People pedal past a building shaped as a Chinese ancient coin on April 21, 2007 in Shenyang of Liaoning Province, China. (China Photos / Getty Images)People pedal past a building shaped as a Chinese ancient coin on April 21, 2007 in Shenyang of Liaoning Province, China. (China Photos / Getty Images)

After a record amount of capital outflows from China in 2016, Beijing is looking to reverse course this year.

Chinese authorities’ efforts to restrict capital outflows appear to be working. Foreign exchange reserves rose for four consecutive months through May, as inflows finally exceeded outflows. Outbound direct investment dropped almost 46 percent during the first six months of 2017 compared to the same period last year, according to official data.

Beijing is using a multipronged approach to stem the money flow. Regulators have restricted fundraising activities of insurance companies, a main source of recent foreign acquisitions. The China Banking Regulatory Commission (CBRC) in late June asked banks to check their exposure to several conglomerates with activities abroad, including the Dalian Wanda Group. And most recently, regulators are applying stricter standards before approving foreign investments and using state-controlled media to root out offenders.

China is especially targeting so-called “asset transfers,” or purchases of foreign assets with little to no potential economic returns. Such purchases, regulators believe, are purely used to shift or launder funds abroad.

“China will continue to encourage only genuine and rule-abiding outbound investments by financially competent companies,” said Wang Chunying, a spokesperson at the State Administration of Foreign Exchange (SEGURO), according to Caixin, a mainland business magazine. SAFE is China’s foreign-exchange regulator.

Reading between the lines, it’s clear that regulators believe some recent high-profile foreign acquisitions were backed by dubious financing, and the quality of such assets raises questions.

Leveraging Media

Beijing has also utilized the state-controlled media to step up criticism of the recent string of high-profile overseas acquisitions by Chinese companies, where academic and business experts publicly question the motivation behind such deals.

During a July 18 segment shown on state-owned China Central Television (CCTV), the host asked why a little-known Chinese appliance retailer would buy the Italian soccer club Internazionale, also known as Inter Milan, given that the company had been losing money for the last five years.

“Some companies are already highly indebted at home, yet they spend lavishly with bank loans abroad. … I think many overseas acquisition deals have a low chance of generating cash flow, and I cannot exclude the possibility of money laundering,” said Yin Zhongli, a researcher with the Chinese Academy of Social Sciences, during the CCTV segment, de acuerdo a el South China Morning Post. The Chinese Academy of Social Sciences is a think tank affiliated with the State Council, China’s cabinet.

Publicly traded shares of Suning, the appliance retailer that bought Inter Milan, immediately fell intraday following the CCTV segment. Yin Zhongli, the academic researcher, later clarified that he did not intend to call out Suning in particular, but was commenting in general about Chinese firms buying assets abroad.

I cannot exclude the possibility of money laundering.

— Yin Zhongli, researcher, Chinese Academy of Social Sciences

Curbing Dealmakers

SAFE spokeswoman Wang said the regulator would focus its attention on cross-border deals in real estate, hotels, entertainment, cinemas, and sports clubs.

The industries cited by SAFE are not coincidental—such companies were main targets of China’s dealmakers during the recent acquisition frenzy.

China’s banking regulator recently asked banks to look into their exposures to several Chinese conglomerates, including Anbang Insurance Group Co., Dalian Wanda Group Co., HNA Group Co., Fosun International Ltd., and Rossoneri Sport Investment Lux, which acquired Italy’s AC Milan soccer team in April.

Foreign real estate and hotels are frequent targets of insurer Anbang and conglomerate HNA, while Hollywood movie studios and cinemas have received heavy investment from commercial developer Wanda.

Ownership of foreign sports clubs has also drawn Chinese regulatory scrutiny. Rossoneri’s original proposal to buy AC Milan almost fell apart after it was postponed several times, due to Beijing’s refusal to sign off on certain funds leaving China. The deal finally concluded in April after billionaire investor Paul Singer’s hedge fund Elliott Management stepped in to provide partial financing. Besides the two Italian clubs, Chinese companies also have ownership stakes in English club Aston Villa, Spanish club Atletico Madrid, and French club OGC Nice.

HNA may be finding itself shunned by leading Wall Street banks and advisers.

Anbang chairman Wu Xiaohui was detained by Chinese authorities in June. Anbang had been one of the most active foreign dealmakers over the last three years. It owns the Waldorf Astoria hotel in Midtown Manhattan—currently closed for renovation—and Chicago-based Strategic Hotels & Resorts. En 2016, Anbang famously launched a failed bid to acquire Starwood Hotels & Resorts Worldwide.

Wu is believed to be a close ally of an influential political faction, dirigido por el ex líder del Partido Jiang Zemin, that is in opposition to the Xi leadership. Jiang was head of the CCP for more than a dozen years (1989–2002) and continued holding sway over the Chinese regime through a network of cronies for another 10 años (2002–2012). Since entering office in 2012, Xi has waged a battle to uproot the influence of Jiang and his faction.

Sources close to Zhongnanhai, the central headquarters of the CCP, told The Epoch Times in June that Wu is one of the key “white gloves,” or money launderers, for the Jiang political faction and the family of Zeng Qinghong, the former Chinese vice premier and longtime Jiang confidant.

HNA and U.S. Banks

Another active foreign acquirer, HNA may be finding itself shunned by leading Wall Street banks and advisers.

Last week, Bank of America Corp. told its bankers to stop working with HNA Group and its affiliated entities on future transactions, due to concerns about the group’s debt levels and opaque ownership structure, de acuerdo a un Bloomberg report. The report also stated that other banks, including Morgan Stanley and Citigroup Inc., gave similar directives to their staff.

A source at a major Wall Street bank confirmed the Bloomberg report.

Actualmente, HNA is closing on the purchase of a majority stake into hedge fund SkyBridge Capital LLC. SkyBridge’s founder and co-managing partner is Anthony Scaramucci, President Donald Trump’s new communications director.

Approvals are required from banks’ compliance departments before bankers can conduct business with potential clients, a process known as KYC (know your client), which scrutinizes a potential client’s credit-worthiness, track record, and ownership. Citigroup and Morgan Stanley struggled to obtain sufficient clarity on HNA’s sources of funding and its ownership structure, según el informe.

Similar to other Chinese conglomerates, HNA has a Hong Kong publicly listed arm, HNA Holding Group Co. Limitado., which is owned by a parent company with obscure ownership identities.

HNA’s ultimate structure is a complex web of investment trusts, provincial and local government agencies, and small-business ventures.

Thirteen individuals ultimately control 76 percent of the company through intermediary companies. Chen Feng, the public face of the company, controls 15 percent of HNA and has connections with former presidential candidate Jeb Bush and American investor George Soros. HNA’s biggest owner, Guan Jun (with a 29 percent stake), doesn’t work for the company and is a relative unknown. Listed addresses for Guan through various public filings and records include a side street beauty salon in western Beijing, a shabby Beijing office building, and a nondescript apartment building in southwest Beijing, de acuerdo a el Financial Times.

HNA is also highly indebted. Al final de 2014, HNA had a combined debt of 196.9 mil millones de yuanes ($29.5 millones) on its balance sheet, compared to only 73.2 mil millones de yuanes ($10.9 millones) of equity, according to prospectuses filed with the Irish securities regulators in connection with a 2015 $1 billion bond offering of one of its subsidiaries.

While actions of individual U.S. banks may have little to do with Chinese politics or regulatory desires, the path forward for Chinese companies looking to acquire foreign assets is becoming more and more difficult.

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People walk past an entrance to the Anbang Group's offices in Beijing, junio 14. (AP Photo/Mark Schiefelbein)People walk past an entrance to the Anbang Group's offices in Beijing, junio 14. (AP Photo/Mark Schiefelbein)

In a move that stunned New York dealmakers at the time, the famed Waldorf-Astoria Hotel on Park Avenue was sold in 2014 to a little-known Chinese company.

That Chinese company is Beijing-based Anbang Group, an insurance conglomerate known for its aggressive overseas asset purchases, including a failed 2016 bid to acquire Starwood Hotels and Resorts. En el momento, Chinese companies were engaged in a global takeover spree, and Anbang appeared to be leader of the pack.

Merely a year later, the once high-flying Anbang is suddenly grounded.

Anbang billionaire chairman Wu Xiaohui has been detained by Beijing authorities. And several Chinese state-owned banks were told to stop their dealings with the company, sources told Bloomberg on June 15. Its more than 30,000 employees and nearly $300 billion of assets are left hanging in the balance.

En Junio 9, Beijing anti-corruption investigators detained Wu, de acuerdo con la Financial Times. While it is yet unclear if the Central Commission for Discipline Inspection will announce a formal investigation of Wu, he is certainly the highest-profile business executive reeled in so far by Chinese leader Xi Jinping’s sweeping anti-corruption efforts.

Anbang’s Meteoric Rise

In a short time, Anbang has risen from relative obscurity to become one of China’s largest holders of foreign assets. Before its activities were curtailed recently, Anbang had become well known among Western private equity firms and real estate moguls as a competitive bidder for assets.

Wu and Anbang have cultivated extensive business and political connections abroad. Wu is known to be close to Jonathan Gray, head of real estate at U.S. private equity giant Blackstone Group. A few of Anbang’s recent asset acquisitions have been bought from Blackstone. Wu was also in discussion to acquire a stake in the Manhattan office tower owned by Jared Kushner, son-in-law and senior advisor of President Donald Trump, but the deal was called off in March.

Hoy, Anbang’s portfolio of well-known foreign assets includes the Waldorf-Astoria Hotel, el 717 Fifth Avenue building in New York, the Chicago-based Strategic Hotels & Resorts Inc., Belgian insurer Fidea, Belgian bank Delta Lloyd, and a controlling stake in South Korean insurer Tongyang Life Insurance.

