China’s capital markets, including its banking and venture-capital sectors and its stock exchanges, remain in the nascent stages. But financial professionals doing business in the country say those markets are developing fast and, once established, could succeed in avoiding mistakes made by their counterparts in the U.S.


So far, the engine of growth for China’s capital markets has been its enormous population and relatively recent embrace of free enterprise, which has set off a flurry of entrepreneurial activity. “China’s population – 1.3 billion – makes it the largest consumer marketplace in the world,” said Sharon Avison, managing partner at the Princeton Global Consulting Group. “And the introduction of more consumer goods and services has begun to provide an infrastructure for consumer-financial services.”


As anyone knows who follows the business news, China is well established as the workshop of the world, with manufacturing plants continuing to spring up across the country. That combination – a huge population hungry for consumer goods and fast-growing manufacturers – is attracting more foreign money every year. “Direct foreign investment in the Chinese economy last year reached $52 billion, up significantly from 2001,” said Avison, who formerly worked for Bank of America. “And direct investment for the first two months of this year was even greater – $22 billion in just two months.”


Avison made her comments earlier this spring during a panel on China’s fledgling financial markets at the Wharton School’s China Business Forum. The forum was held just before the outbreak of severe acute respiratory syndrome (SARS), whose impact even now is difficult to gauge. Some commentators suggest that SARS could dampen the growth of China’s $6 trillion gross domestic product by 1 to 3 percentage points this year; others have said it won’t make any difference. If SARS does slow China’s growth, these observers note, it likely will do so only temporarily given that the spread of the disease already appears to be slowing.


A critical step in the continued rapid growth of the capital markets will be the privatization of the country’s four largest banks, which remain state-owned, Avison said. “The biggest issue facing them is their large amount of bad loans. Official estimates put their rate of bad debt at 25%, or a combined total of $1.8 trillion. It could be even higher.” Since private investors won’t want to assume the risks for those loans, state officials will have to resolve the situation without roiling China’s economy. In addition, Chinese bankers must show that they have reformed their lending policies before they can attract foreign capital.


Concerns about bad debt are slowing the development of the consumer financial sector, too, Avison said. Simply put, the Chinese haven’t had access to financial products such as credit cards and other consumer loans, and lenders are worried they don’t know how to handle them. The Chinese, for their part, are leery of credit cards. “It was the same in the U.S. when credit cards were introduced,” Avison said, adding that lenders might try to attract Chinese consumers to plastic with debit cards first.


Eventually, growth of the consumer finance sector should stoke the growth of other financial sectors, increasing the ability of average Chinese businesspeople to invest in each other’s ventures. “You will start to see consumers saving in a big way, and seed money will come from that,” Avison predicted.


“Talk Is Cheap”

Charles Lee, managing partner and founder of Charles Lee Enterprises, a venture-capital firm, described China’s venture-capital market as “embryonic,” but noted that the venture business in China isn’t all that different from the United States. No matter where Lee invests, his criteria for selecting companies are the same. “I have five. No. 1 is people. No. 2 is people. No. 3 is – guess what – people. No. 4 is the market, and No. 5 is technology. People are the fountain of all ideas.”


Once he invests, his methods are the same anywhere. “If you get my money, you also get me: It’s the same in China as it is in America.” He brings his experience in the telecommunications and information-technology industries as well as a network of contacts in Silicon Valley and on Wall Street.


Jim Miller, chairman and chief executive of China Elite Ltd., a China-based market research company, didn’t disagree with Lee’s assessment of the venture market. If anything, he said, venture capitalists who are trying to invest in China are too much like their counterparts in the United States.


Miller, a former executive with UTStarcom, a California telecommunications company with Chinese plants, started China Elite in 2001. It helps U.S. technology companies such as Microsoft and Oracle identify sales leads, runs call centers for Chinese companies and researches Chinese TV viewing and advertising.


Miller courted venture capitalists when he started China Elite – with little success. “Every VC firm I contacted was very interested, but I soon learned my first lesson about venture capital: Talk is cheap. We ended up getting most of our early funding from strategic partners and angel investors.”


Miller found American venture capitalists to be “very formulaic in what they wanted to invest in.” Mostly, they wanted assurances that they would have an exit – that is, an ability to sell their shares and, ideally, chalk up a gain – within five to ten years. And that’s just not possible in a developing economy such as China’s, Miller argued.


Steve Sammut, a venture partner at Burrill & Co. and a lecturer at Wharton, seconded Miller’s remarks. “There’s a groupthink among VCs; they’re interested only in a finite number of business models,” he said. “And if you are trying to build a national economy, the last thing you want is to adopt a Silicon Valley model of venture capital. We are building the industry de novo in China, and we will need new approaches.”


Miller conceded, however, that venture capitalists need to have clear exits, even if the investment horizons are greater in China. As of today, the Chinese financial markets aren’t developed enough to give them many options.


“Right now, we’re at the low point in terms of exit availability,” he noted. The Hong Kong Stock Market has opened its doors to mainland companies. And as companies from the People’s Republic sell stock there, venture capitalists should be able to sell their shares. The trouble is, some foreign investors are wary of stocks traded on the Hong Kong exchange because its registration requirements aren’t as strict as those of the New York Stock Exchange and the NASDAQ. According to Miller, The People’s Republic has a stock exchange of its own, but “it’s been primarily a vehicle for state-owned companies to sell shares. It’s a highly manipulated market with relatively high P/E ratios. But as foreign investors start pressing for reform, that will become a major source of raising capital from the Chinese consumer.”


A third exit option for Chinese companies is to be acquired.


Until capital markets become well established, the Chinese may have to rely largely on themselves – and on relatives abroad – to finance their ventures, the panelists agreed. That’s what they have done historically, said Lee, who was born in China. “There are 55 million overseas Chinese, and they have always been a big source for repatriation [of money].”


Added Avison: “For many years, we saw a lot of people leaving China, but now we are seeing people staying in the U.S. for awhile and then taking their expertise back home. That intellectual capital is going to build a bridge. Financial capital is very important, but it’s not only dollars China needs. It’s also people with financial knowledge.”