24 February, 2016
On 3 February 2016, the State Administration for Foreign Exchange (SAFE) released the amended Measures for Investment in Domestic Securities by Qualified Foreign Institutional Investors (QFIIs) (“2016 QFII Measures”), which take immediate effect.
Background
SAFE first issued temporary QFII Measures in 2002, soon after the QFII scheme was rolled out. Those were replaced by formal QFII Measures in 2009. The 2009 QFII Measures were then amended in 2012 and, following this recent development, in 2016.
The QFII scheme is the primary legitimate channel for foreign institutional investors to invest in domestic securities in China. Under the scheme, the China Securities Regulatory Commission (CSRC) is in charge of granting foreign institutional investors permission to invest in domestic Chinese securities, whereas SAFE is responsible for approving the quota allocated to each approved QFII, i.e. the amount that that entity is entitled to invest in domestic securities in China. Prior to the 2016 QFII Measures, SAFE approved individual quota applications on a case-by-case basis.
Highlights of the 2016 QFII Measures
Removal of Upper Limit on Quota and Lowering of the Quota Threshold
The 2016 QFII Measures effectively remove the original US$1 billion upper limit on the quota available to each QFII and lower the quota threshold from US$50 million to US$20 million. Instead, the new measures introduce a two-layer system for quota applications: (i) one for base quota, ranging between US$20 million and US$5 billion; and (ii) one for quota for investment exceeding US$5 billion.
Introduction of Filing Procedure for Base Quota
Under the previous QFII regime, each application for quota was subject to the approval of SAFE. However, under the 2016 QFII Measures, applications for base quota will be filed with SAFE via onshore custodians. For applications for quota exceeding US$5 billion, applicants will still be required to apply to SAFE directly for approval.
Onshore custodians are now responsible for reviewing the base quota application documents and filing the application with SAFE on behalf of QFIIs so that QFIIs will not have to deal with SAFE directly. It is believed that filing applications for base quota will be subject to much less scrutiny of SAFE. Moreover, the documents and information to be submitted for base quota application are also simplified.
Clear Guidance for Calculating Base Quota
The 2016 QFII Measures, for the first time, provide in detail the bases on which each QFII’s entitlement to base quota will be calculated. The 2016 QFII Measures provide for the amount of base quota to be granted to a QFII applicant to be determined by reference to: (i) where the principal assets of the QFII (or under its management) are located; (ii) the scale of the assets of the QFII (or under its management); and (iii) whether any RMB QFII (RQFII) quota has been granted (if so, the amount of quota to be granted will be reduced by the amount of RQFII quota already granted to the applicant). As such, QFIIs will now be able to make more accurate projections of the scale of investment they will be able to make under the QFII scheme, prior to lodging their applications.
Shortened Lock-up Period
The previous QFII Measures prohibited QFIIs (except for certain types of QFIIs) from remitting back investment principal for 12 months, but under the 2016 QFII Measures this period has been reduced to 3 months. The lock-up period now starts to run once an aggregate investment of US$20 million has been paid into the QFII’s account with its onshore custodian, rather than at the point of full amount of quota has been remitted into China, as had been the case previously. This adjustment to the trigger to the lock-up period will, therefore, shorten the lock-up period in practice.
Eased Restriction on Remittance of Funds
The 2016 QFII Measures remove the 6-month limitation period, within which investment principal was previously required to be fully remitted into China, although SAFE retains the right to cancel the quota if the quota has not been “effectively utilised” within a year of the filing or approval of the quota, as the case may be. In addition, QFIIs operating open-ended funds may now remit their funds in or out of China on a daily rather than a weekly basis.
Our Observations
Greater Flexibility, Certainty and Access for QFIIs
The expanded quota limit, shortened lock-up period and relaxation of the restrictions on remittance of funds will offer more flexibility for QFIIs when developing their strategies for investment in China under the QFII scheme. Moreover, the simplified filing procedure for base quota applications, combined with clear calculation mechanics, will provide greater certainty for QFIIs as to the application process and the amount of quota that they may be granted by SAFE. The lowered quota threshold will broaden access to the Chinese securities market to smaller foreign institutional investors. Given that the base quota will likely be sufficient to meet the investment needs of most foreign institutional investors, we believe the 2016 QFII Measures will have significant benefits for existing and potential QFIIs, as well as for Chinese entities seeking to attract foreign investment.
Significant Step towards Opening up Chinese Securities Market
The greater flexibility and certainty introduced by the 2016 QFII Measures demonstrate the desire of the Chinese government to encourage inflows of foreign capital into the Chinese securities market, despite recent market volatility. This move may also be prompted by the Chinese government’s determination to secure the inclusion of A-shares in major indices and to internationalise its domestic securities market. We expect to see more measures to open up the Chinese securities market in the near future.
For further information, please contact:
Karen Ip, Partner, Herbert Smith Freehills
karen.ip@hsf.com
