Some Friday Thoughts

I haven’t had chance to complete a couple of analyses that I have planned but I wanted to bang out a couple of thoughts.  First, a couple of follow up thoughts to my Bloomberg View piece on MSCI including China. Second, some thoughts on the news Chinese regulators asked banks to review loans made to Anbang, HNA, Dalian, and others.

People frequently mistake my writings that I do not want China to join the international market place.  Nothing could be further from the truth. I think opening up Chinese financial markets in both directions is good for Chinese and foreign financial markets.  I think for many reasons the RMB becoming a major international currency is a good thing.  I think, and I will provide stronger evidence of this in upcoming writings, that opening Chinese capital markets specifically in equities and fixed income is a good thing.

What was so problematic about the MSCI piece is that pretty much all of the problems they cited last year still exist and some have even gotten worse.  Their entire announcement focuses on issues that they had never before prioritized and additionally programs that had been in existence before.  Near end they spend a paragraph basically restating all the problems they cited last year and saying they hope these things change in the future.  In other words, little has changed but MSCI decided to admit China anyway.

There are a couple of things, if history such as the IMF is any guide, that MSCI acceptance means.  First, this is the end of capital market reform. Maybe some more on the bond market because MSCI hasn’t included China is MSCI bond indexes but for various reasons which I won’t get into at the moment, that is may not be terribly important.  Whatever impetus for Chinese reform is effectively dead, not that there was much before.

Second, there is no rule(s) that won’t be bent by firms to appease Beijing.  I am a big believer in markets but there is no part of Chinese financial markets that is remotely market oriented.  This is setting up all kinds of problems that will need to be dealt with later.  If there is one thing that we have learned not just in the financial industry, ignoring these risks will frequently catch up with you at some point. However, smashing every rule of what constitutes a market is creating lots of risks.

I’m actually very sympathetic to the dilemmas faced by MSCI. I was talking a fund manager recently who said he was torn recently. As he said, they clearly have such enormous regulatory and structural issues that really haven’t been dealt with but they are also too big to ignore.  However, any real hope that MSCI may hold out for continued reform, if history is any guide, is now dead.

Probably the height of irony that just proves my point is that MSCI says it actually has to implement the inclusion due to continued market restrictions. The day it was announced, China reminded MSCI of market regulations that let us just say create problems.

Briefly on the matter of the Chinese regulators telling banks to review loans made to HNA, Anbang, Dalian, and others. I should note that parts here are speculative and anyone who tells you they really know really does not.

First, we should not be under any illusions that these firms are in anyway ethically or legally saints.  At best they have pushed the boundaries of what even in China was considered legal and would definitely be allowed any place else.

Second, it is important to note that these firms were widely encouraged not just in their overseas acquisitions but their domestic build up.  There is a mountain of evidence and other information that these firms were encouraged to do the behavior that is now being called into question.  I do not mean to say this to necessarily defend them but more to provide context on these events.

Third, this begets the questions, so what exactly is going on?  To me there are three basic possibilities (with many variations on these themes). A. Regulators are going through standard management and regulatory processes and these companies just happened to run afoul of the rules.  This is possible but I think less likely.  While these firms may have been the biggest, there are so many firms that could be hauled in for the exact same types of behavior that these firms engaged in.  So why these firms now?

  1. There are political motivations. I think this is more likely than the previous option but not the most likely option. This is what amounts to an election year in China, really only a few months away at this point, so this is not a good look for a regime emphasizing stability and progress.  It is possible they are trying to send a message to other firms but seems like the bigger message is not one they want to be sending right now.  In short, I think it is possible there are political motivations at play here but not the most likely.
  2. I think the most likely explanation is that there are very real financial stresses. I think there is a wealth of evidence of increasing financial stress in Chinese markets.  One thing that has become abundantly clear in Chinese markets is that problems arise unexpectedly and there is always a massive amount of information that should have been revealed before.  I have no secret information but I believe this is the most likely explanation though others are always possible.

2 thoughts on “Some Friday Thoughts

  1. MSCI – i am not sure that I agree with your view that reform is now dead. Reform has always been an incredibly long slow and drawn-out process in China – tending to move forward inch by inch, rather than the western approach of big changes. But although the chinese approach may be extremely frustrating, the western approach also has its failings (look at the excessive levels of compliance imposed post the financial crisis – many in the wrong areas – driven by the short term political need to be “seen to be doing something”). Its worth remembering that although China has now been included in the MSCI indices, its weighting is tiny and the move will have little or no impact on China’s real aim, which is to attract large quantities of foreign investment in its domestic capital markets. I see this more as a “sop” to China, with a list of “to dos” if China wants to see the weighting increase. So far from ending reform, I think it may encourage it. The key lies in the outcome of the party conference in the Autumn – either we get a new group of leaders prepared to grasp the bull by the horns and reform, or the long (and possibly medium) term outlook for China is not good.
    Anbang/HNA/Fosun/Dalian – I think you are right about the context and I think you conclusion concerning the likely reason is probably spot on. I suspect this actually flows from the detention of the Anbang Chairman – following his detention insurance premiums at Anbang have dropped significantly in a very short space of time, and it turns out that Anbang not only has a lot of short term liabilities in the market funding its long term investments, but it has also been a major source of funding in the short term market (particularly for smaller banks) using its significant monthly premium income. So when premiums fell precipitously, the regulators suddenly found a major source of short term liquidity cut off in the market – hence the large PBOC injections of late. This prompted the CBRC to ask the question whether all these big acquisitive groups were equally problematic – if their short term funding for long term assets dries up, do they then withdraw their short term assets from the interbank market leading to a liquidity squeeze (particularly for the smaller banks). My guess is that we have here a case of the political anti-corruption campaign arresting a player without discussing the consequences with the financial regulators and the immediate consequences causing a scare which led to the regulators scrambling to assess the systemic risk associated with these big acquisitive players. But what do I know, as a foreigner, I can never hope to truly understand the nuances of China (political or financial) :o)

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