QFII/RQFII Reforms Offer a More Competitive Regime for Foreign Investors

On September 25, 2020, the China Securities Regulatory Commission (CSRC), the People’s Bank of China (PBOC) and the State Administration of Foreign Exchange (SAFE) jointly issued the new QFII/RQFII regulations, proposing significant amendments to the current QFII/RQFII regime, including unifying QFII/RQFII rules, expanding permissible investment scope, as well as streamlining the application and review procedures, overall offering a more convenient process for QFII/RQFIIs’ investments in China’s capital market, following the consultation paper soliciting public comments on January 31, 2019. The Measures for the Administration of Domestic Securities and Futures Investment by Qualified Foreign Institutional Investors and RMB Qualified Foreign Institutional Investors (“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 (“Provisions”, together with “Measures” as “New Regulations”) shall be officially implemented on November 1, 2020, thereby replacing the Measures for the Administration of Domestic Securities Investment by Qualified Foreign Institutional Investors and the Measures for the Administration of Domestic Securities Investment by RMB Qualified Domestic Institutional Investors and the relevant provisions ( “Old Regulations”).

Below we summarize the key provisions of the New Regulations.

I. Qualifications and Requirements

1.1Qualifications

The New Regulations unify the qualification requirements for QFII and RQFII. A foreign institutional investor is only required to submit the application once to qualify for both the QFII and RQFII to invest with foreign currencies or offshore RMB funds, and there is no need to apply for the QFII and RQFII qualifications separately.

Under the New Regulations, foreign institutional investors include overseas fund management companies (FMCs), commercial banks, insurance companies, securities companies, futures companies, trust companies, government investment management institutions, sovereign funds, pension funds, charity funds, endowment funds, international organizations and other institutions recognized by the CSRC. Compared to the Old Regulations, the New Regulations add international organizations and remove “other asset management institutions” as stipulated in the consultation paper. In addition, the New Regulations also remove the provision under the Old Regulations that prioritized long-term institutional investors such as pension funds and charity funds. We understand the removal of “other asset management institutions” under the consultation paper does not substantially limit the scope of foreign institutional investors qualified to apply for the QFII/RQFII qualification. Based on our observation, the CSRC has already accepted applications for QFII qualifications by overseas hedge fund managers and private equity fund managers. We have seen precedents that overseas hedge fund managers were approved and we anticipate that a few applications by overseas private equity fund managers will be approved very soon. We believe that private equity fund managers and hedge fund managers in compliance with the requirements prescribed by the CSRC shall fall within the scope of institutions recognized by the CSRC and thus may apply for QFII/RQFII qualifications.

1.2Requirements

The New Regulations abolish requirements on the minimum period of operation and size of assets under management for QFII/RQFII applicants, whilst maintaining the requirements on financial soundness, good credit records, experience in securities and futures investment, sound and effective governance structure, internal control, compliance management regime and procedures, and no record of major regulatory penalties in the latest three years or since establishment. Pursuant to the drafting statement for the consultation paper issued by the CSRC on January 31, 2019 (“Drafting Statement”), relaxation of the requirements for QFII/RQFII applicants is meant to align with the requirements for applicants under the Stock Connect, Bond Connect and the China Interbank Market (CIBM) Direct Access, so as to prevent regulatory arbitrage. With the steady opening up of China’s financial market, it is an anticipated trend in unifying the requirements for foreign investors investing in the domestic market via different channels (such as QFII/RQFII, Stock Connect, Bond Connect, CIBM Direct Access etc.). Notably, the New Regulations add a requirement that a QFII/RQFII applicant shall “have no circumstances where it may have a significant impact on the running of the domestic capital market”. We understand the CSRC may assess the possible impact of the relevant applicant’s trading strategies and investment activities on the domestic market on a case-by-case basis in determining whether to grant the QFII/RQFII qualification.

