Leveraging New Opportunities for Cash Investment in China
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.