As financial markets continue to wrestle with the after-effects of COVID-19, China is in the midst of an impressive resurgence. The country’s onshore bond market — valued at $16 trillion — is the second largest in the world, while its domestic stock market capitalisation now stands at $10.08 trillion, a new record and second only in size to that of the US.
Despite the compelling return opportunities currently available in China, local investors still account for the majority of all trading activity. Although foreign participation in the local market has steadily increased following index inclusions, just 3% of Chinese bonds are held by international investors. Similarly, global investors own only 5% of onshore China equities.
Through further liberalising measures, Chinese regulators are now hoping to accelerate the flow of inbound capital into the country’s fixed income and equity markets.
QFII and RQFII regimes are streamlined
Effective November 1, Chinese regulators introduced a number of positive changes to the QFII (Qualified Foreign Institutional Investor) and RQFII (Renminbi Qualified Foreign Institutional Investor) regimes by making it easier for global investors to trade onshore. Firstly, market access for investors has been simplified.
“The QFII and RQFII investment quotas were abolished in June 2020 by SAFE (State Administration of Foreign Exchange). Furthermore, the track record and AUM eligibility requirements for QFIIs seeking authorisation were relaxed as well. Chinese authorities have also opened up the door for alternative asset managers to trade in the local market,” said Aashish Mishra, regional head of direct custody and clearing for Asia-Pacific at Citi.
The QFII application process has been further streamlined with the introduction of e-filing and a promise by the CSRC (China Securities Regulatory Commission) to approve new QFII licenses within 10 working days instead of 20. Elsewhere, the reforms mean global institutions can gain exposures to a wider range of investment products.
“Following the rule changes, investors can engage in securities lending, securities borrowing and bond repos in what will help firms to improve their returns. In addition, QFIIs are now allowed to subscribe to private funds issued by local managers as well as WFOE (Wholly Foreign Owned Enterprises) private fund managers. This will not just be of benefit to QFIIs interested in FoFs (funds of funds) but it will also help WFOEs when fundraising in China. We also anticipate that commodity futures will become available to QFIIs next year,” added Mishra.
Safety first: Enhanced local custody rules
Having been limited to appointing just one local custodian in China, QFIIs are now permitted to have multiple sub-custody relationships. Not only will these changes allow QFIIs to benefit from counter-party risk diversification, but it also opens up a number of commercial opportunities.
“As China continues to open up their markets to foreign investors, QFIIs will look to take advantage of the new financial instruments available to them, expand their network inside China and reduce counter-party and concentration risk," said Bryan Murphy, Global Head of Intermediaries Client Coverage at Citi.
"Many existing QFIIs have legacy custodial relationships based upon licensing or distribution of investment products, and the ability to appoint additional sub-custodians is likely to generate more competition, innovation and efficiency and will ultimately bring better service levels to the onshore market,” added Murphy.
Making for a more attractive investment environment
By optimising the QFII authorisation process; deepening the pool of financial products that can be freely traded by foreign institutions; and introducing meaningful reforms of the local custody rules, Chinese market regulators are playing a significant role in helping to stimulate inbound investment.