BNY Mellon’s Magdalene Tay, Custody Product Manager, Asia Pacific, Asset Servicing, hosted a dialogue between Eugenie Shen, Managing Director, Head of Asset Management Group, Asia Securities Industry & Financial Markets Association (ASIFMA), and Choo Lye Tan, Partner, K&L Gates, on China’s latest capital markets liberalizations that aims to promote foreign participation through upgrades to the qualified foreign institutional investor (QFII) and RMB QFII (RQFII) schemes.
At the start of 2019, markets were positively surprised by the China Securities Regulatory Commission (CSRC)’s proposed new rules, which will simplify access for foreign investors seeking to enter the China onshore market by removing criteria such as assets under management and years of experience for RQFII/QFII schemes.
The January announcement also opened the door to a future merger of the QFII and RQFII schemes, whereby licensed investors can choose freely whether to raise funds in dollars, renminbi or another currency before investing onshore, blurring the difference between the schemes.
The implications of the proposed rules are substantial for foreign investors (Figure 1).
Furthermore, the Chinese government has removed the investment quotas in September this year. According to Shen, this does not have a big impact for existing QFIIs. The upper limit on how much quota individual investors could accumulate was removed three years ago, which meant that investors could have reapplied for additional quota if needed as the total allocated QFII quota is not fully utilized, standing at around US$110bn out of the overall approved US$300bn. (Figure 2)
“The same goes for RQFIIs, with only RMB693bn (US$97.08bn) of the total quotas used. The removal of quota limits is largely symbolic, in order to ensure the scheme remain competitive with Stock Connect, which is being widely used by foreign investors,” said Shen.
According to Tan, the current QFII/RQFII end-to-end process from application to actual investment, in practice, takes around nine months, despite the official shorter time promised by the PRC regulators. However, by easing the entry requirements and eliminating the need for an investment quota, the new proposed rules should simplify and shorten the process to around 2-3 months.
For RQFIIs, there is also a substantial upgrade to the previous jurisdiction-specific limitations when applying for RQFII quota. For example, “RQFII was given to individual jurisdiction like Germany, the UK, where each country received RMB80bn in quotas. Hong Kong had RMB270bn, which meant that any firm applying for an RQFII quota in Hong Kong had to wait in a queue after the quota was exhausted locally,” said Shen. (Figure 3)
With the abolition of the quota system altogether in September, investors no longer have to worry about quotas either on the individual or aggregate level as a jurisdiction. This, according to ASIFMA’s Shen, also opens up the RQFII scheme to any investor outside of the approved jurisdiction, making it a truly global scheme.
That is not to say that global investors seeking to expand exposure to RMB assets no longer face challenges. The lack of true Delivery Versus Payment (DVP) for securities settlement remains an issue that investors face when entering the China onshore market. For equities, the need to transfer shares on Trade Date (T) remains difficult, which means investors will have to rely on brokers for pre-funding. This limitation stands out as a factor determining the speed of the future increases of the A-shares’ weighting in global indices, according to Shen.
There are other limitations in place. Foreign investors can only use three brokers on each of the domestic stock exchanges, which hinder best execution.
The short swing profit rule on returning equity gains within 6 months for shareholders holding more than 5% of stocks of a listed company could become another serious issue. With the planned increases in the weighting of A shares in MSCI indices to 20%, some of the large asset managers will likely exceed the 5% ownership threshold in listed companies. For those managing several funds and having to aggregate trades, this short swing profit rule could become problematic.
The repatriation of funds invested has been another longstanding concern.
Glitches around repatriation process still exist. Shen shared that a fund manager has taken a full year to get funds repatriated out from China, but there are also cases where fund managers have no issue with funds repatriation. Tax clearance is one of the reasons for delays in funds repatriation. To ease fund repatriation, fund managers need to work closely with their local tax consultants to get the tax certificates in place.
The investable universe of QFII/RQFII schemes is set to get a further boost. Stocks listed on the National Equities Exchange and Quotations (NEEQ), an over-the-counter trading platform, will become accessible to QFIIs and RQFIIs, as will private investment funds, and commodity futures on approved exchanges, as well as the options market.
“This means the scope of the QFII/RQFII scheme is much broader with these new proposed rules than other access channels,” said Shen.
“These steps show a substantial acceleration of reforms in China’s capital markets, which is a cause for optimism when looking ahead”, according to Shen. Starting in mid-November, QFIIs and RQFIIs will be allowed to make a free of payment transfer of China Interbank Bond Market (CIBM) bond holdings from QFII/RQFII account to CIBM Direct account without tax consequence. This initiative, however, does not apply to Bond Connect.
As has been the case in the past few years, China will likely continue to surprise, and the pace of further opening of its capital market is expected to accelerate. Shen ended with an optimistic projection that the draft rules on QFII/RQFII merger will likely come into effect by end of this year.
The views expressed herein include external speaker and may not reflect the views of BNY Mellon. This does not constitute legal, tax, accounting, investment, financial or other professional advice on any matter and does not constitute a recommendation by BNY Mellon of any kind.