On January 31, 2019, the China Securities Regulatory Commission (CSRC) issued the market’s long-awaited consultation papers on Qualified Foreign Institutional Investor (QFII) and RMB Qualified Foreign Institutional Investor (RQFII) regulations, namely, Measures for the Administration of Domestic Securities and Futures Investment by Qualified Foreign Institutional Investors and RMB Qualified Foreign Institutional Investors (Consultation Paper) (the “Administrative Measures”) and the Provisions on Issues Concerning the Implementation of the Measures for the Administration of Domestic Securities and Futures Investment by Qualified Foreign Institutional Investors and RMB Qualified Foreign Institutional Investors (Consultation Paper) (the “Implementing Provisions”) (hereinafter collectively referred to as "New Regulations"). Once introduced, the New Regulations will replace the existing Measures for the Administration of Domestic Securities Investment by Qualified Foreign Institutional Investors, Measures for the Administration of Domestic Securities Investment by RMB Qualified Domestic Institutional Investors and the relevant rules (hereinafter collectively referred to as “Existing Regulations”).
The New Regulations unify the qualification requirements for QFII and RQFII. This means foreign institutional investors need only submit a single application for the qualification of investing with foreign currencies and/or offshore RMB funds. Please note, that any institution from a country or region that has not yet obtained RQFII quota should not use its offshore RMB funds to make the investment even if it has obtained the qualifications.
In addition, the New Regulations categorize foreign institutional investors into two types:
The first category is “asset management institutions”, namely foreign fund management companies, commercial banks, insurance companies, securities companies, futures companies, trust companies, government investment management companies and other asset management institutions, and the second category is “other institutional investors”, namely pension funds, charity funds, endorsement funds and other institutional investors recognized by the CSRC.
The Implementing Provisions remove the requirements on the minimum term of operation and size of asset under management on the QFII/RQFII applicants, whilst still retaining requirements on financial soundness, good credit standing, experience in securities and futures investment, sound and effective governance structure, internal control, compliance management regime and procedures, and no record of major regulatory punishment in the latest three years or since the institution's establishment. The draft statement issued by the CSRC on the same day (the "Draft Statement”) explains the intention of relaxing such restriction is to harmonize the requirements of QFII/RQFII with those under the regimes of Stock Connect and the Foreign Direct Access to China Interbank Market (CIBM), so as to prevent any regulatory arbitrage. Please note, it was difficult in the past for offshore hedge fund managers to obtain the QFII/RQFII qualifications. That New Regulations remove the provision that preference shall be given to long-term institutional investors like pension funds and charity funds might imply that there is no longer a policy obstacle for offshore hedge fund managers to obtain QFII/RQFII qualification.
According to the Administrative Measures, an applicant still needs to submit the application for qualification and quota through its custodian. The Existing Regulations require an applicant to submit its application for qualification to both the CSRC and State Administration of Foreign Exchange (SAFE). Compared to the Existing Regulations, Article 7 of the Administrative Measures simplifies the approval process, that is, the CSRC is responsible for the qualification approval whist the SAFE takes charge of quota approval. At the same time, the Administrative Measures remove the requirement that an applicant shall apply for investment quota within one year after obtaining the QFII qualification.
The most notable revision of the proposed amendment is to include financial futures and options, commodity futures and options, and private securities investment funds in the scope of permitted investment.
2.1.1 In terms of the products traded in the exchange market, in addition to the stocks and bonds which have been allowed to be traded or transferred on stock exchanges, the stocks listed on the National Equities Exchange and Quotations (NEEQ) and the depository receipts, bond repos and asset-backed securities traded or transferred on stock exchanges are explicitly allowed to be traded.
2.1.2 In terms of the products traded in CIBM, the New Regulations explicitly define the scope to be “any products traded on CIBM that the People's Bank of China (PBOC) “may allow QFII/RQFII to trade”, this means that, the PBOC may decide the permissible scope of products at its discretion, and the PBOC has the flexibility to allow QFII/RQFII to trade bond repos or other products in the future without the need to amend the relevant regulations.
2.1.3 In terms of the fund products, the New Regulations categorize them to (i) publicly raised securities investment funds; and (ii) private securities investment funds whose underlying assets fall within the permissible investment scope of QFII/RQFII, for which the regulator does not impose any additional qualification or threshold requirements on either fund or fund manager. Such positive change is warmly welcomed by all private fund managers (including domestic-owned, wholly or majority foreign-owned managers) as it enables them to compete equally for QFII/RQFII businesses under the same access conditions.
2.1.4 Under the New Regulations, futures and options products are divided into three categories:
(i) Financial futures contracts listed on the China Financial Futures Exchange (CFFEX);
The financial futures contracts listed on the CFFEX currently are stock index futures and treasury bond futures, and may also include other financial futures contracts in the future. Please note, that the New Regulations still require financial futures trading be conducted for hedging purpose only, and because the treasury bond spot market is regulated by the PBOC, the New Regulations specifically require the CFFEX to periodically report the allocated hedging quota to QFII/RQFII, as well as the trading thereof.
