Understanding RMB Liquidity

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1 Understanding RMB Liquidity The investment case, challenges and changes September 217 This commentary provides a high level overview of the recent economic environment, and is for information purposes only. It is a marketing communication and does not constitute investment advice or a recommendation to any reader of this content to buy or sell investments nor should it be regarded as investment research. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination. The performance figures displayed in the document relate to the past and past performance should not be seen as an indication of future returns. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC Global Asset Management accepts no liability for any failure to meet such forecast, projection or target.

2 A large and evolving market RMB money market funds (MMFs) make up >5% of s mutual fund AUM Despite being a late bloomer, when compared with US and EMEA-based peers, the Chinese money market fund industry is now the second largest in the world. Total assets have gone from a mere RMB3 billion in 29 to over RMB5 trillion in 217, which is more than half the total mutual fund AUM in the country Growth in the asset class took off in 213 driven by a variety of factors including stock market volatility, investors looking for a safe haven, new technologies and increased investor sophistication which prompted significant investments from both institutional and retail investors Size of money market funds in has skyrocketed RMB trillion /9 6/11 12/12 6/14 12/15 6/17 An institutional assets story Driven by - commercial banks outsourcing liquidity management to asset managers A growing amount of cash trapped onshore due to s capital control measures To conduct business onshore, more corporates see greater use for RMB, the world s fifth most used currency that accounts for 11% of Special Drawing Rights (SDRs) basket Countries with highest non-bank payment transactions USD trillion Germany United Kingdom United States coupled with retail flows The adoption of e-commerce in coupled with technological advances have spurred massive inflows to MMFs as it opened up the market to new investors who were allowed to invest miniscule amounts that would have been previously unfeasible At present, the world s largest MMF, with USD212bn in AUM, is operated by a Chinese e-commerce platform operator s online retail sales have outpaced US s USD billion US e 218e 219e 22e 221e Chinese MMFs still have huge growth potential Although the RMB MMF industry is huge, it is worth noting that the total size of its assets makes up only 3% of s money supply (M2). This is much lower than corresponding data from the US and Europe There is plenty of room to grow with domestic investors gradually adopting MMFs as a lower-risk alternative to equity or fixed income funds and higher-returning option to traditional deposits Size of MMF as % of money supply (M2) Europe Size of MMF as % of deposits % 4 US MMF % of US deposits MMF % of deposits US % 5% 1% 15% 2% 25% Source: Bloomberg, Fitch Ratings, SWIFT, BIS Red Book, Statista, HSBC Global Research, HSBC Global Asset Management, data as of September 217 2

3 Factors to consider when investing in RMB MMFs Supported by regulatory regime Regulations limit the interest that banks can pay on deposits and require them to place part of the deposits with central bank to meet the reserve requirements,. This has prompted investors to look for alternative investment products such as MMFs Earnings of MMFs are exempt from enterprise income tax while bank interest is not MMFs are good options for yield and daily liquidity % 8. 7D repo O/N SHIBOR 6. Deposit rate Wgt avg 7D ann. yield Investor flows and concentration Unlike global investors, who invest in MMFs for capital preservation and daily liquidity, Chinese investors primarily expect their MMF investments to offer attractive yields Historically there have been no rules about investor concentration, leading to the formation of a number of funds with a single, large institutional investor. These funds face significant liquidity risk when the majority investor withdraws their assets Number of Chinese MMFs has spiked Liquidity with loose restrictions Chinese regulations currently allow MMFs to have longer weighted-average maturities and weighted average lives than their global counterparts This increases the liquidity and credit risk inherent in RMB MMFs as they seek exposure to longer duration assets The issue is compounded by limited daily liquidity thresholds and smaller weekly liquidity requirements, especially when compared to regulations in the US and EMEA Funds ratings and portfolio quality Many RMB MMFs employ leverage, invest in less liquid and lower quality assets, or concentrate their holdings to improve yields Of the over 3 MMFs available in, there are only four funds, all run by joint ventures with international asset managers, that are currently rated by global rating agencies Many funds market themselves as low risk but invest in a wide variety of assets including derivative products. This practice would not be allowed in more developed Rating markets globally Convergence of regulatory standards Recognising both the increasing size and influence of the industry and the relatively lax regulatory environment, Securities Regulatory Commission (CSRC) has issued new rules that will take effect in October 217 with a six month grace period for implementation Primarily these new rules will strengthen guidelines on the liquidity management, particularly within institutional MMFs with concentrated investor bases The new rules require fund managers to maintain shorter portfolio durations, more liquid assets and more investment diversification, and use mark-to-market valuations under certain circumstances These rules are a significant step forward towards harmonising the policies in with global principles around sound liquidity management, and the market sees this as a beginning and not the end of regulatory tightening The regulatory body has also been holding off on approving new funds until these rules are in effect. Following the implementation of these new rules, there will likely be a number of MMF closures, specifically of funds that were set up as single investor vehicles Source: Bloomberg, Morningstar, IMF, HSBC Global Asset Management, data as of September 217 3

4 Changes on the horizon Chinese MMFs governed by less stringent policies than their global counterparts New rules will bring closer to global regulatory standards US EMEA after Oct 17 if IC* > 2% after Oct 17 If IC* > 5% Max WAM* (days) Max WAL* (days) Leverage N/A N/A 2% 2% 2% O/N liquidity 1% 1% 5% 5% 5% 1 week liquidity 3% 3% 1% 2% 3% Fees Yes Yes 1%** 1%** 1%*** Fees waiver Yes Yes Yes Yes No *WAM = weighted average maturity; WAL = weighted average life; IC = Investor concentration **1% Liquidity fee on the redemption amounts above 1% if 1. Weekly liquidity is below 5% and 2. MTM NAV vs Amortized cost is negative ***1% Liquidity fee on the redemption amounts above 1% if 1. Weekly liquidity is below 1% and 2. MTM NAV vs Amortized cost is negative Why professional asset management for liquidity investments? Transparency One of the goals of the evolving regulatory landscape is to provide investors with more information on how funds operate and the potential risks. Increased transparency will enable investors to make more informed choices Sound risk management Instead of using yield as the only criterion, a professional MMF manager takes portfolio risk into consideration by monitoring overall liquidity and credit risk, and ensuring that clients capital is shielded from market downturns Balanced approach New regulations may lead to the closure of single investor funds and establish a higher entry barrier for future MMF launches As the market evolves, investors would eventually learn to prioritise capital preservation and liquidity, along with yield, when choosing an MMF product Follow global standards Regulatory changes in could have a disruptive impact on MMFs which are not of an international standard However, this implies a strategic advantage for funds that are rated by international agencies, abide by global standards, and continue to focus on their strategy in a dynamic market environment Source: HSBC Global Asset Management, data as of September 217 4

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