Investing in China: Why the Media Has it Wrong
ED LOPEZ: Thank you for joining us this afternoon. This is Van Eck's conference call "Investing in China: Why the Media Has It Wrong." I'm Ed Lopez, Marketing Director for Market Vectors ETFs here at Van Eck. Today, we will be covering trends in market reforms, the current economic landscape, and the local fixed income market.
Why China? Why now? China is an area that Van Eck has long had an interest in and Van Eck has been a pioneer in providing investors with access to China. In 2010, under the Market Vectors ETF label we launched the first U.S.-listed ETF to provide exposure to the local A-share market, ticker symbol PEK. Last year, we introduced the SME ChiNext ETF, ticker symbol CNXT, which provides exposure to A-share equities that primarily focuses on non-state-owned or privately held companies that many consider to be part of China's new economy. Late last year we were also the first to introduce the first U.S.-listed China Bond ETF, ticker symbol CBON. It provides exposure to the large and growing onshore bond market. The fixed income area in particular is where we will concentrate our efforts today.
With that, I will turn it over to Mr. van Eck.
JAN VAN ECK: Why do we think the media has it all wrong, or why do I think the media has it all wrong? I think the subtext for a lot of media stories about China is that there is some big risk that is so big it is what I call systemic risk. And whether that is because growth is slowing, or there is too much debt, or there is a real estate bubble, or there has been overcapacity in one industry or another, there seems to be, and certainly we talk to a lot of investors who have this fear and it really was priced into the market six months ago, a major systemic risk in China and the financial system could collapse. I'm just going to talk about two reforms because the Chinese policy makers absolutely do not want the existence of a systemic risk because their dream is to have a China that does not go through a boom/bust cycle, but rather can deal with its reforms in an orderly manner and have good employment – in fact, they do have a good employment situation in the country today.
Let me just set the stage for one of the concerns, which is the big growth in shadow banking. The background for that is twofold. First, as the world economy stopped in 2009, China probably had the biggest stimulus program and threw a ton of money at projects. In short, if there was a project on a bureaucrat’s desk it got approved and funded. Second, the reformers wanted to provide credit to the private sector and the banks that existed were simply not doing that. They basically said to the market: “OK, go crazy and lend to whomever you can, lend to companies that need credit." That was what was called the "Wealth Management Products." It's basically privately placed loans raised from institutional and wealthy investors for local government projects, companies, and a whole range of different things, which increased debt levels. For the last several years, especially in the last 12 months, policy makers have been addressing it through the various reforms. I could talk about the reforms for hours, but I'm just going to address two.
The first reform to address is that of local government debt. Local governments are very subservient to the central government for funding and had to use a lot of unconventional ways to get funds. One was selling property that was in the cities, and another was getting bank loans through companies that they owned and they borrowed money from, off budget. About a year ago, the central government said, “alright, no more shadow loans. You can't raise any more money that way. I'm going to approve the creation of a municipal bond market." They basically said, "look, if you can't pay your debts, we're going to go to the companies that are owned by your local government, go after their profits, their capital, and then sell the assets or sell the company if we have to." So there was transparency in terms of the assets that they would go to if there were credit problems with this local government debt. There has been about ten major municipal issues all trading at the same or similar credit rating as the central government, but radical reforms. All of that debt has to appear on the books of the local government now. So there's transparency there, which mitigates some of the concerns over debt.
In the financial sector there are basically four legs of financial reform. Number one, the out of control gray market, the private debt, the wealth management products that have been increasingly regulated whereas a bank that's involved in that or other institution has to either very explicitly guarantee the debt or not. Either that's on the bank's books or the investor has to beware. There was a trial balloon, semi-default restructuring last year to clarify the message that the policy makers had towards that market. Secondly, they've removed restrictions on commercial bank lending. There are no restrictions on the lending rate and there are no restrictions on deposit rates beyond five years. Thirdly, there has been the emergence of a bond market that serves corporates. And fourth, they reinvigorated the equity markets. They allowed IPOs again and there were 120 IPOs in mainland China last year. They're looking at issuing preferred stock and in reforming their de-listing systems. That’s the two major reforms: local government and the whole financial sector.
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