Guo Shuqing's call for retail flows: aimed at ETFs?

The chairman of securities regulator CSRC, Guo Shuqing, has made a call for a bold expansion of programmes admitting overseas investment into domestic capital markets, including opening to retail investors -- not just to invest into China, but to enable domestic residents to invest overseas.

This could mark the countdown to efforts by China to get its stock market admitted to the MSCI Emerging Markets Index, where a technical obstacle is daily liquidity. The ability for retail investors to freely trade in and out of a market is a critical condition for MSCI.

Guo did not mention global indices or other ambitions, but custodian bankers tell AsianInvestor that the CSRC has recently held discussions with global bankers and mainland fund houses on its desire to get A-shares included in the MSCI GEM index by the end of 2013.

Bankers say the question of daily liquidity is the biggest hurdle. The sheer size of global emerging-market ETFs means big restrictions must remain on their accessing Chinese stocks.

But the CSRC and the State Administration of Foreign Exchange could negotiate with MSCI on limiting flows and  ETF quotas; the hard part is first creating a mechanism to allow some degree of daily liquidity.

That desire dovetails with what the chairman of the China Securities Regulatory Commission says his team is doing: reviewing regulations regarding renminbi-denominated qualified foreign institutional investors (RQFIIs), to make these flows a bigger part of the Chinese stock market.

That expansion could include creating a new RQFII quota system for offshore retail investors and non-Chinese financial institutions, as well as simply adding new quota amounts.

Currently both RQFII and its hard-currency predecessor, QFII, cater only to institutional investors, and RQFII mandates have gone just to China-connected financial groups in Hong Kong.

Guo says RQFII quotas should be thrown open to all of the 900 financial institutions licensed in Hong Kong, assuming they meet other eligibility criteria.

RQFII began in December 2011, enabling the offshore subsidiaries of Chinese financial institutions to directly invest in mainland equity and bond markets, in renminbi. It has since expanded to include exchange-traded funds.

"QFII and RQFII put together account for 1.5% to 1.6% of the total present A-share market," Guo says, speaking at the Asian Financial Forum staged in Hong Kong yesterday. "We can increase by 10 times or nine times."

As at the end of December, QFII and RQFII quotas amounted to $37.4 billion and $10.7 billion, respectively. The total market cap of the Shanghai and Shenzhen bourses is around Rmb20 trillion ($3.2 trillion).

Guo's remarks suggest that foreign inflow quotas could reach almost $500 billion, although he declined to specify over what time period.

Consider that a single emerging-market equities ETF, iShares' MSCI Emerging Market Index (EEM) ETF, has over $48 billion of assets under management, and the challenge to opening these to trading A-shares becomes obvious.

Were China to account for around 14% of the index, as its market cap suggests it should, a single ETF's allocation would account today for about one-sixth of the entire QFII quota.

Guo says that the CSRC also wants to liberalise capital outflows. The qualified domestic institutional investor programme could also be extended to Chinese individuals.

Cindy Qu, analyst at Z-Ben Advisors, says fund managers should not expect a big-bang opening; quota expansions will be gradual. The tricky part will be to align the timing of admitting retail investors to participate in both RQFII and QDII programmes. She reckons this is necessary to enable investors to trade freely.

This lack of daily liquidity is considered a major impediment to China's eventual admittance to the MSCI Emerging Markets World Index.

Another is how to reform RQFII quotas which require a minimum 20% allocation to the inter-bank bond market. That could also create complications for equity ETFs, implying that the CSRC will need either to fully liberalise these programmes or to create additional tracks, but at the cost to liquidity and efficiency.