How to analyse the Chinese yuan depreciation?

When combing through the past three months of financial market news flow you'd agree that the issue of China has gone very quiet lately which leaves investors wondering, why the sudden silence?

It's fair to say that Brexit and the rally in oil prices have dominated headlines for a while causing a disruption in the coverage on matters relating to China although it must also be said that a number of changes implemented by the Chinese government in terms of a lessening of financial market regulation have gradually been taking shape with the installment of a new Chinese Securities Regulatory Commission's chairman Liu Shiyu.

What we've seen evolve since Shiyu's appointment is a steadiness in the depreciation of the Chinese yuan against the dollar that eclipses the abrupt and sharp devaluation that took place in August last year that sent shockwaves through global markets.

The stark difference between the two events comes down to the fact that Shiyu has allowed the free market to decide an appropriate equilibrium whereas his predecessor, Xiao Gang, liberalised the market far too quickly that by the time it came to regulate the necessary parts in the market, participants saw this as signs of fear from the government.  

#China Onshore Yuan drops to 5.5yr low. pic.twitter.com/BGlT2q6YMz

— Holger Zschaepitz (@Schuldensuehner) June 28, 2016

Working hand in hand with the People's Bank of China (more commonly known as the PBOC) the CSRC has coordinated a greater certainty in policy going forward and in doing so has indirectly cooled down market fears from the height they had reached late last year.

This is yet another positive improvement stemming out from Chinese financial markets that will allow their securities to be included into global investment funds, thus broadening the diversification of investors in China.

However as much as China needs to be applauded with its efforts to align its own financial markets to a global benchmark, the actual depreciation of the yuan begins to tell a worrisome story of the future that'll have a profound impact on the global economy.

It says to us that foreign investors don't perceive a strong bounce in economic activity anytime soon indicated by the level of outflows that have exited the financial system this year alone. In the short term it may pull the brakes on the economy but over the long term it would certainly stimulate exports from China again.

Whether developed nations, who are suffering from severe currency appreciation, take kindly to this is another question altogether and will probably cause fingers to be pointed, increasing the chances of the world seeing a resurgence of currency wars.

Exclusive: China to tolerate weaker yuan, wary of trade partners' reaction - sources https://t.co/rVYUP3BnvT pic.twitter.com/10xVNrxSkj

— Reuters Top News (@Reuters) June 30, 2016

Alibaba's SEC investigation stresses more to be done in China's Stock Exchanges

One of the big news stories I've been following in recent months is the happenings at the Chinese Securities Regulation Commission after the organisation dropped the ball in implementing a long term plan of deregulating Chinese equities that ended rather badly for the image of China as an investment destination having experienced months of violent stock market volatility that eventually spread to the rest of the world.

Under the chairmanship of Xiao Gang, the organisation succeeded in revealing the flaws in its own undertakings as well as the negligence with which it operated in by allowing unscrupulous companies list on stock exchanges with shady financials and backgrounds that would raise the hair on the necks of most global investors who've become accustomed to an accepted standard worldwide.  

On a number of occasions these issues were raised by media houses but to no avail until chaos set in with reputational damage inflicted at the highest possible levels. From there onwards the pressure to remove Gang ensued up to his dismal in January and being replaced with a better suited candidate in former Chinese Agricultural Bank chairman, Liu Shiyu.

You can read more about this shake up by following the link.

A few weeks back I decided to review how well Shiyu had done three months into his new job and concluded that a number of measures he was putting in place in terms of transparency of reporting together with a stricter criteria when issuing additional stock to shareholders were signs that the CSRC was on the mend and would benefit greatly from this boost in confidence.

#Alibaba is taking fire again...This time from the SEC over its #accounting methods: https://t.co/DFNhxJhoXx $BABA via @CRrileyCNN

— CNNMoney Investing (@CNNMoneyInvest) May 25, 2016

Needless to say the rot that set in under the tenure of Gang will inevitably be with investors for some time yet with the latest news out of Wall Street reporting that Alibaba, described as the Amazon of China, is being investigated by the Securities Exchange Commission over the methods it uses to report sales numbers from its hugely successful "Singles Day" campaign.

This isn't the first time doubt has been raised over the variability of actual versus reported growth numbers with many analysts saying the numbers are "cooked" to make the outlook shine brighter than what it seems.

Financial publication house Barron's dug its heels in when it fronted a story that said the company was poised to lose a further 50% market cap devaluation as was speculated by analysts in the industry. This led to founder and chairman Jack Ma to respond back harshly to this assessment of the company saying it was in the driving seat when it came to profiting from the Chinese internet boom and the fears some investors may have in relation to the deepest of the slowdown in China were unfounded.

It should be noted that the company's stock price performance since its listing has been poor given the fanfare it received on the first day it traded publicly on the New York Stock Exchange.

The latest news comes as another blow for the internet giant whose struggled to establish itself as a reputable company worth investing in at a time when Chinese stocks should be thriving from capital inflows with a mountain of opportunities that beckon which brings me to my next point.

Properly regulating Chinese equities not only has a positive impact on locally listed companies but also on those firms such as Alibaba by opening up the doors of possibilities to future investors whether they be based in London, Tokyo or even New York. The ill-equipped stock regulations in China has failed to prepare potential multinational companies to conform to international standards that directly lead to steady investments thus damaging their image.

Perhaps its harsh to judge the Chinese who lack expertise in this field but its also fair to say that its been afforded ample time and patience to implemented proper practices yet decidedly used the chance to fill bureaucratic posts for prominent members of its ruling party.

If government is committed to steady the hand of investors it needs to stress the priority of finding a balance where the interests of public funds are held in the highest regard and the dealings by the companies seeking capital are monitored with hawkeye vision to ensure sufficient investor confidence remains sustainable over the long term.    

