Wall Street beyond the Chinese Wall: Market infrastructures and the slow opening of China’s capital markets

Johannes Petry

a man wearing glasses

On 18 June, JP Morgan received approval to become the

first fully foreign-owned futures company in China

. Despite the Trump administration’s

recent attempts

to sever financial ties between China and the United States, Wall Street is venturing aggressively into China.

Capital markets in China have rapidly developed in recent years and its financial system has grown into a $45 trillion industry that boasts the 2nd/3rd largest bond, futures and stock markets in the world – providing Wall Street with the opportunity of a lifetime.

While previously, the likes of Goldman Sachs and JP Morgan were only allowed to own 49% of their joint ventures, they can take full ownership of Chinese securities, futures and fund management companies as of 1 April 2020.

Consequently, global investment banks and asset managers are paying fortunes for controlling stakes in their Chinese joint ventures after they had been relegated to junior partners for more than two decades. JP Morgan for instance is estimated to spend $1 billion to gain control over China International Fund Management, paying a 33% premium. Goldman Sachs, Morgan Stanley and Credit Suisse have received regulatory approval for similar take-overs.

This opening of China’s financial sector is one of the major outcomes of the ‘phase one’ trade deal between the US and China. In fact, China’s closed-off financial markets had been a key point of contention in the trade war negotiations, with the US trying to facilitate a more encompassing opening of China’s financial system.

Many observers have hence viewed the opening of China’s markets as a major concession to the Trump administration, portraying Wall Street as one of the few winners in the trade war. Others view it as a sign of China finally opening up and that ‘for Beijing it’s a final frontier – and there is no going back’. There is a feeling of a new gold rush as global banks scramble to buy prime office space in Shanghai’s financial district.

Managing markets through financial infrastructures

However, as I argue in a recently published academic article this assessment might be misguided. Instead of focusing on ownership, the crucial factor that enables continued state control over China's capital markets is the organisation of financial market infrastructures.

Based on more than 100 interviews conducted with regulators and market participants in Shanghai, Beijing, Hong Kong and other financial centres, I analyse how China’s state-owned stock and derivative exchanges actively manage and steer the development of its capital markets.

China’s capital markets function differently from ‘global’ markets whose primary function is to achieve efficient outcomes through the generation of private profit, thereby often constraining state power.

In China, capital markets are instead rigorously controlled to serve the interests of the state. Rather than a break with China’s state capitalism, my research demonstrates that the development and opening of China’s capital markets is actively steered by market infrastructure providers such as exchanges. This helps to sustain China’s existing socio-economic system, enabling continued state control and intervention into its economy.

While state ownership is of course still relevant in this respect, importantly a loosening of ownership rules – as we currently see with Wall Street rushing into China – does not equal a retreat of the state.

In the case of China’s capital markets, it is through trading rules and margin requirements, market data and index licenses, position and order (cancellation) limits, capital controls and regulations on the repatriation of profits as well as an extensive investor identification and trading monitoring system that Chinese regulators are able to shape the dynamics of its capital markets – without relying on extensive ownership of its financial industry.

As HKEx’s departing CEO Charles Li fittingly stated during the 2017 FIA Asia Derivatives Conference: “While Europe is struggling with MiFID II, in China you have MiFID 10.”

Market opening with Chinese characteristics

Opening its markets to global banks is in China’s interest as it wants to become a global financial powerhouse. However, as the CEO of a Hong-Kong based asset manager stated, “it is absolutely a love and hate story, they love the money, love the stability, hate giving up control…and hate it if foreign investors want to dominate the term”.

Through financial infrastructures, the Chinese state simultaneously facilitates an opening and apparent liberalisation of its markets while strictly maintaining control over these developments.

A great example of this is the closed-loop system of the Stock Connect and Bond Connect that enables order routing and investment flows between Hong Kong and mainland China while maintaining capital controls.

These Connects have been crucial for MSCI, FTSE Russell, S&P DJI and Bloomberg’s decisions to include China into global equity and bond indices. Consequently, these inclusions triggered record inflows of passive and active investment into China’s capital markets as foreign ownership in Chinese stocks and bonds increased from 1.6% to 3.2% and from 1.7% to 2.5%, respectively, between 2016 and 2020. As ETF Stream noted in a recent article, this has been a ”gamechanger” for the ETF industry. However, these foreign investors have to adapt to Chinese market characteristics and are severely constrained in their actions.

The same logic applies to China’s relaxed ownership roles for financial companies. Even if foreign players can soon fully own onshore financial institutions, they are still registered in China, subject to capital controls and must play according to the rules of the game set out by the Chinese exchanges and regulators.

As one Chinese broker stated: “[While] the regulations have been changing in the last two years, what is not changing is the infrastructure…Yes, the regulation is seemingly becoming more international, [but] they will never change the infrastructure because this is where they can exercise the power.”

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Similarly, a Chinese regulator noted that while there is “closer alignment towards international practices” with respect to financial regulations resulting from the trade war, “the infrastructural arrangements stay the same – because this is where you can control the market!”

Although China’s financial regulations seem to approach international norms, the infrastructural arrangements that enable the Chinese authorities to manage capital markets have remained unchanged.

From this perspective, the “concessions” made by the Chinese government do not represent a departure from its pre-existing path of gradually developing and opening up its capital markets while maintaining control over this process. Rather than a break with Chinese state capitalism, the opening of capital markets in China is shaped in accordance with its socio-economic system.

Chinese capital markets are increasingly integrated with global markets and the world’s largest financial players are active in China, but they have to play according to Chinese rules.

In contrast to Western markets, they are at the bottom of the food chain – and are very likely to remain there. While the powerhouses of Wall Street might have scaled the Chinese Wall, it will be a long way until they gain a real foothold in China’s financial markets.

Johannes Petry is an ESRC Doctoral Research Fellow and PhD Candidate in International Political Economy in the Department of Politics and International Studies, University of Warwick

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