Reforms on Qualified Foreign Institutional Investors (QFIIs)

As part of China's ongoing efforts to open up its securities and futures market, Chinese authorities are working on a series of measures to reform its QFIIs and RMB Qualified Foreign Institutional Investors (QFII/RQFII ) schemes, in order to attract more overseas capital investment and boost and internationalise its domestic securities and futures market.  

On 31 January 2019, the China Securities Regulatory Commission (CSRC) released two consultation papers to solicit public comments on the new consolidated regime under the draft new measures¹ for QFIIs and RQFIIs (Draft New Measures). Key amendments include: consolidating the existing QFII and RQFII programs under a single "Qualified Investor" regime; lowering eligibility criteria for overseas applicants; and providing a much wider scope of permitted investments than currently allowed. Subsequently, China's State Administration of Foreign Exchange (SAFE) has also lifted the quota requirements and simplified the administrative requirements for remittance and repatriation of funds as well as currency exchanges by the QFII/RQFII investors, through a new rule effective on 6 June 2020.

Once officially promulgated, the Draft New Measures will significantly change the existing regulatory landscape for QFII/RQFIIs, and boost the domestic securities and futures markets and private fund industry in China. Foreign investors will be provided with more convenient access to China and greater flexibility in investing in Chinese futures and securities, among other asset classes.

Based on the timelines provided in previous consultations by the CSRC, we expect that the new provisions could come into force at any point this year, and the content of such new provisions would remain largely consistent with those set out in the consultation paper (or at least the underlying principles of the provisions will largely stay the same).

In this article, we will specifically focus on the key changes brought by the Draft New Measures to the investment scope of QFII and RQFII schemes and analyse the practical implications of the Draft New Measures to foreign asset managers and their business.

Expansion of Investment Scope

One of the most significant changes under the Draft New Measures is the expansion of the investment scope. The investment scope of covered futures products will be expanded, amongst others, from stock index futures to include both financial futures contracts and commodity futures contracts that are listed and traded on futures exchanges² approved by the CSRC.

According to the Draft New Measures, the futures exchanges will propose eligible futures contracts for QFII/RQFII to trade and will announce them after obtaining the CSRC's approval. Although specific details have not yet been provided by the CSRC or futures exchanges, it is widely expected that such eligible futures contracts could go beyond those already available to international investors (ie crude oil, iron ore, purified terephthalic acid (PTA) and technically specified rubber (TSR)) to cover more types of financial futures and commodity futures. With each of these exchanges already considering the launch of new futures products that will be accessible to offshore investors, the number of commodity futures is very likely to increase.

With the expanded scope of eligible investments, the new Qualified Investor programme is also likely to attract interest not only from participants in the capital markets space, but also those in the commodities sector, commercial banks and financial institutions with Qualified Investor status, who would be able to offer new products and services to their customers.  This is well received by the market as a positive sign to further vitalize China's futures market, as it will undoubtedly boost China's futures market, which has one of the largest trading volumes in the world.

Another noteworthy reform is to allow for QFIIs and RQFIIs to invest into private securities investment (PFM) funds, provided that the investment scope of PFM funds should conform to the permitted investment scope of a Qualified Investor. Qualified Investor will also be able to appoint its affiliated domestic private investment fund manager for investment advisory services in terms of its investment in Chinese securities and futures. The proposed opening-up of the private fund sector will likely be welcomed by QFII/RQFII investors whose affiliates have already been registered as PFMs in China.

The said move, ie a PFM can raise capital overseas or seed its own PRC onshore product within the group, is expected to ease the pressure of meeting the Asset Management Association of China (AMAC)'s requirement to raise capital and launch the first fund in a rigid timeframe. It will also significantly enhance the governance, risk management and transparency of PFM funds products which would be expected to apply more international standards in capital raising, documents negotiation and fund operation.

Prospects

There are four legal considerations for market participants to consider in relation to the QFII reform.

Firstly, the risk disclosure of offshore QFIIs and RQFIIs will change significantly upon the implementation of the QFII reform. Risk factor updates may include the risks associated with the PFM Regime, the underlying Chinese market risks associated with trading in new types of products such as futures contracts, options contracts and/or other types of derivatives, and additional counterparty risks.  

Secondly, ongoing monitoring and supervision mechanisms would also be enhanced to oversee foreign investment activities in China. Additional reporting and disclosure requirements would be introduced under the Draft New Measures, including requiring: (a) custodians, securities companies and futures companies to report any abnormal and illegal trading activities by a Qualified Investor to the CSRC, the People's Bank of China (PBOC) and SAFE; and (b) Qualified Investors to periodically disclose information as to offshore hedging positions related to onshore transactions (though how to implement this is still being debated by Chinese regulators). QFIIs and RQFIIs should consider disclosure approaches and obligations under different scenarios in light of the obligations imposed by the Draft New Measures.

Thirdly, asset management firms that have a dedicated futures strategy may now wish to consider applying through such affiliated fund managers for a QFII/RQFII licence under the Qualified Investor scheme. This could potentially provide them with another avenue for offshore access to China's commodity futures markets. Such firms should be mindful of potential issues that may arise which are unique in China's future markets, such as China's margin rules.

Fourthly, in light of QFII's enhanced capabilities to invest into China's private fund products, further due diligence should be conducted against Chinese PFMs and a deeper understanding of how a Chinese PFM operates should be pursued.

Please see more details via our Insights on CSRC QFII reforms and SAFE rules.

¹ The proposed draft measures are:

^a the Measures for the Administration of Domestic Securities and Futures Investment by Qualified Foreign Institutional Investors and RMB Qualified Foreign Institutional Investors《合格境外机构投资者及人民币合格境外机构投资者境内证券期货投资管理办法（征求意见稿）》; and
^b 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 《关于实施〈合格境外机构投资者及人民币合格境外机构投资者境内证券期货投资管理办法〉有关问题的规定（征求意见稿）》.

² These exchanges include the Zhengzhou Commodity Exchange ("ZCE"), Dalian Commodity Exchange ("DCE"), Shanghai Futures Exchange ("SHFE"), Shanghai International Energy Exchange ("INE"),  China Financial Futures Exchange ("CFFEX") and any other exchanges that the CSRC may approve in the future. Specific commodity futures products in which QFII/RQFII investors will be able to invest will be published by the relevant exchanges after obtaining consent from the CSRC.