Anbang_holdings

List of major foreign asset holdings of Anbang Group, as of June 1, 2017 (La Gran Época)

‘White Gloves’

Anbang’s sudden fall seems as startling as its rapid ascent. What caused the disgrace of Wu Xiaohui, who led a conglomerate described by the Financial Times in 2016 as “one of China’s most politically connected companies?"

En China, business is always driven by politics. And Wu’s political network could very well landed him in trouble.

Wu was in discussion to acquire a stake in the Manhattan office tower owned by Jared Kushner.

Wu’s background, like many other Chinese tycoons, is relatively obscure. Born in Wenzhou, Zhejiang Province, Wu founded Anbang as a small insurance company in 2004. His fortunes elevated after marrying Zhuo Ran, a granddaughter of former Chinese Communist Party (CCP) leader Deng Xiaoping.

Overseas Chinese language media and sources of this newspaper note that Wu and Zhou are now divorced, although Wu and Anbang have publicly denied such reports.

Wu, 50, is believed to be a close ally of an influential political faction that is in opposition to the Xi leadership. Jiang Zemin was head of the CCP for over a dozen years (1989–2002) and continued holding sway over the Chinese regime through a network of cronies for another ten years (2002–2012). Since coming to office in 2012, Xi Jinping has waged a battle to uproot the influence of Jiang and his faction.

Sources close to Zhongnanhai, the central headquarters of the CCP, told The Epoch Times that Anbang and Wu have close ties to the family of Zeng Qinghong, the former Chinese vice premier, member of the powerful Politburo Standing Committee, and longtime confidant of Jiang.

The source said that both Wu and Xiao Jianhua—the Chinese billionaire and Tomorrow Group owner who was abruptly brought back to Beijing from Hong Kong for investigation earlier this year—are key “white gloves,” or money launders, of the Zeng family and the Jiang faction.

The source added that Wu and Xiao used financial transactions to funnel and launder funds abroad on behalf of the Jiang faction, while at the same time parlaying their roles as business tycoons to spy on and influence foreign dignitaries.

There are questions surrounding the sources of Anbang’s capital. The company was founded in 2004 as a small insurer with a mere 500 millones de yuanes ($73 millón) of capital and eventually became a behemoth with assets of almost 1,971 mil millones de yuanes ($292 millones).

Anbang’s capital suddenly swelled in 2014, with a number of mysterious investors injecting a total of 50 billion yuan into the company. Research by Caixin, a respected mainland business magazine, found that some of Anbang’s 39 investors are obscure outfits such as auto dealerships, real estate firms, and mine operators that sometimes use shared mailing addresses, many of whom are connected to Wu. There’s also a trend of major state-level investors scaling back their ownership, with SAIC Motor Corp. and Sinopec decreasing their ownership levels from 20 percent each to 1.2 percent and 0.5 percent respectively.

Waldorf_hotel_17

The Waldorf-Astoria hotel is shown January 17, 2005 in New York City. (Spencer Platt / Getty Images)

The insurer also relies on fundings from selling risky wealth management products called universal life policies. These products offer high interest rates and are a hybrid bond and a life insurance policy, have been extremely popular with consumers dissatisfied with bank deposit rates of around 1 por ciento.

Crackdown on ‘Barbaric’ Insurance Sector

Xi Jinping has made reforming the financial industry a core focus this year. En un discurso en marzo 21, Premier Li Keqiang urged authorities to take powerful measures to prevent corruption in the financial sector, que es vulnerable a la llegada de la banca en la sombra, los activos tóxicos, y la financiación ilegal internet, according to state-controlled media Xinhua.

Xi has also shown he’s unafraid to challenge captains of industry with extensive political connections. Wu’s detention is the latest in a string of recent disciplinary actions taken against high ranking officials within the financial industry, and thus far, with the insurance sector as ground zero. En febrero, chairman of financial conglomerate Baoneng Group Yao Zhenhua was banned from the insurance industry for ten years. En abril, the former head of China Insurance Regulatory Commission (CIRC) Xiang Junbo was placed under investigation.

Sources close to Zhongnanhai have told The Epoch Times early this year that the Xi leadership is focusing on tackling corruption in the Chinese financial industry in 2017.

China’s insurance industry has garnered immense power—and controversy—during the last six years, a period of deregulation overseen by its former chief regulator, Xiang, currently under official investigation.

De 2012 a 2016, El sector asegurador de China creció 14.3 percent overall, and non-life insurance grew 16.5 percent in premium volume, según los datos de Munich Re. El año pasado, China superó a Japón para convertirse en el segundo mayor mercado asegurador del mundo por primas.

Durante este período, el sector de seguros se ha convertido en una cueva de tiburones financieros.

Insurers are traditionally bastions of conservatism, tenencia de activos estables como los títulos públicos y bonos corporativos. Las aseguradoras, por naturaleza, deben tener en cuenta la preservación del capital de sus clientes como lo más importante. These assets are also liquid and can be easily sold to pay back policy-holders.

Flush with cash from universal life policies, Chinese insurers embarked on a spending spree, amassing portfolios of risky assets not typically associated with insurance, such as stocks, bienes raíces, and foreign companies. Such assets are risky and illiquid, and could impede an insurer’s ability to repay holders during times of distress.

The insurers most closely associated with such practices are Evergrande Life, Foresea Life—a unit of Baoneng—and Anbang. These companies’ business model closely resemble a private equity fund, where capital is expensive and investment returns are the main focus.

El año pasado, Foresea and Evergrande amassed a large stake in residential real estate developer China Vanke. A public and protracted dispute to wrest control of Vanke from founder and CEO Wang Shi—one of China’s most famous entrepreneurs—ensued, creating a market firestorm that was finally dispelled after Beijing intervened in December.

In late 2016, China’s insurance regulator criticized the entire domestic insurance industry, calling its aggressive purchases of Chinese companies “barbaric.” Wang Shi also portrayed Foresea’s stock accumulation as “barbarian,” a reference to the 1989 book “Barbarians at the Gate” about the hostile takeover of RJR Nabisco by private equity giant Kohlberg Kravis Roberts & Co.

In just six months, Xi has replaced China’s top insurance regulator, banned the sale of universal life policies, and for now, seemingly brought a wild industry to its heels.

But years of free-wheeling cannot be corrected overnight.

Foresea, which depends on cash from sales of universal life products, issued a warning last month of financial difficulties leading to potential social unrest from its customers unless regulators lift the ban on such products. En un letter to regulators, Foresea called for a lifting of ban “to avoid mass riots by clients, causing systemic risks and much damage to the wider industry.”

Reference to “mass riots” is anathema to the CCP and a potential challenge to the Xi leadership. The insurance industry, in the end, may not give up without a fight.

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Una tienda de Xiaomi se ve en Pekín Ene. 12, 2015.(Wang Zhao / AFP / Getty Images)Una tienda de Xiaomi se ve en Pekín Ene. 12, 2015.(Wang Zhao / AFP / Getty Images)

Los últimos años no han sido amables con fabricante de teléfonos inteligentes de China Xiaomi, la mayor empresa de China en la industria hace tres años.

la cuota de mercado de la compañía ha erosionado de manera constante desde 2014. En el cuarto trimestre 2016, volumen de envíos de teléfonos inteligentes y cuota de mercado de Xiaomi era 7.4 por ciento, menos de la mitad de su 2015 cuota de mercado y una quinta distante detrás de los líderes actuales OPPO, Huawei, y Vivo, según datos de la firma de investigación de mercado IDC.

OPPO y Vivo-que comparten el mismo padre-salió de la nada para desplazar Xiaomi y dominar el rango medio de los teléfonos inteligentes de China-un segmento de mercado lleno de dispositivos Android de productos básicos como el que se venden a precios más bajos que los dispositivos de Apple y Samsung.

Más allá de las débiles ventas de Xiaomi, sus fortunas se hicieron mella aún más por la salida Enero de Hugo Barra, director de la división internacional de la compañía y podría decirse que su figura más conocida. Barra se unió a la compañía en 2013 como vicepresidente de Google, y ha sido fundamental en la construcción de los negocios de Xiaomi el extranjero sobre todo en la India, donde mantiene una Xiaomi 6.6 por ciento del mercado.

A pesar de la disminución de las ventas, Xiaomi todavía tiene ambiciones más altas. Su Presidente Lei Jun se labró como de cosecha propia de China Steve Jobs, y la compañía recientemente se unió a Apple como uno de los pocos fabricantes de teléfonos inteligentes mundial para el diseño y fabricación de sus propios chips de procesadores.

Xiaomi_China_IDCQ416

(Fuente: IDC)

de cosecha propia de la viruta

Xiaomi anunció su propio chip, llamado sobrevoltaje Piña S1, el feb. 28 en un evento en el Centro Nacional de Convenciones de China. El chip-que tiene ocho núcleos funcionando a hasta 2.2 -GHz se utiliza en teléfonos inteligentes de gama media Mi nueva 5c de la compañía. Con este, la compañía se une de Apple, Samsung, y su rival local Huawei como los únicos fabricantes de teléfonos inteligentes en el mundo con sus capacidades de fabricación propia del procesador.

introducción de un chip hecho a sí mismo de Xiaomi es interesante en unos pocos frentes.

La puesta en marcha privado no ha obtenido capital ya 2014, cuando Xiaomi fue valorada en $45 mil millones por los inversores. Hoy, Ralentización de ventas dados, su valoración es presumiblemente menor. Sin embargo, durante el evento de lanzamiento para dar a conocer su nuevo teléfono inteligente de chip, Xiaomi se desvió de su guión habitual de los inversores las gracias por su apoyo continuo. En lugar, Lei Jun mostró una diapositiva que leer, “Gracias por el apoyo del gobierno,”De acuerdo con el Wall Street Journal.

Si bien algunos detalles sobre la financiación de Xiaomi de Beijing son conocidos, el apoyo parece ser de base amplia. De acuerdo con Lei, apoyo financiero provino de un fondo de desarrollo de semiconductores establecido por Pekín, Ministerio de Ciencia y Tecnología de China, y el gobierno municipal de Beijing.

