one big thing
1. SMIC braces for impact
The hits just keep coming for the Chinese tech industry.
On Friday, the US Commerce Department told American companies that they would be required to obtain a license to sell components or software to China’s Semiconductor Manufacturing International Corporation (SMIC) and its subsidiaries.
Some context: SMIC is China’s largest semiconductor manufacturer and is partially state-owned.
According to a Commerce Department statement, exports to SMIC posed an “unacceptable risk” of being diverted to military end-use applications.
The full extent of US export restrictions are not yet clear:
- SMIC has not been placed on the Commerce Department’s Entity List, which would vastly limit the company’s ability to source key technology and components.
- The Commerce Department’s restrictions are reportedly based on a rule forbidding the export of certain items believed to be destined for military end-use.
But either way, it’s bad news for Beijing:
- SMIC is one of the national champions at the forefront of Beijing’s drive to develop a strong indigenous chip making industry. US sanctions have the potential to badly curtail SMIC’s operations.
On Sunday, SMIC released a statement denying ties with the Chinese military:
- “SMIC reiterates that it manufactures semiconductors and provides services solely for civilian and commercial end-users and end-uses.”
- “The Company has no relationship with the Chinese military and does not manufacture for any military end-users or end-uses.”
Meanwhile, when asked about the development on Monday, a spokesperson for the Ministry of Foreign Affairs gave a typically-worded response about China’s plan to “adopt necessary countermeasures” and “safeguard the legitimate rights of Chinese enterprises.”
- Read: We’ll wait to see how this plays out.
Get smart: The need for Beijing to develop US-free supply chains for key tech components, including a robust and competitive domestic semiconductor industry, becomes clearer to Chinese leaders by the day.
2. Liu He heads meeting of leading group for SOE reform
On Sunday, Xi Jinping’s economic czar, Vice Premier Liu He, presided over a meeting of the Leading Group for State-owned Enterprise (SOE) Reform.
The topic of the meeting was…well…reforming SOEs.
Some context: Liu has been a vocal advocate of SOE reform – specifically making them more market oriented – amid an intense policy debate about the role of state-owned companies in China’seconomy.
During the meeting, Liu laid out key guidelines for implementing the three-year SOE reform action plan which was approved in June by the Party’s Central Committee for Comprehensively Deepening Reform (CCCDR).
The leading group called for SOEs to:
- Become competitive market entities and improve market-oriented operatingmechanisms
- Push forward mixed-ownership reforms
- Strengthen the leadership of the Party
- Make breakthroughs in core technologies through the appropriate use of incentives
- Promote the concentration of state-owned capital in important industries
- Improve industry supply chains and market structure
- Play a fundamental role in safeguarding national economic security and people’s livelihoods
Things that make you go “hmmmm”: The meeting also called for the establishment of a subsidy system “in line with international standards”.
- Subsidies for SOEs have been a major bone of contention in trade disputes between China and other countries in recent years.
- China has refused to give ground on this point, so we’re not sure what this line means exactly.
Get smart: SOEs are an important pillar of the Chinese economy, but policymakers like Liu want to see them act more like normal, profit-driven companies.
What to watch: Liu will have to retire in the next few years. Will this last push on SOE reform finally be successful?
3. The door opens a little wider
On Friday, Beijing took another incremental step toward openingChina’s capital markets to foreign investment.
The central bank, securities regulator, and forex regulator said that foreign investors with Qualified Foreign Institutional Investor (QFII) orRMB Qualified Foreign Institutional Investor (RQFII) status would be allowed to invest in a much broader array of financial products.
- Private investment funds
- Bond repos
- Margin trading
- Financial futures
- Commodity futures and options
Under the programs, foreigners could already invest in:
- Interbank fixed income products
- Securities investment funds
- Stock index futures
Some context: Once upon a time, the only way foreign investors could invest in domestic Chinese securities was by getting a QFII or RQFII license.
