China Capital Markets Research

Yu’ebao had already made Tianhong Asset Management the largest one in the public fund industry in China in early 2014. However, the scale of Yu’ebao has continued to grow with the latest figures showing the AUM of Yu’ebao reaching RMB400bn on Feb 14, 2014, a leap of 60% compared to only one month ago. The speed of capital inflow is still accelerating in 2014. We may witness Yu'ebao becoming the largest money market fund in the world soon. 

The fast expansion of Yu'ebao crosses 400B under managementYue bao AUM data of Chinese money market funds, especially the ones leveraging Internet Finance, reflects the large wealth management demand potential of Chinese market and new innovative finance forms that will appear in the Chinese market in 2014.  

According to data from the China Securities Depository and Clearing Corporation Limited (CSDC), there were 261 new Qualified Foreign Institutional Investor (QFII) accounts opened in 2013 which represents about 43% of the total QFII account number from 2003 to 2013. Compared to 2012 figure. Number of QFII accounts rises by 129%.

So why are foreign investment institutions so interested in opening up accounts to trade the Chinese market when returns are so low? One reason is that the mainland regulators have been pushing towards more open markets and lowering the QFII requirements with the intent of introducing foreign capital to provide better liquidity in an anemic a-share mainland market. In addition to new accounts, more than $49.7 billion in QFII investment quota was approved in 2013.

The potential second reason is that foreign investors see potential opportunities in the mainland market either with current relatively low valuations or in the anticipation of future market growth if the market does pick up. 

 

New QFII account growth

The Shanghai Stock Exchange has been in the doldrums for the past couple of years and was the worst performing Asian exchange of 2013.

2013 will remembered as an incredibly dynamic year for China’s financial services industry. From the increasing number of hedge funds in the market to the emergence and regulation of Bitcoin, industry observers, investors, participants and regulators have had their work cut out for them keeping up with the market.

On November 27, 2013, the Ali-cloud division of Alibaba group announced the launch of Ali Financial Cloud services.

Background

Ali financial cloud services has been developed to provide secure and stable IT resources and internet operation services for financial institutions including banks, funds, insurance companies and securities companies. The service is based on cloud computing, with the cooperation from many well-known financial product solution providers and Alipay’s standard connection portal and a completely sandboxed environment.

At current stage, China's approximately 2,000 small and medium banks are the focus of Ali Financial Cloud as these banks typically do not have enough capital and technology experience to develop their own robust IT structure, so outsourcing is thought to be a low cost and efficient way for these banks to process large amount of data and information.  

The claimed benefits Ali Financial Cloud include:

  1. Enable Small and medium banks to have their own online banking system and mobile banking systems and expand e-commerce and online banking services in the rural areas.  
  2. Provide stable and strong business processing capabilities for small and medium banks during high demand periods
  3. Enable small and medium banks with smaller technology footprints to develop innovative products and solutions that would typically only be available to larger banks
  4. Reduce IT support requirements

One example provided by Ali cloud website shows the processing capabilities of Ali cloud. About 300 million transactions of Yu’ebao could be cleared within 140 minutes, or about 35,000 transactions per second. Some financial firms are already using the Ali fianancial cloud including asset management companies, rural banks, regional banks and insurance companies.  

Historical Context

Cloud computing in China's financial services industry, similar to other global markets, has been slow to take off. Players like IBM have in the past setup comprehensive cloud computing research centers to attempt to move the market, but none have been incredibly successful in gaining a foothold. 

2014 might be the year when we see this change. Cloud technology and security has become increasingly sophisticated and with an increasing profit squeeze due to liberalising interest rates, banks will be looking for ways to increase revenue, reduce cost, and more importantly, stay innovative.

2014 - Year of the Cloud

Certainly Cloud will be a key industry topic as we move into 2014 with major players besides Alibaba including IBM, 21Vianet and Tencent all vying for a part of the increasing cloud computing pie.

It will also be interesting to see the level of innovation that happens in the space. Alibaba has rapidly moved beyond just an IT / e-commerce company to provide a variety of products and services beyond just technology. Its Yu-ebao product is forcing banks to re-think their retail investment products and how they price and distribute them – it has completely changed the industry.

With China's cloud services in the financial indusry being a key topic of discussion in 2014, could we see Alibaba do the same thing it has with 3rd Party Payment Platforms?

The China Securities Regulatory Committee (CSRC) announced in December that the currently non-active A-share IPO market would reopen at the end of January, 2014.

Shanghai Stock Exchange and China Securities Index co.ltd announced that the new TMT (Technology, Media and Telecom) industry index and national defense indices would be released on December 25th, 2013.

