QDII funds get bite of China's A-shares
By Olivia Chung
HONG KONG – Changes to China's Qualified Domestic Institutional Investor (QDII)
scheme announced at the end of the year appear to tug in opposite directions a
project initially set up to allow Chinese people to invest in overseas
securities through authorized financial institutions.
One change to the scheme, which offers an overseas outlet for domestic savings
while the country's currency, the yuan, remains not fully convertible, makes
Britain the second overseas market after Hong Kong in which Chinese banks can
invest QDII funds.
The US markets are expected to be next in line for opening to QDII funds. Li
Fuan, head of the China Banking Regulatory
Commission’s innovation supervision coordination department, last month said
agreement was reached during the two-day third Strategic Economic Dialogue with
the US in December to allow Chinese banks to invest clients’ money in US
markets.
According to the Shenzhen Daily, Li didn't give a specific timetable for
implementation of the QDII expansion, saying only that it would happen "very
quickly".
The expansion will help financial institutions to diversify risks and was
broadly welcomed by the domestic media and economists. A second notable change
in QDII rules had a more mixed reception, with some economists and analysts
describing it as "ridiculous" and "unreasonable".
On December 12, China's fund management firms, securities brokerages and banks
- the main implementers of QDII funds - received a "gauge document" from the
China Securities Regulatory Commission (CSRC) stating that QDII funds can in
future be invested in mainland as well as overseas markets. That means the
funds can be used to trade in yuan-denominated A shares listed in Shanghai and
Shenzhen.
The change was seen by some as another move by the regulator to prop up the
QDII scheme, which has failed to develop as quickly as initially intended.
Others saw it as a reaction to faltering local markets, which after raising
concern of overheating early in the year as they continued the strong gains of
2006, have declined by about 20% since November, threatening the holdings of
millions of retail investors who have little other outlets to increase their
savings.
The QDII scheme, launched in April 2006, is at present the only legitimate
channel for mainland Chinese investors to buy overseas equities. Under the
program, Chinese banks, fund managers and insurers are allowed to invest in
securities, government and corporate bonds and fixed-income instruments on
overseas markets within certain quotas.
One purpose behind the scheme, which allows individuals to convert yuan funds
freely for capital investment overseas, was that it would help trim expansion
of the country's growing foreign exchange reserves, curb excessive liquidity in
domestic markets and reduce pressure on the Chinese currency to appreciate. It
is was also part of moves to liberalize the yuan on the capital account.
China several years ago liberated the yuan in the current account, which
roughly speaking deals with daily flows of money. It only partly opened the
capital account, through the QDII and Qualified Foreign Institutional Investor
schemes, by which overseas funds can enter the mainland market. Only when the
yuan is free on the capital account will it be a fully convertible currency.
"Easing foreign exchange reserve pressures is part of the aim of the
introduction and expansion of the QDII scheme, but more important is further
liberalizing the yuan on the capital account," Guo Song, director of the
capital accounts department at the State Administration of Foreign Exchanges
(SAFE), said at a forum in Beijing in November.
By the end of last March, just before the QDII scheme was launched on April 18,
China's foreign-exchange reserves, propelled by a huge trade surplus and
foreign direct investment, had reached US$875.1 billion, up 32.8% year-on-year.
This amount helped to drive up liquidity in domestic markets and intensified
pressure on the government to allow a faster appreciation of the yuan against
the US dollar.
The QDII scheme was seen as a way of cooling local stock markets by offering a
new channel for the country's more than 100 million stock investors, who have
little more than 1,000-plus companies listed on the Shanghai and Shenzhen stock
exchanges to put their money into. Local and foreign-currency savings had risen
to 31.8 trillion yuan (US$4.4 trillion) by the end of March, of which around
half was from households, according to the figures provided by the People's
Bank of China.
Even so, funds continued to pour into the local stock markets, seen as offering
better returns than overseas outlets even before the subprime mortgage crisis
in the US had started to be felt around the world. China's CSI 300 Index, a
measure of stocks on the Shanghai and Shenzhen exchanges, rose about 160% last
year. That compares with a maximum gain of about 60% in the Hong Kong benchmark
Hang Seng Index.
Some economists said the strength of the A-share market, with the better
returns it offered, was one reason behind the change to allow QDII funds to
invest at home even though the scheme was intended to ease excessive domestic
liquidity.
"QDII should abide by the following rule: capital flows to where profits and
returns are high. That's why the funds can be invested 100% locally or abroad,"
said Wang Lianzhou, a retired securities law professor who led the QDII
Drafting Committee.
The QDII "should be built on sufficient conditions and a solid foundation", he
said. "Its investment performance has not been satisfying ... So the move by
the CSRC is affirmative in correcting the problem once it was found."
As of December 31, the per-share net asset value of the first batch of QDII
products had all fallen below one yuan, translating into a paper loss for
subscribers as the funds were sold at one yuan a unit. For example, Huaxia
Global Selected Stock Fund reported a per-unit net asset value of 0.893 yuan,
Southern Global Selected Stock Fund reported a per-unit net asset value of
0.937 yuan and Harvest Overseas Fund reported 0.897 yuan.