- Other investment channels have since opened up, making the programs less relevant.
- In May, the quotas were scrapped, which in theory allows foreign investors with QFII or RQII status to invest as much money as they like.
On Friday, the authorities also said that the QFII and RQFII programs will be merged and that the process for joining the combined program will be simplified.
Get smart: Beijing is trying to reinvigorate its capital markets. It hopes foreign capital will play a meaningful role in that process.
4. Shadow banking – junior varsity edition
On Saturday, the China Banking and Insurance Regulatory Commission (CBIRC) held a meeting to discuss someinstitutions on the periphery of China’s financial system.
- They’re a hot mess.
The meeting focused on six types of institution in particular (21st Cent Biz):
- Credit guarantee companies
- Pawn shops
- Factoring firms
- Financial leasing companies
- Local asset management companies
What about these companies concerns the CBIRC?
- There are too many companies operating under the above categories.
- Many are of poor quality and have weak leadership.
- There are many zombie and shell companies among them.
- Some have wandered too far from their original purpose. For example, real estate accounts for about half of all pawn shop business.
- Some are involved in illegal activities.
Why have such failings gone unchecked?
- According to the CBIRC, it’s because the regulatory regime hasn’t been up to snuff.
What comes next: You guessed it – a big heaping helping of increased institutional supervision.
Get smart: Keen CMD readers will recall that the CBIRC has warned of the need to stay vigilant against a shadow banking resurgence in recent months.
- Tightened oversight of these fringe financial companies are part of the regulator’s plan on that front.
5. Vanke Chairman discusses impact of the “three red lines”
On Friday, Vanke Chairman Yu Liang commented on the implications of regulators’ “three red lines” policy for the real estate industry.
Some context: The three red lines refer to new restrictions on the amount of debt that developers can hold, which were introduced on a pilot basis for 12 developers (including Vanke) from September 1 (see August 18 China Markets Dispatch).
Yu said that previously, developers with better access to financing could buy more land, enabling them to expand faster than their peers.
- With the new measures, though, developers can no longer rely solely on access to financing as an advantage.
- As such, they will compete using products and services to drive expansion.
Yu added that Vanke had expected these measures, saying its leaders believed the industry had taken on an excessive amount of financing.
- Importantly, Yu said Vanke would do its best to help struggling companies as the new measures put pressure on the industry to change.
Get smart: Most large developers are in much better financial position than their peers, so industry consolidation looks set to accelerate as the three red lines policy is applied more widely.
- Does the “help” Vanke envisions offering include cheap asset acquisitions as the industry consolidates?
6. Investors dump Evergrande shares and bonds
Since aleak emerged last week, reportedly showing Evergrande’s request for government support for anasset restructuring(see September 25 China Markets Dispatch), investors have been busy dumping Evergrande shares and bonds.
- Domestic bonds have fallenbetween 17% and 30%.
- Evergrande’s shares fell as much as 8.8%, while Evergrande New Energy Vehicle Group and HengTen Networks Group fell 14% and 20%, respectively.
Many investors were shocked to see so many small lending companies on the list of Evergrande’s creditors, which was included in the leaked documents.
- Small lending companies charge higher interest rates than banks or trust companies.
- Over-reliance on small lenders is often a sign of financial distress.
But the company says not to worry:
- Evergrande sought to reassure the market,stating that not once in its 24-year history hasit ever been late in payingprincipal or interest on debt.
More importantly, at least one cash infusion in coming:
- On Friday, Evergrande received approval from the Hong Kong Stock Exchange to spin off its property management unit, which is expected to raise USD 1-2 billion.
Get smart: Speculation has been swirling around Evergrande’s financial health since its desperate-sounding missive was leaked last week.
- If the real estate giant really is in financial distress, expect Chinese officials to get involved very soon – to force asset sales and implement a comprehensive debt reduction strategy.
The big question: Will the cash infusion from the property management spinoff be enough to restore investor confidence?