The launch of Shanghai-Hong Kong Stock Connect marks a new milestone in the opening-up of Chinese capital market. Overseas investors have reaffirmed their stable expectation for internationalization of the Chinese capital market, heightening their enthusiasm for participation. More and more large financial institutions are making and implementing long-term plans in the Chinese capital market.
The active and broad participation of overseas investors is a key micro foundation of the market to realize the internationalization strategy. Overseas investors’ reasonable demands for institutional arrangements such as market transparency, as well as their trading cost endurance, serve as a driving force and test stone for furthering capital market reforms. A key task confronting us during the process of internationalization is to learn and understand the characteristics and requirements of overseas investors. The QFII scheme has been around for 12 years since it was introduced in November 2002. By the end of November 24, a total 272 QFIIs have been approved of USD 64.061 billion worth of investment quota. In terms of time span and coverage, QFIIs serve as a window for us to know and understand overseas investors. The experience of QFII practice over the past 12 years provides us great insights and shed light on the following respects:
First, the investment philosophy of QFII. When the QFII scheme was introduced 12 years ago, regulators hoped that QFIIs would be long-term value investors and play a unique role in market stabilization and price discovery. QFIIs come from different institutions including university endowment funds, sovereign wealth funds, investment banks and insurers, demonstrating varied investment styles. In spite of their diversity QFIIs have practiced the value investment philosophy as regulators had hoped in terms of asset allocation preferences and turnover rates. Their investment philosophy was also well known to the market. For example, in 2013, QFIIs’ average holding period was 115 days; the average ROE of the stocks they held was 18% and the dividend yield ratio of such stocks was 1.57%. All these features point to a clear value investment philosophy. In the primary market, QFIIs practice sound risk control in the subscription for IPO shares in contrast to other investors. Our statistics of QFII’s subscription to IPO shares during 2009-2012 revealed that QFII’s bids for IPO shares dropped in terms of both absolute and relative volumes in the irrational bidding inflation. QFII’s stepping away from the market in another way indicated that they adhered to their investment philosophy. In making investment decisions, QFIIs emphasized the importance of corporate social responsibility and integrity of listed companies. They also paid more attention to and were more actively involved in the governance of listed companies. Such philosophy and practice have greatly helped change the investment philosophy of domestic investors. For example, in 2012, thanks to the opposition of a university endowment QFII, a local state-owned assets administrative office changed its appointment of a director to a listed company. After that case, a few domestic institutional investors said: “We indeed do not pay as much attention to corporate governance of listed companies as QFIIs and we must learn from them.” As a matter of fact, it is the investment philosophy pursued by QFIIs that is more likely to put into practice and operation the much-awaited “market-driven restraint mechanism”, thus facilitating progress of the market.
Second, QFIIs’ understanding of real economy and industries. QFIIs have a long history and rich experience of investment in overseas markets. They witnessed industrial life cycles and industry upgrading of both advanced countries and emerging markets. Therefore, they are in a good position to analyze and understand these industries from a broader and long-term perspectives. For example, quite a few industries that are undergoing rapid development in China, including some emerging industries, have become mature in overseas markets. Because of this, QFII’s experience in understanding industries can be adopted in the Chinese market. Our survey shows that QFII has given profound attention to A-share companies. On Shenzhen’s market, their asset allocation to stocks on the SME Board and ChiNext Market have been on the rise in the past few years. Some domestic institutions are also “looking for the next rising star”. This can be seen as an outcome of QFII’s intensive screening in the A-share market. We also hope that QFII’s investment interest and their professional judgment in China’s emerging industries will play a bigger role in the improvement of the market’s risk pricing ability.
Third, QFII’s mature management philosophy and robust management system. We need to learn more from QFIIs in these two aspects, which are currently our weak links. Let’s take selection of domestic asset managers as a case in point. On one hand, QFIIs value long-term ROI and do not put much pressure on managers for short-term performance fluctuations. So they trust the managers they appointed. On the other hand, QFIIs have a very strict and scientific selecting process for managers and only few managers can win their favor. So they never hire any manager they mistrust. For example, in selecting managers, QFII often has three stages. The first round is a mass selection which may involve dozens or even hundreds of managers. The second round is due diligence investigation of investment departments, mainly involving understanding the investment philosophies, stock screening ideas, decision-making processes, risk control and turnover rates and other particulars of managers. The third round is due diligence investigation of back offices, often including only two to three finalists. At this stage, QFII will visit the managers’ offices to communicate with the heads of the latter’s risk control, legal and compliance, order execution and clearing and settlement departments on the issues of day-to-day maintenance. After the global financial crisis, more and more attention has been paid to risk control and legal and compliance of middle and back offices as they often manage large-scale, long-term public or state funds for which security is the foremost issue. After the three rounds of interaction, a list of up to 150 questions will be formed. Such rigorous process and professional and detailed question list not only ensure the selection of a qualified manager, but also unknowingly helped the formation of a domestic professional investment team.
Internationalization of the capital market is a two-way process. We need to know and understand better about overseas investors, while overseas investors also need to know and understand China’s markets, listed companies and institutions. Since 2013, the SZSE has been making active and systemic attempts in these two respects.
On one hand, we established the “Home for Members,” one of whose purposes is to provide training for members on internationalization and other issues.
On the other hand, we launched a series of activities called “Investor Open House Program” for overseas investors. In the past year, we have organized seven such activities and nearly 200 representatives from institutions in the US, Europe, Southeast Asia and Hong Kong have joined face-to-face communication listed companies. During the latest activity conducted in October, more than 20 representatives of overseas investors including Khazanah Nasional Bhd (Malaysia Government’s Strategic Investment Fund) visited eight ChiNext-listed companies including Tempus Global, Tianyuan Dic, Centre Testing. As their communications have been made publicly available on SZSE’s Easy IR platform, retail investors are able to learn from overseas professional institutions such as how they analyze a listed company, hence improving their own investment knowledge.
The newly held fourth plenary session of the 18th CPC Central Committee has adopted a decision policy to comprehensively promote the rule of law inChina. We believe that, relying on the powerful real economy of China which now ranks the second in the world, with the continued improvement of legal environment of the society and markets, China will expedite the two-way opening-up of its capital market in both size and quality. The SZSE will also spare no efforts to improve its level of internationalization.