Hongkou is a geographic district in Shanghai, on the west side of the Huangpu River, north of the center of Shanghai and close to Pudong District. The Hongkou Hedge Fund Park was officially established on Oct. 18, 2013, as the first test-bed specifically for developing local hedge fund industry and introducing foreign hedge funds in China. Through market reforms and special incentives, the Hongkou government hopes to make the Hedge Fund Park a key part of Shanghai, and indeed China’s, hedge fund industry.

yuebaoThe latest figures from Tianhong Asset Management show that the AUM (asset under management) of Yu’ebao deposits, the currency market fund which is co-launched by Alibaba and Tianhong on 13 June, 2013, has rocketed from June 13th to November 14th, 2013, from 0 to CNY100B. Now Yu’ebao is the largest fund in China leveraging it's enormous Taobao, T-mall and Alipay customer base.

The success story of Yu’ebao has not only encouraged the Chinese IT giants and online payment providers to enter the asset management market, but also is a worry to the traditional asset management firms. Currently, most public funds in China sell their products on their own websites or choose to cooperate with the online platforms to sell their products. Asset managers do recognise the benefit of selling funds online including low cost and convenience, but struggle as they simply just do not have the customer base of Alibaba/Alipay.

Date   13 June 30 June  9 Sept  14 Nov
AUM (CNYB)  6.6  55.65  100

The U.S. Government Shutdown and Its Impact

The shutdown of the U.S. government ended as the two U.S. political came to an agreement to delay the decision to January-February of 2014. This means that the global market instability will likely still be on-going until the beginning of next year. This also means that the U.S. market may not be as lucrative and attractive as before, as critical decisions regarding the debt ceiling and government funding are still not solved.

It is important to figure out the impacts of the incident on Chinese economy, as the U.S. and China are the world’s number 1 and 2 economies with strong ties. The index trends in East Asia, oil consumptions and imports by China, and geo-political status of China are all important aspects to consider to understand the impact.

Market Change after the End of Shutdown

Shanghai CSI Peformance

The Chinese stock index fell right after the announcement of the end of the government shutdown, while other East Asian and Southeast Asian market indexes rose. Although, it is hasty to conclude that China had served as a ‘refugee market’ or as an alternative to the U.S. market just from that factor, one could draw certain implications that people were shifting their investments in and out of the US / China as a the appeal of each market shifted.

U.S. – China Relations from multiple angles

According to the U.S. Energy Information Administration’s latest report, China surpassed the U.S. in terms of oil imports in September, due to oil consumption surpassing production. Part of the reason behind this is that the U.S. has been decreasing the total import of crude oil – China is replacing the U.S. demand. If this trend continues, and the decrease of oil price also continues, China will benefit from the outcome by stabilizing the export production cost, but at the same time become more susceptible to the oil price. The economic ties with the U.S. has to be a factor here, as crude oil imports to China are used for the refined oil products and the production of manufacturing goods that go to other nations around the world. Since the U.S. is the biggest individual nation in terms of absorbing Chinese exports, the susceptibility will only be counterbalanced when Chinese exports are sold with minimum hindrance.

China's Oil ImportsThe ultimate factor, however, is the sovereign debt of the U.S. held by China. In 2011 China already became the top US Debt HoldersU.S. government debt holder, accounting for the 8 percent of total U.S. public debt. Even in percentage terms the figure is very high. As long as the U.S. has the economic power to pay back the interest and return the principal for the matured bonds, both the U.S. and China have little to worry about. However, the current talks on debt ceiling and budget talk have changed the atmosphere. For the U.S. when a single country has such high debt in time of financial instability is one more thing to worry about. For China, it is now holding a potential time bomb – even though the chance of the U.S. default is very low, the lessened credibility of the U.S. government bonds means the future investment channel is narrowed. The portfolio of Chinese government requires changes, and the currently-held debt needs to be reevaluated in terms of the possibility of return. Chinese government needs to diversify its risk coming from the U.S. instability.

Geo-Political Movements of China

As China is a well-known politically stable country with one party system, at the moment of the U.S. instability, the characteristic is clearly a benefit to China. However, in modern economy, nations maintain close political and economic relationship. This means the U.S. instability will have a likely negative impact on China.

