Institutional Investor, June 2012
For much of the last 50 years, it has made sense to think of Hong Kong, Taiwan, Macau and the People’s Republic of China as four very separate states. Hong Kong was British, Macau Portuguese; China and Taiwan’s relations were so toxic that they did not formally recognize each other as sovereigns and often seemed close to conflict.
Today, though, it is becoming more and more commonplace to speak of Greater China as a unit in its own right. Partly, this is a consequence of politics: both Hong Kong and Macau have been handed back by their colonial owners and become special administrative regions of China, while Taiwan, since the election of President Ma Ying-Jeou in 2008, has abandoned a previously confrontational policy and instead sought to embrace greater harmony with the mainland in order to foster trade and investment. On top of that, these are – culturally and socially – naturally close places, whose differing economic strengths and levels of market openness can be complementary to one another. And with the liberalization of China’s currency, the renminbi (RMB, also called the CNY onshore and the CNH offshore), Hong Kong has become the established offshore centre for the currency.
Is it time to think of Greater China as an economic bloc? “I think of it more as a single economic force,” says David Koh, head of treasury services for Greater China at JP Morgan (one sign of links between the various states is that more and more people have a title like Koh’s). “As an economic bloc? There have been a lot of improvements of late, both political and economic, from airlines through to financial services and into a lot of other industries. While it’s natural to continue to look at this as three distinctly different countries [leaving aside Macau] with different strengths, they are all synergistic and they feed off each other.”
For Koh, the big impact of this closeness has been for private enterprise. “The establishment of Greater China has enabled companies in China, Hong Kong and Taiwan to grow and become global players. There is a huge financial and economic ecosystem that has enabled a lot of companies to flourish.” Consider FoxConn: though famed as the manufacturer of iPads, iPhones and Kindles from manufacturing plants in China (it is the largest private sector employer in the country), it is actually Taiwanese: FoxConn is the trading name of Taiwan’s Hon Hai Precision Industry. Improved cooperation between the nations has made this possible.
That said, there are clearly differences in the various bilateral relationships. Hong Kong and China are already very well integrated through CEPA [Closer Economic Partnership Agreement, an economic agreement signed in 2003] and a host of arrangements around trade and services. “Whether Taiwan can be included is a more difficult issue, largely because of politics,” says Jun Ma, chief economist for Greater China at Deutsche Bank. “Many agreements are difficult to reach given that the political climate basically determines the pace of negotiation. It can take a long time, even decades, to make progress.”
ECFA [Economic Cooperation Framework Agreement, loosely modelled on CEPA and signed in 2010 between China and Taiwan] is a step in the right direction, lowering many tariffs, “but there are lots of other items that need to catch up if the China-Taiwan economic relationship is to be as close as China and Hong Kong.”
Nevertheless, most multinational banks have sought to integrate their Hong Kong, China and Taiwan operations as much as possible. “As an institution, the last few years have seen us manage Greater China more closely,” says Michael Vrontamitis, head of product management (East) in transaction banking at Standard Chartered.
While trade between Greater China’s constituent nations has been strong for many years, the lifeblood of further integration today is the liberalization of China’s currency. The internationalization of the RMB is surely the most significant step in world currency markets so far this century. China, whose currency was heavily restricted as recently as five years ago, is moving at a heady pace now, with the current account open and the capital account opening wider by the month. Hong Kong is the testing ground, the pilot scheme where new measures are tried out and through which full convertibility will likely be one day achieved.
The pace has surprised everyone. “At the start of the year, everyone was saying that this will likely be a year of slow progress,” says Vrontamitis. “But we have seen more progress in the first four and a half months this year than the last two years in terms of the speed of changes. Whether it’s the further relaxation of trade settlement rules, or a widening of the [exchange rate] band, or allowing more two way flows [RMB in and out of China], we are definitely seeing a lot going on.”
Numbers show that there is, indeed, plenty going on. The volume of cross-border trade settlement in RMB in the first quarter of 2012 was RMB580.4 billion, according to the PBOC, up about 61% on the same period in 2011. “In the first quarter of this year, that volume [cross-border] accounts for 10.7% of China’s total trade,” says Thomas Poon, head of strategy and planning in Hong Kong at HSBC. “I think there is a lot of headroom for this volume to go up.” According to Vrontamitis, cumulatively, that trade figure has risen from zero to RMB3.17 trillion (by March 2012) in barely two years. “Although there has been some slowdown in the pace of growth this year, when we look out to 2030 we see China going from 10% of world GNP to about 24%,” he says. “As a force, the trajectory is pretty positive.”
Alongside trade settlement is the stratospheric development of the dim sum bond market, or offshore RMB (known as CNH) bonds. Although there were some offshore issues in Hong Kong from 2007-9, it was only really in mid-2010 that the market was sufficiently liberalized to get going; in the less than two years since, it has grown into a large, liquid and increasingly diversified market. In 2012 up to April 27, there was CNH95 billion of new issuance, equivalent to more than half the total issuance in 2011, which was itself more than four times more than in 2010. Although the first offshore CNH issues have started to be launched in London – prompting Standard Chartered to claim that the H in CNH no longer stands for Hong Kong, but for hai wai, meaning overseas – until now this market has been almost entirely a function of China trusting Hong Kong as a testing ground, with great success.
