IFLR: What are the main regulatory challenges facing
investors in China today?
Hubert Lem, Morgan Stanley: Coming to grips
with the complexity of the legal, regulatory, tax, accounting
and operational environment and how to achieve optimal
solutions given the constraints from each of these areas. The
complexity is due to many factors, such as lack of clarity in
the drafting of rules, the fragmented nature of the bureaucracy
and the fact that new rules are being issued all the time.
Keeping up with changes in rules and interpretations is a real
Rule making in China has become far more transparent than
before and the rules are becoming more rationalized. At the
same time, China's regulators are becoming more experienced,
sophisticated and comfortable with stepping back and saying
that, unless there is a statutory basis for regulation, they
will not interfere with a certain activity. There are more
rules than ever before and they are becoming more strictly and
consistently applied. Despite these improvements there remain
situations where rules are unclear and there is a need for an
experienced guide that can provide added information or
regulatory interpretation. Approvals always seem to take longer
than expected and the process for receiving approvals is
sometimes not transparent enough.
How do you work to overcome these challenges?
We try to maintain close and transparent relationships with
the regulators so that they understand what we are trying to
achieve and we are comfortable that we understand their views.
We also rely on the advice of our outside advisers and service
providers in a number of different areas, such as our legal,
tax and accounting advisers and our local banks and custodians.
We try to be flexible in terms of meeting unexpected
To what extent has there been consultation with market
participants in the process of issuing new regulations?
There has been a great deal more consultation generally than
in the past. For the financial regulators such as the CSRC
(China Securities Regulatory Commission) and CBRC (China
Banking Regulatory Commission) there has been increasing
consultation with market participants. As China has opened up
financial sectors to foreign participation, many foreign
participants engage in direct consultation with the regulators
and, through such consultation, have helped to develop the
rules governing their industries. Regulators often welcome
working with industry groups such as Isda (International Swaps
and Derivatives Association) to advise them on drafting of laws
and regulations. Regulators sometimes prefer working with
industry groups because they are a source of technical
expertise, which regulators might not necessarily have.
What benefits can strategic foreign investors bring to
domestic companies in terms of risk management and corporate
Foreign investors do not necessarily have a lock on
effective corporate governance. However, due to their
experience with public company requirements overseas, there is
often greater sensitivity to issues of importance for public
investors, treatment of minority investors and compliance with
disclosure requirements. In addition, foreign investors can
bring in more advanced technologies in the form of more
sophisticated management tools and business techniques, for
example, management accounting, technologies that measure
productivity and business performance, and tools for monitoring
credit exposure and financial position.
How have financial institutions been preparing for China's
accession to the World Trade Organization?
Many domestic financial institutions have undergone
restructurings to create more efficient and rational business
organizations, eliminating non-core businesses and assets. Many
have converted themselves to companies limited by shares to
facilitate eventual stock listings. They have been seeking
listings domestically and/or overseas and have been looking for
strategic partners as a source of equity capital, technology
and know-how transfers, and as business joint venture
What specific measures are needed to solve the
non-performing loan (NPL) problems of Chinese banks?
The Chinese banks' NPL problems are caused by a number of
different factors. One factor is the combined policy role that
state-owned banks have had together with their commercial
roles. This policy role to support state enterprises will not
disappear overnight, although it is expected to diminish over
time as the state-owned enterprises restructure themselves into
viable commercial entities. The continued restructuring of the
state sector, if successful, should lead to a diminishment in
the NPL problems.
NPLs are also brought about by uncommercial or fraudulent
lending practices. Better internal controls and risk management
technology will help to reduce these NPLs. Chinese banks are
trying to attract more foreign technology to improve banking
practices. Giving foreign banks a greater stake in domestic
banks could help with ameliorating uncommercial or fraudulent
lending practices and ultimately improve the domestic
The creation of a nationwide credit reporting system will
also aid banks in managing their credit exposure. Lastly,
making legal and adjudication systems more efficient to
facilitate workout of bad debts will make the resolution of
NPLs less time-consuming and expensive.
What legal risks face a foreign investor wanting to buy
non-performing loans in China?