Beijing ha identificado semiconductores como un sector de importancia nacional y el año pasado, numerosos fondos se establecieron a nivel nacional, provincial, y los niveles locales para apoyar sector R&re. el deseo de China de ser autosuficiente en el sector fue impulsado por la oposición del gobierno extranjero para la adquisición de compañías de semiconductores por las empresas chinas por razones de seguridad.

El nuevo chip de Xiaomi es también un tiro de advertencia del líder mundial fabricante de chips Qualcomm por el régimen comunista chino. China tiene el dominio del tiempo de ojos Qualcomm entre los chips de teléfonos inteligentes de gama alta con desprecio. Pekín multa de Qualcomm en 2015 por casi $1 mil millones después de una investigación de años de duración en supuestas “prácticas anticompetitivas”. Como parte de la multa, Qualcomm se vio obligado a bajar las tasas de regalías se cargó fabricantes de teléfonos inteligentes chinos usando chips de la compañía. base de cálculo de regalías de Qualcomm se redujo de 100 por ciento del precio de venta como era la norma en todo el mundo, a 65 por ciento del precio de venta para los teléfonos chinos.

Gama de productos ensanchamiento

política a un lado, introducción de su propio chip de Xiaomi no debería tener un impacto material en el negocio de Qualcomm. Todas las marcas de teléfonos líderes de China utilizan chips de Qualcomm en algunos de sus teléfonos inteligentes, especialmente los más altos del extremo. Y la cuota de mercado global de magros Xiaomi no es probable que tenga un impacto significativo a Qualcomm, incluso si cesa el uso de chips de Qualcomm en su totalidad.

Sin embargo, dada la actual Xiaomi luchas la empresa el año pasado decidió detener la liberación de figuras de los teléfonos inteligentes de envío trimestral chip es todo acerca de su futuro. Tener un chip de primera parte permite Xiaomi a reducir los costos de producción y obtener el control sobre un proceso de integración vertical desde el diseño hasta el hardware al software (Xiaomi tiene su propio sistema operativo a medida MIUI Android).

Este es el modelo de Apple ha construido y perfeccionado a lo largo de dos décadas. Xiaomi y es uno de los primeros pioneros para hacer frente a los “Internet de las cosas” y ecosistemas casa inteligente productos en China. El nuevo chip permite Xiaomi para conectar e integrar su amplia gama de ofertas de productos con mayor eficacia.

Por ejemplo, Xiaomi ha sido un jugador agresivo en el segmento de dispositivos portátiles. Su monitor de muñeca Mi banda tiene una 15.2 ciento cuota de mercado global justo detrás de Fitbit, según IDC. Es el más rápido crecimiento de la marca importante en el sector vestibles, con un crecimiento año tras año de 96 por ciento en comparación con el declive de la Fitbit 22.7 por ciento.

Xiaomi tiene una amplia gama de productos para el hogar y personales conectados abarcan cámaras de acción, enrutadores, máquinas de café inteligentes, y escalas inteligentes. Su producto más reciente es una guitarra inteligente con el acompañamiento de aplicación para facilitar el aprendizaje.

Tomando otra página del libro de Apple y de Samsung, Xiaomi ha estado acumulando en silencio una cartera de patentes.

Xiaomi recientemente compró la propiedad intelectual (IP) los activos de Intel, Broadcom, microsoft, y más recientemente Casio, de acuerdo con IAM, un líder en la industria revista IP. La falta de cartera de propiedad intelectual ha sido durante mucho tiempo un talón de Aquiles para Xiaomi; que es una razón principal para el alcance limitado de la compañía fuera de China. Acumulando activos de propiedad intelectual deben equipar a más de Xiaomi para el crecimiento futuro.

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The headquarters of investment bank JPMorgan at Chater House in Hong Kong. (Philippe Lopez/AFP/Getty Images)The headquarters of investment bank JPMorgan at Chater House in Hong Kong. (Philippe Lopez/AFP/Getty Images)

Two of the biggest global banks, HSBC and Citigroup, announced they are under investigation by the U.S. Securities and Exchange Commission (SEC) for candidate hiring practices.

It’s believed that the investigations focus on the banks’ hiring of so-called princelings, or children of state-owned enterprises or government officials, en Asia. Companies have used this practice to curry favors with local politicians or business executives in order to win business, mostly in China.

Such probes into a widespread industry practice have long been expected, but they serve to further crimp the competitiveness of Western banks in an increasingly difficult market.

HSBC and Citigroup are not the only banks under inquiry. Goldman Sachs, UBS, and Credit Suisse have also received letters from the SEC seeking information related to hiring practices in Asia. The practice is widespread beyond the banking sector, as chipmaker Qualcomm last year was also investigated for hiring princelings in China.

Last November, New York-based JP Morgan Chase agreed to pay $264 million to settle U.S. probes into its hiring of princelings of well-connected officials and executives in China. JP Morgan was the first company to settle with U.S. authorities over hiring practices in China.

HSBC disclosed on its earnings call on Feb. 22 that the impact of ongoing SEC investigation and possible resolution could be “significant.”

‘Quid Pro Quo’

“JP Morgan engaged in a systematic bribery scheme by hiring children of government officials and other favored referrals who were typically unqualified for the positions,” said Andrew Ceresney, Director of the SEC Enforcement Division in a statement after the JP Morgan settlement.

According to Department of Justice records, JP Morgan bankers kept a spreadsheet to track the hiring of princelings, including their relationship to new business. An email from a Hong Kong banker—who copied then-head of JP Morgan’s Asia-Pacific investment banking—even inquired upon how to “get the best quid pro quo” deal from the parents of such princelings.

Amongst the hirings probed by regulators was Tang Xiaoning, the son of the chairman at China Everbright Group, a state-owned financial services holding for which JP Morgan was in initial talks for IPO issuance and other possible deals.

It’s a thin tightrope for banks. Investment banking is a relationship business, and the business culture in Asia emphasizes personal relationships, or “guanxi” in Chinese. En algunos casos, JP Morgan was on the receiving end of referral requests to hire such princelings by senior executives at existing clients, according to Department of Justice records.

Global investment banks were quick to rush into the Chinese market without the opportunity to build a solid foundation—cultivated over years of relationships.

The “quid pro quo” evidenced in the myriad JP Morgan emails obtained by regulators seemed shallow and lacked the presence of real “guanxi.” JP Morgan was far from the first bank to use its princeling hires as leverage. According to a Bloomberg report, JP Morgan ramped up its hiring program after the bank lost a key deal to competitor Deutsche Bank in 2009 because the client’s chairman’s daughter had worked for Deutsche.

It’s not hard to see how “quid pro quo” deals could be tempting for global banks operating in an often-inhospitable market. Banking is a protected core industry to the Chinese Communist Party, and Western banks have been losing market share to domestic Chinese competitors over the last decade. Advisors to companies raising capital often come across sensitive corporate financial data—information Beijing may not want foreign banks to witness.

Take a quick glance at investment banking league tables and it’s evident that foreign banks face an uphill battle in China. Many Western investment banks are retrenching their business in China. Among the top equities advisors in Asia-Pacific (excluding Japan), China International Capital Corp. is No. 1 and Goldman Sachs is the only non-Chinese bank among the top five bookrunners, according to Dealogic. And no foreign bank resides among the top five Chinese onshore debt advisors.

Why Is Hiring Princelings a Crime?

It’s common for U.S. corporations to hire the sons or daughters of American politicians and business executives. American universities also compete to admit the children of powerful politicians, business executives, and celebrities—with the hope of winning business, in their case fully paid tuition bills and possible donations.

But it seems companies operating in emerging markets face greater scrutiny over corruption. The ongoing SEC investigations and settlements reached so far are related to the U.S. Foreign Corrupt Practices Act (FCPA), which bar U.S. corporations from engaging in bribery overseas.

“The FCPA prohibit … authorization of the payment of money or anything of value to any person while knowing that all or a portion of such money or thing of value will be offered, given or promised directly or indirectly to a foreign official to influence… or to secure any improper advantage in order to assist in obtaining or retaining business for or with or directing business to any person,” according to the Department of Justice.

The regulators interpret the hirings of princelings to be bribes (thing of value) to Chinese officials in order to directly curry favors and win business.

In the most public case—JP Morgan—the bank’s hiring of princelings clearly wasn’t just a one-off idea or the under-the-table strategy of one department. The bank seemed to run a well-orchestrated but unfortunately named “Sons and Daughters” program. The plan was documented and recorded within memos and tracked on spreadsheets, and its specific goal was hiring princelings to win new business.

That is the difference between a “wink wink nod nod” arrangement and a documented program. And it came at a cost of $264 million to JP Morgan shareholders.

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Anbang Insurance Group's headquarters in Beijing, marzo 16, 2016. (Foto AP / Andy Wong)Anbang Insurance Group's headquarters in Beijing, marzo 16, 2016. (Foto AP / Andy Wong)

Beijing’s recent decision to crack down on activities of Chinese insurance companies could push insurers toward riskier asset investments and create a liquidity crunch within the industry.

Industry regulator China Insurance Regulatory Commission (CIRC) announced strict new rules late December, curbing an industry that has been flush with cash. The new rules are choking a main source of funding and growth for insurers by lowering their allowed investments into stocks (a 30 por ciento), and barring insurance companies from using customer deposits to fund large equity purchases.

The regulations come after a period of unprecedented growth for the Chinese insurance industry. De 2012 a 2016, El sector asegurador de China creció 14.3 percent overall and non-life insurance grew 16.5 por ciento en volumen de primas, según los datos de Munich Re. El año pasado, China superó a Japón para convertirse en el segundo mayor mercado asegurador del mundo por primas.

Tradicionalmente, insurers are considered to be bastions of security by holding conservative assets such as government securities and corporate bonds.

