By Iris Zhang
On 29 June 2012, the China Securities Regulatory Commission (CSRC) approved two cross-border exchange-traded funds (ETFs) - China AMC's Hang Seng Index ETF and E-Fund's Hang Seng China Enterprise ETF - and their respective unlisted feeder funds. The issuers are PRC fund management companies with qualified domestic institutional investor (QDII) licences. China AMC's ETF is listed on the Shenzhen Stock Exchange whilst the E-Fund ETF is listed in Shanghai. They both track Heng Seng Indices with Hong Kong listed stocks as constituents, and channel China domestic investors' money to the Hong Kong stock market.
The PRC regulators have not so far issued rules specifically covering cross-border ETFs, so they are subject to regulations generally applicable to "authorised funds" and "QDII funds", meaning funds that are mandated to invest into overseas markets.
There are some investment restrictions applicable to QDII funds: (i) QDII funds should primarily invest into stock markets whose regulators have signed an MOU with the CSRC, (ii) investments into non-MOU countries collectively should not exceed 10% of a QDII fund's AUM, (iii) a QDII fund's investments into a single non-MOU country should not exceed 3% of AUM. These rules limit the indices which a cross border ETF may track.
From news reports, cross-border ETFs that are in the pipeline include ETFs tracking the S&P 500 Index, the Dow Jones Industrial Index and the FTSE 100 Index. As Hong Kong, the United States and the United Kingdom have signed the relevant MOU with the CSRC, cross-border ETFs may track these indices. For ETFs seeking to track global equity indices, there might be practical difficulties in complying with the above investment restrictions, depending on the constituent stocks. As of early 2012, CSRC has signed over 50 MOUs: ( http://www.csrc.gov.cn/pub/csrc_en/affairs/Cooperation/201203/t20120315_207208.htm)
QDII rules also include provisions on the use of financial derivatives by QDII funds: derivatives should be used for the purpose of hedging risks and effective management and not for the purpose of speculation or expanded trading; and exposure to financial derivatives by a QDII fund should not exceed 100% of its NAV. However it is not entirely clear whether it is possible for cross-border ETFs to use synthetic replication. Both approved ETFs use physical replication.
These products present new investment opportunities for the PRC domestic market and new business opportunities for foreign parties, such as index providers, investment advisors, overseas custodians and overseas brokers.
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