Funding China's Growth: Will the New Securities Investment Fund Law Help?
November 30, 2003 | BY
clpstaff &clp articles &China has promulgated the long-awaited Securities Investment Fund Law. What is new in the law for securities industry investors? And how does the law fit into the overall effort to create a robust funds industry in China?
By Walter Hutchens Assistant Professor, Robert H. Smith School of Business, University of Maryland
Shanghai, arguably China's most commercially oriented city, is a study in contrasts and reflects much of the country's tumultuous 20th century history. The city's Xintiandi area bustles with trendy, upscale dining, shopping and nightlife spots thronged with a young generation raised in the reform era. A short stroll away, however, a visitor can view the site where Mao Zedong and a handful of others held the first congress of the Chinese Communist Party (CCP) in 1921. Resolutions adopted by that first party congress are on display in an adjoining exhibition hall. "Elimination of the capitalist private ownership system" was among the bold ambitions that first generation of CCP leaders embraced.1
Upon coming to power in 1949, the CCP began to implement policies reflecting its radical goals. Their efforts to reinvent society were predictably hostile towards capitalist mechanisms such as stock markets, and they soon shut down China's securities markets.2
While the CCP remains in power in China, its ideas have changed dramatically. In October 2003 the Central Committee of the CCP issued a new document on economic policy that reconfirms the path of "reform and opening" now followed for nearly a quarter of a century in China, and the document makes it official party policy to "vigorously develop capital markets" and "vigorously promote the development of institutional investors".3
In furtherance of these CCP goals, the Standing Committee of the National People's Congress adopted the PRC's first law on investment funds on October 28 2003 and President Hu Jintao signed the law on the same day. The PRC Securities Investment Fund Law (中华人民共和国证券投资基金法)(the Securities Investment Fund Law) is effective June 1 2004. Its 12 chapters and 103 articles have been hailed as the most important PRC legal enactment concerning the securities markets since the adoption in 1998 of the PRC Securities Law (中华人民共和国証券法)itself.
Given the rudimentary development of the PRC funds industry so far, the high savings rates in China and the huge demand for capital prompted by the country's growing and reforming economy, a tremendous expansion in the investment funds sector is anticipated. Like other facets of China's growth story, the prospect of providing fund management services to an enormous, rapidly growing market has attracted international interest. As part of its WTO accession, the PRC agreed to allow some foreign investment into its funds sector.4 Already several of the world's leading financial firms have responded, establishing foreign-invested fund management companies with Chinese partners. The Securities Investment Fund Law is thus of keen interest to many domestic and foreign investors.
Setting aside the ironies of the CCP's apparent about-face concerning the role of private property and stock markets,5 one may fairly ask what does China hope to accomplish with Securities Investment Fund Law? How will this new law affect China's investment funds sector? Will the CCP's efforts to develop institutional investors in contemporary China be more successful than its pursuit of apparently opposite economic goals as they were announced more than 80 years ago in Shanghai?
Why Develop a Funds Sector?
China's development of securities markets is of course part of the overall effort to make China strong and prosperous. Within the general context of using securities markets to assist development, PRC officials have expressed many reasons for the desire to nurture a funds industry. Funds may attract more capital that can be invested in the state-owned enterprises that issue securities in China. It is also perceived that funds will support the maturation of China's stock markets. As institutional investors, fund management companies are expected to "professionalize" asset management. Fund managers are expected to make rational investment choices based on fundamental analyses and long-term perspectives, and not simply trade speculatively in the hopes of short-term gains. It is also thought that the aggregation of capital in funds will improve corporate governance; institutional investors will have greater incentive and capacity to monitor listed company performance than scattered retail investors. Investing in funds is also perceived as a safer way for some social security and insurance money to enter China's securities markets.6 In sum, developing a funds sector is seen as a way to effectively mediate between the large amounts of capital available in China and the enormous needs for efficient use of that capital.
China's Current Funds Sector
While the new law is the PRC's first law specifically focused on investment funds, a nascent funds industry has been developing in China for several years. In fact, two funds were listed on the Shenzhen Stock Exchange 10 years ago.7 According to recent PRC statistics, China now has 32 fund management companies that have developed 87 securities investment funds under the care of eight fund custodians.8
Initially China permitted only closed-end funds, meaning funds that exist for a fixed term and that permit no additional investment beyond a pre-determined amount. Subsequently China developed open-ended funds and launched the first of these in 2001. Open-ended funds are similar to US mutual funds; new investors may come in at any time, with potentially no limits on the maximum capital or time frame of a particular fund. Of the 87 existing funds in China, 33 are open-ended funds. Many of the closed funds are listed on the PRC stock exchanges, and hence investors are not locked in for the typical 15-year term of a closed-end fund. However, unlike open-ended funds, the price of a unit of a listed closed-end fund is not tied to the underlying portfolio value. Most listed closed-end funds trade at some discount to the underlying net asset value.
The total assets of these existing PRC funds reportedly exceeds Rmb155 billion (US$18.8 billion). This accounts for about 13% of the capitalization of the PRC A share market.9
Codifying the Existing Scheme
Prior to passage of the Securities Investment Fund Law, the legal basis of the PRC funds industry was found in different regulations, with the key enactment being the State Council's Administration of Securities Investment Funds Tentative Procedures (the Tentative Procedures).10 The China Securities Regulatory Commission (CSRC), China's stock market regulator, has elaborated on the Tentative Procedures and has promulgated more than 20 regulations governing investment funds. The Shenzhen and Shanghai securities exchanges and the State Administration of Taxation have adopted other rules regulating the funds industry.
The Securities Investment Fund Law now gives the industry a legal basis in national law, as it was passed by the Standing Committee of the PRC's National People's Congress, China's highest legislative body. However, this adjustment in the legal status of regulations governing the funds industry has not involved an overhaul of the existing regulatory approach. The Securities Investment Fund Law essentially codifies the basic arrangements previously contained in lower-level regulations.
Under the new law, China will continue to have closed-end and open-ended funds. As before, these funds will have a fund manager who organizes establishment of a particular fund and makes investment decisions within the range permitted by PRC law and the fund contract. A fund custodian will actually handle fund assets and execute the instructions of the fund management company concerning investments. Fund management companies may also appoint CSRC-approved sales agents to handle subscriptions, redemptions and record keeping concerning individual investors.
Further, under the new law PRC funds will continue to be essentially trusts
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