Then the question we have to ask is how much impact the U.S. instability will have on Chinese economic growth. It is possible that China would not be able to enjoy high growth rates it used to for the next 3 to 4 months, as the U.S. is one of the top 3 markets for China. If the U.S. market is not able to consume as many goods as it used to be due to the instability, China will face further reduced exports. These exports alone represent about one fourth of the total GDP, and the net export is about one eighth of the total GDP. Therefore, if China export to the U.S. slows by a considerable amount because of the instability, the consequence for China will not be great. Whether it was done to counter such consequence is not clear, but the president Xi and the premier Li’s meetings with the leaders of ASEAN nations can be seen as a type of insurance for China. This will not only increase the geo-political strength of China, thus further stabilizing regional politics, but also create more economic ties with the region to divert exports and investment channels.

However, so far the “magnet of economy” is still at the U.S. market, and the power of the magnet is very strong. In other words, the determinant of global market trends is the U.S. and that fact will be the key to the Chinese economic prospects. The geo-political factor of Southeast Asia is not yet strong enough to counterbalance the current instability formed in the U.S. market and politics.

Possible “Next Steps” for China

The Chinese market may not show a sudden change, but the prolonged instability will certainly diminish the economic strength that China has been showing for a couple of decades. This means China has to prepare for certain changes that could affect its future growth. Before the shutdown, there had been worries on the U.S. Federal Reserve’s (the Fed) tapering on quantitative easing. Now the concern on the U.S. budget and debt ceiling talks adds more worries to developing nations. Nations including China will have to worry about whether to focus on development as they have been doing, or to focus on stabilizing the domestic economy and strengthening the weak links within their own economy. As the government shutdown caused economic instability, the Fed will most likely continue its quantitative easing to secure economic conditions for now. That does not mean the instability of the Fed’s tapering is removed, because it is like the status of the U.S. budget talk: the quantitative easing is only a temporary solution.

Even though China has a huge domestic market, in time of economic instability, the driving force of economy is hard to find. Export is not going to help China go through this hard time as the whole world is suffering together, and domestic consumption growth is still up in the air. In September, Chinese exports faced an unexpected year on year drop. When looking at the income of Chinese people, that does not seem to help increase domestic consumption. Other possible economic boosts such as government spending or investment are still viable options, but the question is “how long and how much the Chinese government and corporates are willing to put money into it?”

Not only that, China also faces the question of liberalization of the market. China has shown strong commitment to liberalize and open up further to the global market, especially in financial and trade sectors. The recent interest rate reform and Shanghai Free Trade Zone were two of the examples that have shown Chinese commitment through action. Since there is instability in the global market, the economy will not be as energetic enough as Chinese government expected it to be for its liberalization process. This means that China can cut its effort down to open up the market and slow down the pace of economic expansion. This could be a problem if the investors around the world, who think China will still show strong growth, find out about the policy changes in China. Even if the investors have anticipated the slowdown, the actual impact of Chinese slowdown will be massive, considering the size of Chinese economy.

Also, Chinese government external debt has increased significantly in recent 10 years, more than tripling since 2002. China has funded many projects through debt, and if the economic expansion diminishes, it will adversely affect the debt / deficit balance in China. The Chinese government will have a harder time borrowing money at the same interest rate, and have a harder time paying back debts as the profit from projects diminishes due to the domestic economic slowdown and the global economic recession. Then the government projects will have to face the new consequence of either reduction in size or complete shutdown, and overall investment and financial inflow will diminish, which can be a vicious cycle. Even though Chinese government will put extra effort to prevent such cycle, the diminishing trend is inevitable.

However, It could be a good opportunity for China in terms of restructuring its domestic economic design. Rather than focusing too much on expansion and growth, China can restructure its economy through strengthening small and medium enterprises, or increase the consumers’ purchasing power. The latter might be a harder task for China, as it includes increased welfare, restructuring of wage systems, and implementation of social safe-nets – this is even hard for other developed nations. However, strengthening SMEs is achievable through several banking reforms that would either guide banks to give more access for SMEs to capital, or allow more commercial and private banks to open up and target SMEs as major customers.

China’s Possible Direction

Overall, China is facing a key decision-making period as the U.S. economic power is in question due to the prolonged debt ceiling and budget talks. With strong economic ties to the U.S., China faces trade-offs: whether to continue its economic expansion policies or to restructure its economy. It will be detrimental for China to continue the expansion as there will be no country to be able to support such moves economically. Especially when the world’s number 1 economy is unstable, the scenario is highly unlikely. Hence China will stay low and withhold any further reforms that can tip off the balance. Possible policies could be to strengthen domestic markets, but even then, the implementation of policies will not come fast, as the instability from the U.S. is not predicted beforehand. Nevertheless, this can be the valid option for China at this moment – the restructuring is an inevitable process for a developing nation. 

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