Markets watchers have likely noticed the acronyms “QFII” and “RQFII” popping up in the headlines lately. But what are these programs? And why do they matter to Chinese equities investors?
Most of the Chinese equity market is comprised of A-shares, or companies incorporated and listed in mainland China and traded in renminbi. More than 2,100 A-shares are currently listed (for more details, see our China A-Shares paper. (FTSE is the largest provider of China equity indexes, which underlie more than 60% of overseas AUM in China ETFs.)
However, foreign investment in these companies is walled off to all but a handful of large financial institutions known as qualified institutional investors (QFII).
Starting in 2002, the Chinese government began allowing QFII to access the A-share market in an attempt to entice more investment into its markets. Using offshore currency accounts, licensed QFII can directly invest in A-share equities on both the Shanghai and Shenzhen exchanges, as well as bonds, index futures, warrants, open/closed-end funds and ETFs.
But not just anybody can become a QFII. Applicants must meet strict criteria set forth by the China Securities Regulatory Commission (CSRC), including minimum thresholds of capital, years of business experience, and assets under management. For example, to become QFII fund companies must demonstrate they have two years’ experience and have managed at least USD $500Mn in securities assets over the past year.
In addition, QFII must prove their financials and credit status are in order, as well as show a clean regulatory record for at least the past three years.
Once approved, QFII receive a quota of investment dollars from the State Administration of Foreign Exchange (SAFE). While the exact allotment varies, generally it’s in the USD $100-300m range, at least for asset management companies.
For all the QFII investors worldwide, current investment is set at $150bn. At just barely 4% of the total A-share market capitalization, that’s barely a blip in the bucket – and in practice, actual yearly QFII investment is much lower, nearer to $50bn.
Furthermore, there are certain rules in place over how QFII may invest. For example, a single QFII licensee cannot hold more than 10% of a given company’s A-shares. In addition, the total A shares held by all QFII investors for any given company can’t exceed 30% of its total outstanding shares. However, these restrictions, implemented to make sure foreign investment never overwhelms domestic, are rumored to be relaxed or even lifted entirely in the near future.
The Renminbi QFII (RQFII) program is a modified version of QFII that facilitates foreign investment in the mainland via offshore renminbi accounts.
RQFII participants can invest in the same range of investment products as QFIIs and are subject to many of the same restrictions. However, a RQFII uses renminbi to purchase securities, while a QFII uses their foreign home currency.
Previously the RQFII program was limited to only Hong Kong subsidiaries of Chinese financial institutions, but this year has seen expansions in the program, first to additional Hong Kong banks and asset managers and then to financial institutions in London, Singapore, Taiwan, and other yet-unnamed locations.
The total RQFII quota stands at RMB270bn ($43.5bn), a fraction of that allowed through the QFII program. So far this year, less than half of this quota has been apportioned, likely due to continued fears surrounding the Chinese equities market.
The RQFII program is notable because it has facilitated the creation of several A-share ETFs and bond funds domiciled in Hong Kong. As the RQFII program expands, this market will likely grow as well.
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