Adequate information on the loan assets is often difficult
to obtain. In many portfolios, there is poor level of
documentation, which makes it difficult to identify and
establish claim on the relevant assets.
Another legal risk is the uncertainty involved in obtaining
judgment against the debtor or assets. That situation is
improving, and it requires experienced local counsel. Some
legal advisers advocate using the legal process as a first step
to establish a legal claim over the relevant assets, rather
than as a last resort. It is important to keep in mind local
government interests and sometimes to involve local governments
as a solution to the problem.
What role does foreign investment have to play in the
restructuring of the financial sector?
Foreign investment could play a significant role in
providing capital, technology, and management skills transfer.
Permitting foreign financial institutions to provide services
domestically will bring efficiencies to many parts of the
Chinese economy, not just to the financial sector. It would
help bring international best practices to the Chinese economy
and the financial sector. Through foreign investment and
participation in the financial system, China's financial sector
could modernize and become efficient more quickly.
How will the listing of Chinese banks on overseas markets
improve the financial system?
Listing on overseas markets will provide learning
opportunities for Chinese banks in dealing with foreign
regulatory systems and will give banks regular exposure to
international standards and best practices. The need to comply
with disclosure rules will force them to become more
transparent. In preparation for foreign listings, many Chinese
banks bring in strategic foreign investors as equity holders
and as partners in certain businesses. Having strategic foreign
investors brings in new ideas, management practices and
experiences, and facilitates technology transfer. Listing
abroad also exposes the banks to a larger community of
analysts, and will make them more responsive on issues that
matter to the investor community, such as shareholder value and
profitability. These challenges will help make them into
How does the regulatory environment in a particular
jurisdiction affect which overseas markets Chinese companies
choose to list in?
The US market has become a more difficult regulatory
environment from a compliance perspective for all listed
companies, whether foreign or domestic. Although the US offers
the world's largest and most liquid capital market, many
Chinese companies will find it a challenge to manage the
compliance requirements of the US regulations. These might
deter some Chinese companies from choosing to list in US until
they are comfortable with the compliance requirements. Many
Chinese companies prefer to list in Hong Kong due to the
widespread familiarity and comfort level with Hong Kong
regulations, both by China's regulators and by Chinese
What reforms are necessary to increase investor confidence
and encourage foreign participation in the domestic capital
China's regulators have been placing a high priority on
improving corporate governance and disclosure, and there is a
great deal of focus by the regulators on the listed companies.
Over time, these efforts help to improve the general quality of
listed companies. The recently announced experiment in the
conversion of legal person shares to tradable shares is also a
positive development that will have long-term benefits on the
development of the equity markets. The loosening of rules
governing acquisition of private Chinese companies will attract
more foreign capital into M&A. The expansion of the
qualified foreign institutional investor (QFII) system and
gradual liberalization of the rules (as we have seen occur in
Taiwan) will continue to attract more investors to China's
equity markets. More specifically, the QFII system could be
expanded by increasing available investment quotas,
liberalizing the repatriation rules, increasing the scope of
products that QFIIs can invest in and reducing the
What sectors have experienced increased liberalization
through new regulations that support foreign investment?
The banking and insurance sectors have opened up
significantly to foreign investment under the WTO rules, and
will continue to open in the coming years. Also, one of the key
areas that opened last year is distribution, franchising and
retail through the Foreign Invested Commercial Enterprise
(FICE) rules, which allow foreign participation in the
wholesale and retail distribution sector of the Chinese
economy. We also expect to see increasing liberalization in
Where else do you see opportunities for further regulatory
The service sectors in general, and financial services in
particular, have not opened up as significantly as other
sectors. In the brokerage and securities industry, the current
regulations limit foreign investors in setting up local
entities. Although there have been several new joint ventures
announced, there could be greater liberalization in the
industry with a view to allowing full foreign ownership of
local entities. The financial services sector should be able to
increase its openness to foreign investment and ownership and
control. However, this will probably take some time to
The views presented are personal to the interviewee and
do not represent the views of Morgan Stanley.