Chinas Capital Markets-The changing landscape 9 Capital in, capital out: Sovereign Wealth Funds (SWFs In terms of the impact on Chinas domestic stock markets, two SWFs, namely the National Social Security Fund (NSSF)and China Investment Corporation (CIC)also The NSSF was set up in 2000 as a fund of last resort ' to help meet Chinas future pension challenge. It has been growing significantly in size, stature and influence since its inception with total assets rising from the initial RMB 20 billion (USD 3.1 billion)to RMB 857 billion(USD 131 billion) by the end of 2010. This makes it by far the biggest institutional investor in Chinas pension sector. In terms of investments, the nSsF must deploy no less than 50 percent in domestic bank deposits and government bonds via direct investment, but significantly it can also invest up to 30 percent of its total assets through appointed fund managers in domestic stock markets The NSSF also has fixed income holdings and investments in Pe funds and has ing a proportion (typically 10 eds of certain state-owned enterprise IPOs. Domestic holdings have increased significantly. especially after the gFC when most domestic equities were trading at historically low levels. This not only reflects the Fund's long-term investment objective, but also dicates an important role for the Fund- serving as a strong stabilising force in the iC has helped to diversify the country' s massive reserves and generate strong returns via long-term investments. With nearly two-thirds of its initial capital of USD 200 billion allocated domestically, ciC holds significant stakes in key national bank KPMG comment and financial institutions on behalf of the government. Such holdings include 49 9 QFlls serve as an intermediary cent of China Development Bank, 35 percent of Industrial and Commercial Bank subject to control and of China, 50 percent of Agricultural Bank of China, 68 percent of Bank of China and measurement of capital flows 57 percent of China Construction Bank. These holdings, combined with the profits nto and out of china. As the generated by its other domestic and overseas investments, brought the total asset capital account liberalises, OFlls size of CiC to almost USD 400 billion by the end of 2010 with the average return on will continue to be a major conduit for foreign investment, Capital outflow -QDII but we expect the quota syste will be relaxed in some ways While the Qfil scheme allows for international capital inflow into mainland financial markets, the Qualified Domestic Institutional Investor(QDiI) programme introduced in April 2006 sanctions five types of Chinese entities to invest abroad-banks trust companies, fund houses, securities firms and insurance companies. These entities can make investments in fixed income, equities and derivatives in approved verseas markets both for themselves and on behalf of retail or other clients Approval for both a licence and quota is required from the respective regulator and from SAFE respectively. As at end 2010, 95 Chinese institutions had been granted QDIl status, with a total quota of USD 68. 4 billion being allocated among 88 of The QDIl market provides more investment channels to Chinese retail and institutional investors. In doing so it helps domestic investors diversify market risk and, by reducing excessive internal liquidity eases the pressure on the RMb to appreciate. In these respects, the QDIl market has also impacted the capital market domestically, by providing alternative investment options and dampening currency Following the launch of a number of mega-funds in 2007, the QDIl market was elatively quiet in 2008 and 2009 before picking up again since December 2009 There are signs of a maturing of the domestic fund houses as many of them seek to develop their in-house QDIl research teams. Over time, international participants bridging role may diminish. It is no longer the case that the QDiI managers will Annual Report. These are not traded on the secondary mply look for special QDIl services that an international partner claims to offer CIC public disdosure reported by Chinese meda. more importantly, they are starting to eye the potential opportunities for their global expansion through partnerships with these international houses 0 2011 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG international"), a Swiss entity. All rights reserved.Capital in, capital out: Sovereign Wealth Funds (SWFs) In terms of the impact on China’s domestic stock markets, two SWFs, namely the National Social Security Fund (NSSF) and China Investment Corporation (CIC) also play a significant role. The NSSF was set up in 2000 as a ‘fund of last resort’ to help meet China’s future pension challenge. It has been growing significantly in size, stature and influence since its inception with total assets rising from the initial RMB 20 billion (USD 3.1 billion) to RMB 857 billion (USD 131 billion) by the end of 2010.8 This makes it by far the biggest institutional investor in China’s pension sector. In terms of investments, the NSSF must deploy no less than 50 percent in domestic bank deposits and government bonds via direct investment, but significantly it can also invest up to 30 percent of its total assets through appointed fund managers in domestic stock markets. The NSSF also has fixed income holdings and investments in PE funds and has benefitted by receiving a proportion (typically 10 percent) of the proceeds of certain state-owned enterprise IPOs. Domestic holdings have increased significantly, especially after the GFC when most domestic equities were trading at historically low levels. This not only reflects the Fund’s long-term investment objective, but also indicates an important role for the Fund – serving as a strong stabilising force in the domestic market. CIC has helped to diversify the country’s massive reserves and generate strong returns via long-term investments. With nearly two-thirds of its initial capital of USD 200 billion allocated domestically, CIC holds significant stakes in key national banks and financial institutions on behalf of the government. Such holdings include 49 percent of China Development Bank, 35 percent of Industrial and Commercial Bank of China, 50 percent of Agricultural Bank of China, 68 percent of Bank of China and 57 percent of China Construction Bank.9 These holdings, combined with the profits generated by its other domestic and overseas investments, brought the total asset size of CIC to almost USD 400 billion by the end of 2010 with the average return on assets over 12 percent per annum.10 Capital outflow — QDII While the QFII scheme allows for international capital inflow into mainland financial markets, the Qualified Domestic Institutional Investor (QDII) programme introduced in April 2006 sanctions five types of Chinese entities to invest abroad — banks, trust companies, fund houses, securities firms and insurance companies. These entities can make investments in fixed income, equities and derivatives in approved overseas markets, both for themselves and on behalf of retail or other clients. Approval for both a licence and quota is required from the respective regulator and from SAFE respectively. As at end 2010, 95 Chinese institutions had been granted QDII status, with a total quota of USD 68.4 billion being allocated among 88 of them.11 The QDII market provides more investment channels to Chinese retail and institutional investors. In doing so it helps domestic investors diversify market risk and, by reducing excessive internal liquidity, eases the pressure on the RMB to appreciate. In these respects, the QDII market has also impacted the capital market domestically, by providing alternative investment options and dampening currency speculation. Following the launch of a number of mega-funds in 2007, the QDII market was relatively quiet in 2008 and 2009 before picking up again since December 2009. There are signs of a maturing of the domestic fund houses as many of them seek to develop their in-house QDII research teams. Over time, international participants’ bridging role may diminish. It is no longer the case that the QDII managers will simply look for special QDII services that an international partner claims to offer; more importantly, they are starting to eye the potential opportunities for their global expansion through partnerships with these international houses. KPMG comment QFIIs serve as an intermediary subject to control and measurement of capital flows into and out of China. As the capital account liberalises, QFIIs will continue to be a major conduit for foreign investment, but we expect the quota system will be relaxed in some ways. 8 NSSF 2010 Annual Report 9 CIC 2009 Annual Report. These are not traded on the secondary market. 10 As per CIC public disclosure reported by Chinese media. 11 Source: SAFE. © 2011 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2011 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. China’s Capital Markets - The changing landscape | 9