What Xi Jinping Doesn't Understand About Financial Markets

In April, China's State Council issued a series of policy guidelines expressly designed to strengthen supervision, risk management and transparency in the country's $9 trillion stock markets and inject them with the kind of urgency and dynamism they have clearly lacked.

The circular’s ​​goals were numerous and vague, as the Chinese government intended. One was to promote the high-quality development of its capital markets. Another was to better protect investors’ interests over the next five years. By 2035, its authors pledged to have established a highly adaptable, competitive and inclusive capital market system, supported by high-quality securities and financing institutions.

This article tells you everything you need to know about how the ruling Party, led by President Xi Jinping, views financial markets in general and, more specifically, the role played by fund managers and investment bankers.

Xi Jinping talks about his desire to promote and protect a system that seems to work effortlessly elsewhere, notably in the United States. But he cannot bring himself to believe in the inherent instability of a world where stock prices can soar one day and plummet the next, without necessarily caring what the government thinks. In the eyes of Chinese cadres, it is a world turned upside down.

One must consider the vagueness of some of its goals. The Party is committed to creating quality financial markets by the middle of the next decade, but, as usual, it does not explain how to achieve this, either because it does not want to reveal its grand plan or, more likely, because it knows it does not have one.

If Beijing really wanted to create a cohort of well-run investment banks with a growing global presence, it could do so. There was a time when it committed to doing just that. For evidence, read our 2012 interview with Mary McLeod, then deputy managing director of ICBC International, the foreign division of the country’s largest lender.

This was at a time when Western investment banks, wounded by the global financial crisis, were still in retreat.

McLeod described the ICBCI's undisputed goals as building a global investment bank with Chinese characteristics and instilling a culture that can fit comfortably into any part of the world.

Of course, that didn’t happen. After coming to power, Xi Jinping touted the power of China’s stock markets, but prices plummeted in 2015. He has never really managed to trust them since, and his grand plans have fallen by the wayside.

One of the Party’s major problems is its deep-rooted fear of the unknown. It loves nothing more than a solid pilot project. It loves to test ideas under controlled conditions: look at how it has built a plethora of special economic zones, or consider the Stock Connect system that allows investors in Hong Kong and mainland China to trade and settle stocks listed on the other market, through their own exchanges and clearing houses. These are examples of controllable trial and error.

But stock markets tend to follow their own rhythm. When Chinese leaders promise 5% GDP growth that year, it magically happens. But they can’t impose a diktat that would force health-care stocks to rise by the same amount in a given year. Even Nostradamus couldn’t achieve that kind of success through micromanagement.

Abroad, the problem is amplified. If Beijing has acquired a leading position in key sectors (wind turbines, solar panels, possibly electric vehicles), it is by subsidizing them at home, before flooding foreign markets with low-cost goods that often kill off its foreign competitors.

In financial markets, this is unfeasible. How could a Beijing-based investment bank bankrupt Goldman Sachs or Morgan Stanley?

“Coming soon: world-class M&A advice at a lower cost” is unlikely to be a compelling argument for foreign multinationals or, for that matter, Chinese companies with global ambitions.

One word that is not tacitly included in April's circular is “transparency,” and yet it appears in every other sentence.

The State Council urges investors and regulators to strengthen supervision of information disclosure and corporate governance, and vigorously introduce new funds into the market to boost long-term investment.

But the problem is that as Asia’s largest economy continues to slow, the opposite is happening. Since the beginning of June, international investors have pulled more than $12 billion out of mainland China-listed stocks, according to data from the Hong Kong stock exchange. Stock Connect is likely to record its first year of net outflows since it launched in 2014.

Investor wariness is palpable. In the current year through Aug. 21, companies have raised just $5.1 billion through 52 IPOs across all Chinese exchanges, according to data from Dealogic. Both figures are modern records, as they are both 21-year lows.

The authorities responded in the only way they know how: by restricting access to important information that would help investors better assess the true value of stocks and sectors. On Monday, daily data tracking net investment flows from foreign funds into local stocks were suddenly made unavailable. Instead, flow figures will be published on a quarterly basis.

This is just the latest in a series of such moves. In May, regulators deleted real-time trading data that tracked how foreign investors were allocating their capital to mainland securities. Last year, fund companies were told not to publish the estimated net worth of mutual funds. In each case, it was because the data sent an unintended message to the world.

And therein lies the rub. More than at any time since the late 1990s, China desperately needs foreign capital. It’s what will power the next generation of world-class mainland companies, from electric vehicle makers to pioneers in everything from predictive healthcare analytics to augmented reality, from space tourism to quantum computing.

As any investment banker based in Shanghai or Hong Kong knows, there are hundreds, if not thousands, of up-and-coming Chinese companies hungry for new working capital and eager to tap new markets and sell shares, ideally overseas.

The problem is that even if international investors believe in them, they may no longer trust those who run the country. Limiting the availability of key data and prioritizing opacity over transparency while pretending to preach the opposite are not measures that promote the best solution.

Can trust return? Yes, without a doubt. But will it be under the current administration, led by a self-proclaimed president for life? The question is probably up in the air.

The sad truth is that Xi Jinping does not like or understand the unpredictability of stock markets and does not trust the non-collective instincts of fund managers and investment bankers.

Worse, all this is happening against a backdrop of an economic slowdown plagued by rising costs, deflation and a moribund real estate sector. Not to mention a growing number of sectors where foreign capital, usually for reasons of national security, is no longer welcome. It is no wonder that when government officials scour the world for capital, they are often met with suspicion and a certain amount of head-scratching.

If China was once a land of plenty for foreign investors, it would be easier to see a clearer path forward, a way to entice them to return with vigor and conviction to a market in which they once instinctively believed.

But let’s think about it for a moment. Xi Jinping was officially elected president in March 2013. Since then, the Shanghai Composite Index, which represents all A-shares and B-shares traded on the city’s main stock exchange, has risen 21.44%. Compare that with the FTSE 100 (up 41% over the same period), the S&P 500 (up 287%) or India’s BSE Sensex (up 327%).

They say data doesn't lie. No wonder Xi Jinping doesn't believe it.