This article was written by Jiang Zhihui and Jonathan Grant (Partners), Tom Harrison (Senior Foreign Legal Consultant) and Kong Xiangyun (Associate).
In a further effort to attract foreign institutional investors to allocate offshore funds into China’s deep equity and debt capital markets, the State Administration of Foreign Exchange (“SAFE”) this past week announced that the Chinese Government will end the system of quotas for both the Qualified Foreign Institutional Investor (“QFII”) and the RMB Qualified Foreign Institutional Investor (“RQFII”) schemes. As next steps, this reform will be formally implemented by SAFE immediately revising its relevant regulations and applying to the PRC State Council to cancel related approval requirements (timing for this step has not been announced).
The QFII and RQFII schemes are an attractive option among the various channels available for foreign investors seeking exposure to Chinese capital markets, with over 400 approved global investors to date, particularly as these schemes enable broad access to China’s entire A-share market in addition to bond markets and other asset classes. The removal of quotas should further streamline the process for institutional investors to access the QFII and RQFII investment gateways, and increase their overall China capital markets exposure over time.
SAFE’s announcement continues a clear trend during 2019 of the Chinese Government seeking to attract additional foreign capital through investor-friendly reforms, including approval of the Foreign Investment Law (see previous KWM alert) and new measures to further open up China’s financial sector (including wealth management, insurance and currency brokerage) to foreign investment (see previous KWM alert).
We continue to closely monitor new developments that improve the ability of foreign investors to invest in Chinese targets (both listed and unlisted), and have deep experience in advising international clients seeking to navigate China’s regulatory framework.
Summary of changes to the QFII and RQFII regulatory framework
Institutional investors seeking to participate in the QFII and RQFII schemes will continue to be subject to qualification requirements and ongoing account management / compliance obligations, but following implementation of this latest reform, will no longer need to apply for an individual quota which sets limits on how much they can invest through the relevant scheme. Prior to this reform, there has been US$300bn aggregate capacity available for foreign investors through QFII, following a doubling of this amount in January 2019 (of which US$111bn had been allocated to specific investors as of August 2019) and the RQFII scheme has operated as a pilot scheme under which various countries and territories received a total quota allocation for their investors (for example, RMB 500bn for Hong Kong Special Administrative Region (“Hong Kong”), RMB 80bn for the United Kingdom and RMB 50bn for Australia).
QFII and RQFII are an attractive option in the overall mix for foreign institutional investors seeking exposure to Chinese capital markets, as the schemes allow access to a broad range of Chinese financial products, including (a) stocks, bonds and warrants traded on the Shanghai or Shenzhen stock exchange, (b) fixed income products traded in China’s inter-bank bond market, (c) securities investment funds (mutual funds), (d) stock index futures and (e) other financial instruments approved by the China Securities Regulatory Commission (“CSRC”) from time to time. QFII/RQFII holders may also participate in new issuance of shares and convertible bonds, further issuance of shares and subscriptions under rights issues.
Earlier in 2019, the CSRC also released draft regulations (which have not yet been finalised), which propose to effectively merge QFII and RQFII into a single scheme. Currently each scheme has different eligibility rules and ongoing compliance requirements. In addition to harmonising and modernising various compliance requirements, the draft regulations propose allowing QFII/RQFII holders to invest in a broader range of financial asset classes than what is currently open to them. Significantly, this would permit QFII/RQFII investments into the following asset classes, which to date have effectively been inaccessible to foreign investors:
- shares of companies listed on the National Equities Exchange and Quotations over-the-counter market (also known as China’s New Third Board or “Xinsanban”), which has attracted over 10,000 listed companies since it began operating in 2012; and
- private securities investment funds which predominantly invest in listed stock and bonds (including shares of Xinsanban companies). This is a highly active market in China, as approximately 25,000 fund managers are registered with the Asset Management Association of China and there are close to 40,000 private securities investment funds on offer. This includes funds managed by leading domestic managers as well as global managers (as several have been actively building businesses aimed at servicing China’s booming asset management market since wholly foreign-owned managers were permitted to be formed in late 2016).
Investing in Chinese A-shares and bonds through QFII/RQFII and other key pathways
As foreign investors are looking to increase their exposure to China’s A-share equity markets, QFII/RQFII continue to have the broadest access to trade in the full spectrum of A-shares. In summary, there are the following key pathways to invest in A-shares of Chinese companies listed on the Shanghai and Shenzhen stock exchanges:
Purchase of A-shares directly through QFII or RQFII. Foreign investors holding QFII or RQFII approval are able to acquire the shares of any A-share listed company (subject to a cap of 30% on total QFII/RQFII ownership of a single company). The other options below either have longer lock-ups on each individual investment or offer access to a more limited A-share investment universe. Note that a single QFII/RQFII investor cannot own more than 10% of an A-share listed company, so strategic investment (discussed below) remains the most viable pathway to acquire a significant >10% stake. QFII holders are also permitted to participate in IPOs of companies listing on the Shanghai Stock Exchange STAR (Sci-Tech innovAtion boaRd) Market, China’s Nasdaq-like market which opened for trading on 22 July 2019.
Purchase of A-shares of listed companies by way of strategic investment. This regime is regulated by the PRC Ministry of Commerce (“MOFCOM”) and has historically been aimed at investments of at least 10% in a listed company. The foreign investor must satisfy certain thresholds to be a “strategic investor”, including having at least USD 100mn total assets overseas or USD 500mn assets under management overseas. Currently every investment under this pathway requires MOFCOM approval, and there is a minimum 3-year lock-up imposed on the investment in the listed company.
In July 2018, MOFCOM released a draft proposal to relax these requirements and make strategic investment a more attractive option by:
MOFCOM has not yet publicly announced when these reforms will be finalised and come into effect.
- removing the 10% minimum investment requirement;
- reducing the lock-up period to 1 year;
- lowering eligibility thresholds (e.g. dropping the abovementioned assets test to USD 50mn and USD 300mn respectively); and
- only requiring MOFCOM pre-approval for investments in listed companies operating in sectors on China’s “Negative List” for foreign investment.
Purchase of A-shares through Stock Connect. The Stock Connect programs between Hong Kong and each of the Shanghai and Shenzhen exchanges are now well-established, and allow foreign investors to acquire A-shares of eligible Chinese listed companies included in certain indices and with RMB 6bn+ market cap (currently around 1,400 out of a total of over 3,700 A-share listed companies). Stock Connect is subject to overall limits on daily inbound trading flows into A-share markets, and is generally best-suited for acquiring passive minority stakes in listed companies. See further details about Stock Connect in a previous KWM alert at the time of MSCI’s 2018 inclusion of A-shares into its major global indices.
Purchasing of shares in a pre-IPO company and continuing to hold these post listing in the A-share market. (This is also an option for investment in Chinese companies which subsequently list on Xinsanban.)
In addition to A-share equity investing, QFII/RQFII holders can also participate in China’s deep bond markets, including bonds traded in the China Interbank Bond Market (“CIBM”, which accounts for the vast majority of mainland China’s overall bond market) and exchange-traded bonds. QFII/RQFII holders may invest directly in the CIBM, or alternatively through Bond Connect’s market infrastructure linkage between Hong Kong and mainland China. See previous KWM alert What Market Participants Need to Know about the Bond Connect for further details.