Bankable Insights – The Custodian Edition Issue 2_v5
Bankable Insights – The Custodian Edition: A collection of the latest insights and perspectives on topics of relevance to the Securities Services industry
*Bankable Insights*The Custodian Edition
**From resilience to recovery
and rebuilding**
July 2020
Welcome to our second issue of The Custodian for 2020. This is a summer unlike any other for most of us, and I hope everyone is keeping well.
COVID-19 is what has defined our collective experience of 2020 thus far, both on an individual and industry level.
In this issue, we examine some of the ways our industry has been impacted by the massive global disruption that COVID-19 has caused. How resilient has our industry proven to be, what vulnerabilities have been exposed, how have we adapted, and how might we rebuild to be stronger?
A firm’s response in global stress situations reveals how deeply embedded their Environmental, Social and Governance (ESG) factors are on the organisational level. The pandemic has placed focus on the 'S' factor in ESG, with firms’ disaster preparedness and health and safety policies coming under scrutiny.
To allow business to continue, organisations have moved many physical processes into the virtual arena due to lockdowns and other COVID-19 restrictions. We look at how this has been implemented in the area of corporate governance. We also discuss how the COVID-19 crisis has prompted greater interest in central bank digital currencies (CBDCs) amidst concerns around the handling of physical cash. These moves signpost baby steps towards a broader acceptance of digital solutions that could raise the bar for operational resilience across the industry.
In the meantime, business goes on and developments continue apace. In India, local regulatory developments in the investment landscape mean greater opportunity and easier access for foreign investors. In China, strong fundamentals spell good prospects in the midst of global uncertainty.
Finally, on the theme of ‘Business As Usual In An Unusual Environment’, The Network Forum’s (TNF) annual summer event takes place from 29 June – 2 July 2020, but this time in the virtual space. Marking another first for the industry, TNF’s Virtual Summer Meeting is a great example of a resilient and adaptive response to global disruption. In times like these it is more important than ever to gather as an industry to discuss topical issues that concern us all. We are excited to be part of this, and hope to (virtually) see you there!
Margaret Harwood-Jones
Co-Head, Financing & Securities Services,
Financial Markets
<Br>Resilience and reform
in a time of COVID-19
**Respond, recover, learn, improve, repeat**
Resilience and reform in a time of COVID-19
Respond, recover, learn, improve, repeat
In October 2019, financial regulators in the United Kingdom wrapped up a public consultation on operational resilience reform. On 5 December 2019, the Bank of England, Prudential Regulation Authority and Financial Conduct Authority published a series of consultation papers1,2 on operational resilience, laying out clear expectations for the financial sector beyond the traditional risk and recovery capabilities and setting the direction for far-reaching reforms.
The year ended with a consideration of what such a regulatory and supervisory shift would mean in practice. How would financial services firms expand their enterprise disaster recovery and business continuity disciplines to incorporate the obligation to – as a firm and as part of the financial system – ‘absorb and adapt to shocks, rather than contribute to them’?3
Business leaders and strategists did not have long to consider these issues before the 2020 global health and economic crisis generated by the COVID-19 pandemic required them to launch an operational resilience response of global and historic proportions.
1 https://www.bankofengland.co.uk/paper/2019/operational-resilience-of-fmis
2 https://www.fca.org.uk/publications/consultation-papers/cp-19-32-building-operational-resilience-impact-tolerances-important-business-services
3 https://www.bankofengland.co.uk/financial-stability/financial-sector-continuity
From our observations of the post trade environment across our footprint markets, we share some perspectives on the industry’s resilience in its response to an evolving situation, lessons learnt from its early experiences in navigating the global disruption, and how this might determine how the industry moves forward.
Pandemic preparedness put to the test
Banking intermediaries in the global post-trade industry have been bracing for a global influenza pandemic for some time. Following the 2008 global financial crisis, for instance, the enhanced sub-custodian performance monitoring standards required sub-custodians to evidence a measure of pandemic preparedness.
As the COVID-19 pandemic took hold, sub-custodians along with other post-trade service providers, regulators and market infrastructures worldwide responded rapidly to collectively safeguard the welfare of their workforce, clients, and communities while continuing to deliver services that are vital to clients and economies in the region.
