This article discusses how the changes that have been proposed to QFII/RQFIIs in China will impact on foreign asset managers.
On 31 January 2019, the China Securities Regulatory Commission (CSRC) publicly solicited opinions regarding the Measures for the Administration of Domestic Securities and Futures Investment by Qualified Foreign Institutional Investors and RMB Qualified Foreign Institutional Investors (Draft for Comments)《合格境外机构投资者及人民币合格境外机构投资者境内证券期货投资管理办法（征求意见稿）》and its implementing rules (The full context of the Draft New Measures and CSRC Press Release are available here and here), the Provisions on Issues Concerning the Implementation of the Measures for the Administration of Domestic Securities and Futures Investment by Qualified Foreign Institutional Investors and RMB Qualified Foreign Institutional Investors (collectively, the Draft New Measures). The Draft New Measures, once officially promulgated, would bring a significant change to the existing regulatory landscape applicable to QFII/RQFIIs as well as a boost of the domestic securities market and private fund industry in China.
We have highlighted the following changes which we believe are key to foreign asset managers: the merging of QFII and RQFII schemes, expansion of investment scope, clarification on the ownership and investment advisory businesses provided to QFII/RQFIIs.
Merging of QFII and RQFII schemes into one
The QFII and RQFII schemes, introduced in 2002 and 2011 respectively, allow overseas institutional investors, banks and asset managers to make capital account investment under Chinese law and trade Chinese domestic securities market. Over the years, the QFII and RQFII schemes have played a positive role in introducing long-term capital, attracting foreign investments and promoting development of PRC capital markets. However, with the introduction of Bond Connect, CIBM Initiatives and Stock Connect programmes which share similar investment scope with QFII/RQFIIs with a much more straightforward administrative registration process, the QFII and RQFII schemes have lost their attraction because of their complicated approval/vetting process, limited quotas and limited investment scopes, among others.
The CSRC has proposed to consolidate the QFII and RQFII schemes into one through the Draft New Measures so that foreign institutions can make a one-time application for a new “Qualified Investor” status (the Qualified Investor). Additionally, the Draft New Measures also remove the quantitative criteria from the eligibility requirements for applicants while maintaining compliance and other eligibility requirements. For example, the AUM requirement previously set for a QFII applicant has been proposed to be removed in the Draft New Measures.
Under the new “Qualified Investor” scheme, the vetting process will be significantly streamlined. That said, it seems that an administrative approval is required. We understand that legislators once discussed the possibility of shifting from the approval regime to a registration/filing regime, which seems to be rather unlikely based on the Draft New Measures. One of the primary reasons as we understand is that changing to registration/filing regime involves a legislative amendment by the superior authority which is rather time consuming and complex.
With respect to the existing QFII/RQFIIs, the Draft New Measures indicate that where an RQFII programme is already available (there are so far 19 countries/jurisdictions), then the QFII quota holders are also allowed to make investment using offshore RMBs (ie not limited to foreign currencies); where an RQFII programme is not yet available, then the QFII quota and new Qualified Investors may still trade Chinese securities using foreign currencies.
Expansion of Investment Scope
The Draft New Measures expand the investment scope for Qualified Investors. Currently QFIIs are allowed to invest in only A-shares, bonds, public securities investment funds and stock index futures. According to the Draft New Measures, the permissible classes of assets of the Qualified Investors may include additionally the following:
- shares traded on the National Equities Exchange and Quotations (NEEQ, ie China’s OTC board)
- depository receipts
- bond repo
- financial futures listed and traded on the China Financial Futures Exchange (not limited to stock index futures but also include bond index futures)
- commodity futures traded on futures exchanges approved by CSRC
- options traded on futures exchanges approved by the State Council or CSRC, and
- foreign exchange derivatives that the foreign exchange authority allows Qualified Investors to trade.
Qualified Investors will also be allowed to participate in IPO, bond issuance, secondary public offering and private placement/allotment of shares of companies listed on stock exchanges/NEEQ, margin trading and securities lending on domestic stock exchanges.
Qualified Investors are also allowed to invest in private securities investment funds whose investment scope conforms to all of the above.
With a widened investment scope, the Qualified Investors will be more competitive compared with other investment approaches, and therefore enhance the QFII’s appeal to foreign investors.
Boost to PFM business
Under the Draft New Measures, Qualified Investors are allowed to invest into private securities investment (PFM) funds which investment scope should conform to permitted investment scope of a Qualified Investor. This will certainly bring a boost to the PFM funds sector in China.
This will ease the pressure of meeting the Asset Management Association of China (AMAC)’s requirement to raise capital and launch the first fund in a rigid timeframe. It will also enhance the governance, risk management and transparency of PFM funds products which would be expected to apply certain international standards for drawing capitals from Qualified Investors who are likely to be institutional investors or foreign affiliates of PFM WFOEs.
Clarification on the ownership
According to the Draft New Measures, the client assets of a Qualified Investor are clarified to belong to the client and are segregated from the Qualified Investor and the PRC custodian. Where the securities account is named as “Qualified Investor + client funds”, the Qualified Investor must separately open sub-accounts thereunder for each separate fund and product, rather than establish a co-mingled account, and identify the investors of each of those separate fund product.
The background for this requirement is to enhance the current practice which is described as follows.
In practice currently there are two ways to set up accounts for private funds clients of QFII/RQFIIs, either as:
- a “manager + client assets” where the assets of all the private funds or managed accounts clients are co-mingled, or
- a “manager + individual fund or managed client account” where assets from each private fund or managed account client are kept in separate accounts.
Option 1 has been the most common way which is generally more cost-effective. That said, although QFII/RQFII managers would usually set up virtual rather than physical asset segregation, there would be more risks setting up an aggregate account for all private fund and managed account clients with a virtual asset segregation, as the assets are still commingled without a clear delineation among separate clients’ assets.
Investment advisory businesses involving QFII/RQFII
The Draft New Measures also provide that a Qualified Investor can appoint its affiliated PFM WFOE as the investment advisor for its investment in Chinese securities and futures. This poses a question upon whether an investment advisory service is a regulated activity in China. In other words, if a WFOE is not registered with AMAC, China’s private fund regulator, as a PFM WFOE, would it still be allowed to provide investment advisory services to its affiliated QFIIs/RQFIIs as some of are doing now? It is also a bit uncertain how one may differentiate between “investment advisory services” and other technical services such as research and data analysis. It is more likely that those questions remain to be resolved by AMAC/CSRC rather than through the Qualified Investor scheme.
The new Qualified Investor scheme could be foreseen to effectively enhance the attractiveness to QFII and RQFII, optimise the investor structure of Chinese securities market and stimulate vitality of the market. We also believe it will be a great opportunity for foreign investors who seek a wide-ranging and deeper cooperation with the Chinese financial market.
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