by Samuel Lum, CFA
With around 10,000 projects now in progress throughout the country, "the urbanization process in China is one that is absolutely unprecedented in human history," said Zheng Xiaoping, the founder of China City Development Foundation, while speaking at the China Investment Conference, cohosted by CFA Society Beijing and CFA Institute. Urbanization is expected to initially boost domestic consumption as rural migrants to cities experience significant increases in income and wealth levels. Then, as those migrants' family members migrate, consumption spending will further increase. This urbanization is a key trend that is transitioning China's economy to a higher share of consumption in gross domestic product (GDP).
Urbanization: New Policies, New Challenges, Unprecedented Opportunities
"Urbanization is not something new in China. It has been going on for 15 years already. And it will keep going on for another 15 years and more," he said. Zheng, who has worked with 25 cities over the past 13 years as an adviser on urban development projects, quoted a McKinsey study that predicted that by 2025, China will have 221 cities with populations of more than 1 million inhabitants. In comparison, Europe currently has about 30 cities with populations of more than 1 million and is expected to stay around the same level over the next 15 years.
China's urbanization movement gives rise to potentially attractive investment opportunities in several sectors, according to Zheng. In addition to conventional housing and mixed-use projects in cities, projects relating to senior care and nursing home facilities have huge potential. In China, there is not yet a single prominent brand in this sector. Tourism and leisure property are also attractive sectors. Coastal waterfront properties are in great demand, and the supply is short. Also, given the new emphasis on the environment, the green sector will grow substantially in the coming years. Suburban and infrastructure development hold much promise as the migration trends continue to accelerate.
With an urbanization movement of such a large scale, there are bound to be problems. Zheng believes that balancing economic, commercial, and industrial elements with historical value preservation and environmental aspects is crucial in any project. Most importantly, comprehensive and effective planning is the key to success.
Zheng believes that the performance assessment system for mayors and local officials needs to give credit to good planning and design, rather than focus solely on the number of projects completed, which tends to encourage rushing through projects without proper planning.
Investment and finance are essential for the urbanization movement in China. Financing models for urban development projects are continually evolving as the central government implements financial sector and capital market reform. Zheng emphasized the need for financial expertise in the urbanization process. Specifically, financial industry professionals will be needed to develop and implement financing models. Further, Zheng recommended financial professionals coach mayors and other local government officials in the financial aspects of urban planning.
Securitization in China: Beyond Theory
While securitization is an important financing tool for urban development in China, it is also becoming key to China's fixed-income market. Walter Cheung, CFA, an industry veteran who is currently Asia-Pacific CEO of StormHarbour, estimates the size of China's asset-backed security (ABS) market at about $15 billion, which is miniscule compared with the $10 trillion market in the United States in 2012. China's ABS market is less than 1% of its fixed-income market ($4.2 trillion), whereas in the United States, the ABS market is 26% of the $38 trillion fixed-income market.
The first bank-sponsored ABS was issued in 1992 by Hainan Sanya, but it was not until 2005 that the market really took off, with three major issues totaling about RMB17 billion. With the global financial crisis, issuance stalled in 2008, and activity did not restart until 2012. Now, after the issuance of definitive securitization regulations by the China Securities Regulatory Commission (CSRC) in March 2013 and with the support of a research agency, China Research & Intelligence, the market is estimated to grow to RMB10 trillion.
One key advantage of securitization is that structuring tranches allows a broadening of the investor base by catering to buyers with different tastes for returns and credit quality. In China, this type of multi-tier investor base may be latent, but distributors are only in the early stages of educating clients on ABS investing, according to Cheung. Most ABS investing remains within the banking system, with little occurring elsewhere. For a mature ABS market to develop in China, Cheung believes it is important for a proper credit culture to be in place in which gradations in credit quality and pricing nuances are well understood.
Cheung believes there are a few additional obstacles for the Chinese ABS market to overcome:
- Cross-border deals being hindered by exchange controls that limit profit repatriation
- A lack of credit enhancement vehicles, such as wrappers
- Limited repackaging opportunities
- Lack of a liquid secondary market
- More tax incentives needed to promote further growth
- Segregation of the market into bank and non-bank regimes
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