What has proven critical is a well-coordinated response in markets. During the initial stages of lockdown and market disruption across Africa and the Middle East, the disparate manner in which some exchanges and depositories responded threatened the end-to-end continuity of market processes. Several capital market authorities stepped up to coordinate a synchronised industry response and communicate evolving industry plans, helping market participants adapt to the changing conditions. This need for proactive and synchronised information-sharing reflects the integrated nature of market operations across infrastructures and allows for the sustained stability of the ecosystem.
Tackling vulnerabilities
The magnitude of the COVID-19 disruption has highlighted vulnerabilities in common industry processes, with the health and safety risks associated with the requirements for physical meeting attendance and physical documentation coming to the fore. Globally, we see regulations being relaxed to adapt to current challenges, allowing shareholder meetings and voting practices to be conducted remotely and extending deadlines for submission of statutory disclosures.
Consequently, the demand for secure virtual connectivity has been fast-tracked, and the adoption of digital solutions for voting and documentation – already at implementation stage in some markets pre-COVID-19 – has taken on a new urgency.
Market volatility and business continuity plans
The COVID-19 pandemic is testing the resilience of market infrastructure providers and the effectiveness of business continuity plans across the board, with the need to manage increased volatility and transaction volumes as well as implementing split-team and remote working arrangements due to lockdown requirements.
To manage the surge in market volatility, market safety mechanisms were triggered across markets in Greater China and North Asia, putting to the test the safety mechanisms already in place such as the Price Limit mechanism in China, Volatility Control Mechanism in Hong Kong, Sidecar and Circuit Breaker in South Korea, and Intra-Day Volatility Interruption mechanism in Taiwan.
With contingency plans in motion, most market infrastructure providers were able to provide much-needed stability and resilience in the financial markets. In China, for example, the State Council of China extended the Chinese Lunar New Year holiday to contain the spread of COVID-19, and the China Securities Regulatory Commission stepped up supervision and guidance to the exchanges and market participants to ensure smooth operation of the markets. For the Shanghai Stock Exchange, the Waigaoqiao Disaster Recovery Centre was activated and changes were made to 28 systems including the trading system, the business system and the mid-end service system, to ensure smooth trading on the first day after the delayed opening of the market.
In other markets, however, the pandemic led to extended stock market closures and trading halts. In March 2020, the Sri Lanka and Bangladesh exchanges were among a handful of stock markets that halted trading as the economy shut down and equity prices plunged. Sri Lanka’s stock market saw a seven-week trading halt while Bangladesh’s stock exchanges were closed for nine weeks. The Colombo Stock Exchange re-opened on 11 May 2020 only to shut within minutes following a drop of over 10% in a gauge of blue-chip shares, highlighting the risks of a long hiatus.
Adaptive strategies
Responding effectively to disruption in Africa and the Middle East has required adaptive solutions. While the extensive investments in more robust infrastructure over the years have been invaluable, limitations still exist in the power and communications infrastructure that present its own set of challenges to post-trade operations and the move to a fully remote workforce.
As such, market infrastructures and firms have had to quickly implement a broad spectrum of strategies to achieve operational resilience. These include ensuring uninterrupted power supply with the installation of solar panels at staff residences to ensure reliable internet connectivity for essential staff in a work-from-home setup.
Building resilience in the post trade industry
A successful response to disruptions of any scale necessarily entails meaningful iteration of the respond, recover, learn and improve cycle of operational resilience. The efforts of industry groups and market associations such as the Association of Global Custodians and International Securities Services Association – working with policy makers, infrastructures and local custodian associations in markets – are key to the process. While international efforts are underway to develop operational resilience policies and standards to guide the industry response to disruption, these are currently a collation of guiding principles drawn in broad strokes by financial sector authorities. The post trade industry will need to come together as a collective to share learnings and refine the approach to setting standards. This will help ensure that it can rebuild better and address specific issues like issuer regulation, physical asset servicing, wet signature and physical documentation requirements as well as e-voting and e-proxy voting.
A successful response to disruptions of any scale necessarily entails meaningful iteration of the respond, recover, learn and improve cycle of operational resilience. The efforts of industry groups and market associations such as the Association of Global Custodians and International Securities Services Association – working with policy makers, infrastructures and local custodian associations in markets – are key to the process.
