This note is an update to a note first published in July 2013. The pace of change in respect of particularly the RQFII scheme has continued unabated as the Chinese authorities continue to liberalise access to China A Shares for foreign investors.
The Qualified Foreign Institutional Investor ("QFII") scheme has since it was launched by the People's Bank of China ("PBOC"), the China Securities Regulatory Commission ("CSRC") and the State Administration of Foreign Exchange ("SAFE") in 20021 been the principal method for foreign investors to invest directly in the securities markets of China. It allows foreign institutional investors to invest in China's capital markets, subject to first obtaining a QFII license from the CSRC and then an investment quota allocated by the SAFE.
CSRC, PBOC and SAFE have taken a gradual approach to broadening the appeal of the QFII scheme to foreign investors by lowering the threshold requirements for applicants seeking QFII licences, expanding the universe of permissible investments available to QFIIs and increasing the total QFII quota in April 2012 by US $50 billion to US $80 billion and on 12 July 2013 from US $80 billion to US $150 billion.
The RQFII scheme which was originally introduced in December 2011 as a means of allowing the Hong Kong operations of mainland Chinese financial institutions to raise Renminbi ("RMB") in Hong Kong for investment in the Chinese capital markets has undergone rapid change from inception. Ultimately those changes gave rise to the possibility of UCITS funds being in a position to invest 100% of their assets into China A Shares, giving investors in such UCITS funds unparalleled access to the A share market.
This opportunity was quickly grasped and the first RQFII UCITS Fund was approved by the Irish Central Bank on the 16th of December 2013, showing the commitment of Ireland as a funds domicile to embrace these developments and to offering fund managers domiciled in Ireland the broadest range of possibilities for investing into the China A Share market as soon as regulatory developments permit. As the first mover in this area, Ireland is continuing its tradition of embracing regulatory developments and responding quickly to them.
Even with these refinements, current investments by QFIIs and by Renminbi Qualified Foreign Institutional Investors ("RQFIIs") are generally estimated to account for less than 2% of the total investments in China's A-share markets.2
The changes continued apace in 2014 and included the announcement by the Shanghai stock exchange that the shareholding limit for both QFII and RQFII in any single company is to be raised to 30% from 20%. The Chinese authorities are also working towards clarifying the tax treatment of gains under the QFII scheme and recently announced an allocation of RQFII quota to France of RMB 80bn. The announcement of an allocation of RQFII quota to France follows announcements in 2013 of allocations of RMB 100bn of RQFII quota to Taiwan, RMB 80 bn of RQFII quota to London and RMB50bn of RQFII quota to Singapore.
As RQFII is extended to more markets around the world a key consideration for those managers is how they can utilize QFII and RQFII to offer their clients in the EU, Latin America, Middle East and Africa access to the Chinese capital markets. In this memorandum we will provide an overview of the QFII and RQFII schemes and how managers in any jurisdiction with RQFII quota can utilise such quota in Irish UCITS and AIFMD compliant funds.
We have set out in this memorandum our understanding of the QFII and RQFII schemes and the interpretation of the rules of those schemes by PBOC, SAFE and CSRC as at April 2014. However, readers should be aware that the rules of both schemes have undergone rapid change and both the rules and interpretation thereof by the relevant authorities are subject to change.
QFIIs and QFII products are broadly classified into three types for both the purposes of the SAFE regulations3 and for foreign exchange purposes:
- Long term investors such as pension funds, insurance funds, charitable foundations, endowment funds, government and monetary authorities ("Long-Term Funds");
- Open-end China funds (essentially a type of fund product managed by a QFII) which are defined as open-end securities investment funds set up offshore by QFIIs via public placements, where at least 70% of their assets are invested in the securities market in China ("Open-end China Funds"); and
- Mandates managed by a QFII, QFIIs' proprietary money if the QFII does not qualify as Long-Term Fund, funds managed by a QFII that do not qualify as Open-end China Funds, etc. ("Other Funds").
Under the QFII regulations4, QFIIs must generally within six months of having each investment quota approved5, remit the investment principal into China, and may not commence investment operations until the remittance of US$20 million or more as investment principal has occurred.
Where a QFII does not remit the full amount of the investment quota within the above timeframe, this will result in the unremitted portion of the quota being forfeited unless an approval allowing an extended period for remittance has been granted.
The QFII regulatory regime also imposes significant restraints upon repatriation of assets from China with the nature of the restrictions on repatriation varying according to the type of QFII making the repatriation or the QFII product to which the repatriation relates (i.e. Long- Term Funds, Open-end China Funds and Other Funds).