(ii) Commodity futures contracts listed and traded on futures exchanges approved by the CSRC;
The commodity futures exchanges hereof refer to the Shanghai Futures Exchange, Dalian Commodity Exchange, Zhengzhou Commodity Exchange, Shanghai International Energy Exchange and any other exchanges that the CSRC may approve in the future.
(iii) Options listed and traded on futures exchanges approved by the State Council or the CSRC;
In terms of the options products, we understand that such products shall include financial options and commodity options. Currently, the Shanghai 50ETF Option listed on the Shanghai Stock Exchange is the only financial option product in the market. To avoid any ambiguity, we suggest this sentence can be rephrased to read, “financial or commodity options listed and traded on securities or futures exchanges approved by the State Council or the CSRC”. In addition, we note the specific statement on futures exchanges approved by the State Council or the CSRC, which may stimulate us to speculate whether the State Council might approve new futures exchange to list options and then delegate other financial regulators to supervise such exchange.
2.1.5 In terms of the foreign exchange derivatives, the Administrative Measures define it as “eligible foreign exchange derivatives for qualified investors according to regulations of the SAFE”. Pursuant to the regulations promulgated by the PBOC and SAFE in June last year, QFII/RQFII may, based on a “real need” basis, engage in foreign exchange derivatives to hedge the foreign exchange exposure stemming from domestic securities investment.
Other than allowing QFII/RQFII to participate in new share issuance, convertible bond issuance, secondary share offerings, and share allocations, QFII/RQFII are able to engage in margin financing and securities lending in stock exchanges. Allowing QFII/RFII to engage in margin financing and securities lending will be another advantage of QFII/RQFII regime compared to the Stock Connect.
The securities or futures exchange will propose to the CSRC the specific products on bond repos, financial futures, commodity futures, and options eligible for QFII/RQFII to trade and will announce them after obtaining the CSRC’s approval. The New Regulations further stipulate that the CSRC needs to consult with the PBOC in terms of bond repos or financial futures to be included. We expect each exchange may propose detailed rules on the specific products to be included very soon. Whilst with regards to the bond repos or financial futures for which the CSRC need to consult with the PBOC, it would mean that the PBOC may take a key role in deciding the inclusion of such specific product.
Under the Existing Regulations, QFII/RQFII may entrust an investment management institution established in China including securities company to manage the domestic securities investments. Article 17 of the Administrative Measures revises the foregoing provision into “a qualified investor may, in accordance with law, entrust its assets to asset management schemes set up by asset management institutions including securities companies and fund management companies”. The literal meaning of the foregoing revision seems to suggest the cooperation between QFII/RQFII and asset management institutions shall be limited to QFII/RQFII’s investing in the asset management schemes, whilst negating an investment mandate model where an investor may grant an investment manager a discretionary investment management mandate, under which the manager has an authorization for the investment decision making and trading execution of the relevant securities and futures account.
We are of the view that QFII/RQFII, as a special type of institutional investor, shall be distinguished from ordinary investors. We would recommend the regulators to make reference to the practice of other institutional investors such as banks, insurance companies, social security funds or pension funds, and explicitly allow QFII/RQFII to cooperate with asset management institutions in a variety of ways, which include (i) entrusting asset management institutions for discretionary or non-discretionary investment management; (ii) investing in asset management schemes or private funds, and (iii) engaging asset management institutions to provide investment advisory services, and clearly stipulate that such asset management institutions should include private securities investment fund managers.
Thus, we suggest that this Article be rephrased to read: “a qualified investor may, in accordance with law, entrust its assets to asset management institutions and private securities investment fund managers supervised by the relevant financial regulatory authorities (“Asset Management Institutions”) for domestic investment, engage those qualified Asset Management Institutions to provide investment advisory services, or invest its assets in asset management schemes or private funds set up in accordance with law, provided, however, that the investment scope of such asset management schemes or private funds shall comply with the scope of investment permitted for QFII/RQFII”.
The Implementing Provisions allow QFII/RQFII to appoint an onshore private securities investment fund manager with which QFII/RQFII has an affiliate relationship, to provide the investment recommendation services, whilst not setting any additional qualification requirements on such an onshore affiliate. This means, after the release of the New Regulations, private securities investment fund managers will be allowed to provide the investment recommendation services on the domestic investment to the QFII/RQFII within its group.
By defining a qualified foreign institutional investor, the Administrative Measures additionally require a QFII/RQFII to invest in China's securities and futures markets “with funds raised overseas”. It is unclear whether this definition is meant to identify, by means of see-through inspections, the ultimate fund resources of the investors of a fund or product managed by QFII/RQFII, and whether only an ultimate beneficial owner holding an interest above a certain percentage (such as 25% interest of a fund) is concerned.
