Over the past several decades, China's international financial influence has expanded multifold. Featuring massive domestic consumption of US$6 trillion for 2020, a renowned export sector and dynamic "dual-circulation" strategy, China has evolved into a prominent global economic force.
However, for a majority of the world's investment capital, the Chinese markets remain heavily restricted. With the late-2020 signing of the EU-China Comprehensive Agreement on Investment (CAI), China's isolationist policies are beginning to change.
Chinese Economic Growth, Investment Options
Boasting an enormous consumer base of 1.4 billion people, China is an attractive venue for investors worldwide. In reality, securing direct access to this market is a challenge. Buying Chinese exchange-traded funds (ETFs), routing capital through market makers in Hong Kong, or acquiring American Depository Receipts (ADRs) are a few of the options available to traders and investors. For companies that aspire to expand operations into mainland China, the barriers-to-entry are high often making such ventures non-starters.
One of the most attractive attributes of the Chinese market is its growth potential. According to the U.K. Centre for Economics and Business Research (CEBR), Chinese gross domestic product (GDP) is due to become number one in the world by 2028. The CEBR projects post-coronavirus (COVID-19) GDP growth to average 5.7% from 2021-2025 before tapering down to 4.5% annually from 2026-2030.
Pertaining to the coronavirus-riddled year of 2020, China's National Bureau of Statistics reported several domestic GDP metrics worthy of note:
- GDP rose 2.3% for 2020
- For the fourth quarter 2020, GDP rose by 6.5% year-over-year
Throughout the COVID-19 pandemic, China led the world's economic recovery. Among all major economies, China's 2.3% annual GDP growth represented the only case of expansion, not contraction.
Comparatively, aggregate EU economic output lagged significantly. The European Commission's Autumn 2020 Economic Forecast broke down the outlook for 2020-2022:
- EU GDP was projected to contract by 7.8% for 2020
- Growth of 4.2% in 2021 and 3% in 2020 was expected
China's positive economic performance during the 2020 COVID-19 pandemic was attributed to strict virus containment policies and focussed stimulus―both products of a streamlined governmental structure. Conversely, EU nations faced a collection of unique challenges in regards to lockdowns, quarantines and the institution of uniform health policies. Amid the humanitarian and financial strife of 2020, international investment began to view China as a return-friendly option. On U.S. stock exchanges alone, Chinese initial public offerings (IPOs) raised US$15 billion for 2020, the second-most on record.
What Is The EU-China Comprehensive Agreement On Investment?
On 30 December 2020, EU and Chinese leadership came to an agreement in principle designed to even the playing field in two-way investiture. Known as the Comprehensive Agreement on Investment (CAI), the deal featured several concessions from China that opened previously off-limit markets to EU investors.
First proposed in 2012, the CAI appeared to be off the table as COVID-19 and humanitarian issues in Hong Kong and Xinjiang strained EU-China relations. Despite the tensions, the CAI was announced in late-2020 following a virtual conference including prominent figures from both sides. Attendees included:
- President of the European Council Charles Michel
- President of the European Commission Ursula von der Leyen
- Chinese President Xi Jinping
- German Chancellor Angela Merkel
- French President Emmanuel Macron
One of the primary objectives of the CAI was to balance foreign direct investment (FDI) between China and the EU. According to the European Commission, the ongoing two-way FDI landscape is as follows:
- Cumulative EU FDI to China over the past 20 years measures upwards of €140 billion.
- For the same period, Chinese FDI to the EU measures nearly €120 billion.
- EU FDI to China remains "modest" with respect to the size of Chinese economy.
- The CAI will be the most ambitious agreement that China has ever entered with a foriegn country.
As stated by the European Council, "the CAI will ensure that EU investors achieve better access to a fast-growing 1.4 billion consumer market and that they compete on a better level playing field in China." To achieve this stated objective, the CAI outlined a series of bilateral commitments. The three areas targeted were market access, equal investing and sustainable development.
1. Market Access
Traditionally, it has been a challenge for foreign companies to secure quality access to the Chinese consumer market. The CAI reduces barriers-of-entry for EU firms through commitments such as the elimination of quantitative restrictions, size constraints or partnership requirements.
Below are a few of the key market access provisions agreed to by China:
- Manufacturing: China has committed to match the EU's openness in regards to product manufacturing, with very few exclusions.
- Automotive: China has agreed to phase out partnership requirements and will promote market access for alternative energy vehicles.
- Finance: In the CAI, China has consented to the removal of partnership requirements and equity caps for banking, securities trading, the provision of insurance and asset management.
- Health Care: Private hospitals may be built in designated cities, particularly Beijing, Shanghai and Shenzhen.
