Major QFII changes seen targeting MSCI inclusion

Beijing has further liberalised the QFII scheme in respect of the quota approval process and capital repatriation rules – moves seen as targeting A-share inclusion in the MSCI global benchmark.
Major QFII changes seen targeting MSCI inclusion

China's foreign exchange regulator has unveiled significant changes to the cross-border qualified foreign institutional investor (QFII) scheme, to address concerns over accessibility to its capital markets.

The reforms include combining the current approval system for quotas with a registration approach, and allowing capital repatriation on a daily – rather than weekly – basis for all institutions.

Industry observers said the mainland authorities were seeking to strengthen the case for index provider MSCI including A-shares in its global benchmarks and to spur foreign flows into the struggling mainland stock market.

The State Administration of Foreign Exchange (Safe) announced the changes late yesterday,which it said were “to promote capital accounts’ convertibility gradually, and to expedite convenience for cross-border investments”.

Eligible licensed QFII investors will now hold a quota based on a certain percentage of their assets under management (AUM), with the initial amount capped at $5 billion and the minimum set at $20 million. Previously Safe had granted quota on a per-application basis; now firms will only need to seek further quota after they have reached their cap limit.

For QFII institutions whose assets are mostly sourced outside China, the initial quota is $100 million plus 0.2% of average AUM over the previous three years, minus any quota under the renminbi-QFII (RQFII) scheme. (Hence a $100 billion fund house would receive an initial quota of $300 million, less any RQFII quota it already has.)

For QFII institutions whose assets are mostly sourced from China – such as the overseas units of mainland fund houses – the initial quota is calculated as Rmb5 billion ($762 million) plus 80% of AUM the previous year, minus any RQFII quota.

But foreign sovereign wealth funds, central banks and monetary authorities will have a little more freedom. Such institutions will receive quota based on their investment needs rather than the percentage calculation, though they remain subject to the $5 billion cap.

Still, asset managers will benefit the most from the changes in that they will see the biggest increase in their QFII quotas, since asset owners had previously held the largest quotas. 

This the first time Safe has adopted a registration approach for its cross-border schemes, following a practice that the China Securities Regulatory Authority is promoting. Mutual fund and private fund licence applications follow a registration system. 

The new rules are effective immediately, but consultants said they had not yet been implemented officially and that QFII investors would need to wait for more details on how they would operate. 

Moreover, Safe now allows capital repatriation on a daily rather than weekly basis for all QFII institutions, to make it easier for them to move money out of China. However, there is a cap on monthly net repatriation for open-ended funds set at 20% of the investor’s total onshore AUM as of the end of the previous year.

The regulator has also shortened the capital lock-up period for all QFII investors to three months from one year. This was already the case for asset owners, government institutions and open-ended mutual funds.

The repatriation changes will particularly benefit foreign hedge funds and move QFII a step closer to RQFII, noted Shanghai-based research firm Red-Pulse. (RQFII investors could already repatriate capital from China on a daily basis.)

Safe’s moves to some extent address capital mobility and access issues, said Shanghai-based consultancy Z-Ben Advisors. MSCI had decided not to include A-shares in its global benchmark last June, citing concerns including the quota allocation process, capital mobility restrictions and beneficial ownership. The index provider's next annual review for inclusion is scheduled for June, but MSCI said it had offered China a flexible timetable.

Despite the recent volatility and capital outflows, Chinese regulators are looking to continue liberalising the domestic financial markets, said Red-Pulse. 

The latest moves come after Safe allowed QFII investors to share previously allocated renminbi quota across their open-ended mutual funds and to re-allocate quotas among different accounts, as reported. Safe also recently moved to exceed the $1 billion quota cap for certain QFII investors in order to further align the scheme with RQFII. 

Industry observers, including bankers and lawyers, expect further harmonisiation of the QFII and RQFII rules.  

A total of 279 institutions hold $80.8 billion QFII quota between them, while 157 hold $71.4 billion RQFII quota, as of January.

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