The Changing State of Equity trading in China

Critical to the continued growth of the Chinese economy is the further development of the financial services industry. Once highly protected and staid, the industry has opened up significantly since China’s accession to the WTO in 2001. Foreign banks have gradually been allowed to enter the market, establish branches and offer RMB denominated services in direct competition with local banks. In parallel with this, the capital markets have developed rapidly with tremendous growth in sophistication driven by an increasing openness and access to the latest in financial technologies.

Through the Qualified Foreign Institutional Investors (QFII) program, foreign investors have a window of access to the local A-share markets, which were formerly completely off limits to foreign investors. However even with this program, foreign investors still face numerous regulatory and technical hurdles in their access to the Chinese stock markets, and the government so tightly controls the granting of new QFII investment quota that many QFII players have had to resort to somewhat unorthodox means to be able to make their investments.

Whilst foreign investors have been eager to enter the Chinese markets, there also exists a huge demand by the Chinese to invest some of the wealth that they have accumulated into overseas markets. The Qualified Domestic Institutional Investor (QDII) program has been created precisely to meet this demand; however it is still very much in its infancy, with the majority of funds invested in familiar Chinese companies listed on the Hong Kong Stock Exchange. Investments by QDIIs in markets further afield have generally shown disappointing results so far, and the way in which QDIIs invest overseas still faces heavy regulation from the government. Nevertheless, QDIIs are expected to expand their product offerings into areas such as US equities and offer a greater choice of country, regional and global funds, which will in turn drive local software and technology vendors to internationalize their product suites and also present opportunities for foreign players to assist QDIIs in their overseas investments.

Foreign firms have also been keen to participate in the burgeoning domestic brokerage business that is currently dominated by local securities houses. With a few exceptions, a Joint Venture (JV) with a local house is still the only way that a foreign firm can obtain a domestic brokerage license. Many view these restrictions as an effort by the government to shield local brokerages from the onslaught of competition that would be brought by experienced foreign firms. However, with the recent granting of a domestic brokerage license to the CLSA JV and other approvals in the pipeline, perhaps this is a sign that the government is finally willing to open up the business to foreign players and possibly stimulate consolidation amongst the country’s numerous domestic brokers.

China’s stock exchanges are also an area which has seen dramatic new developments. In particular, the Shanghai Stock Exchange (SSE) has recently upgraded their technology platform to support faster and higher volume execution, although other technical deficiencies still limit the usefulness of program/algorithmic trading on this exchange. Not to be outdone by its northern competitor, the Shenzhen Stock Exchange (SZSE) is engaged in a FIX hub project which promises to bring global connectivity between local and foreign institutions. The forthcoming year might also see the listing of foreign firms with established China operations on the SSE, giving these firms unprecedented access to Chinese capital, and bringing Shanghai one step closer to its aspirations of being a global financial centre. The SZSE has launched its NASDAQ-style Growth Enterprise Market (GEM). Also, after lying dormant for three years, the Shanghai-based China Financial Futures Exchange (CFFEX) has finally been given approval to launch China’s first exchange-traded financial derivatives product, a futures contract on an index of China’s 300 largest listed companies. Finally, the government has granted permission for small scale trials of margin trading by approved domestic brokerages. Gradual expansion of this scheme is expected to result in a significant boost in transaction volumes and profits for brokers and offer investors a legitimate method of leveraging and the ability to exploit market sell-offs.

As can be seen from the above examples, government regulations both drive and hinder the development of China’s securities market, with the key principles being protection from both foreign competition and unchecked liberalization. Both of these factors are seen by the government as being too great a risk to the stability of the domestic market and by extension the entire Chinese economy, so the government remains committed to a slow and cautious approach to reform. The entire financial services industry in China will have to go through a tremendous amount of consolidation and increased competitiveness before the government will allow the market to be fully opened up.

Original post by Kapronasia Analyst Alexander Fu