On 15 June 2018, the State Council of China introduced a comprehensive list of reform directives aimed at further opening up relevant industries to foreign investors, in order to promote foreign investment activities in China, among which include relaxing the restrictions to establish foreign-invested financial institutions, expanding the scope of sanctioned businesses and broadening the cooperative initiatives between the mainland and foreign financial markets.
Towards the latter goal, the primary measures are focused on establishing a sound and transparent foreign investment system with controlled risk so as to attract overseas capital.
One such measure with arguably the most immediate effect is the overhaul of the rules governing the Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investor (RQFII) schemes.
Changes in QFII/RQFII rules
Likely in preparation of the State Council’s directives, the State Administration of Foreign Exchange (SAFE) issued a newly revised version of the “Provisions on the Foreign Exchange Administration of the Securities Investment in the Mainland by Qualified Foreign Institutional Investors” and, alongside the People’s Bank of China (PBOC), jointly issued the “Notice on Issues Concerning the Administration of Securities Investment in the Mainland by RMB Qualified Foreign Institutional Investors” (the “New Reforms”) on 12 June 2018 to implement a new round of foreign exchange management reforms for the QFII/RQFII schemes. This marks a significant revitalization of the two stagnating initiatives, and is set to push them back into the limelight for cross-border institutional investments.
Overview of the QFII/RQFII scheme
The QFII scheme could be considered one of China’s pathfinding initiatives to opening up its capital market to foreign investors. Inaugurated in 2002 by the China Securities Regulatory Commission (CSRC) and the PBOC, QFII was a transitional arrangement to allow qualified institutional investors to invest in a defined scope of cross-border security products without incorporating a domestic entity. RQFII was introduced a little less than a decade later, allowing qualified institutions in nineteen participating jurisdictions to invest directly into China’s security markets in RMB denominations. For the past number of years, RQFII has generally offered more favourable terms than QFII in terms of lock-up periods and repatriation limits.
The programmes have unfortunately been hampered throughout its development cycle by the myriad of restrictions imposed by Chinese regulators, such as strict eligibility requirements, limited quota and repatriation caps, causing investors to seek other channels to delve into the mainland. Once the stock connect schemes came into play, RQFII/QFII were at risk of being replaced as the main means for foreign investors to engage in cross-border security investments (at least in terms of equity investments). It is not difficult to see why; there is vastly greater flexibility and liquidity in the stock connect schemes when compared to QFII/RQFII.
The New Measures
This situation will likely change with the introduction of the New Reforms, which look to address the following main measures in the QFII/RQFII schemes:
- Remove the monthly fund repatriation limit of 20% of the previous year’s total onshore assets in respect of QFII investors.
- Cancel the three-month investment principal lock-up periods in respect of QFII/RQFII investors (irrespective of the types of products that are launched under the QFII/RQFII programmes; ie regardless of whether the QFII/RQFII fund products are retail funds or private funds), allowing foreign institutional investors to repatriate funds according to their own investment requirements.
- Allow QFII/RQFII participants to perform forex hedging with onshore investments. Prior to this, investors of all cross-border schemes (QFII, RQFII and stock connect) were only able to hedge foreign exchange risks with freely-floating offshore yuan.
Upon introduction of the New Reforms, the QFII and RQFII schemes are now largely consistent in terms of permissible investment, no longer having deadlines for remittance of principal capital or lock-up periods, and repatriation limits. The two programmes still vary in terms of eligible institutions, currencies and relevant quota applicable to each applicant.
The new changes are clearly meant to address the biggest concerns that investors have regarding the flexibility of the initiatives, and would appear to make the schemes more accessible than they were previously. Although QFII/RQFII are still limited by the total quotas allotted by SAFE, institutions with more liquid investment portfolios would no longer need to worry about repatriation confines. The additional availability of onshore hedging would also have a major impact on the initiatives.
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