Impediments to cross-border investing

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Asia Pacific is not an homogenous marketplace, with significant regulatory, cultural and structural differences between countries for institutional investors at an operational or transaction level.

Steps have been taken in many countries in recent years to alleviate the problems and move to a more level playing field. At the same time, some markets, notably China, have been set on a path of deregulation and opening up to foreign flows.

Below is a report published in BRW, Australia’s general business weekly, canvassing some of the issues and possible remedies.

A funny thing happened on the way to the Chinese stock market
By Greg Bright

There’s an old joke in the back offices of funds management firms. It’s not particularly funny, but it is illustrative.

It goes: A portfolio manager swaggers into the office boasting that he’d just scored off a big stock bet. He’d doubled the clients’ investment in just a few days. One of his colleagues, in charge of investment administration, responded: “That’s nothing. We just settled a trade in China!”

The point is: it is one thing to make an investment decision in the so-called developing world, such as Greater China, but it is another to implement the decision in a timely fashion.

Impediments to cross-border investing across the Asia Pacific (APAC) region’s 22 countries were discussed last month by representatives of 11 global custodian banks at a meeting linking participants in Hong Kong, Singapore, Sydney and Melbourne. The meeting was hosted by Laurence Bailey, Hong Kong-based regional head of JP Morgan Worldwide Securities Services, who plans to organise a follow-up meeting in October.

Bailey says that there are various factors which present obstacles to cross-border investing, not just legislative and regulatory differences between nations. There are also structural differences and even cultural differences which impact on the way markets behave or present problems for foreign investors.

He says that the meeting was an informal gathering to see whether there is an appetite for the major custodians to work together to help ease some of the problems which affect all their clients.

“We are just taking baby steps at the moment,” Bailey says, “to identify a few issues which we can better address as a collective than as single banks. It’s early days but it is clear that greater uniformity among the region’s markets would be of benefit to investors and probably aid the development of those markets as well.”

He expects that a further meeting or two will be required before a decision is made whether or not to proceed with a more formal body to represent investors in the operational aspects of their investment decisions.

“We’re just testing the waters at the moment.”

An example of a structural difference with, say, the main Chinese ‘A’ share market (the shares which qualified foreign investors can buy from an expanding quota) and Australia’s, is that the Chinese market is dominated by individual rather than institutional investors. This means that it is very difficult to borrow stock in order to short-sell, as many hedge funds do, even though short-selling is now possible following a relaxation of restrictions and even though foreign hedge funds will next year be able to qualify for a quota to buy China A shares for the first time. According to Deutsche Bank, one of the custodians operating in China, it can cost up to 8 per cent of a stock’s value to borrow, which would make it difficult, if not impossible, for the borrower to make money on a trade, at least in the short term. There is also a cultural element to the Chinese investor behaviour, which is to follow a herd mentality and have a short-term horizon, more so than Australian investors – the famous Chinese love of gambling.

John Moore, an implementation specialist who runs the APAC investment services business for Russell Investments from Tokyo, says that investors need to consider all the costs associated with cross-border investing but the biggest cost will usually have to do with the currency risk they inevitably take on.

The Asian region tends to be a high cost one for investors, Moore says. Brokerage, commissions and other transaction costs tend to be high. He also points out that there are some “interesting” regulatory costs. In Taiwan, for instance, an investor has to pre-pay his share purchases into an approved bank account, which has the effect of losing interest on the money for several days.

“It may not seem like a lot of money as a percentage, but it adds up when you are investing millions,” Moore says.

The currency issue has several aspects. Firstly, many APAC currencies are either thinly traded or not traded at all, which means the spreads between ‘buy’ and ‘sell’ are very wide, which means they are expensive to get into or out of. Secondly, every investor has to take a position on the local currency – either to hedge against a rise or fall, against his or her own currency, or to not hedge. In most cases, the investor will be ill-equipped to make such a decision. Thirdly, transaction costs, due perhaps with having to deal with “authorised banks”, will tend to be much higher in countries which have thinly traded currencies. Sometimes, one’s trusted global custodian will be forced to deal through a third party.

Moore says that none of this should necessarily dissuade an investor from taking a position in what is, still, the fastest growing region in the world. But, he says, investors need to know what costs are associated with, say, changing a fund manager in a portfolio, or buying into a new asset class.

And, to be helped by planned agitation by groups such as Laurence Bailey’s custodian banks, the regulations governing transactions in countries such as China are gradually being relaxed. China increased, in April, its total quota of foreign investment (Qualified Foreign Institutional Investor) from $US30 billion to $US80 billion. And the Shanghai (main ‘A’ shares) market has introduced measures to encourage companies to pay higher dividends, thereby increasing institutional demand.

But, as one of the largest fund managers of foreign ‘A’ shares, the global Martin Currie Investment Management, observes, current demand for Chinese shares is not strong. Kimon Kouryialas, the APAC region business head for Martin Currie, says there appears to be little appetite for dedicated Chinese portfolios, at least from Australian investors. This is partly due to the volatility of the Chinese market, which is down about 30 per cent in the past 12 months and nearly 60 per cent since 2007, and partly due to the concern that many Australian shares, particularly the miners, are already heavily exposed to the health of the Chinese economy.

Kouryialas says that Australian investors who have a strong belief in the continued growth prospects of China should consider various ways of getting set with their exposures, such as emerging markets, which include Hong Kong, Taiwan and South Korea.

Source: BRW, September 20, 2012

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