Joseph A. Field discusses asset management and asset protection challenges and opportunities in China and, more widely, for the Chinese
I am afraid that my speciality is not asset management; I am a lawyer. Nor am I situated in China, and I do not tend to deal with investors solely interested in domestic investment in China. That being said, the Chinese are wealthy and growing much wealthier by the day, but they are beset by a number of investment issues; both internally in China and when they invest abroad. These issues have given rise to a number of problems which are sometimes common to international investors, and sometimes not. In this relatively short article, we cannot make an exhaustive analysis of the Chinese investment plan, or the practice of investors and investment managers within China. Rather, it is intended to discuss some of the more common problems faced by Chinese investors, both at home and abroad.
What is astonishing is the way in which wealth in China is growing. At present, China is minting approximately 101,000 dollar millionaires per year and the number of billionaires is second only to the United States. Yet, the picture is not entirely clear for either the wealthy or super-wealthy. Enormous pressures exist within the economy and the focus is shifting from low-cost manufacturing and real estate to high-tech, medical devices and production involving manufacturing with high intellectual content. Yet the banking and accounting industries are less organized than in the West and transparency is far from the by-word of the day.
SOME DOMESTIC ISSUES
For some time, the Government has been moving against corruption and a great deal of it has been rooted out at the government, corporate and individual levels. Purges have taken place in almost every large enterprise in China and expenses have been greatly downsized. Conspicuous consumption is particularly frowned upon; sedans have replaced limousines and golf memberships have been curtailed, or executives play far less frequently. Indeed, it is rare to see a Chinese wearing a fancy watch, or having a female executive or spouse carry a Louis Vuitton bag. This trend has also been rigorously enforced in the area of exchange control.
For a long time, Chinese residents have been limited to exporting US$50,000 per year. And yet, Chinese purchases of homes in the US and UK amounted to millions of dollars. Many techniques were employed to export excess capital, but most of these have now been stopped. In October of last year, China signed up to the Common Reporting Standard (CRS) and has started collecting data already. Most of the loopholes for exiting funds were closed and in December, draconian new measures were announced to limit people from taking money out of China.
Domestically, there are significant issues, as well. Given the explosive growth in the economy over the last ten years, problems are inevitable, but the scope and scale of some of the investment issues are dramatic. They tend to fall into two broad categories:
• Much of the domestic industrial investment yuan is focused on the coal, steel and real estate, sectors that are now in decline; if some of these investments fail, it could have major repercussions on the Chinese economy; and
- A number of more common investment products sold to individuals suffer from what we would recognize as an almost total lack of transparency and proper
accounting standards. According to the New York Times (19 April 2017), a major scandal has just broken out at one of China’s leading banks in which a “guaranteed capital” product just went bust. Many of these investment products promise unrealistic returns, and enticements include free golf events and foreign travel. Both of these types of investments are supported by off-balance sheet lending, which is said to have helped growth in the national economy, but which is not subject to much in the way scrutiny and are said to be burdened with a very high degree of risk.
At the heart of the most recent scandal is a “secure” product which promised high returns. This was a product which was targeted to the elderly and retirees. However, it would now appear that the entire “investment” did not exist. So where are we? For the Chinese investor, there is still a vibrant investment platform, but for many, it may be fraught with risk. At the same time, there is a very strong incentive for many to try and invest abroad.
Europe and the United States beckon as lands of opportunity with great schools, vast investment possibilities and a relatively great deal of security. Recent political events aside, many in China feel that establishing family, satellite businesses and creating new wealth outside of China is highly desirable. The new Chinese rules limiting the export of capital are beginning to bite, but China has to be viewed as a champagne bottle. There is a great deal of wealth bubbling up inside and anxious to get out, but the cork is firmly wired to the top. Eventually, it will escape, but we just don’t know when.
CHINESE INVESTMENT ABROAD
One of the driving factors for the Chinese, and for Asians in general when looking abroad, is the availability of good schooling for children. This is happening in the US, the UK, Canada, Australia and many other parts of the world. The numbers are very large. When children come to be educated, they are usually accompanied by family members and often buy real estate to house the children.
From this, the investment profile often extends to commercial real estate and then to commercial enterprises. Chinese investment in the United States is vast, ranging from start-ups in Silicon Valley, to movie studios, to the Waldorf Astoria Hotel in New York City. Corporate acquisition and investments through securities markets remain substantial.
But then, we need to circle back to the problem of Chinese funds being able to exit China. Export permission is still granted on a selective basis to large companies that wish to invest in projects favoured by the Chinese government, but the exit of private wealth now seems to be effective and tight.
There is certainly a great deal of money which is already outside of China, but the big question is when will some or all of the exchange controlled funds be released, and under what terms?
It is clear that money will continue to leave China and planning will need to be done for this. There is a great deal of Chinese money outside of China and some will continue to filter out. Investment by Chinese companies will continue. But the flow will diminish rapidly over time. In addition, many controls in the West may well inhibit Chinese investors. Visa and immigration rules are tightening. The UK and the US have both initiated legislation requiring the disclosure of foreign owned real property and the US now requires disclosure of a greater than 25% interest held by foreigners in an American Limited Liability Company (“LLC”). So, life is becoming more arduous for the Chinese investor, both at home and abroad. Flight capital from China is enormous, and it is understandable that the government would want to stem this tide. Real estate, which has long been the preferred investment (at least at the outset) for Chinese investors, but it has become much harder to shield such purchases; both from a Chinese and a foreign perspective and banks, who would normally be looked to as a source of funds, are now extremely careful in their “know your customer” procedures, and often properties are lost because financing can only be found after the deal has gone away.
And yet they come. There is a very strong initiative to diversify capital out of China and the beacon of schooling in the West attracts families. China has been around for a long time, and although the rules are changing, it is clear that at some point the cork will burst out of the bottle and the floodgates will open once again.