The Globe Has No Corners
As regulations converge, Asia opens up to foreign capital

By Maria Trombly | Securities Industry News | September 1, 2005

South and North Korea are two extremes when it comes to Asian investments. In the south, foreigners are allowed to own 100 percent of a company's shares, and there are few limitations on foreign brokerages setting up shop or moving capital in or out of the country--an attractive proposition to global brokerages.

North Korea? Well, how much can be said about one of the most closed markets in the world?

Most of the rest of Asia falls somewhere in between. The good news for securities firms is that almost all Asian countries, with the glaring exception of North Korea, are moving toward greater openness and integration into global markets.

Last year, the Philippines and India joined the California Public Employees' Retirement System's (Calpers) Permissible Emerging Equity Market List, which already included Malaysia, South Korea and Taiwan. This spring, Thailand also made the cut, a sign that these countries are making progress. (Japan is considered a developed country, not an emerging one.) "We are witnessing a greater level of transparency and an increased effort by countries to reform their markets to support institutional investment," says Rob Feckner, president of the Calpers board of administration.

"We see a point of convergence for the regulations in the respective countries," says Ghanshyam Dass, managing director for Asia-Pacific at the Nasdaq Stock Market. "The globe has no corners."

One sign is that countries' accounting standards are becoming more and more aligned with international standards and U.S. generally accepted accounting principles (GAAP). "They're becoming almost the same," says Dass.

For example, at the South Asian Federation of Exchanges, which includes 13 exchanges in seven countries, members are busy standardizing listing regulations, says secretary general Wali-ul Maroof Matin, who is also the CEO of the Chittagong Stock Exchange in Bangladesh. "We just completed pinpointing the differences and similarities of the member exchanges," he says.

Integration Stages

The transition to full integration in the global economy seems to start with goods, such as textiles and computer parts. In China, foreigners are allowed to own factories and can easily move products in and out of the country.

The next stage is currency liberalization. China took a small step this summer with a revaluation, and more liberalization is expected soon under pressure from the U.S. and other trading partners.

Finally, a country opens up its capital markets. China is taking steps here as well, allowing foreign securities firms to set up joint ventures and apply for qualified foreign institutional investor (QFII) status.

When it comes to capital markets, China still has a long way to go. "The service sectors in general, and financial services in particular, haven't opened up as significantly as other sectors in China," says Hubert Lem, executive director in the legal division of Morgan Stanley's Hong Kong office. In compliance with China's World Trade Organization commitments, the China Securities Regulatory Commission (CSRC) allows foreign brokerages in by setting up joint-venture brokerage or comprehensive securities companies, or by acquiring a domestic company. Setting up an actual branch is still forbidden. By comparison, the latter is now quite common in other East Asian countries, such as Thailand, South Korea and Singapore.

Merrill Lynch and Morgan Stanley have branches in Korea, Singapore and India but only representative offices in China. By the end of 2004, only 4 out of 130 securities companies in China were joint ventures. Lem notes that new joint ventures continue to be funded, and he expects to see even greater liberalization, up to full foreign ownership of local firms.

"Financial service liberalization can help enhance market efficiency, promote innovation of financial products and improve the level of financial service," says Xianrong Yi, thedean of thefinancial development division at the institute of finance and banking of Beijing's Chinese Academy of Social Sciences. That's why most countries allow foreigners to own 100 percent of a securities firm.

China's current regulations on foreign ownership of securities firms went into effect in June 2002. Foreign ownership is limited to one-third of a company and requires minimum registered capital of 500 million yuan and at least a decade of experience. China protects its local capital market even further by prohibiting these ventures from trading in any securities on their own account, and they are only allowed to do brokerage business in B shares, which are specifically created for foreign investment. Local Chinese investors and QFIIs can buy A shares, and there are limits on how many B shares a private company can issue.

Other Asian countries allow foreigners to own more of a securities firm. Under a 1997 trade agreement, foreign firms in India are allowed to own up to 49 percent of a local brokerage and up to 51 percent of a securities underwriting firm. In Malaysia, the Securities Commission allows foreigners to own up to 49 percent of a brokerage; however, ownership of an underwriting firm is limited to a maximum of 30 percent.

Limitations

Asian countries put other limitations on foreign securities firms besides limiting the degree to which they can set up shop. Besides having a multi-tier system of stock shares, Chinese firms can choose to list overseas. Shares offered in Hong Kong, for example, are commonly referred to as H shares. There are also limits on what percentage of a company can be owned by a foreigner, says Thomas Liu, finance professor at Shanghai's Jiao Tong University.

There is also a correlation between the degree to which a country allows foreigners to open offices and the freedom given to move money in and out of the country, says Shoubing Ni, an analyst at CnWallStreet.com and law professor at the Shanghai Institute of Foreign Trade. "Though the setup of foreign brokerage offices has an indirect relation to capital account liberalization," he says, "the more open the capital market and the more freely the currency is converted, the less a country protects its financial industry."

One of the first companies granted QFII status in China was Japan's Nomura Group, which obtained better access to the Chinese market. That, however, posed its own set of challenges.

For example, the tax consequences surrounding QFII securities investing are still cloudy, says Larry Heiman, a spokesperson for the company. Nomura used to have QFII status in Taiwan and Hong Kong as well, "but now they're open," he says.

If a country's currency isn't freely convertible, then allowing foreign firms to invest in the local stock market can cause shocks to the local economy, says Wei Zhong, dean of finance at Beijing Normal University. "[QFII programs are] an important transitional scheme introduced to attract foreign capital and open up the capital market," he says. "By using QFIIs, a country can limit and guide the entrance of foreign capital, which helps capital adapt to the domestic equity market."

In addition, QFIIs can reduce the shocks that "hot money" can cause by moving too quickly in and out of a country and can promote capital-market internationalization.

"Foreign investment is good if it stays," said Douglas Naismith, managing director of Fidelity Investments in Hong Kong, at this spring's World Exchange Federation emerging markets conference in Beijing. "Foreign investment can be extremely disruptive if it comes and goes."

But that doesn't mean that foreign institutional investors are happy with these limitations. Says Naismith: "We know that in certain markets around the world, there are reasons why you may want to control capital flow and give certain privileges to local investors--at least initially. For example, there are foreign exchange regulations in Korea [and] the QFII regulations in China. We recognize these barriers, but most certainly we don't agree with them. If you want to see good throughput, you have to create a level playing field with the local marketplace."

Wendy Yu contributed to this report.

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