China to let foreign hedge funds raise RMB assets

Foreign hedge funds will be allowed to register and raise renminbi funds in China under a new pilot scheme, potentially before the end of this month, according to local media on the mainland.

With a forecast initial quota of $5 billion, the qualified domestic limited partner (QDLP) scheme is being finalised for rollout in Shanghai as a way to attract foreign institutions to help build the city into an international financial centre by 2020.

It also falls under the broader theme of renminbi internationalisation as diverting investments overseas is one way to ease pressure on China’s growing foreign reserves.

Chinese media firm Caixin suggests that baring impediments the scheme could be implemented as soon as this month, although Shanghai-based consultancy Z-Ben Advisers offers a more conservative timeframe of the end of this year.

Hong Kong newspaper the South China Morning Post first reported that the Shanghai Municipal Office of Financial Service would allow foreign managers to set up RMB-denominated hedge funds in Shanghai, although they are only allowed to invest outside of mainland China. These hedge funds will then need to obtain a quota from the State Administration of Foreign Exchange.

Z-Ben sees the move as one part of the China Securities Regulatory Commission’s plan to make domestic investment options more flexible and expects it to be implemented in parallel with the new Fund Law, which has now been submitted to State Council for final approval.

“The law aims to clarify a number of regulatory mechanisms, but specific rules on information disclosure, threshold and manager qualifications will be detailed in supplementary guidelines yet to be released, possibly later this year,” Z-Ben’s regional sales director Francois Guilloux notes.

“Although the particulars have yet to be determined, the larger direction that regulators are taking has now materialised.”

Z-Ben believes this new scheme will also open doors for foreign hedge funds to satisfy growing demand among wealthy investors for varied and accessible alternative investments.

But Caixin quoted an unnamed source yesterday as saying that individual investors may not be allowed to invest in these foreign hedge funds, at least initially.

All the same, once foreign hedge funds are allowed to raise funds in China they will presumably provide major competition to qualified domestic institutional investor (QDII) products being managed by onshore fund management companies, brokers, banks and trusts.

Tepid interest in QDII products to date indicates that they are failing to capture this growing demand for asset diversification, notes Z-Ben, so increased competition will presumably have a further negative impact.

“Hedge fund hopefuls must differentiate themselves from their flailing QDII competitors by emphasising the opportunities for absolute returns and full hedging unavailable through domestic private funds and QDIIs,” believes Guilloux.

Moreover, poor QDII results can be also attributed to their limited distribution capacity in China and investors’ low interest in foreign currency assets when RMB is still on an appreciation path.

Of course, these would equally be key challenges for foreign hedge fund managers seeking to enter the market as investment management products in China are still largely sold through banks, while alternative distribution channels remain underdeveloped and unreliable.