Financial Services Quarterly Report - Asia

Qualified Foreign Institutional Investors Now Permitted to Trade Stock Index Futures in China

The China Securities Regulatory Commission (the "CSRC") recently issued guidelines allowing Qualified Foreign Institutional Investors ("QFIIs") to trade stock index futures, with effect from May 4, 2011.1 The Guidelines represent a helpful step in the on-going liberalisation of the Chinese securities markets.

Trading in stock index futures remains relatively less established in China than in other markets, having only been approved for use by Chinese securities firms and money managers in April 2010. There is one designated futures exchange, the China Financial Futures Exchange (the "CFFEX"), and only the CSI 300 Index futures contract is currently traded on the CFFEX. Prior to the issuance of the Guidelines, QFIIs were not allowed to trade stock index futures in any form in mainland China. This restriction may have been prompted by concerns that stock index futures may increase volatility on domestic stock markets. As a result, the Guidelines subject futures trading by QFIIs to a number of limits, the most significant of which restricts a QFII's use of stock index futures to hedging purposes only. However, while the Guidelines note that QFIIs should apply to the CFFEX to obtain a hedging quota, "hedging" is not itself defined, and it is unclear how the CFFEX will evaluate a QFII's proposed use of stock index futures.

Hedging activities of QFIIs are also subject to value and volume limitations. Under the Guidelines, a QFII may not (a) hold stock index futures with an aggregate value in excess of its investment quota at the end of any trading day or (b) trade an amount of stock index futures in excess of its investment quota within any trading day. While the Guidelines are not clear on this point, "value" presumably is determined with reference to the notional value of the futures contracts held or traded by a QFII. If the value of futures contracts exceeds the quota due to price fluctuations, the QFII is required to reduce the value of futures contracts held, within ten trading days.2

Trades may be conducted with no more than three mainland futures companies and only in accordance with the CFFEX's trading rules regarding settlement, trade execution, and margin management. The Guidelines also impose oversight and compliance responsibilities on custodian banks and futures firms, and these entities are required to report to the CSRC any irregular or illegal trading activity by QFIIs. Custodians are further subject to ongoing CSRC reporting requirements as to the securities activities of QFIIs.

QFIIs should benefit from the increased flexibility provided by the Guidelines. It is expected that Chinese regulators will closely monitor whether these Guidelines are successful in limiting the impact of securities index futures on market stability. If the Guidelines prove to be adequate, the CSRC may relax some of the restrictions, or permit QFIIs to trade futures on other reference assets or use other forms of derivatives.

China to Permit U.S. Banks to Offer Funds to Domestic Market

Talks between Chinese and U.S. officials at their annual Strategic and Economic Dialogue summit, held in early May 2011, resulted in several breakthroughs for U.S. financial institutions. At the summit, chaired by U.S. Treasury Secretary Timothy Geithner and Chinese Vice Premier Wang Qishan, China agreed to broaden its financial sector reforms as part of its new five-year plan for its economy. A press release from the U.S. Treasury indicated that such reforms will "further develop [China's] financial services market based on the principles of national treatment and non-discrimination [and] will provide new and significant opportunities to U.S. firms."

The most welcome development was China's agreement in principle to further open its domestic fund market to U.S. financial services companies. Currently, overseas asset managers can access the Chinese fund market solely by means of joint ventures with Chinese companies, which can be costly to establish and burdensome to manage. As announced by the U.S. Treasury, China has agreed to permit U.S. banks with subsidiaries incorporated in China to sell domestic mutual funds to Chinese consumers on the same terms as Chinese banks.3 Such U.S. banks also would be able to obtain licenses to act as mutual fund custodians and as Margin Depository Banks in QFII futures transactions. These developments should assist non-Chinese firms in building brand awareness with Chinese investors. The Chinese domestic asset management market is growing rapidly, with assets under management reaching nearly $400 billion in 2010. It does not appear, however, that the agreement paves the way for offering non-Chinese funds to Chinese retail investors.

The practical impact of liberalisation remains to be seen—U.S. banks will still need to submit to a lengthy licensing process with Chinese regulators, and the criteria for obtaining a license may not be transparent. The timeline for implementation is not yet known. It also remains to be seen whether Chinese consumers will purchase funds from U.S. banks instead of more familiar domestic financial institutions.

The Strategic and Economic Dialogue summit also yielded other agreements. The U.S. Treasury noted that China "continues to make measured progress in increasing total quotas under the QFII program", which have increased nearly 25 percent in the past year to $21 billion. China also committed to move toward "market-determined interest rates to better price risk and more efficiently allocate capital in its economy".


1 The full title is Guidelines for Investment in Stock Index Futures by Qualified Foreign Institutional Investors (hereinafter, the "Guidelines"). The final Guidelines are substantially the same as the draft Guidelines published for consultation in January 2011.

2 For purposes of this quota, long and short positions cannot be offset and must be aggregated.

3 As announced by the U.S. Treasury, this liberalisation will also extend to foreign banks outside of the United States.

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