Measurement of personal wealth reported in the 15th Annual Global Wealth Report released by Merrill Lynch and Capgemini shows that wealth has shifted decisively. There are now more wealthy people in Asia than there are in Europe and the United States—3.3 million vs 3.1 and 3.1 respectively. Much of the change in proportions has taken place quite recently, due mainly to the dramatic increase in Chinese millionaires (and billionaires).
There are today about 11 million people in the world able to freely invest $US 1 million or more, and wealth currently managed by financial institutions totaling about $43 trillion. A chunk of this has been given to hedge funds, or is, as I write this, seeking which of them to rely upon for ‘aggressive’ management of risk and return. In the US and UK the count of hedge funds with more than a $US 1 billion under management are 216 and 65 respectively. In Asia, a nascent market from a direct funds management standpoint, there are already 29. With an estimated $2 trillion to invest, hedge funds have pushed deep into Asia, where resident wealth is beginning to rival the world’s largest pools, and whose capital base is indisputably the most rapidly growing one. Yet the region is under-represented from a funds management standpoint with only 7.5% of the total and of a mere $150 billion managed.
Chinese investors are clearly not yet active players in a global sense. China’s investment landscape remains clouded by practical uncertainty and ponderous about treatment of a host of legal and regulatory questions.
The China Securities Regulatory Commission (CSRC, the Chinese equivalent of the SEC and CFTC in the US, FAS in the UK, BaFin in Germany and Consob in Italy) has not established clear guidelines which either authorize or restrict specific forms of hedge fund activities. The Commission considers many of these activities difficult to control, too risky, unprincipled and speculative as practiced in a market such as Shanghai, which is broadly speculative to begin with. Coming out of the Chinese culture which is naturally more prudent than it might be with the use of debt, but which seeks the excitement and returns of risk-taking, hedge fund leverage is something of a stranger beast to stare in the eye. Although interpretations of general guidelines for investment activities have been asserted, much remains undefined. Chinese asset management and trust institutions authorized by the CSRC to collect and manage private savings resemble hedge funds in many of their freer investment and lending practices—with the distinct absence, however, of leverage, which is where the impressive profits and daunting risks of some US and European hedge funds arise, and tempt others who would dare to try.
The most significant constraint on hedge funds and their equivalents in China today is not regulations or prohibited activities, but the limited number and types of financial instruments available in the markets still forming there. There are also practical and legal obstacles to the use of many forms of derivatives that are simply not recognized either as negotiable property or, in other cases, property that an unspecified number of people can jointly or collectively own.
The Commission therefore finds it unusual, if not baffling, for example in many situations less quixotic to Westerners, that a party must show, in addition to its actual holdings, investments that it is not able to sell and cannot precisely value. If an instrument’s price is tied to increases in specific indices or a bundle of commodity prices, such as many futures commonly traded in other markets, this is something which in China still eludes valuation and other practical features necessary for online marketing, quoting and trading.
The CRSC for the moment seems pleased to remain unburdened with close control of institutions and practices it does not adequately understand, or lacks the resources to regulate. Its being thus in a position of riding a horse without effective reins, the advent of trading activities that are not closely supervised could eventually threaten the stability of banks as well as the holdings of savers.
Many of China’s equivalents of trust institutions already have lending and investment practices (albeit without the leverage) remarkably similar to those of the wild creatures known in the West as hedge funds. More rapid opening of the country’s markets to sophisticated instruments might thus promote risks that prove counter-productive, both in terms of market stability and individual investor risks, and may divert capital from more productive local uses.
As frustrating as this might be to investment organizations eager to offer alternatives to the narrow choices most Chinese savers now have, it would hurt their prospects in the long run if they are permitted to bring instruments and practices into China today which its markets and regulatory capacities are not able to assimilate at a hurried pace. Caution is a parent of care.