Dublin and Luxembourg will have to do a lot more to persuade and educate China on the merits of funds domiciled these locations, writes Mark Godfrey.
The Ritz-Carlton Hotel near the People’s Bank of China (China’s central bank) in Fuxingmen will be the place to be on December 3rd when the Association of the Luxembourg Fund Industry (ALFI) rolls into town for what it’s terming a roadshow to tell China’s financial services industry why it should put its spare cash to work in Luxembourg.
If it’s anything like a previous presentation by ALFI it’ll be deliciously dripped in irony, with European financiers, ex-financiers and government officials promising Chinese financiers and officials that Luxembourg is best because it’s a democracy where investors’ rights are protected. Similar presentations have been made by the Irish Funds Industry Association (IFIA) in Beijing, though in less ostentatious settings. The visits are part of an education process to capture what is expected to dwarf the massive Japanese investment in funds, some of which are ensconced in the IFSC in Dublin, and many more in Luxembourg.
Newcomers
China has been portrayed as the new battleground between Dublin and Luxembourg, but China is a few decades off Japan’s investment sophistication. A cautiously regulated financial system here – largely run by state-owned institutions – means Chinese are relative newcomers to the funds game. Mutual funds remain a new science in much of China. But the current government’s eagerness for financial reform and internationalising the Renminbi/Yuan means more Chinese money will be headed into foreign assets during President Xi Jinping’s tenure than in any time since Mao established the People’s Republic.
Like everything in China, financial reform happens by a long series of trials. This tip-toe approach was personified in the last big move by Beijing to allow domestic investors to put the non-convertible Yuan to work overseas. The Qualified Domestic Institutional Investor (QDII) programme was designed as a quota-based trial for approved, select Chinese financial firms to invest in overseas funds and stock-markets. But the timing was awful: QDII went live just as the financial crisis approached. Moreover, Chinese investors have not been impressed by returns from overseas stock exchanges (though returns from the unreformed Shanghai exchange have hardly been better). Hence they’ve switched to investing in overseas real estate – still the favourite asset class of Chinese investors.
More recently, China has launched a pilot closer to home. First it allowed foreign hedge funds to collect cash in China for investment overseas. But the quota allowed to each of the five hedge funds – $50mn – is miniscule in the context of China’s investment flows. The second pilot is more significant: a new free trade zone in Shanghai which will, according to its promoters, allow foreign financial institutions to offer investment products hitherto off limits in the rest of the country. It’s also in this zone that China is to allow the first free conversion of the Yuan. It’s in Shanghai then, not Dublin or Luxembourg, where China will learn how and where to invest the soon to be convertible Renminbi.
Capital outflows
Paranoid about capital outflows, Beijing is nonetheless being driven to liberalise investment options and capital account controls by dangerous credit and real estate and banking bubbles. Officials have been scared at the potential fallout from soaring real estate prices as well as a proliferation of underground banks and shady wealth management products being offered by local banks to entice deposits.
Given the paucity of options in the domestic market it’s not surprising Chinese investors, holding a still-appreciating currency, are seeking high risk, high return punts with their money. But they’re skeptical of putting money with European money managers given the dismal performances of QDIIs. Chinese also remain very skeptical of financial regimes they don’t fully understand. Dublin and Luxembourg will have to do a lot more to persuade and educate China on the merits of funds domiciled in either location. The financial crisis damaged the image of western finance in China. The Luxembourg funds industry will also have to explain its Bernie Madoff problem. Chinese business magazines like the Economic Observer and Caijing ran pages on Luxembourg’s regulator, the Commission de Surveillance du Secteur Financier, and claims it failed to appropriately deal with a bond fund that violated its investment rules – all of which is currently being investigated by the European Securities and Markets Authority. Madoff is a fear the Chinese recognise, given the proliferation of underground investment schemes here.
Ireland’s travails have also been reported here but the country’s image remains untarnished due to relative lack of awareness about Dublin’s place as a financial services centre given the relentless promotion of London, with which Dublin has been lumped as an addendum in the Chinese mindset.
The IFIA, an industry body which promotes the IFSC has yet to open an office or hire a local representative in Beijing. Unlike the Luxembourg counterparts its website doesn’t have a Mandarin-language section – though it does have an office in Shanghai. Any serious impact by Chinese funds in Dublin remains some years away. But the time to make the case has come.
