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Principal’s Patience in China Pays Off

Iowa firm is among a number of foreign investors taking advantage of recent moves by Beijing to increase access to mainland markets.

Nearly 20 years in China has taught equities investment managers at the Principal Financial Group the value — and necessity — of patience. An arduous application process preceded Principal’s licensing by China’s securities regulator for the Qualified Foreign Institutional Investor (QFII) program, the widest gateway to the country’s foreigner-restricted Shanghai and Shenzhen stock markets.

Next came an eight-month wait for a $150 million quota, which the regulator granted in August 2012, followed by another pause that ended in February, when the firm announced it had fulfilled its quota and could start buying and selling on Shanghai’s A-share market.

But strong confidence in the long-range value of mainland shares has kept Des Moines–based Principal — along with a host of other foreign investors including Canadian pension managers, American universities and Middle Eastern sovereign wealth funds — as active as legally possible while they’ve waited hopefully for wider access to Chinese equities.

In recent months that patience has been generously rewarded. Regulators led by the China Securities Exchange Commission (CSRC), whose former chief Guo Shuqing pushed a reform agenda after taking office in 2011, accelerated market liberalization in ways that benefit foreign participants. Guo was replaced in mid-March by Xiao Gang, a former Bank of China chief who has pledged to stay on the reform track.

Guo in March told a Shenzhen newspaper he expected rising foreign investment to “stabilize” the recently volatile stock market. He also said he’s certain foreigners will invest more because “it’s not hard to make money” trading mainland stocks.

After declining for most of 2011, the benchmark Shanghai Composite Index rebounded in early 2012 but then resumed a steady, downhill slide. In November the index slipped below the psychologically significant 2,000-point line for the first time in three years before rising suddenly by 14 percent in December.

CSRC has expanded QFII participation over the past year to include 213 foreign institutional investors and has increased their combined quota to $80 billion from $30 billion. All have worked hard to get in: Principal, for example, spent long months slogging through licensing and application processes before finally winning a quota for Shanghai A-share investment.

“It will be nice to take a pause from the QFII preparations,” says the firm’s chief operating officer for Asia, Frederick Laydon. “We have invested a great deal of time and energy.”

Much of that energy was expended during a licensing and quota request process that applicants often find slow and sometimes consider downright confusing.

“The new QFII applicant has to learn a vast amount of regulatory aspects before submitting a license application,” Laydon says. “The more you learn, the more you discover you need to learn. Often there is no clear guidance on how to proceed.”

Obviously, though, plenty of firms like Principal have successfully navigated the process. Moreover, they could cheer in February when margin trading and short-selling limits were relaxed. The list of company stocks available for short-selling grew to 90 from 25. It includes 50 companies trading in Shanghai that represent 57 percent of the bourse’s market capitalization, and 40 Shenzhen-listed companies with a 26 percent share of market cap.

Although not intended as a foreigner-friendly initiative, regulators say they believe that margin-trading and short-selling will strengthen the stock exchange overall — including the more than 2 percent of market capitalization held in foreign portfolios — through improved price discovery.

Another regulatory move widening overseas access to China equities came in March when the CSRC told financial institutions, including foreign banks domiciled in Hong Kong, that they could participate directly in the Renminbi Qualified Foreign Institutional Investor (RQFII) program. The RQFII program is a conduit for channeling the fast-growing pool of renminbi deposits held in Hong Kong into mainland markets. Previously, foreigners could take advantage of RQFII only by going through selected mainland brokers.

In addition, the CSRC has announced that the 45 million residents of Hong Kong, Macao and Taiwan — which China considers a renegade province — can invest through the RQFII program. Starting April 1 they will be allowed to open Shanghai Stock Exchange A-share accounts through mainland or mainland-Taiwan joint venture brokers and use their offshore yuan to buy stock — something that until now only mainlanders could do.

“We have eternal trust in the market,” Guo declared in announcing the change, which also complements Beijing’s effort to better the yuan’s acceptance outside China.

Authorities raised the total quota for all RQFII investment in November to $43.4 billion from $11.2 billion, and two months later allotted $16 billion of that total to Taiwan investors. To further encourage Taiwanese trading of Shanghai stock, rules for Taiwan-mainland joint venture brokerages were adjusted so that a single Taiwanese partner can control up to 51 percent.

Laydon said his firm, which has about $3 billion in China assets under management mainly through Hong Kong–listed stock in mainland companies, has been “comforted by China’s decisions and ongoing actions to develop the offshore (yuan) market as a primary avenue for internationalizing its currency.”

The recent jump in QFII participants and analyst forecasts of institutional support for RQFII’s expansion suggest foreign investors have not been spooked by the weakness of the Shanghai and Shenzhen markets over the past year or by China’s slowing GDP growth. Demand for short-selling and the Hong Kong-Macao-Taiwan program may be a different story, analysts say, although it’s too early to judge.

Principal’s managers have turned “more cautiously optimistic about the Chinese equity market and economy in recent months,” Laydon says. “We see valuations as relatively attractive and more signs of the economy avoiding a downturn.”

Foreign investors are also pleased to see Chinese regulators willing to follow through with promises for market reforms, satisfy investor demands for stock market access and reward patience.

“The opening of the A-share markets to offshore investors is one of many avenues China is embarking to internationalize its capital markets and its economy,” says Laydon. “We like countries that do what they say they are going to do.”

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