<BR>The S-factor:
Spotlight on the ‘S’
in ESG
The S-factor:
Spotlight on the ‘S’ in ESG
The COVID-19 global pandemic has brought about unpredictable and unusual circumstances, leading organisations to take measures they never thought they would and sparking an industry-wide conversation regarding the need for a robust resilience plan with wider coverage beyond what we have today.
Resilience and business contingency are no longer only about how to continue operations remotely during a natural disaster. Organisations need to also consider how Environmental, Social and Governance (ESG) factors contribute to tangible financial risks, and how to manage them. By accounting for non-financial factors in their long- and short-term business plans, organisations will be better prepared for such ‘expected unexpected’ impacts, allowing them to optimise performance against current and future material ESG issues.
By accounting for non-financial factors in their long- and short-term business plans, organisations will be better prepared for such ‘expected unexpected’ impacts.
Corporate responses are now in the spotlight, revealing an organisation’s ESG integrity. Just as situations of stress show a person’s true characteristics, how an organisation reacts in global stress situations such as a pandemic is evidence of how deeply embedded ESG factors are in the organisation. The measures that organisations take to ensure employees’ health and safety depend on the type of labour policies in place. The decision to lay off employees during the pandemic relies heavily on the type of governance structure it has. How organisations convey layoffs reflects its culture. Any response can reveal the depth of ESG integration of an organisation, and whether those ESG factors are a part of the company culture or merely a check-box to comply with what’s required.
How an organisation reacts in global stress situations such as a pandemic is evidence of how deeply embedded ESG factors are in the organisation.
The S-factor
On top of the environmental factors that have long been dominant in the ESG landscape, investors are now increasingly interested in the social and governance elements. These newly prominent factors include health and safety policies, disaster preparedness, continuity planning, workforce planning, supply chain resilience, board effectiveness and employee treatment. Not only do these factors contribute to the way organisations handle crises, investors also regard these factors as a signal of future resilience instead of relying solely on historical data. With the data available, investors can now identify companies that can navigate unforeseen stress while highlighting companies that are aligned – or misaligned – to their ESG investment strategy.
An analysis of COVID-19 response signals done by TruValue Labs – such as changes in supply chain, corporate operational responses and labour policies – identified a correlation between positive sentiment and the number of response signals captured1. The same analysis also saw a shift in focus among investors on the policies companies have taken to ensure the health and safety of employees, and companies’ decisions to keep workers on the payroll, furlough or to announce layoffs.
Along with investor perception, corporate responses have also become a powerful branding opportunity. Companies will be remembered and rewarded for their responses – such as charitable donations, monetary benefits and extended childcare leave.
With the data available, investors can now identify companies that can navigate unforeseen stress while highlighting companies that are aligned – or misaligned – to their ESG investment strategy.
1 https://www.truvaluelabs.com/news/press-release/truvalue-labs-introduces-free-covid-19-data-set-and-dedicated-coronavirus-esg-dashboard
What matters now
The pandemic has highlighted the importance of materiality. While the concept of materiality is not foreign, the idea of dynamic materiality is less familiar. Dynamic materiality is when something universally cataclysmic happens in a very condensed time period. An issue that is immaterial today can become material tomorrow, to every company in every industry, for better or worse. We must recognise that the materiality of ESG issues changes over time and could happen slowly or quickly. For example, we typically consider issues of employee health and safety or labour practices to be more material to manufacturing companies where employees are in contact with machinery more often than, say, a bank teller. However, the pandemic has made the issue now material across all industries. With investors paying close attention to corporate responses, organisations should be aware that disclosures and weightage of such factors matter more today than before. An example of a slow shift includes a movement in stakeholder focus towards data security in the semiconductor industry, with data volume increasing from 3% in 2009 to 11% in 2019, signifying that it has emerged to become a material issue within the industry.2
‘E, S and G’ – different but equal
For a while now, the 'S' aspect of ESG had taken a backseat while organisations make headlines with environmental efforts and carbon emission commitments. The pandemic has illustrated the importance of all three components, and the fact that none should be left as simply a box to be ticked. The new focus on ESG will put pressure on organisations to go a step further with disclosures of all aspects, providing in-depth information on actionable items and target outcomes. This comes with a great deal of responsibility to investors, where organisations must uphold their commitments and be accountable for what they do, not simply what they say.