All investment amounts invested through the QFII channel are subject to a lock-up period during which QFIIs are prohibited from remitting such funds out of China. The lock-up period is calculated from the date when the investment principal is remitted in full or when the six-month remittance period falls due, whichever is earlier.
Under the 2009 SAFE QFII Rules, a three month lock-up period applied to Open-end China Funds and Long-Term Funds, while for Other Funds the lock-up period was one year.
Once the initial lock-up period was over, the 2009 SAFE QFII Rules provided that an Open-end China Fund may remit funds to or repatriate funds from China without SAFE's approval on a monthly basis depending on the net subscriptions or redemptions of the fund and provided that the net remittance to or repatriation from China did not exceed US$50 million per month.
For Long-Term Funds and Other Funds, which intended to repatriate either principal or profits following the applicable lock-up period, prior approval of SAFE was required on a case-by-case basis. Any repatriation of principal by funds other than Open-end China Funds results in the QFII quota being reduced by an amount equivalent to the repatriated principal amount.
The custody of assets held by all QFIIs has also given rise to concerns. Under the QFII regime prior to the introduction of the 2012 QFII Measures, QFIIs were required to hold client assets apart from the assets of Open-end China Funds in a single securities account, which gave rise to significant custody and asset segregation risks for QFII clients.
2012 CHANGES TO THE QFII SCHEME
A number of important changes to the QFII scheme were made during 2012 which were intended to continue the process of opening China's securities markets to foreign investors. We have set out the principal changes below:
Easing of Requirements for Applicants
The 2012 QFII Measures have substantially eased the requirements which applicants for a QFII quota have to meet. This has opened up the possibility of obtaining a QFII quota to a much broader pool of potential applicants. Appendix 1 sets out these reduced criteria.
Increase in QFII Investment Quota
Under the 2009 SAFE QFII Rules, all QFIIs were subject to a maximum investment quota per investor of US$1 billion. The 2012 SAFE QFII Rules remove the US$1 billion ceiling for three types of QFIIs, namely sovereign wealth funds, central banks and monetary authorities. The ceiling still applies to other QFIIs.
Expansion of the Scope of Investment
Previously, QFIIs could only invest in (i) stocks, bonds, warrants traded in or transferred in stock exchanges; (ii) securities investment funds; and (iii) other financial instruments permitted by the CSRC. The 2012 QFII Measures permit QFIIs to invest in stock-index futures and fixed-income products traded on the inter-bank bond market. While this expansion in the scope of investments is welcome, it should be noted that the requirement that at least 50% of a QFIIs assets be invested in listed equities remains.
The 2012 QFII Measures also loosened the restriction on the cap of the aggregated amount of China A shares that all foreign investors may hold in a listed company from not exceeding 20% to 30%. The cap of the amount of China A shares that a single investor may hold remains unchanged at 10%.
Relaxation of the limits on Repatriation/Remittance of Funds by QFIIs
The 2012 SAFE QFII Rules continue to distinguish between Long-Term Funds, Open-end China Funds and Other Funds in connection with foreign exchange controls while introducing a number of important changes to the QFII scheme.
Open-end China Funds
Open-end China Funds are now allowed to remit into or repatriate out of China the net difference between subscription and redemption amounts on a weekly basis, compared with a monthly basis under the 2009 SAFE QFII Rules.
In addition, fund remittances and repatriations by Open-end China Funds are no longer subject to SAFE's prior approval, regardless of the amount involved, whereas, under the 2009 SAFE QFII Rules, SAFE's prior approval was required where the net amount remitted or repatriated exceeded US $50 million. Fund repatriation by an Open-end China Fund under the 2012 SAFE QFII Rules remains however subject to a monthly cumulative limit of 20% of the total onshore assets of that fund as of the previous year. This limit is, we understand, calculated separately from other products managed by the same QFII.
Long-Term Funds and Other Funds
Previously, the repatriation of both investment principal and profits by Long-Term Funds and Other Funds required SAFE's approval. The 2012 SAFE QFII Rules however, remove the approval requirement for profit repatriation by Long-Term Funds and Other Funds. As a result, profits may now be repatriated by Long-Term Funds and Other Funds without SAFE's prior approval subject to all required documents being in place.
Under the 2012 SAFE QFII Rules a cap is imposed on total monthly repatriation (principal and profits) by Long-Term Funds and Other Funds, which is set at 20% of its total onshore assets as at the end of the previous year. As mentioned, any repatriation of principal by funds other than Open-end China Funds results in the QFII quota being reduced by an amount equivalent to the repatriated principal amount.
