The Wall Street Journal-20080130-Chinese Investors Get to Bet on U-S- Stocks- SEC Pact Will Open the Door Wider- but a Cautious Approach Is Likely to Prevail for Now

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Chinese Investors Get to Bet on U.S. Stocks; SEC Pact Will Open the Door Wider, but a Cautious Approach Is Likely to Prevail for Now

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Shanghai -- As China's stock market slumps from its recent dizzying heights, investors in the world's most populous nation increasingly have the option to move money into shares traded overseas, including the U.S.

Even so, don't expect them to inflate the Dow Jones Industrial Average into a China-style bubble soon.

In the latest move to give Chinese investors access to the U.S. market, the U.S. Securities and Exchange Commission is expected to sign a memorandum of understanding in the next several days with the China Banking Regulatory Commission that will allow banks in China to develop U.S.-stock mutual funds for their clients, according to a person familiar with the situation.

The move is noteworthy because while mutual-fund companies in China can already offer their clients access to the U.S. markets, banks cannot yet develop their own funds.

The banking agreement is part of a trend in the past 18 months: The door has swung open for ordinary Chinese people to invest more of their $2.4 trillion in savings overseas. Treasury Secretary Henry Paulson has been urging China to ease its capital controls and permit the outward flows. Plans for Chinese money to hit U.S. markets were hatched during meetings this past May and December of the Strategic Economic Dialogue, a bilateral forum that Mr. Paulson helped to launch.

Ethiopis Tafara, director of SEC's office of International Affairs, confirmed the agreement, saying "CBRC and SEC staff have agreed in principle to exchange letters in the near future on information- sharing in connection with the cross-border activity of financial institutions licensed by either the CBRC or the SEC."

A Chinese bank-regulatory spokesman in Beijing referred to past statements the agency has made that it already has similar agreements with counterparts in Hong Kong, Singapore and the United Kingdom, and will set them soon with the U.S., Germany and Japan.

Already, brokerages, banks and fund companies in China are pitching to the country's investors a fast-expanding array of mutual funds and other products that invest in, or reflect values of, world-wide stock and bond markets. Dubbed QDII, for qualified domestic international investor, the program marks the first legal channel for China's investors to put money in foreign financial markets.

Until about mid-2006, tough capital controls made it almost impossible for individuals in China to convert yuan into U.S. dollars and other foreign currencies, much less invest in overseas stock and bond markets. Now, individuals can convert yuan worth as much as $50,000 a year, reflecting how Beijing is eager to offset continued inflows into China by sanctioning more outflows.

HSBC Holdings PLC estimates QDII products worth more than $50 billion have already been approved -- not far off the roughly $66 billion earmarked for overseas allocation by Beijing's much-watched sovereign fund China Investment Corp., which last year bought into Blackstone Group Ltd. and Morgan Stanley.

"You are talking about real international access for retail investors in China," says Peter Alexander, principal of Z-Ben Advisors Ltd., a Shanghai consultancy on China's fund-management industry.

The pending U.S.-China agreement for banks moderately expands the existing channels for foreign investment. Under it, banks in China will be permitted to design their own U.S. stock funds -- instead of selling products on behalf of other firms like mutual-fund companies. Banks are important because their branches are the primary platform for distributing financial products in China.

One hitch is frustrating the QDII industry: Individual Chinese don't yet show much enthusiasm for global investing -- in the U.S. or anywhere else. Almost all of the products introduced so far have been undersubscribed, and many have declined in value.

Quite simply, investors in China don't think the rest of the world looks very attractive right now. The caution reflects the kind of worries about a U.S. recession that have caused global market turmoil. Plus, confidence hasn't completely evaporated from the local stock market -- even with the Shanghai Composite Index into bear-market territory with a 27% loss since October's peak.

But a particular obstacle to faster development of the QDII program is China's currency, and specifically the expectations that the yuan will strengthen more in 2008 than the 7% it gained against the U.S. dollar last year. Chinese investors are deciding they would be better off with their money in simple bank accounts at home than holding a stock or bond denominated in U.S. dollars.

Chinese regulators recently announced QDII funds also will be able to hold part of their investment in domestic markets, which is meant to offset some of the currency risk.

Most of the QDII equity investment has so far been targeted at Hong Kong, which has been unappealing to Chinese investors, as the city's market has been hit hard in the past six months by the U.S. subprime- mortgage concerns.

The U.S. also is starting to see QDII cash, along with markets such as Mexico, Sweden and the U.K. A $3.7 billion pan-Asia fund co-managed by J.P. Morgan Chase & Co. in Shanghai, for instance, reported that about $357 million, or 9.7%, of its stock investment on Dec. 31 was in the U.S. That was largely U.S.-traded American depositary receipts, including those of Icici Bank Ltd. and Reliance Industries Ltd., both of India, plus Posco of South Korea.

Despite his long-term optimism for the trend, Mr. Alexander of Z-Ben Advisors says it is natural to expect China's investors to move cautiously into overseas investing. "You could say the same thing about the U.S.," says Mr. Alexander. "It's called home bias."

Global Markets Climb

Ahead of Fed News

Stock markets around the globe mostly rose, as investors reassessed the scope of the year's declines and, more important, on expectations of a further cut in U.S. interest rates at today's meeting.

The pan-European Dow Jones Stoxx 600 index rose 1.8% to 324.31. The Dow Jones Stoxx 600 index is off 11% for the year, but it has managed to claw back around 5% since Thursday.

In LONDON, the FTSE 100 index advanced 1.7% to 5885.20. Shares of mining firms advanced, as gold futures stayed near recent records. Anglo American gained 5.8%.

In TOKYO, the Nikkei Stock Average of 225 companies rose 3% to 13478.86. Financials led the gains. Mitsubishi UFJ Financial Group rose 4.6%, and Mizuho Financial Group advanced 4.8%.

In MEXICO CITY, the IPC index surged 1.8% to 28263.95. Cemex, one of the world's largest cement makers, was a top gainer, after it reported a 43% rise in fourth-quarter net profit and maintained its forecast for 2008. Its shares jumped 4.7%.

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Bai Lin and Kara Scannell contributed to this article.