RQFII rules relaxed but MSCI challenges remain
The quota system under the RMB qualified foreign institutional investor (RQFII) scheme has undergone a total revamp, the Chinese regulators announced on September 5. While the rules represent a further harmonisation of RQFII and QFII schemes, market participants still see obstacles to Chinese assets entering global indices.
The new rules were issued by the State Administration of Foreign Exchange (Safe) in conjunction with People’s Bank of China, marking the first time that the central bank has stepped in to regulate foreign investment matters traditionally handled by other regulators.
The headline change under the new rules is the streamlining of the quota system to base it on assets under management (AUM) for each applicant, with no minimum or maximum quota limits.
While both RQFII and QFII are now based on AUM-linked quotas, QFII still limits quotas to a minimum of $20m and a maximum of $5bn.
“Based on the official formula you can now figure out your RQFII quota yourself, then you just need to register with Safe, with no approval needed,” Eugenie Shen, head of asset management, Asia Securities Industry & Financial Markets Association (Asifma), told GlobalRMB. “But if you want more than your basic quota, then you will need approval.”
In addition, Safe also said that the AUM-based quota system would not apply to official institutions, effectively scrapping investment limits for the category ahead of the October inclusion of the RMB in the IMF special drawing rights (SDR) basket.
While China had already thrown open the doors to the foreign exchange and interbank bond market for the public sector institutions in 2015, the looser RQFII rules mean that official institutions can now use this channel to invest across an even borader spectrum of products.
With a global asset management industry worth $74tr as of 2014, according to the Boston Consulting Group data, the new AUM-linked rules create the potential for greater inflows to RMB assets.
The impact on asset managers could be meaningful, with global RQFII quota capacity possibly tested in the next six months, Z-Ben Advisors said in a September 6 report.
One analyst at the firm said the timing of the announcement was not surprising.
“This is textbook Chinese regulatory reform,” said Neil Flynn, analyst at Z-Ben. “They reform when demand is not there, so that when demand arrives the programme is already open. China has opened the door that much wider now.”
The reform puts the RQFII scheme more in line with the QFII scheme, which saw its investment and quota rules relaxed in February this year, with the calculation of the quota giving investors a better understanding of how much investment they can achieve without having to wait for the results of a lengthy application process with Safe.
“The new rules make things more transparent on the exposure you can have in China,” said Patrick Wong, head of China sales and business development, securities services, HSBC.
One thing that has not changed is the country-based approach to RQFII quotas, whereby each country receives a set overall investment quota by the Chinese authorities. And, despite the relaxations, the reform did not address the long-standing issue of Hong Kong’s exhausted RQFII quota.
According to Z-Ben’s Flynn, China is unlikely to open the tap in Hong Kong as it seems keen to first increase usage of quotas outside Greater China, where 80% of them are untouched. The US, which received an Rmb250bn ($37.5bn) quota in June, has yet to see any managers enter the RQFII scheme.
“China wants to internationalise the RMB, so there is no point in removing national quotas, since then everyone would just go to Hong Kong,” Flynn noted.
One question that might affect how fast quotas are taken will depend on technicalities yet to be clarified by the regulator.
“If one manager takes a group approach for the calculation of the basic quota, it is not entirely clear the portion of assets invested in China versus assets invested outside China will be calculated and how the relevant individual quota will be attached to a particular RQFII jurisdiction,” said Stephane Karolczuk, partner and head of the Hong Kong office for Luxembourg law firm Arendt & Medernach.
“But since there are a number of countries now having RQFII centre status and quotas still available this should not be an issue. We might see asset managers start combining quotas from various RMB centres if needed.”
But while China has tried to attract asset managers in other jurisdictions, the need for additional clarification of the RQFII regulatory frameworks by overseas authorities has slowed down the process somewhat.
As an example, Luxembourg’s regulator only issued guidance on the RQFII scheme six months after the quota was assigned by the People’s Bank of China in April 2015. In Malaysia, which received a quota in November 2015, the local regulator has only just defined the application process for asset managers seeking RQFII quotas.
The reform should also help China’s chances to get A-shares included in the MSCI emerging market index. The index provider declined again to include A-shares in the index in its June 2016 review, citing concerns across its inclusion criteria.
David Cui, equity strategy at Bank of America Merrill Lynch, wrote at the time that MSCI clients were still concerned about quota allocation, with a number of international investors telling MSCI that their applications had been delayed for months.
On capital repatriation clients said that four months after the February 2016 QFII reform, they were still unable to benefit from the daily capital repatriation that had been introduced. On top of that, monthly repatriation for QFIIs remained an issue.
“The industry has asked the authorities to remove the monthly cap on repatriations by QFIIs, which is 20% of QFIIs total assets as of the end of the previous year,” said Asifma’s Shen. “This limit on repatriation is something we have talked to Safe about. They may see it as a way to control outflows, but from the asset managers’ perspective, it actually hurts inflows.”
The reason is that restrictions on repatriation create problems for asset managers as they have to be able to meet redemptions by their clients or fund investors, Shen explained.
“The monthly cap means that they need to keep sufficient funds outside of China or limit the size of the fund to meet potential redemption requests even if there is a lot of interest in the fund,” she said.
On the RQFII side, however, Safe seemed keen to assuage some of MSCI’s concerns by reducing the lock-up period for non open-ended funds to three months and with the more flexible quota rules.
“This reform is definitely a good signal from the regulators,” said HSBC’s Wong. “They addressed the quota issue by making it proportional to AUMs, and relaxed the liquidity for non open-ended funds.”
One positive side effect of the new liquidity rules was broadening the likely range of RQFII products.
“The relaxation is welcomed by global investors, particularly in terms of the flexibility for client accounts using non open-ended funds,” said Wong. “This creates the opportunity for more flexible product structures being launched into the market. This gives investors more reasons to apply for RQFII quotas to launch A-shares and fixed income RQFII products.”
For Arendt’s Karolczuk, the reform was another indication of the progress in the liberalisation of China’s capital account and the convergence between QFII and RQFII.
“This is a total switch from five years ago when the market discovered RQFII for the first time," he said.
"We have gone from a rather restrictive system of investment quotas to one where, if you are a global asset manager, you will most likely have managers in one or more RQFII centres, especially in Europe, Hong Kong, Singapore, etc. and since more recently the US, to invest back in China.”