Accessing China’s Capital Markets

Author: NICSA

As China stakes its claim as the second-largest economy worldwide, it’s more important than ever for foreign investors to understand cross-border opportunities.

“China’s capital markets have become some of the largest in the world, with the country’s equity market ranking number two, and its bond market ranking third in the world,” Allison Lovett, Vice President of Content Management at NICSA, said as she welcomed participants to the program on #WebinarWednesday. “Nonetheless, foreign investment remains relatively low. Certainly, the challenges and opportunities that lie within these markets, specifically those tied to accessing these markets, continue to evolve—and that’s what we’re here today to discuss.”

The Jan. 10 discussion provided a high-level view of Chinese capital markets, an explanation of investment schemes, and a review of how regulated funds are making use of these channels. “Also of significance is index inclusion and how this, particularly the MSCI changes set to occur this summer, may impact capital flows into China in the near future,” Lovett said.

Florence Lee, Head of China Sales & Business Development – EMEA, HSBC Securities Services, said that China’s onshore bond market—the third largest in the world after the U.S. and Japan—has 9.8 trillion USD in bonds outstanding, but less than two percent of participation by foreign investors. However, data shows that while 403 foreign investors were registered in China at the end of 2016, that number jumped significantly, to 618, by the end of 2017. “That is an increase of 53 percent of the number of foreign investors in the last 12 months,” Lee said.

Lee said the China-Hong Kong Bond Connect structure, “a very innovative design providing very good access in terms of the trading platform,” has proved attractive to international asset managers. “If you want to access China, you no longer go directly to China. You just go to Hong Kong and set up a bond connect account, making use of a global access platform. It’s a much more user-friendly environment for trading, and it can be done electronically.”

Stéphane Karolczuk, Partner, Head of Hong Kong Office at Arendt & Medernach, said the “possibility to implement strategies involving direct investment in the People’s Republic of China (PRC) using the Undertakings for Collective Investments in Transferable Securities (UCITS) vehicle is a key factor in order to further the PRC capital markets and allow wide distribution of those products on a global basis.”

“Each time we’ve seen a development taking place China or in Hong Kong, we’ve seen a quickly-following review by stakeholders managing UCITS funds, as well as regulators, in order to ensure … [that] asset managers [are able to] take full advantage of those access channels,” he said.

Karolczuk spoke about the Luxembourg regulatory approach to QFII and how UCITS funds make use of it. “QFII is the oldest China access channel, available since 2002, and it’s really the very first scheme that allowed the manager to receive a license to receive a quota [of] … investments in the mainland,” he said.

However, there were concerns over the liquidity of the China A-shares market, foreign exchange controls and the fact that QFII was not fully compatible with UCITS. “This was not in line with the first round of QFII rules due to a lock-up period of one year, monthly repatriations at best, regulatory approvals required prior to repatriations and a number of other limitations,” Karolczuk said.

In 2012, new QFII rules were issued by PRC authorities creating the concept of “open-ended China funds.” As a result, the regulator in Luxembourg agreed not to limit exposure to China A-shares in UCITS qualifying as QFII open-ended China funds.

Karolczuk said that R-QFII open-ended funds differ from QFII in that they are not subject to a lock-up period, can proceed to daily repatriations, convert freely from RMB to other currencies and are not subject to maximum repatriation amounts per month.

“R-QFII, when it was launched, was the most flexible system at the time that you could find to invest in the Chinese capital market,” he said. However, it wasn’t until 2013 that sub-managers could use R-QFII quotas with a foreign fund structure.

R-QFII is now used with Luxembourg UCITS and management companies, though in order to approve R-QFII, Luxemburg regulators raise a number of questions in the application process.

CIBM Direct Access
Because revised rules were issued by the People’s Bank of China in 2015, CSSF now allows UCITS managers direct access to onshore RMB fixed-income securities dealt on the CIBM.

This allows managers to increase their allocation to RMB fixed-income securities without QFII or R-QFII licenses and quotas, as long as there is prior approval by the CSSF. Formalities are handled by relevant managers in China and UCITS prospectus must include reference to CIBM Direct Access and risk disclosures.

Index Inclusion
Lee expects to see greater inclusion of China in major bond market indices as well as a significant increase in foreign participation. Last June, MSCI announced a .73 percent China A-share inclusion by two phases in May and August of the coming year.

“We expect that about 250 billion in offshore money will be going into China due to this bond index,” Lee said.
“From a legal perspective, we’ve been expecting MSCI inclusion for a number of years,” Karolczuk said. “Some of the constraints that MSCI was raising were in relation to QFII, R-QFII and the various restrictions applicable to them, and we really had to wait until Stock Connect was fully operational. We expect it will be the same for Bond Connect and bond inclusion in the main bond indices.”

NICSA thanks ALFI for sponsoring this webinar. To view the archived webinar for additional insight, visit here and be sure to share your thoughts with us.

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