Focus: Funds management opportunities in China
4 August 2006
In brief: Recent developments in China support the view that the PRC Government is delivering on its WTO commitments to open up its financial markets to foreign participation. AAR Shanghai office Senior Associates, Julian Donnan and Troy Zhang, highlight measures which will provide offshore funds managers, custodians, securities institutions and asset managers with greater access to one of the world's largest and fastest growing economies.
As barriers to foreign participation in Chinese capital markets are gradually removed, the Chinese Government is implementing new measures governing the level of foreign financial institutions' involvement and exposure to Chinese financial products and assets both onshore and offshore. These measures predominantly focus on qualifying criteria, limits on foreign ownership and investment thresholds.
Foreign participation in China's domestic securities markets has been fairly limited with foreign entities only being permitted to hold B Shares. Unlike A Shares, which are listed in China and denominated and traded in Reminbi, B Shares are denominated in foreign currency and comprise only a small percentage of a listed company's stock.
Two exceptions discussed below, which facilitate access to A Shares are the Qualified Foreign Institutional Investors (QFIIs) program and the recently enacted, strategic investor program. Both programs are the subject of recent reform and take on renewed significance due to:
- the lifting of the year-long moratorium on IPOs on China's domestic exchanges in late May 2006; and
- the ongoing share reform process which is resulting in the conversion of many of the non-tradeable shares in listed companies held by the state into publicly tradeable A Shares.
Qualified foreign investment institutions
QFIIs are overseas funds management companies, insurance companies, securities companies, and other asset management institutions which have been approved by the China Securities Regulatory Commission to invest in A Shares. The program was initiated and implemented in 2002-03 and there are now around 40 approved QFIIs with a total investment quota for the PRC of approximately US$6.3 billion.
QFII applicants are subject to high minimum capital or asset thresholds (such as US$10 billion in assets under management or paid up capital of US$1 billion), asset management experience and corporate governance standards. This has tended to restrict participation to all but the world's largest financial institutions.
The following recent developments indicate a possible gradual relaxation of those criteria in the future.
- The range of QFII applicants may soon be extended to foreign trust firms, pension funds, charity funds, endowment funds and government investment funds.
- Mutual funds and insurance companies may only need to have US$5 billion under management to qualify as a QFII. The current requirement is US$10 billion.
- In February 2006, a draft rule was released which provides for an increase in the maximum quota for an individual QFII from US$800 million to US$1 billion. This rule is expected to become effective in the next few months.
Strategic investor scheme
The new policy, Administrative Measures on Management of Strategic Investors in Listed Companies, issued by five government bodies, including the Ministry of Commerce and the China Securities Regulatory Commission, effective from January 2006, permits foreign investors to purchase A Shares in Chinese companies where those companies have completed certain shareholding reforms. The rules initially provided that the investor, or the parent of the investor, must have tangible overseas assets of not less than US$100 million or at least US$500 million under management.
From 1 July 2006, investment companies which are partly owned by a foreign party may also participate in the strategic investor scheme with registered capital of just US$30 million.
The key restriction is that the A Shares purchased by the foreign investor are subject to a three-year lock-up period. The impetus for this scheme is to promote strategic investment from large-scale offshore entities which may, in turn, have the experience and resources to assist Chinese-listed companies to enhance corporate governance standards over time.
Another significant development is the potential for foreign funds managers and custodians to play an offshore role in managing the investments of PRC financial institutions (many of which have previously been restricted from investing in offshore financial products).
Generally, the financial institutions to which these initiatives apply are referred to as Qualified Domestic Institutional Investors (QDIIs). The QDII program has been the subject of public discussion for many months but gained momentum recently with the announcement by the People's Bank of China in April 2006 that qualified commercial banks, insurers, mutual funds and securities institutions will be permitted to invest money in offshore financial products.
The QDII measures relating to banks promulgated in April 2006, the Interim Administrative Measures for Commercial Banks to Provide Overseas Financial Management Services, provide that PRC banks may be approved by PRC regulators to invest offshore on their own behalf or on behalf of their customers in foreign fixed-income financial products. Each of these investments must be made within a government-approved quota. A PRC bank may also select a foreign bank to act as custodian of its offshore investments on behalf of its customers and that appointment must be made in accordance with prescribed prudential, risk management and commercial criteria. To date, four mainland domestic banks, and two mainland branches of foreign banks have been approved as QDIIs.
PRC insurance companies
PRC insurance companies are permitted to invest assets offshore in foreign fixed income financial products and money market products by engaging a specialised investment institution that meets prescribed criteria, which includes possessing 10 years' business experience, US$60 million in paid-up capital or assets, and a sound corporate governance structure.
Press reports on 1 June 2006 indicated that the PRC's largest insurer, China Life, and the smaller Taikang Life, are permitted to buy foreign exchange up to a prescribed limit. This is aimed at facilitating investment in overseas markets.
PRC pension funds
In May 2006, the National Council for Social Security Funds (NCSSF) issued detailed regulations and pronouncements on the criteria international financial institutions are required to meet if they wish to be appointed by the NCSSF as an investment manager or custodian of its assets offshore. Investment managers must have been engaged in asset management for at least six years and currently manage at least US$5 billion in assets. Custodians must have a long term rating of 'A' from an internationally recognised credit rating agency, paid-up capital of at least US$5 billion or US$500 billion in assets under custody.
Mutual funds and securities institutions
The announcements made in April 2006 provide that PRC mutual funds and securities institutions will be able to pool amounts from the foreign currency holdings of domestic institutions and residents to invest in foreign securities. Reports in the business press indicate that CITCIC Securities and China Merchants Securities Co. Ltd currently have applications submitted for regulatory approval.
To date, however, there have not been specific measures or announcements made for mutual funds and securities institutions which elaborate on the qualifying criteria for the applicants, or the offshore investments managers they may appoint.
If you have any questions on the measures outlined above or any other funds management issue in the PRC, please contact one of the following.
- Nigel PapiPartner,
Ph: +61 2 9230 5179
- Jeremy LowPartner,
Ph: +61 2 9230 4041
- Derek HeathConsultant,
Ph: +61 2 9230 4233
- Mark CerchéConsultant,
Ph: +61 3 9613 8872
- John BeckinsalePartner,
Ph: +61 7 3334 3520