The next round of RQFII (Renminbi qualified foreign institutional investor) quotas is about to be approved after three months of silence, with international fund houses gaining access to China’s onshore markets. But despite the strong global demand for renminbi exposure, investors are likely to proceed with caution.
The China Securities Regulatory Commission (CSRC) and the State Administration of Foreign Exchange (SAFE) have started considering applications for new RQFII products and will hand out more quotas at the end of the month, according to China research firm Z-Ben Advisors.
The total quota is currently Rmb270 billion (US$43.67 billion) which was increased from Rmb70 billion at the end of last year, but none of the new quota has been approved yet.
“We expect that many foreign asset managers such as BlackRock and Fidelity will get approval,” said Cindy Qu, senior analyst at Z-Ben.
A spokesperson from BlackRock declined to comment but said the firm will continue to consider all available options. Fidelity had not responded to requests for comment by press time.
This new round of approvals could negatively impact the dim sum bond market as foreign investors rush to gain exposure to onshore assets, according to investors.
“With foreign access to onshore RMB bonds improving on RQFII expansion, foreign investors may prefer the onshore market due to higher yields despite the greater market risk and taxes. The offshore dim sum bond market may face very mild re-pricing relative to the onshore market as RQFII expands,” said Jack Siu, senior investment analyst at Citi Private Bank.
“To be frank the offshore RMB bond market has been expensive compared to the onshore market. If you look at the CGB [Chinese government bond] for example, it has been trading almost 100 basis points (bp) lower offshore than onshore,” said Ken Hu, head of fixed income investment at Bank of China Hong Kong Asset Management.
“So the increase in the size of the RQFII quota will for sure drain out some of the liquidity in the dim sum market and I expect yields to go back up in the second half of the year, [particularly] as there is likely to be more supply.”
Any meaningful re-pricing of the dim sum market will be limited by the global demand for yield as well as the prospect of renminbi appreciation, according to Siu. But Hu argues that there is also likely to be more supply in the second half.
At a macro level, expansion of the RQFII quota is positive, but some investors have raised concerns.
“This might be contrarian as I think most investors are upbeat about the RQFII programme, but I have two reservations about the onshore RMB bond market. One is the supply. Last year the onshore corporate bond market increased by around 40% and this year I would say the growth rate will increase even more,” said Hu.
Domestic bond issuance volume increased from US$259.98 billion in 2011 to US$438.56 billion in 2012. Issuance year-to-date has already well exceeded issuance over the same period last year, at US$126.72 billion, up from US$97.0 billion. This increase in supply is due to falling yields, which is another cause for concern, according to Dealogic.
“If we want to invest in the onshore RMB market we will need to pay attention to the credit quality. The yields are still attractive due to the fact that CGB yields onshore are still high. But valuations are pretty expensive in terms of the credit spread, which is close to historically tight levels. Investors will need to be cautious of these sorts of short term supply and demand dynamic changes,” he said.
However, others are confident that those fund houses approved by the CSRC or Safe will be sufficiently equipped to invest onshore.
“It may be the first time that international financial institutions will do this sort of business. But most of them have large businesses in Hong Kong as well as many greater China funds and large client base with a strong demand for Chinese assets,” said Z-Ben’s Qu.
The proposed platform for the mutual recognition of funds between Hong Kong and China is likely to be launched this year, according to Qu.
“Xiao Gang, the new chairman of CSRC has just announced that it will be approved very soon. The largest problem is that they want to ensure the regulation is very detailed.”
This is due to fears that investors will likely try to arbitrage the market, said Arthur Lau, head of fixed income for Asia at PineBridge Investments.
“When you say arbitrage, the regulator says no. They don’t like it. The other concern is about back door listing between onshore and offshore using this mutual fund channel. This is something that needs to be resolved before the details can be finalised,” he said.
Other capital market liberalisation measures are likely to include a RQFII quota for Taiwan, worth Rmb100 billion as well as a possible expansion of the mutual recognition of funds programme into Taiwan and Singapore early next year, said Qu.