It is telling of both the excitement and caution surrounding the forthcoming mini-QFII market that the would-be beneficiaries of the scheme are reluctant to openly discuss it.
Excitement, because the scheme could tap into the world’s ongoing fervour with China’s economy, to the benefit of the offshore divisions of mainland asset management companies.
And caution, because none of these companies want to be caught saying anything remotely controversial before China’s sensitive financial regulators officially announce their plans.
The introduction of mini-QFII is expected to be announced any week. The concept is simple. China already allows financially robust asset management companies with proven track records to apply for qualified foreign institutional investor (QFII) status, which once granted basically allocates that company a quota of money that they can invest into mainland’s capital markets.
What mini-QFII would do is let the offshore operations of Chinese asset management companies the same privilege, most likely sourcing such funds from the rising pools of offshore renminbi. They would also be able to get permission to invest offshore money into China’s mainland markets, once granted permission to do so.
Yet while the idea is simple there is a lot of uncertainty about its likely execution. Would-be participants are eager to know exactly how much they will be allotted, while their rivals are more concerned with how stringent the criteria will be for these new market players.
“There’s no clarity yet on what mini-QFII might constitute but it looks likely that the companies will have different criteria than the existing QFII players. That could mean that two tiers of QFII participants are set up, complicating the whole process,” says a senior manager for Asia at a European fund manager.
The potential of mini-QFII has many excited, but the extent of its appeal will lie heavily with how extensive it ends up being, particularly when compared to the market’s existing QFII players.
Kicking off QFII
The potential introduction of mini-QFII comes eight years after China initiated the mainstream version.
The mainland’s financial regulators initiated its qualified foreign institutional investor (QFII) scheme in 2003. The idea was to allow offshore institutional investors some limited access to the country’s capital markets.
The arrangement was, and remains, mutually beneficial. Investor interest was growing in China, given the pace of its economic growth, while the local market benefited from an injection of approximately US$20 billion of new assets via 100 foreign institutions. QFII-approved institutions now include the likes of J.P. Morgan via its Jardine Fleming asset management arm, UBS, Goldman Sachs, Aberdeen Asset Management, and Fidelity Investments Management.
However China’s authorities have always held aspiring QFII members to strict standards. Successful asset manager applicants have had to be able to prove that they have five years track record managing assets, and have managed at least US$5 billion of assets in the last accounting year. Meanwhile securities companies that apply need to demonstrate they have at least 30 years experience in broking and have managed at least US$10 billion of securities assets. Commercial banks have to demonstrate that they rank among the top 100 by assets in the world.
But it will not be possible to apply such stringent standards to the offshore divisions of China’s asset management companies and its securities houses. For a start many of the mainland asset management companies have been operating for relatively short periods; others lack US$5 billion of assets internationally.
This is why it looks likely that applicants for mini-QFII licences will be held to lower standards.
Delving into onshore debt
Signs are growing that prospective bidders could find out whether that is the case very soon. Wang Lin, the head of funds regulation at the China Securities Regulatory Commission (CSRC) told Reuters on May 14 that initial rules for the scheme had been completed and that a launch would be soon.
So far no details have been announced. But one thing seems clear: the emphasis of the mini-QFII will, at least initially, be on China’s bond market.
Peng Hua Choy, head of Harvest Global Investments, the Hong Kong-based division of Harvest Global Funds, says in an emailed response to Asiamoney that “the most popular product type will be a bond fund with up to a 20% allocation to equity”.
This corresponds with previous media speculation that bonds are likely to be the principal beneficiary of mini-QFII. It also tallies with existing onshore bond funds, which are allowed to invest up to 20% of their assets outside of that product type.
Concentrating on bonds first makes sense. For a start, existing mainstream QFII investments are heavily skewed towards China’s stock market, so focusing mini-QFII on bonds means less direct overlap between the two.
It is also logical from a market development standpoint. Concerns over inflation have led Beijing to clamp down heavily on sectors such as property development where prices have been rising fast, while the central bank has simultaneously raised interest rates and hiked the required reserve ratios of local banks, effectively leaving them less able to lend to corporates.
This has left many local companies starved of capital. While some have entered Hong Kong’s offshore renminbi market to meet their needs, many more have been unable to do so. But by injecting funds into the local bond market these companies will have more opportunity to fund themselves.
