investment quota and the country is also on the verge of launching a programme called Wealth Connect. A scheme that, together with Hong Kong, will facilitate investments into foreign markets by households in southern China.

Households will finally have more diverse and legitimate channels for investing in overseas securities.

In February, the stock market surpassed its peak of 2007 and the renminbi had significant gains. Keeping so many savings trapped in one place was questionable and policymakers warned of rising asset prices especially within the property sector where investors continue to chase returns.

Although asset management outflows in China are still minimal, they form part of the significant changes that signify potential expansion and opening up of the country’s financial system.  HSBC estimates that Chinese households will have Rmb300tn ($46.3tn) of investable assets by 2025 —the equivalent of the entire US bond market.

If millions of Chinese savers opt to use some of their annual allowances to buy investments overseas, the country’s savings would have the capacity to flood certain international markets. Even if 10% of households invested their $50,000 abroad, HSBC calculates this to amount to $2.4tn.

These policy shifts, although gradual, will certainly raise questions about the prospect of capital account liberalization and its effects on the global financial system.

In previous years, to circumvent the $50,000 currency limit, Chinese citizens would use credit cards to purchase life insurance policies linked to savings policies in Hong Kong. When policies matured, the investors would be left with a lump sum in Hong Kong dollars.

When the regulators caught wind of this, the central bank placed a ban on dual currency credit cards being used for foreign purchases through networks such as Visa and Mastercard. Unionpay (a major credit card provider) was also banned from being used to purchase insurance in Hong Kong.

Hong Kong was often used as a channel for illicit outflows of money from mainland China and now through the Wealth Connect programme, a greater array of legitimate methods to invest outside the mainland are being made available.

The Wealth Connect Programme

The Chinese government is expected to launch the Wealth Connect programme with Hong Kong this year. The initial programme will be piloted in 9 Chinese cities in the Greater Bay Area (about 70m people) and will enable households and savers to invest up to Rmb1m ($154,000) in low and medium-risk funds domiciled in Hong Kong.

This could solidify Hong Kong’s strategic role as the access point into international markets and the opening up of mainland China’s financial markets to offshore investors.

Through Wealth Connect, offshore investors will also be able to buy mainland products.

The first phase of the scheme reflects government’s cautious approach and total flows in each direction are capped at Rmb150bn ($23bn). It will also operate according to a closed-currency loop, meaning investors will be required to convert the proceeds back to the renminbi when they cash out.

“Wealth Connect will be the first time that China has legitimately allowed mainland residents to directly move money out of the country for the purposes of offshore investment,” says Anthony Lin, Standard Chartered chief executive for the Greater Bay Area.

Citibank has noted that domestic mutual funds in some form, have already been bought by hundreds of millions of people in China and with the diversified overseas investment options, this trend would surely continue. It is likely that these same middle-class citizens would flock to invest in western markets.

What it Means For International Banks and the BVI in Particular

For international banks, the scheme is only a part of a China savings opportunity. The banks are looking to build their customer base and are not focusing on short-term income generation. When China further opens up its capital account, the banks will take the opportunity to further grow their customer relationships.  The BVI has also traditionally been the route that Chinese residents adopt for their offshore holding vehicles, so the impact there could be quite dramatic.  This is also likely to impact on the fund management industry based out of BVI and Cayman Islands but managed out of Hong Kong or Singapore.

HSBC announced a spend of $3.5bn over five years to develop its wealth and personal banking operations in Asia, which already accounts for two-thirds of its global wealth business.

Citibank and Standard Chartered also have plans in place that aim to double wealth management staff numbers and income in mainland China and Hong Kong over the next five years.

For these foreign players, it is hoped that the gradual loosening of constraints on the growing household wealth will gather momentum. Goldman Sachs has partnered with ICBC and plans to offer “overseas products” in the future and other major US banks have partnered with Chinese counterparts to emphasize the offshore opportunities.

Greg Hingston, HSBC’s head of wealth and personal banking for Asia Pacific says, “The opportunity is enormous, even if you only get a small share of it.”

Time To Invest

Following a rapid recovery from the pandemic, a surge of inflows into the Chinese stock and bond markets coupled with the strengthening of the renminbi have resulted in a booming asset management industry. Foreign and domestic businesses are keen to take advantage of the new opportunities.

In June, there was an increase of $10bn (to $147bn) in the total quota for the Qualified Domestic Institutional Investor (QDII) Scheme, a scheme which allows companies to invest overseas on behalf of their clients.  The largest increase in the history of the scheme since its inception in 2006.

Analysts have concluded that the move was partly due to the strength of the renminbi but could also  be relevant to the future of China’s capital account.

Inflated domestic asset prices, especially in the property market, have become more frequent and have raised concerns that this could lead to “bubbles” in the domestic markets . While the government has moved to restrain leverage across large real estate developers, the property prices have continued to climb.

Last year, for the first time, foreign direct investment into China surpassed inflows into the US with a total of $163bn.

While full liberalization in Chinese markets is unlikely, the groundwork for further reform is being laid and further policy changes and capital controls would need to be relaxed in order to achieve its stated goal of internationalizing its currency.

It is perhaps time that the offshore investment industry refocused their offering with the new investment offerings that need to be made available.  In our view the BVI and Cayman industries combined with wealth managers in Hong Kong and Singapore are likely to be at the forefront of those developments.