Perception of China is key element in opening China's capital account

All is about trust in the business of managing money, and particularly managing other people's money. This maxim is particularly true in periods of turbulence and doubts on the powers of governments to influence market events. This was true in 2008 during the financial crisis, and in relation to the current situation in China it means that not only the timing of the Chinese governmental authorities on the opening of the Chinese capital account but also the perception of the outside world on the nature of the financial markets in China will determine the moment of the full opening of those markets.

According to certain forecasts the share of foreign investment in the Chinese Stock Markets could rise significantly over the next years to reach up to 30 percent of its value. In order for this to happen, access channels into the markets have to be broadened and simplified pending full liberalization of the capital account and full convertibility of the RMB.

There is currently important demand in Luxembourg for the creation of investment structures providing exposure to the PRC securities markets (bonds and/or equities) through RQFII, QFII and Stock Connect. International and, increasingly, Chinese asse tmanagers are using Luxembourg as a stepping stone to benefit from the infrastructure and experience of the No. 1 cross-border investment fund center in the world to create their RMB product offering.

The international financial press reported recently that this trend is likely to continue despite the recent turmoil on the Shanghai and Shenzhen Stock Exchanges. From an investment fund lawyer's point of view the reform process in China must therefore continue (as announced by the Chinese government) to ensure a functioning of the securities markets in China permitting corrections of overvaluations and enhance their regular operation in a manner compatible with regulated investment fund activities.

Legal certainty, clear processes and independent actors are a must for the creation of open financial markets reflecting the strength of the Chinese economy.

Public intervention may have stabilized prices for the time being but it is yet unknown at which time and to which extent the support of the Chinese taxpayer will be withdrawn to provide a transparent and realistic pricing level in the markets.

As long as pricing levels in the market are subject to these types of uncertainties and the management of the crisis is not creating the required trust, European retail investor interest in China products will remain low. The RMB has to be more than an international trade currency to achieve the status of a trusted reserve and investment currency and in addition to aspects linked to the currency itself the RMB asset class has to become a trusted alternative to the US and European markets.

Another obvious step for stabilizing and opening the PRC financial markets would be the opening of other investment opportunities to the local investor base. The solution cannot be the adding of a large number of foreign investors into an already crowded market environment but rather a true two-way flow of investments from and into China for the mutual benefit of foreign and Chinese investors. Again, Luxembourg investment funds (mainly UCITS) can be part of the solution by offering tested, secure and well regulated products which could be offered to Chinese investors. The recent developments on the QDLP and the QDII reform offer encouraging signs.

The overall economic importance of China on the world stage is however likely to prevail over concerns on the PRC securities markets for investments by institutional investors if the necessary trust-building measures are rapidly taken. The current discussions on the inclusion of RMB in the basket determining the value of IMF special drawing rights (SDR) will also be influenced by recent events in the financial markets and the different debates will remain interconnected with a focus on the convertibility of the RMB.

The author is a partner at the Luxembourg headquarters of law firm Elvinger, Hoss&Prussen.