1.3Procedures for Application and Approval

Given the official removal of the QFII/RQFII quota restrictions, the New Regulations abolish the requirements for quota application and approval under the Old Regulations. Moreover, the New Regulations greatly simplify the application procedures, application documents required and approval procedures. According to the Provisions, applying for QFII/RQFII qualification now involves two steps, namely, online filing and submission of application documents. Applicants shall complete the application form on the CSRC website, and submit relevant application documents via the entrusted custodian.

In terms of the application documents, the New Regulations no longer require an applicant to provide an application report and investment plan, and abolish the notarization and certification requirements for the business license, proof of business operation qualification, and a power of attorney  authorizing the representatives signing the application form, though in practice the custodians may still require such documents for verification purpose.

Under the New Regulations, the CSRC is responsible for approving the QFII/RQFII qualifications. The review time has been shortened from 20 working days to 10 working days, which significantly speeds the process for determining QFII/RQFII qualification.

II. Investment Scope

The expansion of investment scope, among other amendments proposed under the New Regulations, is undoubtedly the most impactful for market participants.

2.1RMB Financial Instruments Permitted for Investment

The amendment includes financial futures and options, commodity futures and options, and private investment funds in the permitted investment scope.

2.1.1In terms of the products traded in the exchange market, in addition to the stocks and bonds permitted 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 (ABS) traded or transferred on stock exchanges are explicitly permitted to be traded. 

2.1.2In terms of the Inter-Bank Market regulated by the PBOC, the New Regulations explicitly include the following into the permissible scope: (i) the products traded on the China Inter-Bank Market, and (ii) the bond-type, interest-rate-type, foreign-exchange (“forex”)-type derivative products, both of which the PBOC may allow QFII/RQFIIs to trade. 

With regard to bond-type and interest-rate-type derivative products, the PBOC has clarified in the PBOC Circular [2016] No. 3 (“Circular”) and its follow-up Q&A session that various types of foreign institutional investors may conduct bond lending, bond forwards, forward interest rate agreements, and interest rate swaps based on hedging purposes, and that regulation of the investments by QFII/RQFIIs in the CIBM shall refer to the provisions of the Circular. The New Regulations are consistent with the foregoing rules of the PBOC.

As for forex-type derivative products, the New Regulations emphasize that the SAFE only allows QFII/RQFIIs to trade forex derivative products based on hedging purposes, which is in line with the Administrative Provisions on Funds for Securities and Futures Investments in China by Foreign Institutional Investors and the Q&A’s jointly issued by the PBOC and the SAFE on May 7, 2020. Accordingly, QFII/RQFIIs may trade forex derivative products based on its genuine needs to hedge against forex risk exposures arising from their domestic securities investments.

The specific types, investment restrictions and timetables of other products tradable in the CIBM are still to be determined by the PBOC according to the market conditions.

2.1.3As for fund products, the New Regulations categorize them into (i) public securities investment funds; and (ii) private investment funds whose underlying assets fall within the permissible investment scope of QFII/RQFIIs, which were legally set up by securities and futures operating institutions or private fund managers (PFMs) duly registered with the Asset Management Association of China (AMAC). Compared with the consultation paper, the New Regulations add private investment funds issued by securities and futures operating institutions, that is, private asset management plans issued by securities companies, FMCs, futures companies or their subsidiaries engaging in private asset management businesses. 

2.1.4Under 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 include the stock index futures, treasury bond futures and may also include other types of financial futures contracts in the future. Notably, that the New Regulations no longer require that financial futures trading be conducted for hedging purposes only. However, Article 8 of the Provisions provides that QFII/RQFIIs shall trade financial futures in compliance with applicable rules of the CFFEX and we understand that at this stage the regulator still insists that QFII/RQFII must trade financial futures for hedging purposes. It remains to be seen whether CFFEX will amend the existing rules on investment in stock index futures by QFII/RQFIIs and whether it will formulate relevant rules on investment in treasury bond futures by QFII/RQFIIs.

