Fighting Currency Outflows, China Proposes Further Opening its Securities Markets to Fund Managers and Foreign Investors

March 24, 2016

Faced with redemptions and currency outflows from the country, Chinese regulators have taken welcome steps to make it easier for fund managers and other institutional investors to invest in China. Fund managers, in particular, stand to benefit from two recent proposals. To date, with certain exceptions – such as Stock Connect1 – fund managers have needed to obtain licenses from the Chinese government in order to invest in Chinese debt or equity. The first proposal would ease the process of obtaining one type of license (the “qualified foreign institutional investor”, or QFII license), while the second proposal would give a broad range of institutional investors access to China’s inter-bank fixed income market. 

Reform of the QFII Program 

Since its inception in 2002, the QFII program has been the primary means for fund managers to access the Chinese securities markets. However, following the introduction of other market access programs – notably, the Renminbi Qualified Institutional Investment (RQFII) and Stock Connect programs – the terms of QFII licenses have become onerous by comparison. While the RQFII program allows certain open-ended funds to withdraw money from the program on a daily basis, the QFII program allows withdrawals only weekly and subject to additional limitations. Similarly, Stock Connect generally allows any kind of fund to sell shares and withdraw proceeds from the program at any time.2

Despite the QFII program’s shortcomings, however, it remains an important means of accessing the Chinese securities markets. Not all managers could meet the conditions for the more favorable RQFII program; licenses remain available only in certain jurisdictions (most notably, Hong Kong, Singapore and the United Kingdom).3 Nor is Stock Connect appropriate for all investment strategies – the program covers only certain Shanghai-listed equities, but bonds, Shenzhen-listed stocks and many Shanghai-listed small cap stocks are not available. 

The limitations of the QFII program became increasingly apparent following the volatility in the Chinese stock market that began in June 2015. Faced with a difficult market environment, devaluations in the Chinese currency, and QFII repatriation restrictions, a number of managers simply withdrew as much money from the program as possible. On February 4, 2016, perhaps recognizing that the repatriation restrictions were causing QFIIs to withdraw money, the Chinese foreign exchange regulator (the State Administration of Foreign Exchange, or SAFE) issued new rules that narrow the gap between the QFII and RQFII programs.4 Under these new rules, “open-ended China funds”5 are now allowed to repatriate on a daily basis (i.e., the same as their counterparts under the RQFII program). 

The reforms will also simplify the process of obtaining a QFII quota. Previously, managers needed to obtain a QFII license from the Chinese securities regulator, followed by obtaining a foreign exchange quota from SAFE. The reforms partly eliminate this second step – under the revised QFII program, new QFIIs will no longer need to obtain SAFE approval of their quotas on a case-by-case basis, but may obtain a “base quota” through a notice filing (made by the QFII’s Chinese custodian). As calculated, the base quota will range from US$20 million to US$5 billion.6 The simplified notice process may also be used by existing QFIIs to obtain additional quotas. 

Access to the Inter-Bank Bond Market 

The Chinese inter-bank bond market currently accounts for nearly all of China’s bond trading. But until relatively recent reforms permitted investment by QFIIs and RQFIIs, non-Chinese investors were largely locked out. After the onset of the Chinese market crisis in 2015, certain foreign institutions (including sovereign vehicles and central banks) were allowed to engage in bond trading, lending and various other transactions without a license. The latest round of reforms, announced on February 17, 2016, would allow additional foreign institutions (including banks, insurance companies, brokers and fund managers) to invest directly without any need for prior approval. To take advantage of the most recent reform, a fund manager would need to meet certain basic eligibility criteria7 and appoint an onshore settlement agent, which would submit any necessary filings to the People’s Bank of China. As with QFII custodians, this settlement agent would be part-service provider and part-regulator, tasked with monitoring the investor’s compliance with the eligibility criteria. 


These reforms will, after implementation, represent a significant step in the opening of China’s securities markets. Their timing is, of course, not coincidental – the regulators are trying to encourage investment in China in a difficult market environment. Even with the yields on Chinese bonds outpacing yields in many other jurisdictions, some investors may be reluctant to invest in Chinese bonds until concerns fade regarding currency devaluation. But the fact remains that these reforms should simplify the process of investing in China for those investors willing to take the plunge. 


1) For further information regarding Stock Connect, please refer to Dechert OnPoint, The Through-Train Leaves the Station: Hong Kong-Shanghai Stock Connect Launches.
2) While Stock Connect is subject to a market-wide quota, the quota only limits new purchases of securities through the program; absent extraordinary action by the regulators (e.g., terminating the entire program), managers would always be allowed to sell under the terms of Stock Connect.
3) Various other jurisdictions have also been included in the RQFII program but, in some jurisdictions, implementing regulations have not yet been released.
4) These rules are set forth in the Provisions on Foreign Exchange Administration of Domestic Securities Investment by Qualified Foreign Institutional Investors (合格境外机构投资者境内证券投资外汇管理规定).
5) As defined, an open-ended China fund must be an open-ended securities investment fund established outside of the PRC by a QFII through a public offering, where at least 70% of such fund’s assets are invested in the PRC. Various structures have arisen that would allow, for example, non-China-focused U.S. 1940 Act funds to take advantage of the favorable terms offered to open-ended China funds.
6) The base quota is calculated as follows: A. Where the assets of a QFII are mainly located outside of China, the quota is US$100 million plus 0.2% of the QFII’s average assets under management over the last three years, less any RQFII quota (if applicable; such quota being calculated in USD ); and B. Where the assets of a QFII are mainly located within China, the quota is RMB 5 billion plus 80% of the QFII’s assets under management from the previous year, less any RQFII quota (if applicable; such quota being calculated in USD).
7) These criteria include, among other items, (a) being legally incorporated in accordance with the laws of the investor’s jurisdiction, (b) having sound corporate governance and not being subject to material punishment during the prior three years in connection with bond investments.

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