The State Administration of Foreign Exchange (Safe) removed the total $300bn quota set for the entire QFII programme and individual quotas assigned to each QFII and RQFII last week. The decision, other than helping to attract more foreign capital, also demonstrated China’s effort to revive the country’s two oldest access schemes.
Reformation of QFII and RQFII has accelerated since 2016, after the launch of the Shanghai-Hong Kong and Shenzhen-Hong Kong Stock Connects. The same year, the China Securities Regulatory Commission (CSRC) cancelled a requirement that at least half of the QFIIs’ investments must be in stocks. It went up a gear in June 2018, by removing the three-month lock-up period on repatriation of principals and the 20% cap on repatriation of principal and profits from QFII investments.
While those developments are positive, they have only scratched the surface when it comes to turning the QFII and RQFII schemes around.
What China needs to do is remove two big obstacles present in the access schemes and in almost all of its market opening-up measures — strict outbound capital controls and onerous administrative procedures.
A key reason why foreign investors moved to the Stock Connects is they offer easier repatriation of proceeds. After all, foreign investors will be trading through Hong Kong SAR, a much more open market in terms of capital controls.
Although regulators did make attempts to make repatriating profits from QFII and RQFII investments easier, foreign investors still face a considerable number of barriers remitting money back home.
For example, the Chinese tax authorities and Safe require QFIIs and RQFIIs to file their investment profits with local tax bureaus. Further, the QFIIs and RQFIIs have to present “stamped” filings to the remitting banks before the banks can repatriate their schemes’ proceeds offshore. These requirements have slowed down repatriation and disincentivised foreign investors from using QFII and RQFII.
What is more curious is that the filings are no longer used to determine the amount of tax liabilities foreign investors have. Rather, their sole function is to help Safe keep track of capital outflows generated by foreign investors. For now, foreign institutional investors are exempted from tax on interest gained from investing in Chinese domestic bonds and equities.
In addition, Safe reserves the right to jump in and control QFII repatriation if China’s national economic and financial situations change or it needs to maintain supply and demand in the FX market, according to the most recent rules governing QFII and RQFII.
The clause has existed for years, despite suggestions from market participants and trade associations that it should be scrapped. This year, for example, China has tightened capital control quite a bit compared with last year, onshore bankers believe.
This tight control doesn’t work for foreign investors, who want laws to protect their ability to repatriate money offshore rather than being subject to the whims of Chinese regulators. The concern has also been heightened recently since foreign ownership of Chinese securities is set to rise dramatically due to index inclusions of Chinese bonds and equities by global index providers.
The nail in the coffin for QFIIs and RQFIIs is the fact that the CSRC only allows them to be traded through three brokers on the Shanghai Stock Exchange and three on the Shenzhen Stock Exchange. This makes it hard for foreign institutional investors to offer more choice to their clients and discourages open competition among onshore brokers.
All these are enough reasons for foreign accounts to ditch QFII and RQFII. That they have stepped back from them is already clear. Only $111.4bn of the $300bn aggregated QFII quota had been allocated to foreign investors by the end of August, according to Safe. And only Rmb693.3bn ($97.4bn) of the Rmb1.99tr RQFII quota available was taken up.
That’s not to say the two channels don’t offer perks. QFIIs and RQFIIs can bid in primary market activities, such as onshore IPOs, which offers much higher profitability than trading in China’s secondary market in China.
Secondly, the scope of available securities is much wider for QFIIs and RQFIIs compared to their Stock Connect counterparts. For Stock Connect participants, only stocks that belong to the four key indexes or those that have corresponding H-shares listed in Hong Kong are eligible. But for QFII and RQFII schemes, bonds, stocks, warrants, funds and index futures are all eligible, providing foreign investors more hedging tools.
There are key benefits for using one access channel over the other. But if the regulators have set their sights on reforming QFII and RQFII, there’s more work yet to be done.