Pero no en China. Detectando oportunidad en un entorno de bajos tipos de interés, Chinese insurers have expanded outside of traditional insurance activities. They have been the biggest issuers of wealth management products called universal life policies. Estos productos, que ofrecen altas tasas de interés y son un híbrido entre un enlace y un seguro de vida, have been extremely popular with consumers dissatisfied with bank deposit rates of around 1 por ciento.

Muy bien de dinero, sino que cargar con la promesa de pagar altos rendimientos, Chinese insurance companies poured money into assets not traditionally associated with insurers. Estas empresas tomaron posiciones en las grandes empresas que cotizan en bolsa y chinos hizo con activos en el extranjero, incluyendo las empresas extranjeras y bienes raíces.

Por ejemplo, Evergrande vida-una unidad de promotor inmobiliario de China Evergrande Grupo-vio sus primas aumentan más de 40 doblar en 2016. It used the proceeds to accumulate a significant stake in rival developer China Vanke last year.

Como industria, insurance has been a major driver of Chinese foreign acquisitions. Anbang Life is at the forefront of such purchases. It made headlines in 2015 para la compra de hotel de Nueva York Waldorf-Astoria de casi $2 millones. En 2016, it bought Strategic Hotels & Centros de Blackstone Group para $6.5 millones. Más reciente, Anbang has been in negotiations to purchase U.S. life insurer Fidelity & Guaranty Life for $1.6 millones, a deal which has been put on hold for New York insurance regulatory review. Anbang’s biggest gambit was a failed $14 mil millones de oferta para adquirir Starwood Hoteles & Resorts Worldwide.

Riskier assets—such as equities—accounted for 49 percent of the insurance industry’s assets at the end of November 2016, un 27 percent increase from the end of 2013, according to a report by Moody’s Investors Service.

Como industria, insurance has been a major driver of Chinese foreign acquisitions.

“In particular, the industry’s rising exposure to single-name equity investments is increasing concentration risk, and leaves the insurers’ profitability and capital profiles sensitive to capital market movements,” analyst Kelvin Kwok wrote in the Moody’s note.

Cashflow Problems

Chinese regulators are concerned about the size of stock investments on insurers’ balance sheets. Such stock investments are risky and volatile, and could put depositors’ capital at risk.

CIRC’s fears are not unfounded.

Traditional insurers manage their business by attempting to match projected payouts of liabilities—such as annuities and insurance payouts—with assets whose cash inflows are stable and predictable enough to fund the outflows.

But the explosive growth of universal life policies, and the insurers’ acquisitions of riskier, longer-dated assets, throw this model out of the window. Insurers such as Evergrande Life have marketed universal life policies with very high yields (hasta 8 o 9 por ciento). And to attract even more customers, these products often have no penalty for early withdrawal.

As such, insurers are forced to buy riskier assets to grow their capital enough to fund such high promised returns. But with insurers holding such large stakes in Chinese listed companies, if depositors withdraw their capital en masse, it could suddenly force the insurers to sell their stakes and cause the stock market to plunge.

China Life holds a 44 percent stake in China Guangfa Bank and a 30 percent stake in Sino-Ocean Group. Foresea owns large stakes in Gree Electric Appliances and China Vanke. If they are forced to sell their stakes, the Chinese stock market could see a sudden downturn.

Insurers such as Anbang, which owns several entire foreign companies, has trapped cash and will find it even more difficult to raise money quickly.

This means that to stay liquid, insurers are forced to sell more universal life policies in the short term—with new proceeds used to pay interest on existing policies.

But that source of capital is quickly drying up, and a liquidity crunch could ensue. Anonymous sources told Chinese-based 21st Century Business Herald that is CIRC is preparing to block sales of certain universal life policies entirely. The CIRC temporarily suspended a handful of insurers late December, including Evergrande and Foresea, from selling universal policies over the internet.

Buyers of new policies are finding the returns have lowered. Marketing a 4.7 percent return on a two-year universal product, an Anbang customer service agent in Shanghai told a reporter from the South China Morning Post, “It could be the highest return on the market nowadays. Next time you come, you might not get hold of a product with no fees on early surrender of two years.”

Some insurers have already felt the squeeze. Evergrande Life, according to regulatory filings, reported that its solvency rate dropped from 180 percent to around 110 por ciento al final de 2016.

Solvency rate of 100 percent is the minimum threshold for insurers in China.

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Shoppers walk pass a Cartier store in Beijing, Ago. 25, 2015. (Kevin Frayer / Getty Images)Shoppers walk pass a Cartier store in Beijing, Ago. 25, 2015. (Kevin Frayer / Getty Images)

Luxury shopping is back in vogue in China. Sales growth increased year-over-year for the first time since growth stalled after Chinese communist leader Xi Jinping began its anti-corruption campaign in 2013.

Hoy, much of the sales growth is coming from within China, with consumers eschewing overseas shopping trips to make their purchases domestically and online.

Luxury goods sales growth had historically been strong in China. The market expanded 19 percent annually from 2007 through 2014, according to consultancy Bain & Co. “But since 2014, China has seen a more modest performance,” Bain said in its 2016 Luxury Goods Market Study.

During 2013 y 2014, luxury sales were hampered by Xi’s anti-corruption campaigns. That was followed by 2015’s stock market crash which further sapped consumer spending power. "Sin embargo, en 2016, at constant exchange rates, the market grew 4%, the first sign of a revitalization in three years.”

China_Bain_growth

Chinese luxury market expanded at 4 percent adjusted for effects of currency (Bain & Co.)

Kering Group, which operates Gucci and YSL brands, said on Feb. 10 ese 2016 same-store sales increase of 11 percent in Asia ex-Japan, which was mostly led by a rebound in China. LVMH, which owns brands such as Louis Vuitton, Bulgari, and Hennessy, also highlighted positive momentum going forward in its fourth quarter earnings call with investors. Hugo Boss Group’s Mainland China same-store sales also increased close to 20 percent during 2016, adjusted for currency.

That’s good news to the luxury goods sector—from Swiss watches to high fashion and expensive cognac—for which Chinese consumers make up around 30 percent of all global sales. In a note to investors, analysts at investment firm Exane BNP Paribas expects growth to continue to trend upwards during 2017, with Swatch Group, Richemont SA, and Burberry the companies most likely to gain.

The growth during the second half of 2016 was led by middle-class consumers, a segment that retailers and luxury brands aim to court going forward. Middle-class sales will be especially important as sales in the super high-end bracket could be volatile this year leading up to the 19th National Congress of the Communist Party in the autumn.

E-commerce Gains

Positive contribution is also expected to come from a platform that has been underutilized by luxury brands in the past—e-commerce.

But that is quickly changing, according to a joint study by Exane BNP Paribas and ContactLab. Luxury brands are increasing their presence online and on mobile across a variety of platforms, including standalone websites and storefronts on popular Chinese e-commerce portals such as Tmall, Secoo.com, and JD.com. This is a departure from luxury sales strategy in the West, where most of such sales still originate from physical stores and white-glove customer service is a large driver of purchase decision.

China_luxury

(Illustration by Exane BNP Paribas and ContactLab)

Increased personalization and localization has helped some brands in China.

Montblanc and Chanel are two luxury brands that set up stores within the social networking hub WeChat, to take advantage of Chinese consumers’ affinity for mobile shopping. Burberry is also one of a handful of brands that offer localized website content, such as partnerships with Chinese celebrities and region-exclusive promotions.

Overseas Sales Lag

There are some headwinds facing luxury retailers, such as a weak yuan and Beijing’s crackdown on overseas spending. These factors will help increase sales domestically at the expense of overseas purchases.

The growth during the second half of 2016 was led by middle-class consumers.

Last year’s so-called parcel tax enacted by the Finance Ministry has already put a dent in online overseas purchases of luxury goods. The tax, similar to import duties, is levied on all consumer online purchases shipped directly to China. Al mismo tiempo, Beijing also cut actual import duties on imported goods such as clothing and cosmetics to drive down domestic prices and repatriate overseas Chinese consumers spending.

These efforts—along with recent terrorist attacked in France and Germany—have largely kept Chinese consumers home in the second half of 2016.

Pricing decisions by luxury retailers also contributed to this trend. Luxury goods maker Richemont—which owns Cartier, Van Cleef & Arpels, and Dunhill—and Chanel were two of the first companies to normalized prices globally, setting the same price on a single product across all markets before effects of local currencies and taxes.

This trend served to narrow the price difference on the same item between China and abroad—a principle reason why many Chinese consumers previously made purchases outside of China.

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Pakistani and Chinese workers sit on an excavator as they leave the newly built tunnel in northern Pakistan's Gojal Valley, de sept. 25, 2015. The project is part of China's ambitious One Belt, One Road initiative. (Aamir Qureshi/AFP/Getty Images)Pakistani and Chinese workers sit on an excavator as they leave the newly built tunnel in northern Pakistan's Gojal Valley, de sept. 25, 2015. The project is part of China's ambitious One Belt, One Road initiative. (Aamir Qureshi/AFP/Getty Images)

China’s “One Belt, One Road” initiative seeks to makes infrastructure investments in more than 60 countries across Asia, África, and Eastern Europe. But it also could burden China’s already capital-constrained banks with even more risky assets, increasing default rates and further destabilizing the country’s financial system.

The program lends to developing countries to finance roads, bridges, and other infrastructure projects as part of Beijing’s broader efforts to expand trade and influence.

While policy banks such as the Asian Infrastructure Investment Bank (AIIb) have pledged support, a large portion of financing expects to come from China’s major commercial banks.

Source of Demand

The project has been described as China’s version of the “Marshall Plan.” It aims to do more than just upgrade the infrastructure of developing countries. The initiative was created partly to cultivate new markets to buy up China’s large excess capacity in the steel, carbón, and container shipping industries.

Beijing for years has looked to cut dependency on heavy industries. But it cannot do so without simultaneous lowering economic growth rates and creating potential social instability in its poorer inland and Northeastern provinces whose economies depend on coal and steel production.

