Quick Thoughts: China’s New Regulatory Cycle

China is in the midst of a tightening regulatory cycle which has led to some investor uncertainty and heightened market volatility. Our Chief Market Strategist, Stephen Dover, discusses China’s aspirations to increase economic growth while also providing social fairness and stability.

    Stephen Dover, CFA

    Stephen Dover, CFA Chief Market Strategist, Head of Franklin Templeton Investment Institute, Franklin Templeton

    Since first visiting China in 1982, I’ve witnessed the country’s phenomenal transformations and the many challenges it faces as it develops economically. China has a long history of managing, in certain sectors, foreign direct investment. The country is now in the midst of a tightening regulatory cycle, implementing anti-monopoly, data security, and industry-specific regulations which have led to some investor uncertainty and heightened market volatility. When investing, it is critical to evaluate the alignment of companies with China’s long-term strategic goals.

    • China’s recent regulatory activities cross many industries and are part of the Chinese government’s determination to develop China into a “modernized socialist economy,” including objectives of common prosperity, green development, and independence in key technologies and industries.

    • China’s policy approaches are more cultural- and principles-based, focusing on desired outcomes, rather than legal rules-based creating higher regulatory risks.

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    • Chinese companies have used variable interest entities (VIEs) to mimic direct equity ownership, thus allowing them listings on foreign exchanges. Chinese authorities have not formally approved these structures. China recently banned VIEs in the education sector. Investors must consider what would happen to valuations if this regulatory stance was extended to a broader universe of sectors.

    • Chinese companies’ American Depositary Receipt (ADR) listings will be required to allow US regulators to audit their financials. This is raising concerns for the Chinese over possible sensitive data-sharing with the US government.

    • While we remain positive on foreign investment options in China–including both equity and fixed income–we do expect these regulatory cycles to continue as the country aims to increase economic growth while also providing social fairness and stability.

    • We believe China’s government will continue to use public equity and fixed income markets to foster innovation, despite new regulations. We also see opportunities where China is becoming more open, such as in the Chinese bond market.

    For deeper analyses across Franklin Templeton, read “Heightened Regulatory Scrutiny In China: What Investors Need to Know,” by Franklin Templeton’s Emerging Markets Equity team; “The Certainty of Change: Evolution of Investor Access to China,” by Dina Ting, Head of Global Index Portfolio Management Team, Franklin Templeton ETFs; and “China Calling: The Rise of the Chinese Bond Markets,” by Franklin Templeton Investment Institute.


    WHAT ARE THE RISKS?

    All investments involve risk, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments; investments in emerging markets involve heightened risks related to the same factors. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments.

    China may be subject to considerable degrees of economic, political and social instability. Investments in securities of Chinese issuers involve risks that are specific to China, including certain legal, regulatory, political and economic risks. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the portfolio’s value may decline. In general, an investor is paid a higher yield to assume a greater degree of credit risk.