Money Market Funds in China Become Less Systemically Risky [Real Clear Markets]

Last year, China’s stock market took a tumble, which sent shock waves through the global securities markets. Now, money market funds are booming in China and could present the next systemic risk. While Chinese regulators have taken steps to reduce that risk, the question is whether they have gone far enough.

Assets of Chinese money market funds have doubled in the last year – from approximately $350 billion at the end of 2014 to over $700 billion at the end of 2015. These funds are primarily sold online to individual investors by Internet giants like Alibaba and Baidu.

Money market funds have become so popular in China because they offer higher interest rates than retail bank deposits. But these funds achieve higher rates by investing in a much riskier array of debt securities than U.S. money market funds – and the average Chinese investor may not be aware of the level of risk involved. If there were significant defaults in the debt securities held by

Chinese money market funds, investors would likely run for the exits, just as they did last summer in the Chinese stock market.

To prevent these potential problems, the Chinese Securities Regulatory Commission has adopted rules, which became effective in February of this year. These rules are designed to decrease the riskiness and increase the liquidity of Chinese money market funds, although the rules are still looser than the regulations for U.S. money market funds.

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China’s pension problems will not be solved by more children [Financial Times]

On October 29, China adopted a policy of two children per family, instead of one. This change is, in large part, intended to mitigate the adverse demographic trend plaguing China’s social security system: the rapidly declining ratio of active to retired workers. The ratio is falling from over 6:1 in 2000 to under 2:1 in 2050.

However, the new two-child policy is not likely to have a big impact on the worker-retiree ratio, so China’s retirement system will remain under stress. To sustain social security, China needs to implement other reforms — moving from a local to a national system and expanding the permissible investments for Chinese pensions.

The one-child policy always had exceptions, such as for rural and ethnic communities. These exceptions were broadened in 2013 to cover couples where both were only children. Yet the birth rate did not take off.

Why? A combination of rising levels of urbanisation and housing costs, more education and jobs for women, and rapidly increasing expenses for child rearing. These factors have driven fertility rates down in other south-east Asian countries, such as Singapore and South Korea, without any government restrictions on family size.

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Surge in China internet money funds is risky [Financial Times]

Co-Authored with Theresa Hamacher

The money market fund offered by Alibaba, China’s leading ecommerce company, has gathered the equivalent of $65bn in less than one year. During that period, the assets of all money funds sponsored by internet companies have soared to the equivalent of more than $100bn.

In response, the governor of the Bank of China recently suggested that this new online product needs to be supervised closely. What are the benefits and risks of these internet money market funds, and how should they be regulated?

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China Must Reform For Life After The Iron Rice Bowl [Financial Times]

Co-Authored with Theresa Hamacher

The new leaders of the Chinese Communist party recently announced that the market would play an expanded and “decisive” role in allocating China’s resources. Yet the same announcement reaffirmed the continued “vitality” of the state-owned enterprises that dominate the country’s economy.

While these two goals appear to be in conflict, they could both be advanced by allocating substantial blocks of shares of such enterprises to the National Social Security Fund, a Chinese manager of pension assets. This approach would have the added virtue of strengthening the pension system by increasing pre-funding of retirement benefits.

In China, a small group of state-owned enterprises hold a near monopoly of power in key sectors – such as banking, energy and transportation – and pay little or no dividends. If China’s economy is to become more productive, they must become more responsive to market forces, with lower customer prices and lower operational costs than competitors. As a result, China has begun negotiations with Europe and the US on investment treaties, which would allow foreign companies to compete in some of the sectors dominated by state-owned businesses.

Chinese leaders should also adopt another strategy to make them more responsive to market forces: establishing a large institutional shareholder that could put pressure on the state-owned enterprises to run more efficiently and pay more dividends. Although most of the large examples have sold shares to public investors, these investors are widely dispersed throughout the world, and have little influence on the corporate strategies of state-owned businesses or their dividend policies.
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In China, big opportunities for investors, if mutual funds can find a way in [Washington Post]

Co-authored with Theresa Hamacher:

For U.S. mutual fund marketers, China is the Holy Grail. Given the country’s fast-growing economy and its large and rapidly aging population needing to save for retirement, China’s fund market has enormous potential for growth. Although the fund industry started in China only a decade ago, funds in that country already hold close to $350 billion in assets. And given the expanding size of China’s economy, its fund assets could easily grow to several trillion dollars over the next decade. But the Chinese market has been tough for U.S. firms to break into, because both regulation and local preferences tend to favor homegrown funds over U.S.-sponsored offerings. In general, China encapsulates the difficulties that investment managers must address when trying to export mutual funds — one of the United States’ most successful financial products — to other countries.

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My quick thoughts on the Euro deal

This is a tremendously complicated subject and not all details are known. But here are some of my quick thoughts on the matter.

  • If banks “voluntarily” take a 50% haircut on Greek debt, I do not believe that a €106 billion recapitalization of the banks will be enough. I don’t think the dealmakers considered quite how big of a hit that haircut will be to struggling banks.
  • It appears that roughly half of this €106 billion is already built in to existing bailout plans for Greece, Spain, Portugal, and Dexia. However, that leaves over €50 billion in equity capital to be raised by large EU banks, which will have a hard time doing so. Although they can sell assets and cut dividends, in the end some of that equity capital may have to come from France and other national governments.

What about China?

  • The main source of potential new money is China. In theory, China could contribute capital to the EFSF and thereby help expand its scope.
  • In fact, the terms and conditions of Chinese participation are far from complete, so we should not consider it a done deal. China is likely to want an easing of trade restrictions and currency concerns that may be difficult for European leaders to accept.