The flows through Hong Kong are beginning to correct an area in which China differs from all other emerging markets: a total lack of openness to foreign investors. Ma’s calculations show that, considering the domestic A-share market and interbank bond market, foreigners hold only 1% of the available securities. “That is very low relative to the openness of almost all other emerging markets.” He has calculated that emerging equity markets have, on average, a 26% level of openness (in terms of foreign participation) and bond markets 13%. “China is less than one tenth of the openness of these countries.” The increase in QFII quota [qualified foreign institutional investors – a mechanism for non-mainland institutions to invest in mainland securities] in April, from $30 billion to $80 billion, was a clear signal of intent to become more open. “In the last decade only $30 billion of QFII quota was allowed, cumulatively. An increase of $50 billion is a major step forward and that’s not the end of it. It’s the beginning.” He expects the bond market to have reached 5% openness within a few years.
“We are three to four years away from basic liberalization of the capital account,” he says. “By then we are likely to see individuals and corporates allowed to convert RMB into hard currencies with a much bigger quota than they are subject to right now; it’s even possible the quota will be lifted after five years.” Even if the quota system is not gone, he says QFII quota “could double or triple in coming years”.
Taiwan-China links remain a story of potential rather than volume. Trade is certainly happening, but not as much investment as was hoped for, and in particular there has been disappointment in the financial services sector that things have not moved quicker.
“A lot of the frustration that my fellow practitioners have experienced is the pace of relaxation of the regulations,” says Paul Yang, President and CEO of CDFH, a Taiwanese financial holding company, and President of CDIB, the investment banking arm which includes the country’s most renowned private equity operation. “People have been frustrated by the amount of capital they can use to invest in mainland China, which kinds of banks can apply for a licence in China. But of course regulators take a cautious view, whereas practitioners always like to see changes tomorrow. There is a natural pull and push.”
But despite the slow pace, “business has really been happening,” he says. Through overseas banking units, Taiwanese institutions can service companies in mainland China in dollar denominated business, “and that is meaningful, because it helps margins. We expect in a year or two, we will have a substantial amount of our loan portfolio related to China business. We now sense momentum.” Now Taiwanese banks are setting up rep offices and subsidiaries in the mainland, usually around Xiamen, where Fubon made its pioneering first investment in Xiamen City Commercial Bank in 2008. Leasing companies are a current area of focus, with 12 applications in the last month.
CY Huang – who is CEO of FCC Partners, chairman of the Taiwan Mergers & Acquisitions and Private Equity Council, and chief advisor to Polaris Financial Group – also believes progress is being made. “There is significantly more cross-strait investment as well as trade,” he says. He agrees flows did quiet down ahead of the recent Taiwanese election, with China watching to see if the more anti-China opposition made much headway, but in fact the incumbent President Ma won comfortably, prompting a revival of cross-straits activities. “We have seen a significant increase in PRC tourists, and steps towards liberalization of cross-straits activities,” says Huang. The Taiwanese government recently announced a third batch of industries allowing PRC investment; previously around 220 industries were permitted, but few were of interest, and the latest liberalization brings the number to around 300.
“A key agenda this year is to facilitate cross-strait investment activities,” says Huang. “Previously there has been a lot of talk about the concept, but now people are talking about getting into action and getting something done. The reality is there haven’t been a lot of investments getting done yet and that is the key priority this year.”
Commentators have tended to focus on one direction in cross-Straits flows: Taiwanese entering China, since doing so is so crucial for the otherwise clogged and competitive Taiwanese economy. But it is a two-way street. Chinese banks are opening branches in Taipei; China Mobile has opened a new subsidiary in Taiwan; and gradually more industries are being opened to cross-Straits investment. Taiwanese are somewhat nervous about this.
One area where the currency and Taiwan themes come together is in Taiwan as an RMB centre. UBS, for example, has begun settling trades in RMB in Taiwan. Huang says the Taiwan government recently announced the building up of a cross-straits financial platform that would, among other things, facilitate RMB-related trade flows as well as investment activities. “That is a sign that Taiwan recognizes that RMB internationalization is a very important trend, too big to ignore,” Huang says. “Previously Taiwan has shied away, but now it is looking at tapping into the opportunity.” The idea of Taiwan as an offshore RMB centre previously encountered some resistance locally, since it is politically sensitive, and appears to show a further inevitability about Taiwan becoming a part of China. “But Taiwan does have certain advantages,” says Huang. “There are huge trading flows between Taiwan and China. Hong Kong is more financial services; you don’t see many solid industries or high tech companies in Hong Kong wanting to invest in China. Taiwan has a lot more economic direct investment from industry, and nobody should overlook that.”
A key way to assess Taiwan’s intentions is in what it allows Bank of China to do. In Hong Kong, Bank of China was instrumental in the launch of RMB business since it is a clearing bank there and provides most of the RMB liquidity in Hong Kong. In Taiwan, it has been given permission to upgrade its rep office to a full branch (as has Bank of Communications), so it will be interesting to see if it becomes a clearing bank for RMB in Taiwan.
Would offshore RMB business be good for Taiwan? “For its own financial sector, definitely,” says Ma. “If it doesn’t allow RMB business, most of the demand will be met by Hong Kong. Taiwan’s corporates who need RMB for trade settlement or investment will all come to Hong Kong.”
One can argue that Taiwan-China ties and Chinese currency liberalization are all linked on the same path of growth and intervention. “The entire international trend of RMB internationalization is making the RMB more of a regional currency, and that ultimately is going to force three unique geographical entities – China, Taiwan and Hong Kong – to cooperate and compete,” says Huang. “At the say time they will be gradually converging – I wouldn’t yet say integrating – into a bigger Greater China entity.”