A Comprehensive Overview on China’s Qualified Foreign Institutional Investor (QFII) Phase 2
In a significant move towards liberalising its financial markets, China introduced the Qualified Foreign Institutional Investor (QFII) system in 2002. This system marks the first instance where large foreign institutional investors are permitted access to China's "A" share markets, which were previously restricted to domestic investors using Renminbi (RMB). The QFII system is set to enhance the dynamism of China’s capital markets by attracting foreign capital, although with stringent regulatory controls.
What is the QFII?
The QFII system was enacted by the China Securities Regulatory Commission (CSRC) and the People's Bank of China (PBOC) on November 5, 2002, and came into effect on December 1, 2002. Under this system, qualified foreign institutional investors are allowed to convert foreign currency into RMB to invest in China’s domestic securities, specifically the "A" shares listed on Chinese stock exchanges. These shares, until the implementation of the QFII measures, were exclusively available to Chinese nationals.
The primary objectives of the QFII system are to:
• Infuse foreign capital into China’s financial markets.
• Enhance market liquidity.
• Improve the overall quality and transparency of the market by introducing global standards and practices.
Key Components of the QFII Measures
The QFII measures require foreign investors to establish a custodial relationship with a Chinese financial institution, set up a RMB bank account for investments, and appoint a single broker to manage transactions. SAFE grants an investment quota to foreign investors, determining the amount of foreign currency that can be converted into RMB for purchasing securities. Participants must manage at least USD 10 billion in assets and meet stringent financial and operational standards. QFIIs must work with an in-country custodian to manage their investment quota and a single broker for transactions.
Permitted investments include RMB-denominated financial instruments such as stocks, treasury bonds, convertible bonds, and corporate bonds. QFIIs can repatriate invested capital and profits only after a specified period and with SAFE’s approval. CSRC and SAFE conduct annual reviews to ensure compliance, with penalties for violations.
Implications of a Second Phase of Regulation
The initial phase of the QFII system has laid the groundwork for integrating foreign investment into China’s capital markets. A second phase of regulation could further liberalise these markets and address some of the initial system’s limitations. Potential developments in the second phase might include:
• Increased Quotas and Expanded Access: Allowing larger investment quotas and expanding the types of securities available for investment.
• Streamlined Approval Processes: Simplifying regulatory and approval processes for easier market entry.
• Enhanced Market Liquidity and Fungibility: Making "A" shares and other instruments more liquid and aligned with global markets.
• Improved Regulatory Coordination: Strengthening coordination between regulatory bodies for efficient monitoring and reporting.
• Diversified Investor Base: Encouraging a broader range of institutional investors to reduce market volatility.
The QFII system represents a crucial step in opening China’s financial markets to the world. While the initial measures are designed to ensure controlled and regulated entry of foreign capital, the second phase of regulation holds the promise of further liberalisation, increased investment opportunities, and enhanced market integration. As China continues to evolve its financial landscape, the QFII system will likely play a crucial role in shaping the future of global investment in China's expanding economy.