Projects sponsored by One Belt, One Road provide a vehicle to sell such surplus coal and steel to developing countries, and increase utilization of maritime shipping.

Repayment Question

According to estimates from Fitch Ratings, total overseas loans—including One Belt, One Road—extended by Chinese banks during the first half of 2016 totaled $1.2 billones, with commercial banks providing two-thirds of the funding.

“The lack of commercial imperatives behind OBOR (One Belt, Un camino) projects means that it is highly uncertain whether future project returns will be sufficient to fully cover repayments to Chinese creditors,” a Jan. 26 Fitch report warned. En otras palabras, the ratings agency is skeptical as to whether the loans would be repaid as agreed. Fitch assigns “junk” ratings to several markets China invests in, but a few nations, such as Laos, have no rating at all and are highly risky.

The entire project is more of a political gamble than a calculated commercial venture. It would be less a concern if One Belt, One Road was primarily funded by infrastructure or policy banks, or the Chinese government directly. The issue lies in that most of the funding for the initiative was provided by commercial banks. These banks hold most of the cash savings of ordinary Chinese consumers, are publicly listed, and their stocks are widely held by retail investors.

“Banks do not have a track record of allocating resources efficiently at home, especially in relation to infrastructure projects—and they are unlikely to have more success overseas,” Fitch said.

Systemic Risks

One Belt, One Road hardly represents the first instance that commercial banks have been forced to put political interests ahead of profitable commercial activity.

While the structure of most loans is not public, it is believed that the loans have variable seniority, with the most senior (least risky) tranches going to the commercial banks. But if returns are subpar, the initiative could put further strain on an already taxed banking system.

Chinese domestic infrastructure loans already make up a disproportionately large part of total non-performing loans (NPL) within the banking sector.

Oficialmente, China’s NPL ratio—the ratio of NPLs to total loans outstanding—was 1.81 percent during the fourth quarter 2016, a bit higher than the 1.76 percent reported at the third quarter, according to the China Banking Regulatory Commission.

But independent estimates peg the actual rate of NPLs at much higher. Third-party estimates from CLSA and other banks state China’s NPL rates to be as high as 15 a 20 por ciento.

Infrastructure loans already make up a disproportionately large part of total non-performing loans (NPL) within the banking sector.

Beside the rate of bad loans, the speed of growth in total debt has been dizzying. Debt in the non-financial sector grew almost 75 percent since 2011, compared to the 8.6 percent in debt growth during the same period leading up to the 2008 financial crisis.

Additional loans from the One Belt, One Road initiative will likely only exacerbate China’s growing NPL problem, and could lead to a banking system crisis.

And the crisis wouldn’t just be confined to the Chinese banking system. From the perspective of borrowers, failure to repay the loans could trigger crises for the governments and regional economies of the countries receiving the investment.

Some countries, such as Laos, provided guarantees or asset collateral to backstop their One Belt, One Road loans, which could raise lending recovery rates in the event of repayment difficulty. Por ejemplo, Kyrgyzstan’s debt from China’s Export Import Bank was almost 20 percent of its GDP in 2015.

Whether the ambitious One Belt, One Road project can succeed will have huge ramifications within the Chinese banking system, and impact the economic well-being of several regions.

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A driver uses his smartphone to pay the highway toll using Alipay, an app of Alibaba's online payment service, at a toll station on the Hangzhou-Ningbo Expressway in Hangzhou, China.
(STR / AFP / Getty Images)A driver uses his smartphone to pay the highway toll using Alipay, an app of Alibaba's online payment service, at a toll station on the Hangzhou-Ningbo Expressway in Hangzhou, China.
(STR / AFP / Getty Images)

By most accounts, China is the global leader in internet banking and financial technology (fintech) investments.

Fintech’s relevance in China will be on full display this month—during last year’s Chinese New Year holiday week, consumers used Tencent’s WeChat app to send out more than 30 billion digital red envelopes.

Chinese search provider Baidu Inc. in January became the latest technology giant to open a direct bank, joining forces with investment firm China CITIC Bank to form Baixin Bank. Baixin will offer online-only banking and lending services for consumers and small businesses.

With this launch, Baidu joins internet giants Alibaba and Tencent Holdings (together, BAT) in offering direct banking through online banks. Tencent, which runs China’s largest social network WeChat, formed WeBank in 2014. Alibaba introduced two of China’s most successful fintech ventures in MYBank and Ant Financial.

Other Chinese companies are following BAT into the internet banking foray. In late December Xiaomi, one of China’s biggest online smartphone sellers, bought a 30 percent stake in Sichuan XW Bank, a major internet bank in Western China which leverages data to target small-businesses and consumers. Meituan.com, a website that specializes in group buying, also formed an internet bank called Jilin Yilian Bank, which received its banking licenses on Dec. 16.

Fintech investments surged to $8.8 billion in the twelve months ended June 30, 2016, according to a joint report by DBS Bank and consultancy firm EY. A comienzos de 2016, Ant Financial alone raised $4.5 millones, the largest single private placement in fintech history, putting a $60 billion valuation in the Alibaba-affiliated company. En total, fintech attracted around half of all of Chinese venture capital during 2016.

The major internet banks have performed well financially relative to other startups. In an interview with Chinese media last December, WeBank CEO Gu Min said that financial performance was above expectations and the internet bank was on track to break even or eke out a small profit for 2016.

Two Factors Driving Growth

Fintech’s growth in China is largely an extension of services from BAT, China’s dominant technology giants. There are more than 700 million smartphones in use in China. Those three companies control much of the online and mobile life of Chinese internet users, and converting millions of captive users already in the fold is an evolution of their product strategy.

But the pervasiveness of fintech isn’t just about sheer numbers. In the United States, Facebook and Amazon.com both have millions of captive users, but the companies’ banking and payment services are still in their nascent stages with low adoption rates.

The biggest growth enabler of fintech and internet banking is the traditional banking industry in China. The major banks’ complete neglect of large swaths of consumers, small businesses, and private enterprises has single-handedly spurred recent rise of fintech in China.

China_bank_access

(Fuente: EY and DBS data as of 2014. Illustration by The Epoch Times)

The phenomenon is akin to consumers in parts of Africa quickly moving from having no telephone service to widespread mobile phone adoption, skipping land line service entirely.

China’s big banks generally focus on serving local and regional governments, empresas de propiedad estatal, and large private companies.

Despite being the world’s second-biggest economy, one in five of China’s adults doesn’t have a bank account, according to the DBS and EY report. Bank access for consumers is especially poor outside of major cities. Besides solving the access issue, online banks provide consumers with cheaper and more tailored, customized products.

Small and medium-sized businesses make up another segment overlooked by major banks. While accounting for 60 percent of China’s GDP and 80 percent of urban employment, they make up only 20 a 25 percent of total loans originated by banks.

Despite being the world’s second-biggest economy, one in five of China’s adults doesn’t have a bank account.

This under-served sector has been a major benefactor of internet banks in recent years. During the first eight months after its launch, MYBank said it disbursed over 45 mil millones de yuanes ($6 millones) of credit to over 800,000 small to medium-sized businesses.

Large banks also haven’t kept pace in digital infrastructure. The consultancy McKinsey & Co. estimated that major Chinese banks only invested 1 a 3 percent of their pre-tax income to new technology and digital innovations, far below the 17 a 20 percent earmarked for technological innovation at global banks outside of China. The Industrial and Commercial Bank of China, the country’s biggest bank by assets, has recently upgraded its mobile apps and online access, but such services are only available to its corporate clients as of now.

Risky Business

The growth of internet banking in China has also seen its share of problems. Peer-to-peer (P2P) lending is one area within fintech that fizzled in 2016 after explosive initial growth.

Ezubao—at one time China’s biggest P2P lender—turned out to be a Ponzi scheme, defrauding almost $8 billion from 900,000 investors. The company’s collapse set into motion new regulatory rules issued last year to regulate P2P lender activity, including requirements to register with the state, appoint bank custodians, and disclose their use of deposits.

P2P’s rise and fall underscores the risks of fintech’s quick growth in China. Internet banks must receive banking licenses, and fintech solutions provided by major companies such as BAT are often self-regulated and have large internal credit departments.

But other corners of fintech—a broad term that covers everything from mobile payments to online wealth management—are lightly policed and often little understood. Regulators have often been slow to react to market trends and sheer number of new companies formed.

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A user posing with an iPhone showing an installed New York Times app on Jan. 5 en Beijing. (Fred Dufour / AFP / Getty Images)A user posing with an iPhone showing an installed New York Times app on Jan. 5 en Beijing. (Fred Dufour / AFP / Getty Images)

China’s “Great Firewall” has been central to the Communist Party’s strategy of controlling what residents can and cannot browse online. Websites ranging from search engines, discussion forums, to online media are closely monitored and censored.

Up until now however, mobile apps occupied a corner that has largely been under the radar of the “Great Firewall.” Alphabet Inc’s Google Play Store isn’t available in China and Apple Inc.’s App Store has a severely limited selection of apps in China. Outside of a few major domestic players, Chinese mobile app stores haven’t been heavily regulated.

Last week, new regulations were passed aimed at reining in the hundreds of unregulated mobile app stores in China. The exact number of app stores are unknown, but marketing firm AppInChina estimates that over 200 exist currently. Most of these stores have little to no established process to vet apps before their release.

The announcement was released by the Cyberspace Administration of China (CAC). Since Jan. 16, mobile app stores must register with the CAC to continue to operate legally. Such registration will make it visible to authorities who owns the app store and how many apps are present, allowing regulators to shut down stores as necessary.

Fragmented Market

Despite Beijing’s stance on regulating mobile app stores, the environment and fragmentation of the market makes it almost impossible to enforce the new measures.

The biggest smartphone platform in China—a country with more than 700 million smartphone users—is Google Android. But Google Play, the default app platform of the operating system, is disabled in China. This gave rise to a proliferation of third-party app stores, the biggest ones are those run by the nation’s large technology companies such as Tencent, Baidu, Xiaomi, and Alibaba. App stores run by these large companies are self-regulated.

