April 28, 2008 / 5:43 AM / 10 years ago

Turf wars hobble China's financial markets

BEIJING (Reuters) - If institutional infighting were an Olympic sport, China would sweep the medals at August’s Games.

Turf battles in the financial sector have erupted over everything from beefing up the bond market to diversifying the government’s currency reserves and allowing people to invest directly in Hong Kong shares.

The received wisdom that China is a political monolith that can’t put a policy foot wrong has been shown to be wrong.

China does not have a lock on poor inter-agency cooperation: witness the U.S. subprime debacle and the failure of a trio of regulators in Britain to spot looming trouble at Northern Rock, a home-loan lender that had to be bailed out by the government.

But the cost of inadequate regulatory teamwork is rising as the economy becomes more complex, said Stephen Green, head of China research at Standard Chartered Bank in Shanghai.

“We are moving to the stage where we do need more coordination, but we get more competition instead. You can see that across the environment sector and energy policy as well. It’s at the stage where it’s holding back reforms,” he said.

Take the market in corporate bonds, a mainstay of any advanced economy, where institutional investors ensure capital is allocated efficiently by passing judgment on the profit prospects of firms before deciding whether to buy their paper.

In China, the corporate bond market is tiny and tangled up in red tape. If a firm needs money, it usually turns instead to state-owned banks, which are still dogged by a reputation for lending for political patronage, not profit.

“Why don’t we introduce more market discipline into financing? Why do we rely on the banks so much? That’s an inefficiency which is holding the economy back,” Green said.


Prospects for the bond market brightened last year when the securities regulator was empowered to authorize listed firms to issue bonds. Previously, the economic planning agency had been the gatekeeper, imposing strict quotas and a thicket of conditions that kept issuance to a minimum.

But then things got messy.

The banking regulator, worried that banks were being exposed to undue risk, ordered them to stop guaranteeing corporate bonds -- standard practice hitherto.

The insurance regulator concluded that if banks had to be shielded from risk, so did insurers. So it barred them from buying bonds issued without a bank guarantee.

The result? Still next to no corporate bond issues.

Frustrated at the deadlock, the People’s Bank of China took matters into its own hands. Earlier this month the central bank created a new bond market at the stroke of a pen by extending, to five years, the maximum 12-month tenor of short-term commercial bills traded among banks.

The PBOC had set up this commercial paper market in the first place in 2005 to break the direct-financing logjam.

Seven Chinese companies duly sold an initial batch of 39.2 billion yuan ($5.6 billion) of medium-term notes last Tuesday.

But fund management companies were not among the investors: they were prohibited from buying the paper by the securities regulator, which, according to market sources, said it needed time to evaluate the liquidity of the fledgling market.

A senior PBOC official, clearly unhappy, told Reuters the central bank would be “resolute” in promoting the new notes.


To be sure, the squabbling has not prevented China from clocking up five straight years of double-digit economic growth.

    But the lack of transparency, and the broad discretionary powers that regulators enjoy, means China is missing an opportunity to build a more efficient financial system.

    “Financial market innovation requires clear rules, and China’s in desperate need of financial market innovation,” said Michael Pettis, a finance professor at Peking University.

    The repercussions of Beijing’s turf wars are also being felt globally as rival managers of China’s currency reserves slug it out for supremacy.

    It was no surprise when China Investment Corp (CIC), the $200 billion sovereign wealth fund set up last September, bought into U.S. private equity giant Blackstone and investment bank Morgan Stanley. CIC’s mandate, after all, is to take more risk to earn higher returns on a chunk of China’s vast reserves.

    What was a surprise was when the State Administration of Foreign Exchange (SAFE), an arm of the central bank that separately manages $1.68 trillion of China’s reserves, showed up on the share registers of a trio of Australian banks and of Western oil majors Total SA (TOTF.PA) and BP Plc (BP.L).

    The investments have raised eyebrows because SAFE has up to now invested mainly in low-risk, low-yielding bonds.

    By buying equities, SAFE is encroaching on CIC territory. Word has it in Beijing financial circles that CIC is furious.

    Handled clumsily, SAFE’s purchases could drive up the price of assets CIC wants to buy. Moreover, by drawing a veil over its investments, the agency has fed Western concerns about the opacity and motives of sovereign wealth funds.

    Perhaps these and other episodes show that competition between fund managers and among regulators is healthy.

    But so is joined-up government: a senior official, who declined to be named, said that, owing to a communications gaffe, the first Premier Wen Jiabao knew of CIC’s $5 billion stake in Morgan Stanley was when he heard about it on the television news.

    Wen, the official said, was not amused.

    ($1=7.009 Yuan)

    Reporting by Alan Wheatley, Editing by Sonya Hepinstall

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