Investment in mainland markets has also been made more attractive by the
appreciation of the yuan since the government scrapped the currency's direct
link to the US dollar in July 2005. The yuan strengthened about 7% last year
and forward contracts indicate it may gain a further 9% against the US currency
this year. Even so, the domestic stock market has declined by about 20 per cent
since November, as government measures such as increased interest rates to cool
the economy have started to bite.
By that light, the gauge document was also "a responsible move for regaining
investors' interest", Wang said.
Zhu Geyu, director of marketing at China International Fund Management Company,
one of the fund managers approved to invest in overseas stocks, said it was
wrong to say permission to invest in the domestic market was granted due to the
temporary loss in value of QDII products.
"Every policy launch is considered from the angle of long-term development by a
regulatory authority, which would not change a policy solely because of
short-term volatility or temporary drop of the products' initial-offer prices,"
he said.
He said the gauge document confirmed institutional investors' right to choose
where to put funds and was in line with the QDII products' concept of global
investment.
The QDII scheme was introduced with an initial total quota of $14.2 billion,
and 17 banks and funds were awarded quotas to invest overseas. Only $4 billion
was remitted as of March 2007, due to restrictions imposed by the authorities
on the design of QDII products, the appreciation of the yuan and the greater
returns to be gained from investing in the domestic stock market.
Beijing later eased regulations to include brokerage houses and other
institutions to invest through QDII, so that the total investment quota had
reached $42.17 billion as of the end of September, of which $16.1 billion was
granted to banks, $19.5 billion to fund management companies and $6.57 billion
to insurers, according to the 21st Century Economic Herald.
Among institutions granted QDII quota are 20 insurers including China Life
Insurance Company, Ping An Insurance (Group) Company, PICC Property and
Casualty Company and China Reinsurance Company, the China Insurance Regulatory
Commission said at the end of November.
The expansion of the QDII to mainland stocks was criticized by Yi Xianrong, a
researcher with the Institute of Finance and Banking under the Chinese Academy
of Social Sciences (CASS). The scheme, as implied by its name, was for
investing in overseas markets, he said
"Allowing QDII to invest in the A-share market will only mean it will miss its
goals of reducing excess liquidity and foreign exchange reserves. Meanwhile,
there are many A-share funds in China for those who want to buy domestic
shares, so it's ridiculous for the institutional investors to buy A shares
after trying so hard to get the QDII quotas," he said.
"The possible high returns from the soaring A-share market should not be a
reason for the new change as each market has ups and downs."
Issac Meng, a Beijing-based economist at BNP Paribas Securities, echoed Yi's
views, saying it was ridiculous for QDII funds to invest in A-shares as this
would cause operational and regulatory issues. "The change might pose
operational issues such as how the awarded quotas should be divided into
overseas or A-share markets, or if the institutions with QDII quotas need to
ask for extra quotas for the A-share market," he said.
Industry players expect the amount of QDII funds that will flow into A-shares
to be less than the amount going overseas. Zhu, from China International Fund
Managemement, said funds could be used for combinations such as "China and
India" investments that would include A shares.
Hao Kang, fund manager of the China Opportunity Global Stock Fund at ICBC
Credit Suisse, argued that the change extended the institutional investors'
"right to choose" in investing in overseas markets, which in turn would enhance
their profit opportunities at different stock markets.
"However, given that time for China to fully open its existing capital market
to the world is not ripe, even if QDII funds will be allowed to invest in the
A-share market, the proportion of funds under my management that will be
allocated to the A-share market will be limited to about 10%. The fund will
focus on overseas markets," Hao said.
Wang Jingxin, an analyst at Guosen Securities, expected the proportion of QDII
funds that will be allocated to the A-share market to be limited in the short
term. "I don't think much of the share of funds will be invested in the A share
market. Otherwise, the QDII funds will turn out to be A-share funds," he said.
An official at China International Capital Corp (CICC), who asked not to be
named, said "priority will be given to H shares, though the QDII quotas will be
allowed to invest in A-shares and other overseas markets, as we know the Hong
Kong stock market better". H shares refers to mainland-incorporated companies
listed in Hong Kong.
CICC, in which Morgan Stanley holds a 34% stake, said on December 17 that it
had received a $5 billion quota for its QDII fund and expected to launch a
product before or after the Chinese New Year in early February.
Yi, from CASS, said that despite the increasing number of markets in which the
QDII funds can be invested, H shares will benefit most as the mainland
institutions have a better understanding of the Hong Kong stock market and the
mainland companies listed there.
Jun Ma, chief economist at Deutsche Bank, expected that between $50 billion and
$70 billion will flow to Hong Kong from the mainland via the QDII program in
the next six to 12 months.
Olivia Chung is a senior Asia Times Online reporter.
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
