The litany of ignoring global diversification warnings is familiar to any student of portfolio management. With Canada representing less than 5% of global equity markets, it’s only fitting that investors diversify globally to find best-in-class companies no matter where they’re located. Of these, emerging and developing economies account for 85% of the world’s population and close to 50% of its economic output, according to the IMF World Economic Outlook.

While the IMF World Economic Outlook projects global growth to reach 4.25% in 2010 and 2011, advanced economies are set to be relative laggards, topping 2.5% in 2011. Conversely, growth in emerging and developing economies is projected to be over 6.25% during 2010/11, and China leads the way with expected growth close to 10% in both 2010 and 2011. IMF reports that this growth will be supported by stronger private consumption and investment as opposed to the publicly driven infrastructure investment that characterized activity in 2009.

There are other significant reasons for investors to refocus their attention on China in the coming years, including continuing changes to the operation of legal norms and financial institutions within China. Structural shifts, driven by Asian economies that were less affected by damage to financial sectors, are reflected in rankings of the world’s leading financial centres. Asian cities take five of the top 10 spots, with three—Hong Kong (No. 3), Shenzhen (No. 5) and Shanghai (No. 10)—located in China and fast-rising Beijing moving quickly up the list. According to the Global Financial Centre Index (GFCI), the results correspond with the fact that many Asian economies are currently faring better than the main western economies. The Asian centres of Hong Kong and Singapore are now much more closely grouped with London and New York than they have been in the past, and centres such as Shanghai and Shenzhen are expected to become increasingly significant in the next few years.

Indicators in the GFCI assessment include such factors as evidence of a fair and just business environment, market access, people, infrastructure and general competitiveness. As interaction between regulatory regimes and practices in China and the western economies increases, opacity indexes will reflect better assessments of financial information disclosure and reporting by China-based companies.

Two China initiatives in particular—the qualified foreign institutional investor (QFII) and the qualified domestic institutional investor (QDII) programs—are benefiting Canadian and Chinese investors alike through facilitation of investment in and out of China and increasing interaction with western securities regulatory regimes.

Investing Outwards
Perhaps the key regulation supporting the outward flow of Chinese portfolio investment is the QDII program. QDII encourages domestic institutional investors, such as select Chinese banks and insurance companies, to invest in overseas capital markets.

Under QDII, selected Chinese banks, fund management companies, trust companies, insurers and securities firms that have been approved as QDIIs, may raise domestic assets for investment in overseas capital markets. However, they are subject to three levels of regulation.
• They must abide by the QDII regulations of various Chinese regulatory bodies, which have put in place different savings ratios and other fiduciary requirements specific to the industry.
• There must be a supervisory co-operative agreement (SCA) in place between the China Banking Regulatory Commission (CBRC), in the case of banks, and the host country’s capital markets regulator.
• The investment must be made in compliance with the laws and regulations of the host country.