Content that would be strictly blocked on a Chinese website sometimes could be found inside mobile apps.

But hundreds of other smaller third-party app stores have also sprouted, many with low security and vetting standards. Content that would be strictly blocked on a Chinese website can sometimes now be found inside mobile apps downloaded from these platforms.

Like many Chinese regulations, the guidelines are vague and open-ended. “It’s almost impossible for the regulators to register and supervise all the millions of apps there one by one,” Zhu Wei of the China University of Political Science and Law told the Wall Street Journal.

Hard to Enforce

Judging by the CAC’s language, the enforcement, monitoring, and censorship of content within these apps seems to fall on those operating the mobile app stores. The model CAC has adopted is to police the app stores, with the hope that the app stores will police the apps within.

But that’s a strategy that has proven faulty.

Earlier this month, the New York Times app was taken down by Apple after Chinese government censors demanded Apple remove it. Apple told the Times that its app violated local laws, without elaborating on which laws it violated.

This is hardly a surprise, until one realizes that the New York Times’ website has been blocked by China since 2012. This means that while Chinese censors intended to fully block access to New York Times’ content since 2012, Chinese residents were still able to access New York Times content through its mobile app for the last five years.

And this example involves Apple and New York Times, two of the most visible targets of Chinese censors. There are millions of Chinese mobile apps across hundreds of app platforms, most of which are small, private, and lack the resources to self-censor all of the apps and their content.

How long will it take to cull all of them?

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Entrance of Chinese peer-to-peer (P2P) lender Ezubao is seen in Hangzhou, Provincia de Zhejiang, on Dec. 17, 2015. Ezubao, once China's biggest P2P lender, was uncovered as a massive Ponzi scheme. (STR / AFP / Getty Images)Entrance of Chinese peer-to-peer (P2P) lender Ezubao is seen in Hangzhou, Provincia de Zhejiang, on Dec. 17, 2015. Ezubao, once China's biggest P2P lender, was uncovered as a massive Ponzi scheme. (STR / AFP / Getty Images)

Boom-to-bust cycles come and go quickly in China. Chinese peer-to-peer (P2P) lending growth slowed significantly in 2016, as a leading P2P lender was caught in a massive fraud and the industry faced a slew of compliance regulations to weed out unqualified firms.

P2P lending exceeded 2.8 billones de yuanes ($400 millones) en 2016, a jump from 2015 but at a far slower pace than the increase from 2014 a 2015. P2P lending activity stalled during the second half of the year after authorities issued strict new rules expected to cripple the majority of industry players in the next year.

P2P allows individuals to lend to other individuals while earning high interest rates. As a platform, P2P has been at the forefront of China’s financial technology industry. Thousands of P2P firms sprouted in the last few years, which connect investors (lenders) with borrowers.

These firms help fill a gap in the market. Banks—already buckling under piles of bad loans—are reluctant to offer credit to consumers or small businesses, many of whom are internet-based and cannot provide collateral. Middle-class investors, mientras tanto, are flush with cash but have few places to put it for a return. P2P firms offer platforms to connect yield-hungry investors with cash-strapped individuals or small businesses.

New Barriers to Entry

Following a slew of P2P industry scandals in 2015 y 2016, the China Banking Regulatory Commission (CBRC) and three other regulators issued rules last August for P2P lenders. Compliance is mandatory by August 2017.

The rules aren’t directed at P2P arms of giant internet firms such as Tencent and Alibaba—which have in-house credit rating arms to weed out suspect borrowers. Authorities seek to regulate the massive underbelly of the industry, consisting of thousands of small and poorly run P2P lenders often targeting unqualified borrowers and promise high returns to investors. En el pasado, the industry’s very low barrier to entry meant that “almost anyone can open one of these platforms,” Barry Freeman, cofounder of Chinese P2P lender Jimubox, told Business Insider last year.

China’s “Big Five” banks have been reluctant to take on P2P lenders as custodian clients.

CBRC’s new rules will require P2P lending companies to appoint qualified banking institutions as custodians and disclose their use of deposits. The custodian rules is especially important as it would require the funds to be held outside of the company at a state-regulated bank to minimize misuse or theft of investor deposits.

Authorities also expect to conduct on-site examinations of risk management, IT infrastructure, and shareholder verification before certifying P2P lenders.

Most P2P Firms Expect to Close

Hasta aquí, China’s “Big Five” banks have been reluctant to take on P2P lenders as custodian clients, despite recent regulation. Most of the P2P firms that did sign up custodians have used small regional banks.

For banks, servicing most P2P firms is unprofitable due to the industry’s fragmentation and small scale, and its recent negative publicity—once large P2P firms such as Ezubao and Boliya turned out to be scams. Custodian fees charged to P2P lenders vary but is believed to be high, with annual maintenance fees of up to 300,000 yuan ($40,000) and up to 20 basis points (0.2 por ciento) of commissions on deposits.

The new barriers mean rule adoption has been slow for P2P lenders. Only around 180 firms, or less than 10 percent of viable P2P lenders, have signed up with custodian banks at the end of 2016, according to P2P001, an industry tracker.

Solamente 200 P2P lenders—a fraction of the P2P industry which is believed to have between 2,500 a 3,000 total lenders—are expected to pass the regulatory review process and remain viable by next year, according to estimates by the South China Morning Post. The majority will shutter their business and return capital to investors.

Biggest P2P Fraud Case Set to Begin

The weeding out process begins just as the much-publicized trial of the executives of Ezubao—once China’s biggest P2P lending platform which turned out to be a scam—is set to commence.

Ezubao, which once held around 60 millones ($9 millones) yuan in deposits, was deemed a Ponzi scheme. The lending platform allegedly defrauded between $6 y $8 billion from 900,000 investors during its 18 months in operation. As part of the Ezubao scandal, Beijing launched a website specifically dedicated to rooting out P2P industry fraud as a channel for investors to submit complaints online.

As many P2P firms prepare to close and return funds to investors, the question becomes how much investors’ capital has already been lost.

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En una foto de archivo, miners push carts containing coal at a mine in Qianwei county, Sichuan. (Liu Jin / AFP / Getty Images)En una foto de archivo, miners push carts containing coal at a mine in Qianwei county, Sichuan. (Liu Jin / AFP / Getty Images)

A rebound in global coal prices became one of the biggest stories in commodities during the second half of 2016. A more than 90 percent increase since mid-year in the benchmark Australian thermal coal prices has lifted stocks of international coal producers.

But don’t tell that to Chinese coal producers. The recent rally in coal prices hasn’t reversed the fortunes of many Chinese coal producers still wallowing in overleveraged balance sheets, high debt burden, and weak demand.

Recent bond market travails of these companies signal more defaults may lie ahead for Chinese onshore issuers as trillions of yuan in bonds become due in 2017.

Sichuan Coal Default

State-owned Sichuan Coal Industry Group missed a bond payment on Dec. 25. Un total de 1 mil millones de yuanes ($150 millón) in principal plus interest were due.

It was the second default for the coal company this year. Sichuan Coal also missed an interest payment in June but that default was ultimately resolved after the Sichuan government stepped in. Bond investors were paid at the end of July with loans from state-owned Sichuan Provincial Investment Group and a consortium of local and national banks.

ATC_Coal

Australian thermal coal prices during last twelve months (Indexmundi.com)

Other Chinese state-owned enterprises (EPE) are experiencing similar liquidity issues. China’s biggest lender—the Industrial and Commercial Bank of China—on Dec. 30 agreed to invest in Taiyuan Iron & Steel Group, Datong Coal Mine Group, and Yangquan Coal Industry Group via debt-to-equity swaps. Such swaps have been a key tool of Beijing to reduce leverage amongst SOEs by exchanging debt for equity. The swaps instantly eliminate debt and reduce leverage ratios at the cash-strapped firms.

Steel, carbón, and other heavy industries have languished on weak global and domestic demand. Beijing also launched a program to shut underperforming mines and plants and reduce its coal producing capacity. China’s Shanxi Province in the northeast is its biggest coal-producing area, accounting for more than 25 percent of the country’s coal production last year.

Trillions of Yuan Becoming Due

Historically, bond defaults have been unheard of in China. Pero en 2016, 55 corporate defaults were recorded, more than double the number for 2015. Y 2017 will likely see even more defaults.

Mas que 5.5 billones de yuanes ($800 millones) in bonds will mature in 2017, o 1.8 trillion yuan more than 2016, according to China Chengxin International Credit Rating Group. That’s a significant amount of cash Chinese companies must come up with during the next year.

Sichuan Coal’s default—assuming the local government declines to extend another bailout—could signal that Chinese Communist authorities are willing to allow more bond defaults going forward. In truth, analysts have expected massive bond defaults for years, while Beijing has been selective in choosing which SOEs to bail out. Independientemente, the number of such bailouts has decreased, underscoring authorities’ increasing comfort level with letting companies fail. With the significant amount of bonds due in 2017, a spike in bond defaults will likely result.

Furthering the challenge facing Chinese companies is the economic backdrop, which doesn’t look friendly for the Chinese bond market.

China’s rickety financial system is built entirely on overleveraging with cheap debt.

Like the rest of the global bond market, Chinese bonds have already been under pressure from the U.S. Federal Reserve’s plans of raising short-term interest rates. This has raised yields across the globe. China’s 10-year government bond yield settled at 3.07 percent on Dec. 30, slightly lower than mid-month but far higher than the 2.8 percent range at the beginning of 2016 (bond yields and prices move in opposite directions).

Faced with increased risk of capital flight, China may elect to guide its own rates higher. But in such a scenario, raising new debt would become prohibitively more expensive during a time when many Chinese companies are facing liquidity problems amidst slowing economic growth. The central bank’s actions would further squeeze Chinese borrowers in need of new debt to roll over existing debt.