QFII Account Structure
The 2009 SAFE QFII Rules introduced a multiple bank account structure. A QFII was permitted to open a foreign exchange account and a corresponding RMB special account for proprietary funds and client funds respectively and was required to open a foreign exchange account and a corresponding RMB special account for each Open-end China Fund. While this provided for segregation of the QFII's assets from client assets, it meant that for QFII clients other than Open-end China Funds their assets were contained in one omnibus securities account, which invariably gave rise to serious custody and segregation concerns and risks.
Under the 2012 QFII Measures and the 2012 SAFE QFII Rules, the QFII account structure was amended in such a manner as to address some of these concerns regarding custody and asset segregation by permitting a QFII to open up to six "RMB special deposit accounts" for its clients. Further to the implementation of the 2012 QFII Measures and the 2012 SAFE QFII Rules, the rules regarding accounts which can be opened and operated are as follows:
- a QFII is required to open a separate segregated securities account for its own proprietary capital;
- a QFII is required to open a separate segregated securities account for its clients' assets. Client assets (other than assets of Open-end China Funds and Long-Term Funds) are contained in this single omnibus client account. Such a securities account may be named as "QFII-Client Name";
- when a QFII opens a securities account for a Long-Term Fund under its management, the account may be named as "QFII – Fund (or Insurance Fund, etc.) Name" and the assets in that account will belong to the Fund (or Insurance Fund, etc) and shall be independent from the QFII and the custodian.
- when a QFII opens a foreign exchange account and a RMB
dedicated deposit account for an Open-end China Fund, it shall open
a separate account for each Open-end China Fund;
Accordingly where a QFII opens a separate segregated foreign exchange account in respect of an Open-end China Fund, a corresponding segregated RMB dedicated deposit account and securities account will also be required to be opened. While these separate segregated securities accounts may be opened in respect of individual funds, the accounts will be in the joint name of the QFII and the fund. However, pursuant to the 2012 QFII Measures, the Open-end China Fund will be the sole legal owner of the securities held in the account.
- QFIIs may open up to six "RMB special deposit accounts" which are permitted to be linked to a RMB securities account for its clients. Funds are not transferrable between these RMB special deposit accounts. This will allow QFIIs to segregate and distinguish some of its clients' assets from the assets of other clients and address the aforementioned custody and segregation issues for certain clients. This may provide QFIIs with the ability to meet the concerns of clients who are not Open-end China Funds or Long-Term Funds regarding the segregation of their assets from other clients' assets managed by the same QFII.
In summary, the implementation of the 2012 SAFE QFII Rules and the 2012 QFII Measures provide additional flexibility to QFIIs regarding account opening.
For QFII clients other than Open-end China Funds and Long Term Funds, the ability of QFIIs to now open up to six RMB special deposit accounts should assist in addressing the custody and segregation concerns which exist with regard to the assets of various clients of the same QFII being held in an omnibus client account.
1 The Interim Administrative Measures for Securities Investments in China by Qualified Foreign Institutional Investors (1 December 2002).
2 A-shares are equity shares subscribed and traded in Renminbi. QFIIs have traditionally focused on A-shares traded on the Chinese stock exchanges located in Shanghai and Shenzhen.
3 See footnote 4.
4 The main regulations governing the QFII scheme are the revised "Administrative Measures on Domestic Securities Investment by Qualified Foreign Institutional Investors" issued by the CSRC, the PBOC and the SAFE in 2006 ("2006 QFII Measures") and the Provisions on the Foreign Exchange Administration of Domestic Securities Investments by Qualified Foreign Institutional Investors issued by the SAFE on 29 September 2009 ("2009 SAFE QFII Rules"). The 2009 SAFE QFII Rules set out detailed provisions on quota applications, remittance and repatriation of funds, QFII accounts, etc.
In 2012, the Chinese regulators sought to broaden the appeal of the QFII scheme to foreign investors. In July 2012, the CSRC issued the "Provisions on Relevant Matters concerning the Implementation of Measures for the Administration of Securities Investment within the Borders of China by Qualified Foreign Institutional Investors" ("2012 QFII Measures"), which revised the "Provisions on Relevant Matters concerning the Implementation of Measures for the Administration of Securities Investment within the borders of China by Qualified Foreign Institutional Investors" issued by CSRC in 2006, while in December, 2012, the SAFE revised its QFII rules by issuing the " Provisions on Foreign-Exchange Administration of Domestic Securities Investment by Qualified Foreign Institutional Investors." ("2012 SAFE QFII Rules").
5 We understand that QFII licences and quotas are specific to each QFII and not transferable between entities, even within a group, however a QFII may delegate the QFII investment management function to another group entity.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.