On November 5, the China Securities Regulatory Commis-sion (CSRC) and the People’s Bank of China (PBOC) enacted the Interim Measures for the Administration of Domestic Securities Investment by Qualified Foreign Institutional Investors (the Measures), which came into effect on December 1.
The Measures were quickly followed by:
(i) State Administration of Foreign Exchange (SAFE)-promulgated supplementary regulations for the QFII Measures on November 28 (also effective December 1);
(ii) the posting of Application forms for Qualified foreign institutional investors (QFIIs) and ‘custodians’ on December 1; and
(iii) the promulgation by the Shanghai and Shenzhen Exchanges of their own CSRC-approved implementing rules for the QFII program on December 1.
The Measures and all of the subsequent enactments create the first small breach in the wall restricting foreign participation in China’s ‘A’ share market – publicly listed shares of Chinese issuers listed on Chinese stock exchanges that hitherto could be purchased and traded only by PRC persons using the not-fully-convertible Renminbi yuan.
The intent behind the Measures is to breathe new life into China’s domestic capital markets, notwithstanding high capitalization and approval and review thresholds, and perhaps onerous restrictions on repatriation of dividends and capital gains. Those factors – along with the quality of China’s ‘A’ share issuers and the stock of listed equity available for actual investment – and the premium on ‘A’ share as compared to Hong Kong-listed ‘H’ shares (often issued by the same company), may make foreign institutions reluctant to take up this new opportunity in the immediate term.
The Measures call for QFIIs to set up a custodial relationship with a single financial institution based in China, to establish a special Renminbi bank account operated by the custodian initially to receive investment funds (converted from hard currency) and subsequently to collect investment proceeds and current income, and to appoint a single broker to purchase and sell ‘A’ shares.
Foreign investors are granted an ‘investment quota’ that is equal to the amount of investment ‘capital’ that the QFIIs are allowed to bring into China in hard currency, convert into Renminbi, and use to purchase listed ‘A’ shares. This initial quota is a marker for the amount of Renminbi proceeds on the sale of ‘A’ shares that can, after one year for most investors and three years for closed-end fund investors, be converted from Renminbi into hard currency and remitted abroad to the QFII.
All proceeds that the QFII intends to use for investment – the amount of ‘investment quota’ granted to the QFII – must be in China within three months after the issuance of a QFII permit, and all such proceeds remitted into China by the QFII must immediately be converted into Renminbi and deposited in the special Renminbi account.
QFIIs must be very significant players – with a minimum of US$10bn of assets under management for fund management companies, insurance companies, securities companies and commercial banks. There are also seasoning requirements for fund management companies (five years), insurance companies (30 years), and securities companies (30 years), and a total assets threshold for commercial bank participants (they must be ranked in the ‘top 100’ in total assets in the world). To attract medium and long-term investment, China will give priority to qualifying closed-end China funds, and pension funds, insurance funds and mutual funds that ‘have good investment records in other markets’.
Because the QFII program affects both the PRC securities markets and foreign exchange control, the CSRC and SAFE are each empowered to examine and approve various aspects of QFII activity, qualification, investment and repatriation of revenues. These approvals are separately considered and separately rendered – thus a QFII may win qualification as a QFII from the CSRC, yet not be permitted to actually make investments due to a lack of SAFE foreign exchange control approval or any approved quota.
Renminbi bonds, convertible instruments, ‘other’ financial instruments, and equities (other than ‘B’ shares) are all permitted subjects of investment for QFIIs. The subsequent Shanghai and Shenzhen Exchange implementing rules make clear however that, for the time being, QFIIs shall not be permitted to purchase and trade government or enterprise bonds. A single QFII may own no more than 10% of the ‘total amount of shares’ of a listed issuer, and (ii) no single listed company may have more than 20% of its ‘total amount of shares’ held by QFIIs. The various limitations on foreign investment in various sectors in China are to be respected even with respect to QFII investment.
The Measures create a strict regime governing the repatriation of original investment capital amounts, and after-tax returns. Most QFIIs may apply to SAFE to repatriate invested capital only one year after remittance of the same into the PRC, and in installments that may not exceed more than 20% of original investment amounts, with an interval of at least one month between installments. QFIIs that are ‘closed end China funds’ may apply to SAFE to repatriate invested capital only three years after remittance of the same into the PRC. Additional approval is required to use Renminbi ‘realized after-tax profits’ (i.e. amounts in excess of the incoming investment principal) to purchase hard currency and repatriate the same. In addition, the state maintains the power – through SAFE approvals – to disallow such distributions if the state’s ‘foreign exchange balancing’ may be disturbed.
It is noteworthy that the SAFE supplementary regulations add to the power conferred on SAFE in the Measures. These add to the power given to SAFE to adjust and shape proposed conversions of investment returns into hard currency and remittance out of the PRC, by also stipulating that SAFE may command adjustments to the time schedule for the original remittance into the PRC of hard currency to fund a QFII program – in accordance with China’s ‘international payments’ situation.