China’s rickety financial system is built entirely on overleveraging with cheap debt. It is especially susceptible to rate hikes and without the type of economic growth required to withstand such rate increases.

With so much debt becoming due and armed with few options to raise new capital, 2017 could spell disaster for cash-strapped Chinese companies.

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Oppo's OnePlus 3 smartphone is seen at a launch event in New Delhi June 15, 2016. (Money Sharma/AFP/Getty Images)Oppo's OnePlus 3 smartphone is seen at a launch event in New Delhi June 15, 2016. (Money Sharma/AFP/Getty Images)

It’s the end of 2016, and the most popular smartphones in China—a nation of 700 million smartphone users—aren’t made by Apple, Samsung, or even Chinese cult brand Xiaomi.

Oppo and Vivo, two little-known companies in the West, have come to dominate the Chinese smartphone market using seemingly antiquated marketing strategies.

As of the third quarter 2016, Oppo held the biggest smartphone market share at 16.6 por ciento, with Vivo closely behind with 16.2 por ciento. Huawei and Xiaomi came in third and fourth, con 15 percent and 10.6 percent respectively, according to market research firm Counterpoint. Apple was a distant fifth with 8.4 por ciento del mercado.

The two companies came out of seemingly nowhere to sell millions of smartphones. Oppo’s sales were 84 percent higher than last year, mainly on the popularity of OnePlus, a line of smartphones with edgy designs, high-end specs, and low prices. Vivo relies on simple but solid designs and rock-bottom prices, a formula that propelled its sales 114 percent higher than prior year’s.

A Vulnerable Xiaomi

The phone market in China is fairly simple to enter, but difficult to dominate.

At the high end of the market, Apple still reigns. Alrededor $60 billion of Apple’s total sales were generated from China alone last year, and it wasn’t too long ago that Apple vied with Xiaomi—which hailed itself as China’s own Apple—for top smartphone market share. While Apple still has a stranglehold on the top end of the market, its position has eroded over the last year due to Beijing’s blockage of iTunes, una desaceleración de la economía china, Xi Jinping’s anti-graft measures, and a flood of cheaper but high-quality alternatives.

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(Fuente: Counterpoint Research)

It’s the middle range of the market that’s more interesting, and it’s where Oppo and Vivo have recently excelled. This is a market that has seen numerous winners emerge over the years such as Lenovo, Huawei, and most famously, Xiaomi. Xiaomi CEO Lei Jun styled himself as a China version of Steve Jobs, focusing on design, high-end specs, but at a lower price point than Apple. Xiaomi—popular with urban millennials—was known for its high-profile launch parties and until recently, an internet-only sales model.

But Xiaomi runs a version of Google’s Android operating system. And without an app ecosystem to lock in users, companies found that customer loyalty was almost non-existent amongst commodity-like smartphones that run Android. Even a brand with cult status like Xiaomi was susceptible to newer entrants.

Going Brick-and-Mortar

Oppo and Vivo are both owned by Guangzhou-based BBK Electronics, a company started by billionaire investors and entrepreneur Duan Yongping. Both brands have similar approaches to selling phones.

They observed that Xiaomi was a favorite of urban millenials—at least those who want a cheaper or Android-based alternative to the Apple iPhone. Xiaomi until recently only sold phones directly via its website, and promoted each phone release via hip launch parties.

Oppo and Vivo saw an opening in working with retail stores, where two out of three phones are still sold in China. The companies especially targeted stores outside of large cities and in rural areas, where consumers are more price-sensitive, have less access to the internet, and place more reliance on local technical and customer support. Oppo and Vivo partnered with retail sales professionals in small vendors and offered sizable affiliate sales commissions and subsidies to sales reps.

“Oppo and Vivo are willing to share their profit with local sales,” Jin Di, an analyst at market research firm IDC, dijo a Bloomberg.

“The reward was an extremely active and loyal nationwide sales network. They’re doing something different—they do local marketing.”

It’s an antiquated strategy, but it’s a fit with Chinese consumers outside of major cities. The small vendors serve as the companies’ local salesmen, technical support, and customer support. With the added incentives, they help promote the products to friends and consumers on WeChat, and steer sales away from competitors toward Oppo and Vivo phones.

Their other killer app? Oppo and Vivo phones often carry powerful, zoom-enabled front cameras for selfies.

Xiaomi, mientras tanto, has moved up market in recent years. It now manufactures a variety of other products such as video cameras and “Internet of Things” home devices in an effort to position itself as China’s homegrown Apple.

Through the success of Oppo and Vivo, Xiaomi also realized the value of having a retail presence. It now runs a few hundred stores in China.

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Investors watch price movements on screens in Beijing Feb. 22. China's insurance regulator said risky stock market bets by domestic insurers undermines market stability. (Greg Baker / AFP / Getty Images)Investors watch price movements on screens in Beijing Feb. 22. China's insurance regulator said risky stock market bets by domestic insurers undermines market stability. (Greg Baker / AFP / Getty Images)

NEWS ANALYSIS

Beijing has cracked down on domestic insurers, suppressing the industry over what regulators have recently deemed speculative investments. The move hurt insurance stocks, driving down the Shanghai Composite Index 3 percent in the week ended Dec. 15.

It’s a move that further cements China’s “Wild West” business reputation: the landscape is mostly lawless, but you never know who will ride into town to spoil the party.

Chen Wenhui, vice-chairman of the China Insurance Regulatory Commission (CIRC) announced stricter regulations over the industry on Dec. 13, including lowering the ratios of equity to be held, and barring insurance companies from using insurance deposits to fund equity purchases.

Chen denounced the insurance companies for making speculative stock market bets and disrupting market stability, according to an editorial in the Communist Party mouthpiece People’s Daily. en adición, CIRC launched investigations into two privately-held insurance giants—Evergrande Life Insurance and Foresea Life, a unit of insurance giant Baoneng.

Beijing has been closely monitoring insurance companies’ activities for months. Their highly leveraged asset purchases are risky and if stock prices fall, their fortunes could quickly unravel.

But the timing and nature of the crack down is intriguing. For one, Beijing has been attempting to restrict the outflow of cash, and insurance companies have been a major agent of foreign asset acquisitions in the last twelve months. Al mismo tiempo, CIRC’s investigation into two specific insurers may be driven by an entirely different motive.

Stemming the Outflow

Chinese insurance companies are flush with cash from selling so-called “universal life” products, a high-yielding hybrid product combining death benefit and investments. Foresea’s “universal life” products, por ejemplo, promise returns of between 4 a 8 por ciento. To fund the high returns, insurance companies have been leveraging up to purchase assets both within China and abroad.

Como industria, insurance has been a major driver of foreign acquisitions. Anbang Life is at the forefront of such purchases. Anbang made headlines last year for purchasing New York’s Waldorf-Astoria hotel for nearly $2 millones. A principios de este año, it bought Strategic Hotels & Centros de Blackstone Group para $6.5 millones, and most recently, Anbang has been in negotiations to purchase around $2.3 billion of Japanese residential real estate assets, also from Blackstone. Anbang’s biggest gambit this year was its failed $14 mil millones de oferta para adquirir Starwood Hoteles & Resorts Worldwide.

The timing and nature of the crack down is intriguing.

Fosun is another conglomerate which funds asset purchases from insurance subsidiaries. Fosun has a diversified portfolio of foreign assets, including well-known foreign assets such as vacation resort operator Club Med, circus performance troupe Cirque du Soleil, accessory maker Folli Follie, women’s fashion label St. John, and downtown Manhattan skyscraper One Chase Manhattan Plaza.

Cash leaving the country has accelerated yuan’s devaluation. But perhaps of greater concern for Chinese authorities is liquidity and cash leaving the nation’s banking system. China’s banks already face high delinquency rates and receive regular liquidity injections from the central bank. While official non-performing loan ratios at major banks are low (alrededor 2 por ciento), true delinquency rates—which affect banks’ cash and liquidity—are estimated at between 20 a 30 por ciento.

Restricting insurance companies’ ability to generate cash—which could be used to fund foreign acquisitions—therefore indirectly limits cash withdrawals and preserves liquidity at Chinese banks.

Beijing Intervenes in Vanke

Outside of general restrictions on insurers’ activities, CIRC’s crackdown on Evergrande and Foresea are the most severe.

Regulators barred Foresea from issuing “universal life” policies which made up almost 90 percent of the firm’s premiums. Foresea has used such premiums in recent months to increase its ownership in a number of high-profile Chinese companies.

CIRC also banned Evergrande Life, the insurance unit of major property developer China Evergrande Group, from investing in equity securities. In an announcement on its website, CIRC said Evergrande’s “asset allocation plan is not clear, and its capital funding operations are not standardized.”

Beijing’s decision to intervene in Foresea and Evergrande is interesting, given that the two insurance giants are both major shareholders of China Vanke, a major residential real estate developer. Evergrande and Baoneng both own major stakes in other Chinese companies, but Vanke is the most public and well-known.

Baoneng—through Foresea and several other subsidiary insurers—is Vanke’s biggest shareholder and has been locked in a protracted dispute to wrest control of the company from Vanke founder and CEO Wang Shi, one of China’s best-known and earliest entrepreneurs.

Last week, CIRC criticized the entire domestic insurance industry, calling its recent investments into other Chinese companies “barbaric.” The tone and characterization is similar to Wang Shi’s portrayal earlier this year of Baoneng as “barbarian,” a reference to the book “Barbarians at the Gate” about the 1988 hostile takeover of RJR Nabisco by private equity giant Kohlberg Kravis Roberts & Co.

Evergrande is another top shareholder in Vanke and has been building up its shares quickly over the last few months. Its intentions so far are unclear, but Evergrande’s parent is poised to overtake Vanke as China’s biggest residential developer in 2016.

Both companies could demand board seats at Vanke’s shareholder meetings in March 2017, which could determine the fate of Wang Shi.