2 TruValue Labs, Dynamic MaterialityTM: Measuring what Matters, page 13
COVID-19 and corporate governance
COVID-19 and corporate governance
The COVID-19 pandemic has prompted all industries to evaluate how digital platforms can be leveraged to ensure the continuation of business. Corporate governance is one area where we have seen an acceleration of the adoption of digital methods, most notably with virtual meetings and electronic proxy voting.
Challenges faced
Most market rules dictate that a company’s Annual General Meeting must be held within a certain period after the financial year ends. How these are held is directed by the company constitution. For example, in Africa and Middle East the conduct of shareholder meetings and management of transfer secretarial practices are often not addressed in trade or settlement regulation but are left to be addressed in company law regulations.
The current restrictions due to COVID-19 make it almost impossible to meet the physical attendance requirements of an AGM. We have seen transfer secretaries lag behind in their ability to adapt their people, processes, systems, and solution configurations to enable them to continue providing critical services under national lockdown and movement restriction orders.
Some markets have responded by allowing the postponement of meetings or the extension of deadlines by which a meeting must be held. For example, on 21 February 2020, Thailand’s Securities and Exchange Commission (SEC) announced that companies could seek a delay in submitting their financial statements. In addition, a request for delay could be sought if a company’s operations or the travel plans of the board of directors has been impacted by the COVID-19 outbreak to the point that the board is unable to hold a meeting to approve its financial statements. On 30 March 2020, the SEC issued the notification for all listed companies affected by the COVID-19 situation that they could consider postponing Annual General Shareholders' Meetings (AGM) by submitting the declaration letter to the registrar.
While postponement is the simplest response, many markets are now only starting to slowly reopen and deadlines continue to be extended creating a situation of uncertainty.
Virtual meetings
An alternative solution is to allow the hosting of virtual meetings (fully online meetings) or hybrid meetings (a combination of virtual and in-person).
A virtual meeting of shareholders is one that takes place using online technology. It can either be a 'virtual-only meeting', which is held exclusively online, without a corresponding in-person meeting, or a 'hybrid meeting', which is held in-person at a physical location with the ability to allow online participation.
There are challenges to this as many corporate constitutions may not have the provisions allowing for virtual attendance. The other important consideration is whether the technology required is available in each market.
Benefits of a virtual meeting include better shareholder accessibility, increased shareholder participation, reduced costs and disruption, and a reduced carbon footprint. Potential concerns of virtual meetings include a decrease in the quality of shareholder participation, challenges with meeting management, perceptions around the effectiveness of communication, IT issues and legal uncertainty as to whether holding a purely online meeting satisfies all legislative requirements that apply to shareholder meetings.
A virtual meeting of shareholders is one that takes place using online technology. It can either be a 'virtual-only meeting', which is held exclusively online, without a corresponding in-person meeting, or a 'hybrid meeting', which is held in-person at a physical location with the ability to allow online participation.
Electronic proxy voting
As part of this acceleration towards digital methods, we are seeing some markets utilise electronic voting platforms rather than requiring physical attendance at a shareholder meeting in order to vote, making the proxy voting process more efficient.
Electronic proxy (e-proxy) voting, where shareholders can vote on corporate issues remotely from computer terminals has been rapidly gaining global popularity over the past years. These electronic mechanisms have the benefit of providing timely voting outcomes and providing greater efficiencies by reducing the need to appoint a proxy, as well as providing environmental benefits by reducing printed communications.
In Taiwan, e-proxy voting is available. All listed companies have adopted the electronic transmission as one of the methods for exercising the voting power since 1 January 2018.
