Until fairly recently, foreign investors in the People’s Republic of China ("PRC") have been allowed to trade only in the dollar-denominated B-Share market, which makes up a fraction of the traded securities on the PRC’s Shanghai and Shenzhen stock exchanges. Prior to December 1, 2002, only PRC nationals were allowed to trade in the yuan-denominated A-Share market which is comprised of approximately 1,200 companies, which collectively have a market capitalization reported to be approximately US$500 billion.
A recent joint circular issued by the China Securities Regulatory Commission ("CSRC"), the Ministry of Finance and the State Economic and Trade Commission ("SETC") announced China’s Qualified Foreign Institutional Investors ("QFII") program, which lifts the ban on foreign investment in the A-Share market, including listed A-shares as well as listed treasury, convertible and corporate bonds (collectively, "A-Shares"). The new regulations became effective December 1, 2002 and grant unprecedented access to the A-Share market to foreign investors. According to the Assistant Chairman of CSRC, several large European, Asian and U.S. banks and investment banks have expressed interest in applying for QFII qualification.
As discussed below, the PRC central government continues to impose severe restrictions on foreign investment in the A-Share market, including limitations on which entities are qualified to invest in the market and restrictions on repatriation. However, as the PRC central government relaxes its requirements, this new program will likely boost foreign mergers and acquisitions activities in PRC domestically listed firms and increase participation by foreign investors and advisors in this market.
Who Can Invest in A-Shares
Only certain institutional investors who meet the QFII requirements are allowed to invest in A-Shares on the Shanghai and Shenzhen stock exchanges.
To qualify under QFII, the investor must be a foreign fund manager, insurance company, brokerage, bank or other financial institution approved by CSRC and the State Administration of Foreign Exchange ("SAFE"). In addition, the securities regulators of the investor’s home jurisdiction must have in effect a memorandum of understanding with CSRC. Some of the QFII requirements include the investor being in good standing in its home jurisdiction and meeting, among other criteria, one of the following experience and asset requirements:
Foreign Fund Managers – industry experience of over five (5) years and management of assets of not less than US$10 billion.
Foreign Insurance Companies and Brokerages – industry experience of over thirty (30) years, minimum paid-in capital of at least US$1 billion and management of securities-related assets of not less than US$10 billion.
Foreign Commercial Banks – in the last fiscal year, the investor must have been one of the one hundred (100) largest banks in the world in terms of assets and had management of securities-related assets of not less than US$10 billion.
If the investor falls into one of the categories described above, the investor may apply to participate in the QFII program. The investor’s application to CSRC includes a written application, a custodian agreement (described below) and certain financial information about the investor. CSRC may take up to fifteen (15) business days to either grant or reject the application. Once the application is accepted by CSRC, the same application goes to SAFE for its review and SAFE may take up to another fifteen (15) business days to review the application. In all, the QFII application review process by CSRC and SAFE may take up to thirty (30) business days. However, in order to attract long and mid-term equity investments, certain pensions funds, insurance funds and mutual funds that meet the eligibility standards described above are expected to be given priority in the QFII approval process.
How to Invest in A-Shares
The trading in A-Shares by a qualified investor is done through a custodian (which may be a PRC commercial bank or a PRC branch of a foreign bank). Among other requirements, the custodian must be a financial institution that routinely handles custodial matters and has paid-in capital of not less than US$1 billion. The custodian must have its eligibility approved by CSRC, SAFE and People’s Bank of China ("PBOC"). The custodian is in charge of holding all of the investor’s investment assets in the PRC, accounting for the investor’s investment transactions in the PRC and monitoring the investor’s investment activities in the PRC. The custodian is required to report any illegal trading activities by the investor to CSRC and SAFE.
What Restrictions Apply to A-Shares
Any one qualified investor cannot have more than a ten percent (10%) equity interest in any PRC domestically listed company and the total permitted foreign equity interest in any domestically listed company cannot exceed twenty percent (20%) of such company’s capitalization. Certain industries are also off-limits; foreign investors may not purchase stocks of listed companies engaged in an industry not open to foreign investment under the Industry Catalogue for Foreign Investment, which includes, for example, certain traditional medicine manufacturers.
Also, the custodian accounts may only be yuan-denominated accounts and the funds in such accounts are subject to a one-year lock-up period during which the foreign investor cannot remit overseas its investment principal. Although after the lock-up period the foreign investor may remit its principal investment overseas, a maximum of twenty percent (20%) of the principal investment may be remitted, on only one (1) occasion, during any three (3) month period. Investments made through closed-end China funds can be remitted overseas after three (3) years, but a maximum of twenty percent (20%) of the principal investment may be remitted on only one (1) occasion during any one (1) month period.
Under the QFII program, all repatriations of investment principal and realized profits are subject to SAFE adjustments based on the PRC central government’s foreign exchange needs. However, our discussions with senior officials at CSRC indicate that SAFE would only further restrict repatriations in extreme cases.
Although the immediate effect of the opening of the A-Share market to foreign investors is unclear, the new QFII program is a signal of China’s progress towards integrating its financial system into the global market. If the results of the QFII program appear positive to the PRC central government, investors can perhaps look forward to a further relaxing of the requirements to allow wider access to the A-Share market for overseas investors.
Client Alert is published solely for informational purposes and should in no way be relied upon or construed as legal advice. For specific information on recent developments or particular factual situations, the opinion of legal counsel should be sought. Paul, Hastings, Janofsky & Walker LLP is a limited liability partnership.
© 2003 Paul, Hastings, Janofsky & Walker LLP.