The extra funds would also promote a more developed bond market. China’s banks are the largest buyers of onshore bonds, which basically leaves them exposed to the same companies than they would otherwise lend money to. But introducing more offshore investors to buy bonds would diversify the buyers of these instruments. It may also encourage the development of the country’s thin secondary market.
Onshore bonds may also appeal to offshore investors. While rising inflation is a concern, the returns of bonds are easier to calculate, coupon levels are higher than for equivalent offshore renmini bonds, and the principals of the bonds will also benefit from the continued appreciation of the renminbi.
Awaiting the green light
The Hong Kong-based divisions of Chinese asset management companies are not waiting around for regulatory permission before beginning their plans for this new market.
Fund managers such as Guotai Junan, Bosara Asset Management, and Harvest Global Funds, all of which possess operations in Hong Kong, look to be among the frontrunners to launch mini-QFII products once they are allowed.
“We have been preparing [for mini-QFII] for quite some time and think we are almost ready,” Zhao Xuejun, CEO of Harvest Global Funds, tells Asiamoney. “We already have the product channels and distribution agreements in place; we’re just waiting for the regulations to be announced.”
Choy adds that Harvest’s Hong Kong unit has been preparing for mini-QFII since late last year.
“By launching funds offshore using mini QFII Chinese asset managers will be able to gain international expertise, build an overseas client base and establish track records, with Hong Kong as a base for global expansion,” he says, adding that retail banks and private banks are showing a lot of interest in this avenue of investment, due to the interest of their renminbi depositors.
Chinese operations are very confident about the potential of these new operations. Currently offshore investors find it frustratingly difficult to gain as much access to China’s markets as they would like, so there is a lot of pent-up demand.
As Zhao notes, “The only thing we have to worry about is that the size [of assets we are permitted to raise] is too small.”
Choy adds that the likely initial allocation is expected to be no more than US$200 million per quota. “Given that the amount of renminbi deposits in Hong Kong is currently estimated to be Rmb500 billion (US$80 billion) and there is huge interest from distributors, there is still a lot of opportunity for the mini QFII quota.”
Such restrictions make sense, given that existing QFII applicants have had strictly limited quotas. Swiss private bank Julius Baer revealed that it had been granted a QFII quota for US$100 million by the State Administration for Foreign Exchange (SAFE) on May 23. Aviva Investors gained a similar US$100 million quota last month. Even the largest QFII player only has an allotment of US$800 million, according to Choy.
If China’s asset management companies have similar restrictions—and they might well be stricter, at least initially—this promising outlet for international investor money might swiftly be filled.
Proud pedigrees
The likely two-level entry criteria of mini-QFII funds versus regular QFII licence holders could also be an area of dispute.
“If the likes of Citi and J.P. Morgan have to qualify for main QFII but then you have this easier-to-enter mini-QFII it raises the question: why have main QFII at all?” says the senior asset manager. “I think there is tremendous pressure from some of the Chinese companies that are missing out of a big part of the market due to the fact that they are Chinese. I understand their frustration at not qualifying under normal QFII, but my concern is that it creates a two-tier market.”
One fear is that if mini-QFII funds have lighter entry requirements to gain licences they may be less responsible.
However, what existing QFII holders probably fear more is that the mainland connections of mini-QFII players via their onshore parents might also ensure that they gain preferential treatment for new deal distribution versus the existing QFII operators.
Additionally, if the new mini-QFIIs enjoy a lighter and more liberal hand when it comes to investment restrictions and criteria, they may be a more appealing vehicle for offshore investors.
Yet while such concerns are understandable it’s unlikely that large numbers of existing end-investors will desert the likes of Schroders or Credit Suisse Asset Management en masse for mainland competitors purely because they offer slightly improved terms. There is a reason that these companies enjoy longstanding pedigrees, after all—they have demonstrated their capabilities over many years or decades, something that the offshore divisions of China’s fund managers cannot state.
Ultimately mini-QFII offers a way for more offshore investor liquidity to enter China’s needy markets. As Beijing seeks to continue liberalising its financial markets, it makes a lot of sense to provide international end-investors with more avenues to do so.
Provided China’s authorities do not confer too many advantages on the Hong Kong divisions of their home-grown fund managers, everyone should be a winner.