Are things looking better at China's stock market regulator?

With the onset of volatility grappling a directionless market at the moment, it doesn't quite compare to the hair raising periods most traders have experienced over the last year in financial markets. In attempt to pinpoint exactly where the troublesome environment grew from, traders wouldn't find it difficult to point in the direction of the Chinese equity bubble that's seemingly put the brakes on global equity valuations going higher.

At the time, August 2015 to be precise, there had been a protracted build up of negative sentiment flowing from China as to the raunch daily movements in stock prices that had taken place after an effort to liberalise the financial markets to be able to reach more participants had taken a wrong turn, sending investors into a flight of panic over the safety of their investments.

It appeared that former Chinese Securities Regulatory Commission Chairman Xiao Gang had overplayed his hand and allowed an excess of freedom for brokers to exploit individuals, most of these people inexperienced and ill-equipped to deal with financial instruments, by offering high levels of leverage that would offer them exposure at a fraction of the price thus creating a speculative frenzy to thrust valuations into the stratosphere.

This in effect caused wild price moves to develop once the CSRC decided to clamp down out of fear that it had caused an equity bubble to develop that could be devastating to the entire global financial system if it were to burst which at the time seemed highly probable given the extended rally.

The world noted this anomaly and took the que that now would be the best time to begin an anticipated selldown that had been expected to come some months before. All eyes were now squarely focused on the Chinese stock market, a position that didn't fit comfortably with government officials who prefer to hold their cards close their chests prompting them to enter the fray and halt the hemorrhage.

China moves to contain technology bubble https://t.co/nAEMhMk6oT

— CNBC (@CNBC) May 11, 2016

Pressure was on Gang to rectify his mistakes but it was too late and by the time it came to implement circuit breakers in January of this year, the signs were on the wall that his tenure as chairman of CSRC was coming to an end. The failure of the circuit breakers proved to be the end of Gang with Liu Shiyu taking over the reins.

At the time I wrote that Shiyu had a difficult task ahead in bridging the gap between the rules needed to be in place that would allow for functionality, marketability and transparency and the forces of supply and demand that would be harmed if too much intervention was placed in the market.

Three months into his new job and the emergence of the type of policy Shiyu will be bringing to the market is taking shape with the latest news that the CSRC will prevent companies that intend issuing new stock for the purpose of buying assets that don't form part of their core business from doing so in an effort to curb what many speculate to be a new bubble.

Opening up financial markets affords the companies looking for additional means of capital injection as much freedom as it does to the individual investor dictating over his financial freedom. However as we've witnessed with the newly founded Chinese investor, the level of aptitude hasn't matched the sophistication of their international counterparts.

This has led companies to neglect the business which forms part of its primary operations and find alternate ways of raising fresh cash from the market under the veil of hopeful prospects in industries that are benefitting from forthcoming positive sentiment due to their positioning in a transitive economy.

What confidence Shiyu measures give to the market is that public money is considered sacred, a juxtaposition from his predecessor who liberated investors but failed to foresee the shaky foundation companies issuing stock were standing on.

Although seen as more intervention rather than less, a contradiction to what authorities said wouldn't happen, I believe the move is in the right direction by emphasising the importance for companies listed on the exchange to be transparent and diligent when using funds raised from the public, a sign of progression when it comes to financial markets in China.

Hopefully this is just the beginning of great things to come from CSRC chairman Liu Shiyu who's started out on the right footing by calming fears and bringing order back into Chinese equities. However the challenges will come when global markets experience pressure from the lack of evidence of a healthy economic climate which would weigh down heavily due to China's part in the equation. The true test will be whether these officials stand steady in their convictions and if they've done enough to prevent a total collapse.

MSCI non-committal to Chinese stock inclusion

During the height of volatility in Chinese equities that occurred in September 2015, MSCI CEO Henry Fernandez had stated that Chinese mainland stocks could be included in their portfolio of indices much sooner than many had expected and volatility would not play a role in deciding whether or not the inclusion of these stocks would happen.

But in an about turn stance, the index tracking company has now said that the interference by the State in preventing a financial market crash could hamper the inclusion of Chinese equities into its global indices and stressed to authorities the importance of ensuring that the errors of the past do not happen again thus reinstalling confidence into the financial system.

At the time of Fernandez's comments I said that it was a rather unbalanced opinion given the developments that had unfolded in the preceding weeks which at the time didn't feel stable by any degree. These concerns were confirmed by the summer long support by the Chinese government of equities.

Where to from here?

Well it must be said that the government's decision to remove CSRC Chairman Xiao Gang and replacing him with Liu Shiyu was a step in the right direction following the mishaps of Gang's tenure which included failure to properly implement circuit breakers to create an orderly market that proved to be the last straw for authorities.

Shiyu takes over after having served in a similar roles throughout the Chinese financial system but perhaps the biggest vote of confidence comes from his involvement in developing the bond market in China, the one half that forms part of the capital markets with the other being the equity market. Having participated in one part of the capital market gives Shiyu a sense of the longer term responsibilities that need to implemented in order to attract foreign investment.

It's vitally important that China heeds the call from MSCI if it wants to complete its transformation from an ineffective system that fails to work for its citizens into a fully fledged global financial system that's interconnected to the world's biggest financial markets. The final step in its completion of this goal requires free flowing foreign investment that isn't hindered by meddling from third parties, something that doesn't feel anywhere close to being reached.

MSCI is not quite ready to let China into the fold - yet https://t.co/Sd1ln1SGpA pic.twitter.com/V5uPSS7FIj

— Bloomberg Markets (@markets) March 31, 2016