In Indonesia we have seen an acceleration of the e-voting initiative as a result of the pandemic. Indonesia’s regulators had planned to allow electronic proxy and electronic voting in shareholders’ general meeting for a while now. In view of the COVID-19 outbreak, Indonesia’s Central Securities Depository (KSEI) has expedited the system’s launch: eASY. KSEI is expected to support current government efforts to mitigate the impact of the COVID-19 outbreak by avoiding mass gatherings such as general shareholders’ meetings. Accordingly, all general shareholders’ meetings called after 20 April 2020 are required to use the e-proxy platform. The Otoritas Jasa Keuangan (OJK) – Indonesia’s financial services authority – had also extended the deadline for reporting and holding a General Meeting of Shareholders (GMS) for Capital Market Industry participants in a response to the emergency conditions due to the COVID-19 situation in Indonesia.
In Jordan, e-voting and e-proxy voting have been allowed as temporary measures. The resolution released temporarily suspended a few provisions of the Companies Law relating to the requirements and formalities of the general assembly. Board meetings of public, private shareholding and limited liability companies can be held via electronic means, and proxy voting will be allowed under the temporary rules on remote meetings provided the normal procedures for appointing proxies are adhered to. Each company will provide an invitation link where voting steps via proxy will be shown.
Wholesale reform required
Overall, many asset servicing, shareholder meeting and voting practices have been temporarily adapted through regulatory relaxations that allow the conduct of remote meetings and grant time extensions for submission of statutory disclosures. The approach has been piece-meal and its temporary nature remains unsatisfactory given the health and safety risks associated with existing practices. Wholesale reform towards digital solutions is an imperative if operational resilience is to be attained. In the interim we observe increased interest in e-voting and e-proxy voting from among policy makers, service providers and clients.
<BR>Central bank digital currencies gather momentum in the COVID-19 crisis
**It’s time for custodians to act**
Central Bank Digital Currencies gather momentum in the COVID-19 crisis
It’s time for custodians to act
Initiatives focused on Central bank digital currencies (CBDCs) are becoming increasingly ubiquitous. Interest in CBDCs, an electronic form of central bank money that can be used by both businesses and consumers to make payments, is gathering momentum and has the potential to fundamentally transform financial services.
In fact, the COVID-19 crisis has accelerated a number of CBDC initiatives amid mounting public health concerns about the handling of physical cash, according to the Bank for International Settlements.1 In addition to expediting cross-border payments; reducing cash management costs; enhancing transparency and facilitating wider financial inclusion among un-banked communities, CBDCs could significantly reshape the securities services model. Standard Chartered assesses how custodian banks will need to evolve in order to meet the increasing institutional client demand for digital assets, including CBDCs.
1 Reuters (June 11, 2020) Pandemic pushes central bank digital currencies into top gear
The market for CBDCs
According to John Ho, Head of Legal, Financial Markets, at Standard Chartered, a number of countries have launched their own CBDC trials or proof of concepts. These include China, the UK, Canada, Singapore, France and most recently the US, a shift that has happened largely in response to investors’ attitudes towards digital assets. A recent study by Fidelity Digital Assets, for example, found 36% of institutional investors have exposures to digital assets, while 60% agreed that these instruments should have a place in investment portfolios.2 Many clients increasingly believe that digital assets, such as CBDCs, could be quite attractive in these current market conditions as they are uncorrelated to other asset classes and maintain demand for central bank money.
Jyi-Chen Chueh, Head of Group Custody Services Product at Standard Chartered, said some investors believe CBDCs carry a reduced counterparty risk relative to stablecoins as the former are issued by central banks and the latter by commercially-run institutions. As a result, investors transacting in CBDCs will be taking on central bank risk whereas those using stablecoins have to consider their exposures to private issuers, which might be more decentralised, less regulated and whose value and liquidity may be affected by market forces. Trading CBDCs is therefore seen as being less risky among investors.
However, Fidelity pointed out that some investors still have reservations about digital assets, citing their volatility; a lack of fundamentals and concerns about market manipulation.3
2Fidelity (June 2020) The Institutional Investors Digital Asset Story
3 Fidelity (June 2020) The Institutional Investors Digital Asset Story
Time for custodians to act
In response to growing client interest in digital assets generally, more custodians are starting to develop digital asset servicing capabilities. Zhu Kuang Lee, Head of Product Innovation at Standard Chartered, said a handful of custodians are looking to create digital wallets to facilitate the safekeeping of CBDCs. However, Lee added the industry does need to collaborate and agree on standards around CBDCs, especially for cross-border transactions.
