China – Client Briefing: Marking The First Anniversary Of QFI Reform.

Just one year ago, the China Securities Regulatory Commission (CSRC), the People’s Bank of China (PBOC) and the State Administration of Foreign Exchange (SAFE) jointly issued the long-awaited rules on QFI reform, i.e. the Administration of Domestic Securities and Futures Investment by Qualified Foreign Institutional Investors and RMB Qualified Foreign Institutional Investors and the Provisions on Issues Concerning the Implementation of the Measures for the Administration of Domestic Securities and Futures Investment by Qualified Foreign Institutional Investors and RMB Qualified Foreign Institutional Investors (collectively, “Rules on QFI Reform”), proposing significant amendments to the current QFII/RQFII (collectively, “QFI”) regime, including the unification of QFII/RQFII rules, the expansion of permissible investment scope, as well as the streamlined procedures for approval of applications, overall offering a more convenient process for QFI investments in China’s capital market.

 

Over the past year, ancillary documents of the Rules on QFI Reform were issued in an orderly fashion on top of the unwavering opening-up of the Chinses financial market. The regime for QFI itself also plays an important role in the further opening-up of the Chinese financial market, and together with other opening-up measures, is invigorating the Chinese capital market. At the first anniversary of the implementation of the Rules on QFI Reform, this briefing aims to revisit the development of the QFI regime over the past year and offer our clients expectations for the future.

 

1. Significant Increase in the Number of Applicants

 

Key amendments in the Rules on QFI Reform, including the relaxation of eligibility requirements for applicants, the simplification of application materials, and the significant shortening of the approval timeline, attracted a large number of QFI applications from foreign institutions. According to public information on the CSRC website, since the Rules on QFI Reform were issued, a total of more than 200 foreign institutions have submitted QFI applications; and in just 11 months since the Rules on QFI Reform were officially implemented, the CSRC has granted QFI licenses to 140 foreign institutions in total, accounting for about one-fifth of the total number of institutions approved, and more than the total number of institutions approved from October 2015 to October 2020, after the Stock Connect, which competes with the QFI regime, was introduced in November 2014.

 

In terms of the types of QFI applicants, in addition to asset management institutions, sovereign funds, and other long-term institutional investors, many foreign proprietary institutions, hedge funds, private equity funds, as well as family trusts have obtained QFI licenses since the implementation of the Rules on QFI Reform. In terms of the jurisdictions of the institutions approved since the implementation of the Rules on QFI Reform, there are 78 institutions located in Hong Kong, accounting for more than half of the 140 institutions approved, followed by Singapore and the United States, with 17 institutions and 16 institutions respectively, and five British institutions and five Cayman Islands institutions, while the remaining 19 institutions are from other jurisdictions, including the UAE, Kuwait, South Africa, and Saudi Arabia.

 

2. Scope of Investment Steadily Expands

 

The expansion of the scope of investment, among other amendments proposed under the Rules on QFI Reform, is undoubtedly the most impactful for market participants. Particularly, the Rules on QFI Reform add exchange-listed commodity futures, exchange-listed treasury bond futures, and private investment funds into the permissible investment scope of QFIs, as well as allow QFIs to participate in the bond repo, margin financing and securities lending, and securities refinancing, all of which are of great interest to foreign institutional investors.

 

• As for securities refinancing, just on the first trading day following the implementation of the Rules on QFI Reform (i.e., November 2, 2020), several securities companies made the first securities refinancing deal for QFIs.

• As for private investment funds, on December 15, 2020, Barings invested in the Barings China Aggregate Bond Private Securities Investment Fund No. 1, a private securities investment fund launched by its onshore WOFE PFM – Barings Overseas Investment Fund Management (Shanghai) Limited, which was the first transaction that QFI subscribed for PFM product launched by its affiliated WOFE PFM. And up to now, many QFIs have successfully invested in onshore private investment funds. 

• As for commodity futures, the CSRC released the Announcement on Qualified Foreign Institutional Investors and RMB Qualified Foreign Institutional Investors Participating in Financial Derivative Trading ([2021] No.24) on October 15, 2021, allowing QFIs to trade commodity futures, commodity options, and stock index options listed and traded on futures exchanges approved by the State Council or the CSRC starting November 1, 2021. 

