by Aidan Shevlin, Managing Director, Head of Asia Pacific Liquidity Fund Management, J.P. Morgan Asset Management
China remains one of the most dynamic and compelling markets for corporations globally, despite a recent softening in growth. As corporations either expand into China, or their operations in the country become more mature, investing surplus cash is becoming an increasingly important issue. As they face significant developments in the liberalisation of the interest rate environment, together with new regulations for money market funds (MMFs) and the emergence of new financial products, treasurers need to understand what opportunities may now exist to meet their investment objectives.
Increase in risk awareness
Most treasurers would typically prioritise security, liquidity and yield in that order when defining a cash investment strategy; however, the specific market dynamics in China have often subverted this ranking. In particular, there has been a widespread assumption that the Chinese government would not permit a bank to fail. As a result, investors have been less concerned about counterparty risk in China than in other jurisdictions. With the launch of a deposit protection scheme in April 2015, however, the government is now explicit about the amount of cash that would be protected in the event of bank collapse.
There are three major implications of this development. Firstly, treasurers now need to consider counterparty risk with the same degree of scrutiny as in every other market. Secondly, this may result in a cash outflow from some smaller banks, further increasing risk to these counterparties. Finally, the deposit protection scheme implies a potential for higher interest rates as banks try to attract cash from institutional investors, an important potential driver in interest rate liberalisation.
Financial markets in China are becoming increasingly driven by free market dynamics.
Paving the way for new instruments
While this is one example of how the financial markets in China are becoming increasingly driven by free market dynamics rather than regulation and quotas, it has not taken place in isolation. The floor on lending rates was removed in 2013, although these are still typically priced based on the benchmark rate. The ceiling for deposit rates was raised on several occasions over the past year before being fully removed by the People’s Bank of China (PBoC) in October 2015, thus allowing commercial banks much greater ability to control the price of risk.
Alongside these developments we are seeing the PBoC encourage new negotiated certificate of deposit (NCD) issuance as a way of diversifying bank funding and allowing banks to match assets and liabilities more closely. NCD yields will be based on SHIBOR and covered by the deposit protection scheme up to the limit. The removal of the cap on bank deposits and the introduction of NCDs are very significant steps on the path towards full liberalisation. Such actions will allow banks to set deposit and lending rates based on their credit quality, together with their need for funding. Meanwhile, greater competition should encourage the introduction of new deposit products and more attractive, market driven yields for depositors.[[[PAGE]]]
A new generation of MMFs
Corporate investors will be keen to manage their investment risk in China by leveraging the deposit protection scheme and taking advantage of investment opportunities with high quality counterparties. In addition, MMFs also offer a valuable investment option for many treasurers. Since they were first launched in China eleven years ago, both retail and institutional MMFs have experienced enormous growth. Not only do MMFs provide convenient access to high quality assets and next-day liquidity, but they typically offer competitive yields in comparison with PBoC-controlled deposits. In addition to the opening up of the deposit market, and the emergence of new instruments, we expect to see MMF growth continue as investors remain attracted to AAA ratings and the competitive yield of institutional MMFs.
Chinese MMFs are not immune to regulatory change, however, and new MMF guidelines recently issued by the China Securities and Regulatory Commission (CSRC) represent the most significant regulatory development since MMFs were introduced in 2004. These changes, driven by both market dynamics in China and developments in the US and Europe, will further boost the resilience of the Chinese MMF sector. For example, limits on the concentration of assets will reduce credit risk while higher levels of cash assets within the portfolio will enhance liquidity.
Widespread support
Removal of the bank deposits caps & the introduction of NCDs are very significant steps towards full liberalisation.
We see two broad categories of investors in MMFs in China: those motivated by yield, and those motivated by security. The new regulatory guidelines are likely to be welcomed by both of these groups, particularly investors that focus on security. Foreign investors that have used MMFs in other markets have occasionally been less inclined to invest in MMFs in China as the regulations have been less rigorous. But the new CSRC guidelines are likely to provide greater reassurance, particularly as bank credit quality tends to fall quickly beyond the top few banks. In addition, Chinese companies are becoming more conscious of risk in the light of recent volatility, and many are turning to MMFs to manage their cash investment objectives.
Some foreign investors have been discouraged by the T+1 (next-day) liquidity terms in China compared with T+0 (same day) liquidity in the US and Europe. However, the constraint to offer T+1 liquidity will no longer apply once the new rules take effect, so providers will be free to offer T+0 in the future, offering further opportunities to investors.
The new MMF regulations are now in their consultation phase. Once this has been completed, fund managers will have a certain period of time to become compliant. However, we expect the new requirements to be adopted quickly as fund managers and investors recognise the value of more secure, resilient funds.
Economic and investment outlook
The juxtaposition between an accelerating reform agenda and slowing growth marks a very positive chapter in China’s economic development and one that will ultimately benefit all market participants. As growth levels move to more sustainable levels, underpinned by robust, balanced regulations, we expect to see further developments in the interest rate market, deepening liquidity and continuing expansion in the investment opportunities for corporate treasurers. It will therefore be important to keep up-to-date with evolving market and regulatory developments, and continue to review investment policies in line with emerging opportunities.
Engagement and expertise
At J.P. Morgan Asset Management, investors can draw on the insights and experience of a leading global liquidity provider to help navigate the new terrain. With our joint venture partner China International Fund Management Co., Ltd. (CIFM), we continue to leverage our impressive track record and depth of presence in China, taking a rigorous, consistent approach to investment and credit analysis. We aim to offer a seamless experience, whether a client is investing with us at a local, regional or global level. We maintain close relationships with local treasury and finance managers in China to support their investment objectives, whilst also engaging with regional and global treasury centres to provide advice and education on the regulatory, market and risk environment in China.
