Three Ways to Profit From China's New Anti-Corruption Regulations

[Editor's Note: Money Morning Investment Director Keith Fitz-Gerald is currently in Mainland China. Look for additional installments of his investment travelogue next week.]

XIAN, People’s Republic of China – China is toughening up its disclosure rules for government officials, the latest in a series of moves that should level the playing field for foreign investors who like the country’s profit potential, but fear its risk.

According to the Central Commission for Discipline Inspection (CCDI), top officials at various levels of government must now file reports that detail their personal property holdings and their investment activities. What’s more, these reports must also disclose investment moves made by spouses, children and other members of the immediate family.

This represents a major upgrade from a 1997 disclosure rule that required top party officials to report whenever they bought or sold houses, married foreigners or traveled abroad.

Known then as the Regulations on Reporting Personal Matters by Leading Officials, the 1997 rules applied only to congressional members, administrative senior staff, judiciary members and those in China’s state-owned enterprises (SOEs) who held a rank of county official or higher.

Now these rules have been broadened, and they apply to everyone with the rank of county official or higher. And the expanded rules now also require the disclosure of local “gifts, salaries and cash accepted for work-related reasons.”

Big Changes Should Translate Into Big Profits

This is a big change – and represents very good news for China investors. Consistent, long-term investment profits are at their maximum in markets where there’s enough regulation to govern business behavior, safeguard profits and protect property rights, but not so much that it stifles the entrepreneurial spirit.

These latest moves by China are perhaps the strongest evidence we’ve seen yet that Beijing understands – and is even striving for – this delicate balance. And it also shows me that China’s leadership is serious about weeding out inefficiencies and boosting the government’s regulatory muscle – even as it adds to the economic freedoms available to China’s citizens.

Although that seems like a contradictory statement, it really isn’t. Much of what Beijing is doing with the new regulations is in direct response to citizens who voiced displeasure upon learning that there are huge disparities between what the average citizen earns and the compensation being given to some of the senior managers running China’s SOEs.

For instance, there was a real, palpable outrage here in China last year when earnings disclosures revealed that Fu Chengyu, who heads up CNOOC Ltd. (NYSE ADR: CEO) took home a record-setting $1.77 million (12.07 million yuan) at a time when the average annual worker’s urban income is a mere $4,400 (30,000 yuan).

In one sense, this is nothing different than what the West has experienced as part of the fallout from the global financial crisis. But there’s one exception. Wall Street, for instance, is already back up to pre-crisis bonus levels and up to its old tricks. Here in China, where the government is clearly committed to putting some real teeth into its regulations, don’t expect a subsequent relaxation of those efforts.

In fact, I can outline two very specific incentives for stronger financial regulations. One involves the cost of corruption, and the other has to do with China’s long-term global aspirations.

Foreign investors – especially those who are new to China – tend to view corruption as an entrenched and permanent problem in this country. Beijing wants to abolish as much of that corruption as possible. That’s partly because it wants to change that perception, understanding that the fear of corruption can keep foreign investors at bay.

But there’s also a concrete cost: Corruption is estimated to have sucked at least $50 billion out of China’s economy since market reforms began in 1978, the Global Times reported recently. No wonder Premier Wen Jiabao noted during an Internet chat last March that the new regulations will serve as a “major incentive” against corruption.

Just what that “incentive” will be remains unclear for now. But having spent two decades in Asia – a good chunk of it as a close observer of China’s emergence – I can promise you this: Beijing won’t mess around here. Expect the penalties to be immediate and stiff for those who violate the law.
Then there’s China’s wish to become a true global financial force – an objective it’s pursuing with a zeal that Western leaders would do well to watch and learn from.

As Beijing continues to grow and to assume a more active role in the world’s financial affairs, it will do everything it can to avoid “losing face” by allowing problems to surface that might cause global investors to question its market-modernization efforts.

Now that we’ve detailed China’s commitment to tougher financial regulations, what should investors do to attempt to capitalize on this newfound insight?

I think the answer is very simple.

In fact, here are three things to look for that will position you for maximum possible profits.

Consider the Future: Look for companies that are positioned to benefit from the future goals that China is pursuing. And remember, not all these firms will be China-based. There are plenty of companies – even some based in the United States – that are poised to grow “because of” China’s growth-and-development initiatives. This is a strategy I’ve written about often here in Money Morning, and that I’ve spoken about to the many audiences I’ve addressed throughout the world.

It’s one thing to find small, unknown companies that are trying to carve out a niche in a ferocious, newly capitalist market here. But it’s quite another to select a large-scale entity – with a market cap in the billions and a listing on the New York Stock Exchange – that can benefit from China’s explosive growth, even as its shareholders enjoy the stringent protections afforded by a Big Board listing, FASB-accounting and honest government regulation.

Location, Location, Location: I know, it sounds like a bad real-estate joke. But hear me out. Beijing has deemed certain areas as being vital to China’s overall development. That means you want to look for companies in the Shaanxi province or other inner provinces. Much of the anti-corruption efforts have been aimed at cleaning up regional authorities. If there’s an immediate benefit, it’s probably going to be at the secondary or tertiary level, which means regional cities and inner provinces that haven’t yet participated in the manufacturing-driven growth of China’s more-highly-developed Eastern seaboard, and cities such as Shanghai.

Connect With ‘Connections’: As I mentioned in a Money Morning article earlier this week, the concept of guanxi (in essence, personal connections) is a guiding business precept in China. Look for companies – and company leaders – that demonstrate strong guanxi.

Guanxi is about respect. And with the increasingly hard line that Beijing is taking on corruption, guanxi will be worth a premium when used properly.

[Editor’s Note: When it comes to China investments, Money Morning Investment Director Keith Fitz-Gerald may well be the dean. It’s not just that he’s worked and lived in Asia for two decades – including long stints in Japan and numerous sojourns into China. It’s that Fitz-Gerald is a true student of the Asian marketplace.

As the editor of The New China Trader service, Fitz-Gerald can now make those market insights available to you. Fitz-Gerald has not only chronicled the many changes that have taken place in China over the past several years – in many cases, he’s actually predicted them. Subscribing to The New China Trader is akin to hiring a guide to help you navigate, and profit from, a market that’s perhaps the most complex in the world – and that promises to be the most profitable for decades to come. For more information, please click here.]

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About the Author

Keith is a seasoned market analyst and professional trader with more than 37 years of global experience. He is one of very few experts to correctly see both the dot.bomb crisis and the ongoing financial crisis coming ahead of time - and one of even fewer to help millions of investors around the world successfully navigate them both. Forbes hailed him as a "Market Visionary." He is a regular on FOX Business News and Yahoo! Finance, and his observations have been featured in Bloomberg, The Wall Street Journal, WIRED, and MarketWatch. Keith previously led The Money Map Report, Money Map's flagship newsletter, as Chief Investment Strategist, from 20007 to 2020. Keith holds a BS in management and finance from Skidmore College and an MS in international finance (with a focus on Japanese business science) from Chaminade University. He regularly travels the world in search of investment opportunities others don't yet see or understand.

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