Aside from supporting clients’ growing digital asset ambitions, custodians could also net a number of operational benefits if CBDCs become more widespread. A 2020 survey of 145 market participants by the International Securities Services Association (ISSA) and The Value Exchange found 60% of respondents believed CBDCs would be the primary payment funding mechanism to enable DLT (distributed ledger technology) adoption in the wholesale cash and securities markets, putting them well ahead of real-time gross settlement interfaces.
Chueh explained CBDCs could – in theory – be transacted 24/7 using DLT which would reduce settlement risk, especially on cross-border trades where, for instance, inherent frictions linked to time-zone differences might be alleviated. This could potentially alter how CSDs (central securities depositories) and CCPs (central counter-party clearing houses) operate from the perspective of a trade lifecycle. Additionally, the growth of CBDCs may also result in changes to the role of network management as new technologies and market infrastructures emerge to support trading of digital assets.
Chueh added that while network management will evolve, the principles behind it would remain the same. “In a CBDC world, there will still be a network of custodians and market places to manage and oversee. However, some of the traditional, and often local market infrastructures and connectivity might change with the increased adoption of transnational digital assets. Moreover, the role of the custodian in providing expertise and easy access to multiple markets, including new digital ones, will still be there,” he said.
As CBDCs are such an embryonic concept, few network managers have yet to fully digest what the implications of this asset class will be. However, some forward-thinking network teams are beginning to educate themselves about CBDCs as they prepare to future-proof their businesses against disruption.
In terms of economic potential, few would question that India has the wind at its back. The country’s Gross Domestic Product (GDP) growth has been among the highest in the world in the past decade – consistently achieving an annual growth of between 6 – 7 per cent1 . This rapid rise has been fueled by a raft of reforms introduced by the Government of India to improve India’s business climate, including its infrastructure and regulatory framework, to attract foreign investment into the country.
According to Bloomberg’s survey of top international asset and fund managers2, 92 per cent of respondents say that they would increase participation in India’s financial markets if access was easier. A majority of investors (76 per cent) also find that it is more difficult to access India’s financial markets as compared to other markets they participate in.
As India looks to become a more attractive destination of funds held by foreign investors and increase foreign participation in its capital markets, market regulators recognised the need to further ease restrictions on foreign investors and entry norms for Foreign Portfolio Investors (FPIs).
In 2019, the Securities and Exchange Board of India (SEBI) introduced prominent changes like the removal of broad-based requirement, simplification of Know Your Customer (KYC) documents, re-categorisation and rationalisation of FPIs into two categories instead of three under the SEBI (FPI) Regulations, 2014, and eligibility of central banks of foreign countries to register as FPI.
1 World Economic Forum. (2020, February 19). India is now the world’s 5th largest economy.
2 Bloomberg. (2019, December 3). Accessing India’s Financial Markets.
To further improve the ease of doing business in India, the government of India introduced the Common Application Form (CAF) in January 2020.3 The CAF helps foreign investors coordinate with a single agency i.e. the custodian or Designated Depository Participant (DDP) in India for: (i) FPI registration, (ii) allotment of Permanent Account Number (PAN) with Central Board of Direct Tax (CBDT), (iii) KYC, and (iv) for opening of bank and dematerialised accounts in India. With this form, the government has eliminated various touchpoints for foreign investors when making investment in India. This paves way for FPIs to have seamless access to Indian capital markets through reducing processing timelines and enhancing operational flexibility.
3 Government of India. (2020, January 27). Ministry of Finance (Department of Economic Affairs) Notification No. F. No. 4/15/2016-ECB.
Our view – current highs and lows
Over the past few years, India has progressively eased controls on foreign investments into the bond market. The Reserve Bank of India (RBI) had introduced the Medium-Term Framework (MTF) in October 2015, for investment by FPIs in Government securities such as Central Government securities (G-Secs) and state development loans (SDLs).10 The RBI has been progressively relaxing restrictions.
In March 2019, the Voluntary Retention Route (VRR) was introduced as a new channel of investment available to FPIs.11 The VRR aims to encourage FPIs to commit long-term investments into debt markets while providing them more operational flexibility to manage their portfolio by making the investments under this route free of macro-prudential requirements and other restrictions, otherwise applicable to FPI investments in debt securities.