(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 such products shall include financial options and commodity options. Currently, the financial options products include the Shanghai 50ETF Options and CSI300 ETF Options listed on the Shanghai Stock Exchange, the CSI300 ETF Options listed on Shenzhen Stock Exchange, and the CSI300 Index Options listed on the CFFEX. 

2.2Margin Financing and Securities Lending

Apart from allowing QFII/RQFIIs to participate in new share issuance, bond issuance, ABS issuance, secondary share offerings, and share allocations, QFII/RQFIIs are able to engage in margin financing, securities lending and refinancing. It is worth noting that, compared with the consultation paper, the New Regulations expressly allow QFII/RQFIIs to lend out securities through securities refinancing regime in addition to borrowing securities from securities companies, which is an obvious advantage over the Stock Connect. 

2.3Timetable for Inclusion of Specific Products

Pursuant to the New Regulations, the specific types and trading methods of financial futures, commodity futures and options that are tradable by QFII/RQFIIs shall be submitted by the securities and futures exchanges to the CSRC for approval. The CSRC will consult with the PBOC and the SAFE and release the specific types and trading methods of the aforementioned financial derivatives after obtaining consent from the PBOC and the SAFE. We look forward to the regulators approving the plans submitted by the relevant securities and futures exchanges that may fully satisfy the needs of QFII/RQFIIs as soon as is practical.

III. Engagement with China Managers

Under the Old Regulations, QFII/RQFIIs may entrust domestic investment management institutions such as securities companies to conduct domestic securities investment management. The New Regulations abolish the provision and instead stipulate that QFII/RQFIIs may invest in private investment funds (i.e., private asset management plans) established by securities and futures operating institutions. It can be observed from the foregoing amendment that the New Regulations limit the possible cooperation between QFII/RQFIIs and domestic asset management institutions to one scenario, namely, a QFII/RQFII, as an investor, invests in an asset management plan and holds shares or fund units in such asset management plan, while denying the entrusted investment management model, that is, the QFII/RQFII authorizes the entrusted party to conduct investment management through contractual arrangement, under which the entrusted party is authorized to make investment decisions and trade execution with respect to relevant securities and futures account on behalf of the QFII/RQFII. This means that securities and futures operating institutions are the same as PFMs in the sense that their cooperation with QFII/RQFII clients is limited to product-level cooperation, that is, QFII/RQFII clients invest in domestic asset management plans or private funds and hold relevant shares or fund units; securities and futures operating institutions and PFMs shall not accept QFII/RQFIIs’ entrustment to conduct investment management activities with respect to the securities and futures accounts under the name of the QFII/RQFIIs based on the terms of an investment management agreement.

Additionally, the Provisions allow a QFII/RQFII to appoint an onshore PFM, which is controlled by the QFII/RQFII or under the same control as the QFII/RQFII, to provide investment recommendation services, whilst not setting any additional qualification requirements on such onshore PFM, meaning that, after the official release of the New Regulations, PFMs will be allowed to provide investment recommendation services for QFII/RQFIIs within the same group in connection with their domestic investments.

IV. Ongoing Supervision

4.1Funding Sources

When defining qualified foreign institutional investor, the Measures additionally require a QFII/RQFII to invest in domestic securities and futures markets with funds raised overseas, and also encourage a QFII/RQFII to use offshore raised RMB funds to invest in domestic securities and futures.

4.2Trade Monitoring

4.2.1Abnormal Trading

The Provisions reiterate that custodians, securities companies and futures companies are obliged to continuously monitor the trading activities and fund flows of QFII/RQFII and make timely reports on any abnormality or any violation of laws or regulations to the CSRC, the PBOC and the SAFE. The Provisions 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/RQFIIs.

4.2.2 Overseas Hedging Positions

The consultation paper provides that a QFII/RQFII shall, in accordance with the requirements of the CSRC, report its overseas hedging positions related to its domestic securities and futures investment via its custodian within 10 business days following the end of each quarter. The Provisions amend the aforementioned provision as the CSRC, based on its regulatory needs, may require QFII/RQFIIs to report their overseas hedging positions related to domestic securities and futures investments.

