Legendary investor Mark Mobius recently ran into problems transferring money out of Hong Kong.
Mobius, the founder of Mobius Capital Partners, has invested in emerging markets for more than four decades and has been an enthusiastic believer of China’s growth story.
His recent experience highlights the risks and uncertainties associated with investing in China, even for investment veterans. International investors often overlooked the technical obstacles stemming from China’s capital controls, a first-level risk associated with investing in the country.
Inbound foreign investment is one of the three most important economic engines pulling China’s economy ahead for the past 40 years. To channel more international capital into the country, China in 2002 established the Qualified Foreign Institutional Investor program, an investment instrument designed to attract and manage international investors and their money. The program allows foreign investors access to the stock exchanges in Shenzhen and Shanghai.
However, currencies cannot be exchanged freely in China, and outbound flow of foreign currency is subject to strict regulations, which might not have been disclosed to international investors at the time when the inbound investment was arranged.
Problems such as that faced by Mobius are not limited to capital investors. Many international enterprises have also faced similar prohibitive capital restrictions when repatriating profits or divesting their operations in China.
Firms from Taiwan and Japan were among the most affected by China’s outbound capital regulations in the past, but now US companies and individuals seem to be in the crosshairs, too.
International investors could be easily misled by China’s investment culture — the inflated rating practice and lack of transparency at corporation and governance levels — that differs from developed countries. In China, the balance book of a given company, regardless of whether it is publicly traded or not, is only available to the company itself and government audits.
Investors have to rely on the above two sources to gauge the true financial health of Chinese companies, and so following the recommendations of China’s rating agencies seems to be the only option available to investors for making investment decision.
It is no surprise that most local companies traded in China’s stock exchanges have the highest possible rating, until the moment when defaults or major scandals hit the news.
The overnight fall of Evergrande from glory in 2021 is a perfect example of how a “sound” investment could lead to financial ruin in China, thanks to the country’s rating mechanism, lack of corporate accountability and absence of government oversight.
However, flawed ratings lure international capital seeking growth potentials in high-quality companies in emerging markets such as China. What these international investors did not realize is that the real value of an “AAA” rating in China is often on par with the junk grades in mature markets. The US$300 million accounting fraud scandal that led to the plummet of the market capitalization of the NASDAQ-listed Chinese company Luckin Coffee, which managed to conceal its balance book while raising capital in the US, is a case in point.
Then there is China’s legal system. One of the characteristics of Chinese law is its ambiguity. This ambiguity leaves the authority and law enforcement branch plenty of room for arbitrary interpretation of the law and exercising it at will.
The lack of a boundary between jurisdiction and administration is another feature of China’s legal system. Mobius was asked by Chinese financial regulators to provide “all the records from 20 years of how you made this money” when he wanted to repatriate it.
This demand is not made by law; both Mobius and China’s capital control authorities knew that. Had he taken his case to court, it would have been unlikely that he would win. Even if he won, the court ruling would unlikely be enforceable without administrative obstacles. Within the Chinese legal framework, international investors often find it difficult to protect their interests in the event of a dispute with their Chinese partners or the authorities.
In the 40 years since China opened up to the outside capital world, China’s treatment of international investors has changed, often swinging back and forth between welcoming and the other extreme. The direction of the change is always in sync with China’s foreign policy and international relationships. International investors who happened to enter China’s market during a welcoming period could easily mistake the warmth for a permanent investment atmosphere.
International investors should also consider the rapidly changing geopolitical climate when investing in China. US-China and EU-China trade tensions have intensified in the past few years, and the initial trade disputes are turning into political and ideological rivalry.
The geopolitical tensions surrounding China will likely make the investment environment in China more turbulent, and China’s policy toward international investors might change more abruptly and frequently.
Investors should look at how their own governments assess the situations in China, and the rules their governments set to govern how China-related business should be carried out. Mobius and people like him have been attracted to China by promising opportunities.
China will continue to grow in the long term, and it continues to be a land of opportunity. The questions that international investors need to ask today is not whether they should invest in China. The question should be, more precisely: When and at what price?
Daniel Jia is founder of consulting firm DJ LLC Integral Services in Spain.
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