Since the inception of the VRR route in March 2019, about USD7.1 billion has already been invested under the scheme as on 31 December 2019.12 To put things into perspective, data available on the website of National Securities Depository Limited showed that net FPI investment in debt category was close to USD3.74 billion in debt for the whole of last year.13
10 Reserve Bank of India. (2015, October 6). RBI A.P. (DIR Series) Circular No. 19 RBI/2015-16/198.
11 Reserve Bank of India. (2019, March 1). RBI/ 2018-19/ 135 A.P. (DIR Series) Circular No. 21.
12 The Economic Times. (2020, January 23). RBI raises VRR limit for FPIs to Rs 1.50 lakh crore.
13 National Securities Depository Limited. (2019). FPI/FII investments [Data file].
With effect from 1 April 2020, the RBI has allowed non-residents to invest in specified G-secs dated securities without any quantitative limit.14 To enable this, RBI has launched a separate channel called the Fully Accessible Route (FAR). The central bank has also increased the limit for investment by FPIs in corporate bonds from 9-15 per cent of the outstanding stock for the 2020 / 2021 financial year.
The moves to attract foreign investment in the India onshore debt market comes at a time when foreign investors are in exit mode due to the global COVID-19 pandemic. In March 2020, the net outflow by FPIs in the debt market was USD7.36 billion, while equities have seen a net outflow of USD7.54 billion, making it the highest-ever sell-off by foreign institutional investors in a month.15 The uncertainty around the impact on India’s economy, due to an extension of the country’s nationwide lockdown, means that volatility is likely to continue in the coming months.
As India starts to take tentative steps towards restarting its stalled economy, the government of India announced its decision to increase the limit on foreign direct investment (FDI) in defence manufacturing under automatic route to 74 per cent from the existing 49 per cent.16 After the government amended the FDI policy in April 2020, FDI, under the automatic route, excludes investment by China and other nations that share a border with India. Relaxation in FDI restrictions may help to get India’s economic growth back on track.
As India starts to take tentative steps towards restarting its stalled economy, the government of India announced its decision to increase the limit on foreign direct investment (FDI) in defence manufacturing under automatic route to 74 per cent from the existing 49 per cent.16
14 Reserve Bank of India. (2020, March 30). RBI/2019-20/201 FMRD.FMSD.No.25/14.01.006/2019-20.
15 Sultana, N. (2020, March 30). March sees highest ever sell-off by FIIs. Mint.
16 Ministry of Finance. (2020, May 16). Finance minister announces new horizons of growth; structural reforms across eight sectors paving way for Aatma Nirbhar Bharat [Press release].
Supporting clients in India
India is full of opportunities and local regulators have made continued progress in easing access for foreign investors.
Regulatory changes continue to be a constant theme in India. The fast pace of change in India makes local partnerships highly beneficial for foreign investors who are keen to invest in India’s capital markets. A key role to be played by local partners is to provide foreign clients with an understanding of the investment landscape and requirements of the local capital market.
China market access – an update
China began opening-up its market in the late 1970s. In the past four decades, China has transformed from a centrally-planned economy to a more market-oriented economy, leading to the gradual establishment and development of its capital market.
Initially, China’s capital markets emerged in response to the incorporation process of Chinese enterprises. Since then, a series of major reforms were implemented to facilitate further development of the capital markets.
The first chapter of the recent liberalisation has focused on opening the door to foreign investors through various access schemes such as Qualified Foreign Institutional Investor (QFII), Renminbi QFII (RQFII), Qualified Domestic Institutional Investor (QDII) and China Interbank Bond Market (CIBM) Direct scheme, China-Hong Kong Stock Connect and Bond Connect.
Government Bond–Emerging Market Indexes (GBI-EM), have included China stocks or bonds in their benchmark indices since 2018. Meanwhile, the China regulators have been improving the market infrastructures, as well as operational efficiency. Some recent enhancements include the launch of the Prime Brokerage Business in the China Interbank foreign exchange market, allowing foreign investors to choose a longer settlement cycle, allowing more flexibility in the handling of failed trades.