• As for financial futures, QFIs are permitted to trade stock index options for hedging purposes only and are subject to the same restrictions as stock index futures, reflecting regulatory authorities’ consistent prudential regulatory attitude toward foreign participation of trading of stock-related financial derivatives.

 

Currently, QFIs are not allowed to trade ETF options, treasury bond futures, or participate in bond repo transactions in practice. In addition, certain types of QFI investors like hedge fund managers or securities institutions offering structured products are still not eligible for entering into securities borrowing and lending transactions at current stage.

 

3. Interactions Between QFIs and Onshore/Offshore Funds

 

3.1 Establish offshore A-share funds

 

According to news releases and our observations of actual practices, establishing offshore China funds has become one of the main channels for foreign investors to allocate to the Chinese underlying products.1 Such offshore China funds may invest in the Chinese market through QFI and/or Stock Connect. 

 

3.2 Invest in onshore private funds

 

QFIs may invest in private funds launched by their onshore affiliates, or in funds managed by onshore non-affiliated private fund managers (PFMs). Their investments in the private securities investment fund launched by their affiliated onshore WFOE PFMs will effectively ease the pressure of raising funds due to the lack of performance records of WFOE PFMs at the initial stage. It is also beneficial for the WFOE PFM to test its strategies in the Chinese market and accumulate a track record with seeding capital provided by its group.

 

In the meantime, many QFIs are meant to or have invested in private funds launched by onshore non-affiliated PFMs. The Rules on QFI Reform explicitly stipulate that the investment scope of onshore PFM funds invested by QFIs shall conform to the permissible investment scope of a QFI. Hence, onshore PFMs may need to tailor-make a fund with a single investor, i.e. a QFI. Furthermore, onshore PFMs shall strictly comply with the investment scope of QFIs when managing their assets. Specifically, stock index futures or stock index options trading shall be conducted for hedging purposes only. QFIs shall not circumvent the aforesaid regulatory requirements by investing in onshore private funds. Additionally, onshore PFMs shall refrain from providing “channel services” for QFIs. In other words, the investments of QFIs in onshore private funds must be "genuine", with the investment decision-making power exercised solely by the PFM rather than the QFI investor.

 

3.3 Act as an investment advisor to affiliated QFI

 

The Rules on QFI Reform allow a QFI to appoint an onshore PFM controlled by it or under the same control, to provide investment advisory services. Some WFOE PFMs entered into investment advisory service agreements with their affiliated QFIs and provided investment advisory services for QFIs and/or the offshore funds to which its affiliated QFI acting as an investment manager or advisor in connection with their domestic investments. This may facilitate global asset managers to further leverage onshore research resources to support their global trading activities.

 

4. Special Attention to PRC Trading Rules and Information Disclosure Requirements

 

With the continuous expansion of QFI investment scope, QFIs’ onshore investment activities involve more sophisticated trading rules and regulatory requirements, thereby attracting special attention from foreign investors in PRC securities and futures laws and regulatory rules. Many foreign investors have acknowledged the gap between the trading rules in China’s market and those in mature western markets. We also noted that requirements on shareholding restrictions, shareholding aggregation and exemption, and information disclosure and reporting obligations have become key areas of concern for foreign investors. Many of our QFI clients have requested us to provide them with compliance training on PRC trading rules in terms of securities, bonds and futures trading.

 

In a drafting statement to the consultation paper of the Rules on QFI Reform, the CSRC specifically highlighted reinforcing the “look-through” regulation, which not only implies a strengthening of information disclosure requirements but also reflects the regulator’s focus on structured products. In the latest QFI annual report form released by the CSRC, QFIs are required to report specific types of structured products such as P-Notes, SWAP, options, QFI role in such product transaction (i.e., the issuer, market maker, or others), as well as trading volume.

 

Our Observations

 

From the increase in QFI applications after the implementation of the Rules on QFI Reform, it can be seen that the Rules on QFI Reform have stimulated the interest of foreign investors in the QFI regime. With the continuous opening-up of China’s financial markets, we expect that more foreign investors will likely apply for a QFI license. Those Stock Connect investors already invested in the China A-share market are likely to apply for their QFI qualification as well, in order to better capture trading opportunities and utilize the different advantages of these two regimes. Although there seems to be an inevitable competition and a level of interchangeability between the QFI regime and Stock Connect regime, we believe that in the long run, the two regimes may promote each other and in effect deepen participation in a more opened and prosperous China capital market.

