China Updates Qualified Foreign Institutional Investor Rules and Encourages Additional Foreign Investment in China
Since its launch in 2002, the Qualified Foreign Institutional Investor (QFII) program has been the principal means for foreign investors to invest directly in the securities markets of Mainland China. In an effort to facilitate increased foreign participation in China’s securities markets, the China Securities Regulatory Commission (CSRC) recently adopted rule changes that will make QFII quotas more flexible and more accessible to a larger audience of foreign investors.1 As discussed in more detail below, the primary impact of these reforms is to: (i) open the QFII program to a wider array of financial services companies by lowering the qualification requirements applicable to QFIIs; and (ii) facilitate the investment activities of QFIIs by giving them greater investment latitude and improving convenience of account management.
Under the QFII program, foreign investors may apply to the CSRC for a QFII license to invest in China’s securities markets. QFII applicants are classified as belonging to one of five different categories: asset management companies, insurance companies, securities companies, commercial banks, and other institutional investors.2 Applicants in each category must meet certain qualification requirements and be approved by the CSRC in order to become QFIIs. Prospective investors have criticized the application process for being overly time consuming (typically requiring 12-18 months from the date of application until receipt of a QFII license) and subject to bureaucratic interference by Chinese regulators.
Since the launch of the QFII program in 2002, the CSRC and the People’s Bank of China (PBOC) have continued to refine the securities and foreign exchange rules applicable to QFIIs. Over time, the CSRC gradually has relaxed QFII qualification requirements, expanded the scope of the permissible investments for foreign investors, and increased the amount of investment quota available to QFIIs.
Main Changes to the QFII Program
The recently-enacted QFII Implementation Rules represent a continued opening of China’s securities markets to foreign investors, and introduce the following principal changes:
Relaxed Qualification Requirements
The QFII Implementation Rules significantly lower the assets under management (AUM) and capitalization requirements, as well as the minimum number of years of experience needed, for various kinds of institutions to qualify as QFIIs, as follows:
- Asset Management Institutions, Insurance Companies and Other Institutional Investors must have a minimum of two years of operating history, with AUM of no less than US$500 million for the latest fiscal year. Under the previous requirements, five years of experience and AUM of no less than US$5 billion were required.
- Securities Companies must have five or more years of operating history, net assets of no less than US$500 million, and AUM of no less than US$5 billion for the latest fiscal year. Previously, securities companies were required to have 30 or more years of operating history, paid-in capital of no less than US$1 billion, and AUM of no less than US$10 billion.
- Commercial Banks must have at least 10 years of operating history, with tier 1 capital of no less than US$300 million, and AUM of no less than US$5 billion. Previously, commercial banks had to rank in the top 100 global banks, with AUM of no less than US$10 billion.
More Investment Opportunities for QFIIs
While additional guidance is required of Chinese regulators, the QFII Implementation Rules will provide QFIIs with significantly enhanced investment flexibility.
Enlarged Scope of Investments
The new QFII Implementation Rules expand the permitted scope of QFII investments. In addition to the China A shares and listed bonds and warrants in which QFIIs have been able to invest, the QFII Implementation Rules explicitly permit QFII investment in the inter-bank bond market (which currently accounts for approximately 95% of fixed income trading in China), private placement bonds of small- and medium-sized enterprises, and stock index futures. However, as a practical matter, additional guidance from the PBOC expressly permitting QFIIs to maintain multiple renminbi (RMB) denominated accounts and addressing various custody issues may be necessary in order to permit trading and clearing of futures by QFIIs.
Similarly, many aspects of QFII investment in the inter-bank bond markets also remain unclear at the present time. For example, it is not yet known whether QFIIs will enjoy the preferential tax treatment applicable to certain bond products traded on the inter-bank bond market. Further clarification is expected to be provided in the near future.
- Higher QFII Shareholding Ceiling
Under the QFII Implementation Rules, QFIIs may now hold up to an aggregate of 30% of the outstanding A shares of a listed Chinese company. The former limit was 20%. However, a single QFII shareholder may hold no more than 10% of the outstanding A shares issued by a listed Chinese company.
- Separately-Managed Accounts (SMAs)
The QFII Implementation Rules allow domestic fund management companies to provide SMA services to QFIIs and open corresponding accounts for them.
Enhanced Account Management
The QFII Implementation Rules also include important reforms that will facilitate the registration and investment operations of QFIIs.
- Securities Accounts with Multiple Brokers
QFIIs previously were permitted to open only one securities account with respect to each of the Shanghai and Shenzhen Exchanges, which would correspond to the approved RMB account of the QFII, and could choose only one broker for each of these securities accounts. The QFII Implementation Rules remove this limitation. Under the new rules, QFIIs may maintain multiple securities accounts corresponding to the QFII’s RMB account, and choose different brokers for these securities accounts.
- Segregated Securities Accounts for Different Clients of a QFII
The QFII Implementing Rules also address the prior requirement that QFIIs generally were required to maintain a single securities account with respect to the assets of all clients on whose behalf the QFII invests in China. The use of a single securities account potentially raised significant custody, asset segregation and bankruptcy risks that needed to be addressed by QFIIs. Under the new rules, QFIIs now are required to maintain a securities account for the assets of each client on whose behalf they invest in China. This development will improve segregation and protection of different clients’ assets and help mitigate custody risks.
Simplification of Filing QFII Applications and Compliance Reports
The CSRC has long contemplated a simplification and acceleration of its review and approval process. The QFII Implementation Rules reflect this vision. Foreign investors eventually will apply for QFII licenses and file compliance reports electronically. The CSRC also has informally indicated that it will no longer necessarily require an in-person meeting in connection with the consideration of a QFII license application. In addition, the new rules reduce the number of audited financial statements that must be included in a QFII license application to one year (formerly three years of audited financial statements were required), and no longer will require the submission of articles of association (or other constitutive documents of the QFII applicant).
It is intended that these changes will streamline the QFII license application process and reduce the CSRC’s processing time, with the eventual goal of reducing the application process to approximately six months.
The QFII Implementation Rules build upon several significant recent changes to the QFII program that are intended to make investment in China more attractive to foreign investors, and follow extensive consultations with custodian banks and other industry participants. Some of these other recent changes include:
- The State Administration of Foreign Exchange (SAFE) has increased the total QFII investment quota from US$30 billion to US$80 billion.
- The CSRC has relaxed a former internal operating policy that significantly restricted the ability of affiliated companies with a common corporate parent to each obtain a QFII license. Given the size and scope of various global financial services firms and the common use of holding company structures, the former policy severely impinged on the ability of global financial services firms to obtain a meaningful QFII investment quota.
- The CSRC increasingly is approving larger QFII investment quotas, with several recent US$300 million quotas having been approved.
- The CSRC no longer requires QFIIs to invest at least 50% of their assets in equities, thus permitting more significant investment in fixed income instruments. However, the CSRC continues to prohibit a QFII from holding more than 20% of its QFII quota in cash or cash equivalents.
The QFII Implementation Rules and other recent changes to the QFII program represent an important liberalization of the QFII program, and reflect the CSRC’s clear desire to facilitate foreign investment in China and respond to industry input regarding aspects of the QFII program that have served as stumbling blocks to such investment. Particularly significant is the lowering of the experiential and AUM requirements applicable to QFII applicants, which should encourage the eventual entry of a much broader array of QFIIs. In addition, QFIIs in time will be able to invest in a more diverse range of securities, with less emphasis place on equity investments. While significant aspects of these recent changes still await further clarification from Chinese regulators, these developments make clear that the door to the Chinese securities markets is being opened more broadly to foreign financial services firms.