QFII and RQFII Liberalization: Changing Dynamics in the Greater China Capital Markets

At the opening plenary session at the Asian Financial Forum in Hong Kong in mid-January, attendees were paying close attention when then-China Securities Regulatory Commission (CSRC) Chairman Guo Shuqing addressed the topic of the RQFII 2 and QFII 2 programs that would enable foreign individual investors to access China’s A shares market. But what really set social media channels humming was his mention of a probable 10-fold quota expansion for the existing Qualified Foreign Institutional Investor (QFII) and Renminbi QFII (RQFII) programs, which permit licensed foreign institutional investors to access China’s A shares. Such moves would bring the total quota to around 15% of the aggregate capitalization of the market. The Shanghai-Shenzhen market index (CSI 300) immediately perked up on the news, rising almost 4% for the day — and then climbed another 8% over the next three weeks before peaking.

The QFII program has grown slowly since its inception in 2002, but it has been getting a boost since last year from rapid and sizable approvals. Meanwhile, the quota on the much newer RQFII program, which launched in late 2011, has quickly increased to a sizable RMB 270 billion. With Guo’s speech suggesting that both programs were moving into a new phase, the Hong Kong investment services industry was elated. It didn’t have long to wait for specifics. On 6 March, CSRC announced the anticipated enhancements to RQFII, which included the following elements:

• As generally expected, Hong Kong subsidiaries of mainland banks and insurance companies are now eligible to apply for RQFII licenses, together with asset management firms domiciled in Hong Kong. The latter would include subsidiaries of foreign firms, and the talk is that 15 or more of these are likely poised to apply for RQFII licenses and quota in the near future.

• There is also significant relaxation of investment restrictions on RQFII funds. Previously, at least 80% of the assets had to be invested in fixed income instruments, except for index-tracking ETFs managed with full physical replication. Now, there are no longer any restrictions on the asset mix, and index futures are also permissible. This pleasantly surprised many industry participants who expected more gradual easing of the restrictions.

• One significant control remains, however: Any single foreign entity cannot own more than 10% of a Chinese company’s stock, and total combined foreign ownership remains capped at 30%.

One interesting development to watch is how the well-established synthetic China ETFs that have been on the market for years and enjoy deep liquidity will cope with the competition from their RQFII full-replication physical ETF counterparts. Will they apply for RQFII quota and move into a full physical replication management strategy? Will they use a mix of synthetic and physical replication strategies that enhance cost-effectiveness, implementation choices, and risk management? Will the cost of participatory notes (P-Notes) or China A-Share Access Products (CAAPs) be considerably lowered as the aggregate quota is increased by a factor of 10 times — and demand reduced as more market participants obtain RQFII licenses such that synthetics actually become more attractive?

Toward a New Era 

Cross-strait initiatives are also underway. Shortly after an unprecedented meeting in late January between Guo and Taiwan Financial Supervisory Commission Chairman Chen Yuzhang, a 100 billion RQFII quota for Taiwan-based institutional investors was announced, together with a series of measures to open China’s securities and derivatives markets to Taiwan. There was also talk of plans to permit individual investors in Taiwan to invest in A-shares. Cross-strait relations have been improving since the Economic Cooperation Framework Agreement (ECFA), a preferential trade agreement between Taiwan and China, was signed in 2010. The recent unprecedented meeting between Chinese Communist Party Secretary General Xi Jinping and Lien Chan, the Honorary Chairman of Taiwan’s Kuomintang, indicates that there will likely be further efforts to strengthen financial ties. During their meeting, these officials mentioned peaceful development of ties between the mainland and Taiwan as well as peaceful “reunification,” and referenced compatriots from both sides of the Taiwan Strait cooperating to make the “Chinese dream” come true.

Meanwhile, the pace of capital markets reform in China appears to be quickening. Just a few days after the RQFII announcement in early March, the much discussed new RQFII2 scheme was announced: Individual investors from Taiwan, Hong Kong, and Macau who are resident or working in the mainland will be allowed to open brokerage accounts in the mainland to buy A-shares starting on 1 April. Although only 450,000 individuals are estimated to be eligible — and any substantial impact won’t be felt until large institutional asset owners start to include A-shares in their asset allocation benchmarks — there is considerable optimism that the investment services industry in Greater China is entering a bright new era.

Such optimism was given a further boost just this past weekend, when Bank of China chairman Xiao Gang was tapped to take over as CSRC chairman. Xiao is generally viewed as belonging to the energetic and vigorous group of younger top management talent in the financial sector.

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

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