 

We will continue to monitor the situation and keep our clients apprised of any important developments.

 

A Review of Important Events of the Last Two Years of QFI Regime.

 

September 10, 2019

SAFE announces removal of investment quota restrictions on QFII/RQFIIs
 

May 7, 2020

PBOC and SAFE jointly issue the Administrative Provisions on Domestic Securities and Futures Investment Capital of Foreign Institutional Investors (officially implemented on June 6, 2020)

– Simplifies capital inward remittance and repatriation process

· Allows qualified investors to choose the currency and timing of capital inward remittances

·A qualified investor may repatriate capital with written application or instructions as well as a commitment letter that it has fully paid relevant taxes in accordance with applicable PRC tax laws and regulations

– Removes limitations on the number of custodians and permits each qualified investor to entrust multiple domestic custodians, while designating a main reporter
 

September 25, 2020

Rules on QFI Reform were released
 

October 30, 2020

The Shanghai Stock Exchange (SSE) and the Shenzhen Stock Exchange (SZSE) released the detailed implementation rules on securities trading activities of QFIs respectively

– Expands investment scope, adding depositary receipts, stock options, government-backed bonds, margin financing, securities lending, securities refinancing as well as bond repos to the permissible investment scope of QFIs

– Improves requirements for information disclosure and statutory shareholding reduction: (1) lowers the shareholding percentage of foreign investors in a single listed company which triggers the initial information disclosure obligation, namely, lowering the aggregate shareholding percentage of all QFIs and other foreign investors in a single exchange-listed company which triggers the initial information disclosure obligation from 26% to 24%; (2) improves statutory shareholding reduction requirements when the aggregate shareholding percentage of all QFIs and other foreign investors in a single exchange-listed company exceeds 30%
 

– Facilitates investment activities: (1) removes limits on the number of securities companies that QFIs may entrust; (2) specifies the requirements for handling transfers by agreements or non-trade transfers by QFIs

 

China Financial Futures Exchange (CFFEX) released the Circular on Matters Concerning Qualified Foreign Institutional Investors and RMB Qualified Foreign Institutional Investors Engaging in the Trading of Stock Index Futures

– Clarifies the varieties and trading methods for QFIIs/RQFIIs to engage in financial futures trading, namely, QFIIs/RQFIIs may trade stock index futures in compliance with relevant administrative rules of the CFFEX on hedging

 

China Securities Depositary and Clearing Corporation Limited (CSDC) issued the amended detail rules on securities clearing 

– (1) Enriches the types of clearing participants that QFIs may select; (2) Clarifies for the first time that securities companies may carry out clearing business for QFIs as clearing participants.

– Specify that different securities accounts may choose different clearing participants
 

November 1, 2020

The Rules on QFI Reform, the Shanghai Stock Exchange/Shenzhen Stock Exchange detailed rules on securities trading activities of QFIs, the CFFEX detailed rules, and the CSDC detailed clearing rules were officially implemented.
 

November 2, 2020

Several securities companies such as the CITIC Securities, Guotai Junan Securities, Guosen Securities, CICC, UBS Securities completed securities refinancing transactions for QFIs.
 

December 15, 2020

Barings invested in the Barings China Aggregate Bond Private Securities Investment Fund No. 1, a private securities investment fund launched by its affiliated WOFE PFM – Barings Overseas Investment Fund Management (Shanghai) Limited, which was the first transaction that a QFI subscribes to a PFM fund product launched by affiliated WOFE PFM.
 

October 15, 2021

CSRC released the Announcement on Qualified Foreign Institutional Investors and RMB Qualified Foreign Institutional Investors Participating in Financial Derivative Trading ([2021] No.24), allowing QFIs to trade commodity futures, commodity options, and stock index options listed and traded on futures exchanges approved by the State Council or the CSRC from November 1, 2021.

 

1. Please refer to the Shanghai Securities News: Enticing Alpha Gains – Global Quantitative Giants Compete for Establishing China Funds, released on October 12, 2021, written by WANG Peng.
 

 

 

Natasha (Qing) Xie, Partner, Jun He

xieq@junhe.com