What are the major developments you’re seeing in the Chinese market?
When international investors look into Chinese onshore securities, there are two major markets that they should consider. One is the equity market, which is available via the two local stock exchanges, and the other is the China interbank bond market (CIBM). Accessing each of these is quite different, but both attract international investors.
Investing in Chinese securities from the offshore market is easy, you can just buy Hong Kong H-shares or go through the stock connect programme, but the onshore market is still very restricted. It’s subject to quota systems, lengthy application processes and regulatory hurdles.
To invest in the equity market, you have to obtain a qualified foreign institutional investor (QFII) licence. The QFII scheme has been around since 2003, when China first opened up the onshore securities market to foreign investors, allowing a lot of the investors such as central banks, pension schemes, endowment funds, international asset managers and banks to access China. However, there were still a lot of restrictions.
In 2011 China rolled out the Renminbi QFII (RQFII) scheme, which is more tailored to fund/asset managers, to provide more flexibility in terms of liquidity for those financial institutions managing UCITS funds or other regulated funds.
But RQFII has its own restrictions. It works on a country-to-country level negotiation, where quotas are specifically allocated to certain countries or markets. At the moment there is a total of 17 countries/markets in the RQFII scheme, and if you’re a fund manager in a country/market that is not on the list, you will have to work through a legal entity domiciled in country/market with an RQFII quota.
The China access programmes typically start small—for example, the RQFII scheme used Hong Kong as a kind of testing ground. It was very modest, very simple, and very small in scale; but once the regulators felt comfortable that the model was working, they extended it by increasing the scale and the coverage.
Over the last three or four years, the programme has been expanding, and now it covers Australasia, the Middle East, Asia and Europe. In the Americas, however, it was only rolled out to Canada and Chile. The US was conspicuously absent until June this year, when it was finally named as an RQFII market.
What was the significance of the US being granted RQFII status?
The US is no doubt one of the biggest markets in terms of fund assets and investment managers, and it is a major financial centre, so there were questions around when it would get its RQFII quota. Once the Chinese government and the People’s Bank of China (PBOC) announced that they had grated RQFII status to the US, they gave the market a huge RQFII quota of RMB 250 billion ($37.39 billion), the largest quota ever awarded to a market at initial stage.
That is very significant. Firstly, because it means China realised the US market was a gap, and that they had been working on it, but also because it shows they’re thinking about utilisation.
In the past, the large US fund managers would have used their overseas offices, in Singapore for example, to apply for an RQFII quota, but it’s beneficial to them to have more direct access. The smaller US managers, those that focus on the US—and the US local market is a big one—can now also have an RQFII quota to buy China A-shares.
When the Chinese government sees demand from international investors, it can be very quick to react; for example they have taken similar approaches in Singapore and South Korea when they noticed high volumes of applications. China has seen that the US market will be significant for RQFII, and I think both governments will have done some research to estimate the demand, and to come to this RMB 250 billion figure.
What does it mean for the Chinese market?
In China, the domestic market is still very infant, comparatively. It started to develop in equity in the 1980s, and it is still dominated by local retail investors. It’s not a very rational market, and it is a natural evolution for the government to try to introduce more institutional investors.
Emerging markets typically have at least 15 percent, sometimes as much as 30 percent, foreign participation. At the moment, because China has historically been so difficult to access, it has foreign participation of just 5 percent. At times, this has fallen to 3 percent. These changes are opening a door to foreign institutional investors.
Liquidity is important for international investors, too. Fund managers need to know that they can get their money back in order to meet their daily liquidity requirements, not just for investors, but also to meet regulatory requirements. That is why the RQFII allows fund managers to use the UCITS structure to invest, and why it strives to remove barriers and provide more flexibility.
The Chinese economy is growing quickly; it’s already the second-largest economy in the world, but the equity stock market is not reflecting this. It’s a large stock market, and now the doors have been further opened it will benefit the market and investors alike.
How is the bond market faring?
Again, in China there is a very big bond market. The CIBM has an outstanding value of over US $7 trillion, making it the third-largest bond market in the world after the US and Japan. However, again, foreign participation is still very low, less than 1.5 percent.
The CIBM has grown very quickly, and there is a high demand for capital in China—in the past investors have had to rely on the top local banks lending. The government is trying to move on to develop a new, more sophisticated capital market, allowing investors to rely more on bond issuance to raise capital.
A lot of foreign investors are interested in these Chinese government bonds as the credit rating is relatively good—they have a yield of 2 to 2.5 percent, which is rarely found in government bonds these days.
So, the fund manager is relatively safe; given that there’s an attractive yield and good credit rating, plus the chance to get some currency gain depending on the market conditions. It’s very suitable for central banks and sovereign wealth funds, whose risk appetites are very conservative. In theory, it’s a natural matching.
Previously, investing in the CIBM involved a very long process. The fund manager had to be certified by the Chinese regulator as a QFII or RQFII, gain a quota allowance from a second regulator, and then get permission from a third regulator to buy in to the CIBM. All in all, it could take nine to 12 months, and involved a lot of work and determination.
In February, however, the PBOC amended this, so that those who want to invest in the CIBM simply have to find a bond settlement agent, like a sub-custodian in China, and complete a much simpler filing process.
How has the process been improved?
In the past, the application could have involved 11 or 12 documents for each of the three regulators. Now, all investors have to do is find a local settlement agent, such as HSBC China, and complete a much simpler registration form of two or three pages.
There is also no quota requirement. In the QFII and RQFII programmes, investors would have to tell the regulators how much they wanted to trade, and they would be granted a quota amount as decided by the regulator. There was a limitation to the amount they could trade, and if they got close to the limit they would have to flag it up and go through another process to request more quota.
Now there is less commitment to that figure. Investors can indicate how much they intend to trade, but if they exceed that, they just have to inform the PBOC via a filing process.
The changes simplify and streamline the whole process, and, working on a conservative estimate, the whole market setup process can take just two to three months.
It is a very significant change, as it not only makes access much easier for foreign fund managers, but also for central banks, insurance companies, commercial banks, pensions, active funds and passive funds, which can access China via this registration process now. It also removes geographical barriers, as funds don’t have to get the RQFII approval first.
Have you seen any immediate effects of the changes?
Since the changes to CIBM access in February, the market has responded well. One notable development is that some of the index providers have agreed to look into including China bonds in major indices, and have made this announcement public. That would be a ground-breaking move, which could change the game again for fund managers, and may encourage more capital to gradually flow into the market.
If you look at the wider picture, China is opening up more and more doors to foreign investment, and those doors are opening wider and wider. I don’t think they’re going to close again. The government wants to internationalise the currency and cement it as an investment currency, so it has to get people making use of RMB-denominated assets.
It is just a matter of time at this stage. This trend will continue, and it will affect our industry, not just in the US or Europe, but globally.