In light of Article 5 of the Implementing Provisions that QFII/RQFII is obliged to verify the identities of the investors of the fund or product under its securities or futures accounts as well as the statement in the Draft Statement that “strengthening see-through supervision on qualified investors’ accounts”, we believe a see-through to the ultimate beneficiaries of the relevant fund or product may be required and would suggest to clarify whether a see-through inspection is required and if yes, to clarify the minimum percentage of interest held by the ultimate beneficial owner required to be seen through.
4.2.1 Abnormal Trading
The New Regulations restate that both the custodians and the securities or futures brokers are obliged to continuously monitor the trading activities and fund flows of QFII/RQFII and make timely reports on any abnormal situation or any violation of law or regulation to the CSRC, the PBOC and the SAFE. They also add the requirement that the exchanges, the depository and clearing institutions, and the market monitoring, and surveillance institutions shall make periodic reports on the domestic investment of QFII/RQFII.
4.2.2 Overseas Hedging Positions
Article 10 of the Implementing Provisions adds a new requirement that QFII/RQFII shall, in accordance with the requirements of the CSRC, report its overseas hedging positions related to its domestic securities and futures investment through its custodian within 10 business days following the end of each quarter. Further clarification is needed from the CSRC to clarify the practice on how to determine the relevance to the domestic securities and futures investment, and the scope of information to be reported.
4.2.3 Shareholding Percentage Limits and Information Disclosure
The shareholding ratio limits provided by the New Regulations, remain the same as the Existing Regulations, which are, (i) a single investor shall hold no more than 10% of the total shares of an exchange-listed or a NEEQ-admitted company; (ii) the aggregate shareholding percentage of all the foreign investors in an exchange-listed or a NEEQ-admitted company shall not exceed 30% of the total shares of such company; and (iii) strategic investment in listed companies by foreign investors in accordance with law shall not be subject to the aforementioned percentage limits. The New Regulations further clarify that stricter shareholding ratio limits held by foreign investors imposed by other relevant laws and regulations shall prevail.
Compared to the Existing Regulations, the Administrative Measures add a new provision that “a foreign investor shall disclose relevant securities investment information of the persons acting in concert according to the information disclosure rules of listed companies”. The Draft Statement emphasizes that foreign investors investing in domestic capital markets through QFII/RQFII schemes shall comply with the information disclosure rules of listed company in order to reinforce the requirements on see-through supervision.
Both the Existing Regulations and New Regulations stipulate that if a foreign investor’s domestic securities investment triggers a disclosure obligation, the foreign investor shall, as the obligor of information disclosure, submit the disclosure document to the trading venues through a QFII/RQFII and QFII/RQFII is obliged to ensure that the foreign investors under its name strictly comply with relevant information disclosure rules. We note that the Existing Regulations are silent on the penalties that may be imposed on a QFII/RQFII where it fails to ensure its clients to perform their information disclosure obligations. However, Article 31 of the Administrative Measures explicitly lists QFII/RQFII’s failure to perform the information disclosure obligations as one of the violations, and we cannot exclude the possibility that a QFII/RQFII may be determined as having committed a violation under Article 31 due to its failure to ensure its clients to perform their information disclosure obligations. We suggest QFII/RQFII pay special attention to its own compliance risks that may likely arise from its client’s violation of information disclosure obligation.
Compared to the Existing Regulations, Articles 31 and 33 of the Administrative Measures set forth specific circumstances of violation as well as the administrative regulatory measures and administrative penalties that may be imposed on QFII/RQFIIs, custodians, or their principal persons in charge or persons with direct responsibilities or involvement. The administrative regulatory measures include, amongst others, supervisory talks, issuing warning letters, ordering for participation in training, ordering for periodic reporting, or disqualification of the individual. In the event of overdue rectifications or severe violations, a warning and/or a fine of no more than RMB 30,000 may be imposed. With the above provisions in place, the legal basis of the law enforcement on the violations of QFII/RQFII and custodians has been clarified.
In addition to the aforementioned provisions, the New Regulations also remove the restriction on the numbers of custodians that a QFII/RQFII can engage with. If a QFII/RQFII engages more than two custodians, it shall designate one custodian as the principle custodian. Each QFII/RQFII may engage no more than three domestic securities companies in each of the Shanghai Stock Exchange, Shenzhen Stock Exchange and NEEQ to trade securities, and may engage no more than three domestic futures companies or securities companies in total to trade futures or options.
Connect Programs like Stock Connect and Bond Connect provide diversified and convenient channels for foreign investors to invest in domestic capital markets but cause a significant “crowding out effect” on QFII/RQFII regime. It is expected that the new amendments made to the QFII/RQFII regulations, especially the expansion of the permissible investment scope, will highlight the advantages of the QFII/RQFII regime when competing with the Connect Programs.
We will continue to pay close attention and will share the latest developments with our clients.