So it is clear that there are many compelling reasons for investors to be interested in China: firstly, China’s stock market is at relative lows which has opened up some unique and historically cheap opportunities to get into the market. Secondly, although growing at a slower rate, the Chinese economy is still one of the fastest growing in the world, which offers better investment opportunities as compared to other market. Finally, demand for a more mature finance industry from both the government and investors is very strong both from the aspect of Shanghai becoming an International Financial Center as well as the current lack of investment channels and products for China’s wealthy. However, threats and problems always stand along with opportunities.
One of the largest challenges is the lack of a mature credit system. In particular this is hurting SMEs in China as they are struggling to obtain financing through banks and have had to rely on informal lending channels. This is not because banks are unwilling to lend money, they are lending plenty, but mainly to large state owned enterprises – very little is making it to SMEs. We may see this change however as there is a pilot reform in Wenzhou, Zhejiang province to provide innovative financing solutions for SMEs.
In addition the lack of a mature credit system, government officials are still very unsure about whether to officially introduce hedge funds into China or not as policy and governance of hedge funds is not clear cut. Multiple government regulators manage the financial market and as the regulation is unclear around hedge funds, moving forward in any particular direction is challenging.
Further, local competing products such as PE funds, trusts and wealth management services in China are all considered ‘substitutes’ for hedge funds, which should be thought of as a barrier to entry as Chinese investors are more willing to invest what they are familiar with rather than something they aren’t.
So now the question is how to enter China for hedge funds: QFII and QDLP are thought to be two justified and legal methods for hedge funds to enter Chinese market, however, QFII quota is not allocated directly for hedge funds, so some additional legal structuring needs to be done if hedge funds plan to enter through QFII. QDLP is currently more suited for PE rather than hedge funds and typically not really suitable for large scale financing.
Normally, hedge funds enter China through retail trading such as opening private accounts using Chinese citizen’s ID cards, which is within the grey area of the current regulation system. H-Shares in Hong Kong are also a good place for foreign investors including hedge funds to get exposure to the Chinese economy and financial markets. While not a perfect hedge, it is functional as some large Chinese companies are listed on both the A-share and H-share markets and many Hong Kong companies have factories and companies in China mainland. Further, the Hong Kong market is seen as being more mature with better access to various hedging products.
In general, the event sentiment was that although there were challenges along with the opportunities, most hedge funds who take early mover advantage are usually not short-sighted and understand what they are getting in to and for the sake of long-term profit, accept the risk.