China’s Path to Financial Globalization

China’s global profile and influence has vastly expanded over the last three decades. What is the key to its growing success and challenges?

By China Business Knowledge @ CUHK

Mr. David Wu, lead partner of PwC’s Beijing Office, looks at the latest trends in China’s financial globalization and its various challenges and rewards.

How is China doing in terms of financial globalization and what is the key to success?

I would say China hasn’t yet achieved financial globalization but it is poised at the threshold. China is still a country with foreign exchange control and its interest rates are centrally determined by the People’s Bank of China — the financial system is therefore more national than global. However, over the past 10 years China has made substantial progress toward establishing a sound financial system. Banks have cleaned up their balance sheets and are reforming. From 2003 to 2006 the government recapitalized the large four state banks so they had healthy balance sheets and they weren’t affected by the financial crisis in the West. China has also made progress in professional and regulatory supervision and control by establishing regulatory commissions for the banking and insurance sectors and the China Securities Regulatory Commission for capital markets. These regulatory commissions show a high level of professionalism and have sound policies in place to help China toward financial globalization.

Is this the path China definitely wants to take?

Yes, a strong economy needs a reliable financial system that can channel capital to meet the needs of industry. This encourages innovation and entrepreneurship, which enables the economy to grow. Over the past 20 to 30 years, China has turned itself into a manufacturing economy using cheap labor to produce goods. But this manufacturing base has no more room to expand and China’s next move is to transform its economic infrastructure, which will rely heavily on efficient capital markets. This is why China needs to reform the financial system, strengthen the regulatory framework and more importantly, establish a legal framework to support China’s credit culture.

Why does China seem unaffected by the global economic slowdown? Is this to do with the use of capital controls?

I want to answer this question in a different way. China’s economy has been heavily affected by the global financial crisis. China’s economic growth depends on three pillars: exports, infrastructure investment, and domestic consumption. China’s economy has slowed down because exports to the United States and Europe have slowed down. But in response to the financial crisis, the government policy has been to spend heavily. The government put four trillion RMB into the system — a stimulus package which helped the economy to grow.

But other governments have provided financial support, and yet their countries are still in recession. Why not China?

China’s economy is growing and has momentum. A mix of free-market entrepreneurship and increased efficiency due to innovation and improved technology, combined with government spending, has seen the economy expand more than any other countries. But this growth comes at a cost—China’s economy now relies heavily on state-owned enterprises rather than the private sector. The use of capital controls as a means of regulation isn’t that relevant to the economic slowdown. It doesn’t affect economic growth that much, though it does insulate China from the financial crisis.

Chinese companies have run into problems once they have been listed in the United States. Has your company (PwC) done anything to tackle this issue?

Accounting problems have arisen with some listed companies, especially those listed in the U.S. with reverse takeover arrangements — this refers to a shell company listed in the United States but with the main cash-generating assets based in China. These companies are supposedly under U.S. jurisdiction but the main business is so distant and the business culture so different that U.S. regulators can’t understand and supervise them. So we encourage Chinese and U.S. regulators to cooperate in order to promote good corporate governance, improve transparency and implement good accounting practices. We are only talking about a small group of companies, but they have caused substantial problems and damages to the capital markets. If these companies don’t practice good corporate governance, promote transparency and comply with the law, capital becomes more expensive as it becomes riskier to invest—which damages China’s economic development. As auditors we always work with clients to comply with laws and practice good governance.

Will we see a trend of these “reverse takeover” companies moving to list on Hong Kong’s exchange rather than in the U.S.?
Listing in Hong Kong does have its advantages — if the company is reliable, has a good cash flow and decent corporate governance to encourage the board to be accountable to shareholders. Authorities in Hong Kong understand China’s business practices more than their U.S. counterparts. They are able to ask the right questions and request that companies comply with local rules, thereby creating a stronger framework in which to govern these companies. This will attract more Chinese companies to be listed—Hong Kong provides a unique opportunity to vet these firms.

Doesn’t the same apply for Singapore’s stock exchange too?

Not necessarily. Hong Kong enjoys a unique position as a gateway to China and is part of China. As a respected financial hub with authorities of high professional standards, accountants and lawyers, Hong Kong can attract large flows of capital for China’s businesses. Capital markets reward companies with accurate information disclosure and if you paint an incorrect picture, you will ultimately fail in the market. That’s why it’s so important that Chinese businesses don’t falsify their accounts.

But there still seems to be a stigma attached to Chinese companies listed abroad…

And that’s why it’s so unfair — good companies get penalized alongside the bad. So how do reliable companies continue to finance their growth within China? This takes time. I hope that a combination of professional accounting services with companies who are willing to be open, encourage good governance and provide shareholder returns, will eventually encourage capital to flow.

What further advice do you have for Chinese companies still interested in making an IPO, whether in Hong Kong, London or New York?

If you want to be listed abroad, you must have several things in place. China doesn’t lack market size and if a business model is sound, it will succeed. But that’s not enough. You need to instil good corporate governance to ensure that management and the board are all acting in the shareholders’ best interests. Companies must also adopt good accounting and reporting practices, and have good internal control and risk management systems, which can shield the company from fraud and corruption. Employing the services of professionals such as PwC will raise the bar and reinforce reputations.

Going global has become such a popular term — a lot of cross-border RMB deals have been done in the past few years and it appears as if Chinese companies are seeking finance to pursue global ambitions. Are there any alternative business strategies you could suggest?

Chinese companies want to go global for a number of reasons: Firstly to acquire resources because China is short of these. Secondly to acquire technology and knowledge: For example, a car manufacturer might acquire MG Rover to gain technological know-how to enable China to build efficient cars. A third reason is to gain access to potential markets. Chinese companies need to identify their knowledge and skill gaps, such as a lack of experience in management or lack of understanding of the laws and culture of a particular country. If Chinese companies don’t already have good corporate governance and controls in place, a rapid expansion can create challenges. Chinese companies should be aware of the risks of going global — it can be a very costly lesson. China’s domestic market is big enough — if you are innovative and technologically savvy, you won’t remain just a local company. What I suggest to many of my clients is to build a strong local Chinese company first, and then consider strategies of global integration.

David Wu is a member of the managing board of PwC China and Hong Kong, the lead partner of PwC, Beijing Office. His specializes on providing assurance and advisory services to banking and capital market clients in China.