4.2.3 Shareholding Restrictions and Information Disclosure

Limits on the shareholding ratio provided by the New Regulations remain the same as the Old Regulations, namely, (i) a single investor shall hold no more than 10% of the total shares of an exchange-listed or an NEEQ-admitted company; (ii) the aggregate shareholding percentage of all the foreign investors in an exchange-listed or an 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 limits. The New Regulations further clarify that stricter limits on the foreign shareholding ratio as imposed by other relevant laws and regulations shall prevail. 

Compared to the Old Regulations, the New Regulations add a new provision that QFII/RQFIIs shall disclose relevant securities investment information of the persons acting in concert according to the information disclosure rules. The Drafting Statement to the consultation paper specifically emphasizes that foreign investors investing in domestic capital markets through QFII/RQFII schemes shall comply with the information disclosure rules of the listed company in order to reinforce the requirements for look-through regulation. 

Both the Old Regulations and the New Regulations stipulate that if a foreign investor’s domestic securities investment triggers a disclosure obligation, the foreign investor shall, as the information disclosure obligor, submit the disclosure documents to the trading venues through QFII/RQFII. The New Regulations emphasize that a QFII/RQFII shall be fully aware of the domestic securities positions of foreign investors under its name, and urge the foreign investors to strictly comply with the relevant rules on information disclosure. We note that the Old Regulations are silent on the penalties that may be imposed on a QFII/RQFII where it fails to ensure the performance of information disclosure obligations by its clients. However, Article 25 of the Measures explicitly lists a 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 25 due to its failure to ensure the performance of information disclosure obligations by its clients. We recommend QFII/RQFIIs carefully monitor its own compliance risks that may likely arise from its client’s violation of information disclosure obligations.

V. Non-Trade Transfer

The Provisions allow a QFII/RQFII to carry out non-trade transfers under certain circumstances. According to Article 17 of the Provisions, when a QFII/RQFII improves its investment and operation efficiency or streamlines its account structure through the means of transferring its qualification to another entity under the same control, rearranging its own accounts, or changing managers of its fund products or accounts, it may conduct non-trade transfers according to the rules issued by the securities depository and clearing institution and securities trading venues.

We believe that non-trade transfer will be more convenient for QFII/RQFIIs than the Stock Connect.

VI. Law Enforcement

Compared to the Old Regulations, Articles 25, 26 and 27 of the 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 persons directly in charge or other persons responsible, including, amongst others, regulatory talks, issuing warning letters, ordering for periodic reporting, etc.. If a QFII/RQFII commits any major violation of laws or regulations in the process of carrying out domestic securities and futures investment, the CSRC may suspend the trading activities of all relevant securities and futures accounts or take other regulatory measures according to law. The foregoing provisions provide the legal basis for the law enforcement on the violations of QFII/RQFIIs and custodians.

VII. Other

The New Regulations lift the restriction on the number of custodians that a QFII/RQFII can engage. At present, a QFII/RQFII may engage multiple custodians; if a QFII/RQFII engages more than two custodians, it shall designate one custodian as the principal reporter. The New Regulations also abolish the limit on the number of securities companies and futures companies, namely, it is no longer required that each QFII/RQFII engage no more than three domestic securities companies in each of the Shanghai Stock Exchange, Shenzhen Stock Exchange and NEEQ to trade securities, and engage no more than three domestic futures companies or securities companies in total to trade futures or options as provided under the Old Regulations. 

Our Observations

Connect schemes such as 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 the QFII/RQFII regime. It is expected that the new amendments made to the QFII/RQFII regulations, especially the significant expansion of the permissible investment scope, will support the advantages of the QFII/RQFII regime when competing with the connect schemes.

We will continue to pay close attention and will share the latest developments with our clients.