And here’s where Beijing steps in as Wang’s white knight. Wang is a celebrity with a rock star-like reputation, and one of China’s first-generation entrepreneurs who is synonymous with the rise of Shenzhen as a business hub. Since founding the company in 1984, Wang carefully managed his relationship with local and regional Communist party organs. Vanke largely followed party blueprints to develop and build homes and apartments across China during the real estate boom, and is said to have a wealth of Communist Party connections.

To Western observers, the Vanke takeover battle seems routine. Activist investors such as Carl Icahn and Daniel Loeb shaking up corporate boards is commonplace in the United States. But the showdown over Vanke is a rarity in the Chinese markets, where the ruling Communist Party craves stability and control above all.

En años recientes, regulators have increased rhetoric about letting free-market forces play a more decisive role in shaping the country’s financial markets. Analysts had been wondering how the Chinese regime would handle a possible downfall of one of China’s most successful businessman, which will reveal much about its market intentions.

It looks like we have our answer—CIRC’s crackdown on Vanke’s top shareholders will likely stop Baoneng and Evergrande’s further advance.

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Flags fly outside headquarters of chip equipment maker Aixtron in Herzogenrath, Germany on Oct. 25. Acquisition of Aixtron was blocked by President Obama last week.
(Oliver Berg/AFP/Getty Images)Flags fly outside headquarters of chip equipment maker Aixtron in Herzogenrath, Germany on Oct. 25. Acquisition of Aixtron was blocked by President Obama last week.
(Oliver Berg/AFP/Getty Images)

A Chinese company’s pending purchase of German chip equipment maker Aixtron SE was blocked by President Obama on the basis of national security concerns Dec. 2. The move underscores growing sentiments of increased scrutiny on Chinese investments in the West.

The presidential order effectively barred the acquisition of Aixtron and its U.S. subsidiaries by Fujian Grand Chip Fund. Aixtron was notified by the Committee on Foreign Investment in the U.S. (CFIUS) earlier that it would advise the president against approval of the merger.

The decision wasn’t unexpected. In late October, the German government withdrew its prior support for the €670 million ($714 millón) Aixtron-Fujian tie-up on “previously unknown security-related information.”

While CFIUS never discloses reasons for blocking cross-border deals, the decision is said to be driven by production techniques of a compound called gallium nitride, sources told Reuters. The little-known material—which Aixtron’s technology helps produce—is used in production of military equipment such as radar, antennae, and lasers. It suffices to say that the U.S. government isn’t keen on Beijing obtaining the military-grade technology.

Increased Inquiry

The Aixtron decision reflects growing sentiments in the U.S. and Europe against Chinese investments in general as the world’s No. 2 economy has overtaken the United States as the world’s biggest asset acquirer.

Sigmar Gabriel, Germany’s economics minister, has signed off on legislation to limit foreign acquisitions of EU companies involving “key technologies that are of particular importance.” German concerns over Chinese investments increased after Chinese appliance manufacturer Midea purchased German robotics and engineering firm Kuka earlier this year for €4.5 billion ($5.0 millones). Kuka is a key supplier to many German and U.S. industrial firms and defense contractors.

The United States is also ramping up review of cross-border deals. CFIUS earlier this year blocked a buyout of Lumileds, a lighting company under Dutch technology giant Philips NV, by Go Scale, a Chinese private-equity firm. En febrero, China Tsinghua Unigroup abandoned a proposed deal to purchase digital storage manufacturer Western Digital Corp. also due to impending CFIUS investigation.

Large swaths of Chinese industry are still off limits to foreign acquisition or foreign majority ownership.

Analysts believe that Chinese investments into U.S. companies will receive further scrutiny once President-elect Donald Trump enters office. During his presidential campaign, Trump pledged to conduct more stringent review of Beijing’s trade and economic policies.

China’s Protectionism

What Chinese companies encounter in the West today is still a far cry compared to the obstacles Western companies confront in China. Large swaths of Chinese industry are still off limits to foreign acquisition or foreign majority ownership, such as banking, securities, telecom, transporte, and professional services.

While some industries were taken off of the “restricted” list by Chinese authorities in recent years, some Western companies believe protectionism sentiments are increasing in recent months.

“German companies here feel that there has been a considerable rise in protectionism,” Germany’s ambassador to China, Michael Clauss, told Reuters.

“We are receiving more and more complaints, especially since the beginning of this year,” Clauss said. While German companies—especially the automakers—have benefitted from a growing Chinese economy in the past decade, they still must manufacture cars within China with local partners.

NOS. firms in China had similar experiences. In the most recent survey of American Chamber of Commerce in China conducted earlier this year, one in 10 NOS. companies with presence in China said they planned to move or had already moved a portion of their activities away from China due to regulatory obstacles.

Companies within the technology, industrial, and natural resources sectors were the most downbeat on Beijing’s attitude towards foreign companies—83 percent said they felt unwelcome. And the sentiments were reflected in their financials—64 percent of U.S. businesses in China were profitable last year, desde 73 por ciento en 2014.

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Chinese retirees walk on the street in Beijing Oct. 16, 2014. (Kevin Frayer / Getty Images)Chinese retirees walk on the street in Beijing Oct. 16, 2014. (Kevin Frayer / Getty Images)

To boost returns and support a growing population of aging pensioners, China is embarking on a plan to centralize management of pension funds and divert more money into riskier asset classes.

The blueprint calls for transferring portions of local and regional pension funds to the centrally managed National Social Security Fund (NSSF), which is based in Beijing and has broader mandates to invest in riskier assets such as stocks, stock funds, and private equity.

The expansion of the NSSF and deployment of money into the stock market serves a dual purpose for the Chinese communist regime. En teoria, investing in the stock market should generate greater returns and boost the size of the fund to cover growing pension commitments. This is something the local and regional funds couldn’t previously accomplish due to their investment restrictions and the low interest rate environment.

en adición, funneling more institutional money into China’s equity markets could reduce stock market volatility by decreasing influence of fickle retail investors. The more stable fund flow from pension funds should stabilize markets which has suffered from sudden retail investor inflow and outflows in the last two years.

Beijing began outlining a transfer of assets to the NSSF since last June, in the midst of Shanghai’s stock market bubble and subsequent crash. Guangdong Province was the first to transfer assets to the NSSF, and other provinces are following suit. As of December 2015, the NSSF managed 1.9 billones de yuanes ($276 millones) of assets.

High Reward, Higher Risk

Actualmente, local and provincial pension funds are restricted to investing in safer asset classes such as bank debt and government bonds to preserve capital. But due to low interest rates, such investments have generated such meager returns that many pension funds find themselves unable to cover retirement payouts at a time when more state employees are approaching retirement.

The NSSF has no such restrictions and can invest up to 40 percent in stocks. Al final de 2015, 46 percent of NSSF’s assets were direct investments into companies, while the remainder were managed assets and investments, including stocks. According to the National Council for Social Security Fund which administers the NSSF, its assets appreciated 15.2 por ciento en 2015 y 8.8 percent inception-to-date.

Those are good returns, assume the figures are believable. But investment returns and monetary policy are often fleeting. Within a different set of circumstances—a higher interest rate environment, for example—the fixed-income heavy local and provincial pension funds could beat the returns of the riskier NSSF.

What this asset transfer from provincial funds to the NSSF means is that going forward, the fortunes of all Chinese state retirees now rest upon investment managers in Beijing.

The problem isn’t the disparate investment strategies between funds—competent investment managers can disagree on asset allocation philosophy. Pensioners should be concerned that the interests of NSSF investment managers in Beijing may not always align with those of the retirees.

Exposure to Non-Performing Loans

The NSSF already appears to be doubling down on its risky bets by dipping into increasingly more toxic asset classes that could partially be motivated by political pressures.

The four massive state-owned asset management companies—set up to buy piles of non-performing loans (NPLs) from Chinese banks—are in the midst of raising new capital from a combination of IPOs and strategic investments from insurance companies and pension funds.

The NSSF will invest in at least two of these “bank banks,” as they’re commonly referred to—China Great Wall Asset Management and China Orient Asset Management. Both are also seeking IPOs early next year.

The bad banks were set up by China in 1999 to resolve the nation’s NPL problems resulting from years of bank loans to mismanaged state-owned enterprises (EPE). The bad banks bought NPLs from state banks, freeing the latter’s balance sheets so they could keep lending to SOEs.

These bad banks essentially act as clearinghouses for China’s bad-debt problem. Beijing is able to shift such devalued—and sometimes worthless—assets away from the banks’ balance sheets, swapped out for either cash or bonds issued by the bad banks. That’s how the country’s big banks can claim sub-2 percent bad-loan ratios.

Inicialmente, bad banks were given ten-year loans to finance the asset purchases and were supposed to go away after winding down the NPLs in ten years. But China’s debt-fueled economy has been generating so many NPLs that these bad banks are here to stay and need capital infusions to keep buying more NPLs.

And that’s where Beijing wants the NSSF and other retail investors to step in. Need more evidence that the interests of Beijing are going to increasingly influence management of pension assets? China’s recently deposed Finance Minister Lou Jiwei was appointed as the new chairman of NSSF, according to financial magazine Caixin.

Early Retirement and Social Unrest

Al mismo tiempo, some Chinese provinces are instituting early retirement plans to push workers off active state payrolls. At least seven provinces—mostly in the Northeast—announced the plans, in part to comply with Beijing’s directive last year to reduce steel and mining capacity.

Similar to the 1990s policy enacted by then-Prime Minister Zhu Rongji, these early retirees don’t count toward official unemployment statistics and their pension benefits are deferred. China’s official retirement age for state employees is 60 for men and either 55 o 50 for women depending on position. Early retirement plans generally accelerate those rules by five years. They get a reduced monthly stipend during the five years, but must wait until the formal retirement age to enjoy pension benefits.

This alone has generated a spate of small but growing protests in the nation’s rust belt. If NSSF’s returns falter and the fund has trouble meeting its liability payments in the future, Beijing’s problems could quickly exacerbate.

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