walls street of asiaValue Investing In Asia

Trader Homework: The Wall Street of Asia

This is an edited extract from Value Investing in Asia: The Definitive Guide to Investing in Asia by Stanley Lim Peir Shenq and Cheong Mun Hong (published by Wiley, November 2017)

The Wall Street of Asia

When it comes down to financial improvements in Asia, look no further than how far China has come in the last few decades, with banks that could rival their peers in Western nations. Even Jamie Dimon, Chairman of JP Morgan Chase & Co. (“JP Morgan”), highlighted in a 2016 interview that Industrial and Commercial Bank of China (“ICBC”) was already earning nearly twice as much as JP Morgan.

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He also highlighted that China’s banks are probably growing faster compared to US banks and could one day be much bigger than them. At the moment, China’s financial industry has four mega-banks:

  1. Industrial and Commercial Bank of China Limited (“ICBC”)
  2. China Construction Bank Corporation (“CCB”)
  3. Bank of China Limited (“BOC”)
  4. Agricultural Bank of China Limited (“ABC”).

However, China’s financial market is still viewed as highly regulated and somewhat underdeveloped. One reason is that almost all banks in China are viewed as state-owned enterprises where the government has a large influence over their directions. Even though the country has embarked on financial reforms with the objective of opening up its financial system, it is still a distance from being deemed a “free market”.

The stock markets in China still experience wild fluctuation every now and then due to regulatory intervention. As recently as January 2015, the China Securities Regulatory Commission suspended three big brokerages from opening new margin trading accounts for three months after suspecting them of financing high-risk margin trading. The market started freefalling after that. On 28 July 2015, the Shanghai Index fell about 8.5%, the largest percentage fall since February 2007.

On the same day, more than 1,700 stocks listed on the exchange went down by their daily limit of 10%.3 Such swift and strong curbs are not common in markets in the US and Europe. However, such actions are not uncommon for the Chinese financial regulators.

Such interventions might not be all negative for investors though. There are some who believe that timely interventions could possibly mitigate financial meltdowns of epic proportions such as the 2008 Global Financial Crisis.

Table 1: Market Size

The developing financial market in China also holds huge opportunities. The present tight credit regulations mean that there is a huge potential for the financial sector to expand greatly as regulators open up the financial system.

The country is already experimenting with multiple initiatives such as the free-trade zone in Shanghai, the “Shanghai–Hong Kong Stock Connect” and the opening of Chinese Yuan clearing centres in major markets globally. The Chinese government is also paving the way for the Chinese Yuan to become a reserve currency. Imagine the potential of a liberalised Chinese financial system.

China’s debt market is another area of possible growth. From Table 1 above, we can see that bank credit still made up the bulk of financing for China’s economy. It is worth mentioning that most of the credit still flows to large corporations, in particular to the state-owned enterprises.

However, as the industry liberalises, we might be able to see a more efficient financial system, allowing smaller companies to raise funds more easily, resulting in a more vibrant economy. Nevertheless, there is still risk in the financial sector in the short term.

Tight regulations have led to many companies resorting to “creative” fundraising methods, commonly known as “shadow banking”.

Currently, the authorities are not reining in on them forcefully as they have not been proven to be a major disruption to the whole economy. However, if the situation gets out of hand, we might see significant short-term disruptions to the financial system.

This is an edited extract from Value Investing in Asia: The Definitive Guide to Investing in Asia by Stanley Lim Peir Shenq and Cheong Mun Hong (published by Wiley, November 2017)