Our view –
current highs and lows
Highs
Thanks to the inclusion in global indices, continuous growth of the GDP in the last forty years up to the end of 2019, and, relatively low correlation to other markets, China has been one of the favourite investment destinations for global investors. Today, China has emerged as one of the largest economies globally with the world’s second largest stock market, as well as second largest bond market.
While the COVID-19 outbreak adds to the uncertainty of global markets, investors are showing increased interest in China. A low-interest-rate environment around the world makes China's bonds market even more attractive to global investors.
As of the end of the first quarter of 2020, foreign investors held a total of CNY6.4 trillion in onshore China assets, including CNY1.9 trillion of equities, CNY2.3 trillion of bonds, CNY0.9 trillion of loans and CNY1.3 trillion of deposits. Despite the global market sell-off, foreign appetite in China bonds and equities rebounded strongly in April with the China-Hong Kong Stock Connect net inflows turning positive to CNY53 billion in April 2020 from outflows of CNY68 billion in March 2020. In terms of bond holdings, the total amount of Renminbi (RMB) bonds owned by foreign investors under the China Central Depository & Clearing Co (CCDC) posted 17 straight months of increase, reaching 30.45 per cent at the end of April 2020 from a year earlier to more than 2 trillion.
Continued opening-up policies are expected to drive further interest in the China market. The China Securities Regulatory Commission announced that it will be removing the foreign ownership limit in securities companies, effective from 1 April 2020, inspiring many foreign companies to set up wholly-owned subsidiaries in China. This move comes eight months earlier than the original timeline and is a strong indication of China’s regulator’s determination to reform its market despite the COVID-19 challenge the global markets are facing.
Another long-waited announcement is the implementation of the revised QFII and RQFII rules. Effective 6 June 2020, overseas institutional investors will no longer need to apply for investment quota. They will be able to choose the currency and timing of injection, enjoy more streamlined repatriation process through providing a tax commitment letter instead of special audit report and tax filing documents for profit repatriation. In addition, overseas institutional investors will be able to appoint multiple custodians (without cap). Some market analysts believe the relaxed QFII and RQFII rules will attract more capital inflows and help offset the economic downside risks from COVID-19. This may also help reduce market fluctuations due to short-term speculation because foreign institutional investors tend to have a long-term investment style.
Lows
Global economic slowdown and renewed US-China tensions may cast a shadow on China’s outlook. Standard Chartered Global Research expects1 China to resume positive growth from the second quarter of 2020, led by policy stimulus and the normalisation of economic activity since mid-February. While approximately 17 per cent of China’s economy is driven by external demand, the escalating recession risk in the rest of the world is likely to weigh on its recovery. The recent US proposal to block the Thrift Savings Plan, a government retirement fund, from investing in China assets has raised concerns on the impact on China’s market. It is expected that if this risk materialises, capital outflows from China would be limited, given that US pension funds’ current allocations to China bonds and equities are relatively small, according to the analysis of Standard Chartered Global Research2. As at end-2019, US pension funds’ assets were USD32.3 trillion with modest allocations to China equities or bonds, which is approximately 0.6% of asset under management (AUM).
To further increase foreign participation in China’s capital market, more work needs to be done to bring China even more aligned with international standards. For example, reform on Shenzhen Stock Exchange’s ChiNext Board or the adoption of DVP settlement mechanism for equities settlement to minimise counterparty exposure. FTSE Russell has deemed the delivery versus payment (DVP) settlement as one of their key considerations when reviewing whether or not to further increase the weighting of China A shares in its index.3
1 Global Focus – Economic Outlook Q2-2020 ‘Darkest before the dawn’
2 Global Research – Local Market Alert – Assessing US pension allocations to China assets
3 ASIFMA - China’s capital markets – the pace of change accelerates
Supporting clients in China
With the strong fundamentals and enormous opportunity, China continues gaining traction despite the volatility in global financial markets during COVID-19. China financial markets have been operating as usual after the extended Chinese Lunar New Year Holiday which ended on 2 February 2020. While global markets suffered 20 - 30 per cent declines in the first quarter of 2020, China CSI 300 was down by just 9.63 per cent during the same period and the World Bank anticipates China will still record positive economic growth of about 1% in 2020.4 As markets around the world start to move out of lockdown, China remains a market leader in terms of interest for investors.
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