- Biological Research and Development: China has stated that no new restrictions will be implemented on EU entities. If previous restrictions are lifted, EU entities will be granted the concessions.
- Technology: China has agreed to lift the investment ban on cloud services, but remains subject to a 50% equity maximum. A "technology neutrality" clause outlines the removal of equity caps from services offered online.
As it relates to the EU markets, the previously standing General Agreement on Trade In Services (GATS) governs Chinese FDI in the EU. However, the CAI does preserve EU interests in the arenas of energy production, fisheries, agriculture and public services.
2. Fair Investment
Despite the fact that two-way FDI over the past 20 years is roughly even, the CAI is designed to improve the flow of EU capital into China. The agreement promotes EU investiture by addressing several key facets of finance:
- State-Owned Enterprises (SOEs): Chinese SOEs are directed by the CAI to adhere to commercial considerations and not discriminate in their purchases or sales of goods and services. This is an important concession as SOEs account for more than 30% of China's GDP.
- Subsidies: The CAI obligates China to provide transparency for any subsidies aimed at the services sector. Taking World Trade Organisation (WTO) rules a step further, the CAI requires that China engages in consultations to ensure EU investment interests are protected.
- Forced Technology Transfers: Intellectual property, technologies and trade secrets are protected by the CAI. Agreed upon rules are more strict than the existing WTO regulations.
- Transparency: The CAI affords equal access to standard-setting bodies for EU companies operating in China. Legal certainty and procedural fairness are promoted in the agreement.
3. Sustainable Development And Conflict Resolution
Extensive provisions are built into the CAI governing environmental issues, labour concerns and conflict resolution. The goal of such verbiage is to ensure that investment is conducted in a responsible fashion and beneficial to all involved.
The key concessions in these areas are as follows:
- Sustainable Development: The CAI binds parties to sustainable development principles, featuring a high degree of transparency and civility.
- Labour and Environment: China pledges to maintain standards of environmental and labour protections, regardless of impact on investment. Also, labour and environmental standards are not to be used for economic protectionism, with China promoting social responsibility by its companies.
- Climate: The Paris Agreement on Climate is to be effectively implemented.
- International Labour Organisation (ILO): China is to ratify any outstanding ILO Conventions, specifically two pertaining to the elimination of forced labour.
- Conflict Resolution: The CAI outlines state-to-state dispute settlements per a pre-defined enforcement mechanism. In addition, a monitoring mechanism is created to evaluate any complaints or disputes at a political level, ahead of any litigation.
Controversy And Market Impact
The initial reaction from Chinese and EU leadership to the late-2020 announcement of the CAI was positive. An official press release from the European Commission touted the agreement as being a relative breakthrough:
"The CAI will be the first agreement to deliver on obligations for the behaviour of state-owned enterprises and comprehensive transparency rules for subsidies."
President Xi Jinping also weighed in on the agreement, stating that China and the EU "rose to the challenge" of negotiating the deal despite the impact of COVID-19.
However, the CAI also proved to be controversial. Officials from EU members Spain, Italy, Poland and Belgium argued that the agreement largely ignored ongoing humanitarian violations in China. Italian Undersecretary for Foreign Affairs Ivan Scalfarotto echoed this sentiment by stating "we are giving a positive signal to China at a time of significant human-rights concerns." Additionally, critics of the CAI warned that announcing such an agreement ahead of then-new US President Joe Biden being inaugurated threatened to destabilise EU trade relations with the United States.
From a practical standpoint, the market impact of the EU/China investment deal is extremely challenging to measure. China made several important concessions regarding access, which theoretically will stimulate EU FDI in the region. If adhered to, the reduced barriers could spur economic growth and two-way trade, benefitting all involved. Under this scenario, the yuan renminbi (RMB, CNY) would be positioned to appreciate in response to an effective Chinese dual-circulation strategy.
For the EU, the euro (EUR) would likely gain from an aggregate uptick in economic growth. Additionally, a diversification of international commerce and foreign trade could bring bullish forex sentiment to the EUR. Further, the CAI sets the stage for a revitalisation of Chinese FDI in the EU, which fell to US$19 billion in 2019. Given the 31 December 2020 exit of the United Kingdom from the EU, increased Chinese FDI could help make up for any negative Brexit fallout.
The EU-China Comprehensive Agreement on Investment took several years and dozens of negotiations to craft. While the arrangement is controversial, the CAI sets the stage for increased two-way FDI between the global financial powers. If successfully integrated, the CAI could be a catalyst for robust growth in both China and Europe, promoting appreciations of the CNY and EUR.
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…