In a significant move anticipated by the market for some time, on June 20, 2007, the China Securities Regulatory Commission (“CSRC”) issued “Tentative Measures for the Administration of Overseas Securities Investment by Qualified Domestic Institutional Investors” (hereafter, the “Tentative Measures”).
On the same day, CSRC also issued implementation guidelines for the Tentative Measures under the name of “Circular on Related Issues Concerning the Implementation of the Tentative Measures for the Administration of Overseas Securities Investment by Qualified Domestic Institutional Investors” (hereafter, the “Circular”, together with the Tentative Measures, the “CSRC QDII Regulations”).
The CSRC QDII Regulations officially permit Chinese fund management firms and securities companies to invest in overseas equity markets.1 Preciously, the QDII regime had been limited to banks and insurance firms.
I. Background of the Promulgation of the CSRC QDII Regulations
Since the late 1970s, the sustained growth of the Chinese economy has resulted in China’s rapid increase of accumulation of foreign currency due to recurring trade surpluses, which has prompted mounting international pressure for China to revalue its currency. At the same time, the continued high rate of savings by the Chinese population is exerting pressure on Chinese monetary policy as Chinese banks trying to address excess liquidity. In addition, the increased inflow of capital into China and capital into the Chinese stock market have made it an urgent task for the Chinese regulators to search for guided channels for capital to flow out of China.
The concept of overseas investment by QDIIs has been gradually introduced in China in the last few years. In 2004, China first permitted insurance companies to invest in overseas markets. Insurance companies, however, could only invest in banking deposits, bonds, and commercial paper. In April 2006, the People’s Bank of China (the “PBOC”, China’s central bank), the China Banking Regulatory Commission (“CBRC”), and the State Administration of Foreign Exchange (“SAFE”) jointly issued Tentative Measures for the Administration of Overseas Investment on Behalf of Their Clients by Commercial Banks (the “2006 Regulations”), which allowed commercial banks to invest overseas. At the time the 2006 Regulations were promulgated, they were seen by the market as a major shift in policy as China in the past had been emphasizing policies designed to attract foreign investment while restricting investment outside of China by Chinese entities. The 2006 Regulations placed strict restrictions on the type of products that qualified banks could invest in, prohibiting direct investment in equity and its structured products.
In April, 2007, CBRC took a step further, and for the first time promulgated a set of comprehensive regulations (the “CBRC Regulations”) implementing the QDII regime for commercial banks, relaxing certain of the investment restrictions contained in the 2006 Regulations. In May 2007, CBRC issued a new circular, making certain adjustment to the CBRC Regulations. Under the CBRC’s Regulations and the new circular, although the prohibition on equity investment is removed, some restrictions remained. For example, investment in securities can not exceed 50% of the net value of the total assets of a QDII product, and investment in a single stock can not exceed 5% of the value of the total assets of a QDII product.
The latest move by CSRC with the promulgation of the CSRC QDII Regulations is just another step the Chinese regulators are taking to encourage more outflow of capital.
The market has reacted very positively to the introduction of the CSRC QDII Regulations, and expect that the CSRC QDII Regulations will provide alternative investment channels for the Chinese investors.
II. Highlight of the CSRC QDII Regulations
The CSRC QDII Regulations provide fairly detailed requirements for (i) qualifications for domestic fund management firms or securities firms that will be approved to engage in overseas securities investment, (ii) the hiring of overseas investment advisors, (iii) the use of banks as custodian of assets, (iv) fund raising in China, (v) instruments and products that QDIIs can invest in, and (vi) information that needs to be disclosed to the regulators and the public.
Below is a summary of certain key provisions of the CSRC QDII Regulations.
1. QDII Qualifications Under the New Regulations
A domestic fund management firm or securities company meeting the following requirements will be granted QDII status under the CSRC QDII Regulations by CSRC to engage in overseas securities investment:
- For a fund management firm, its net assets must not be less than RMB 200 million2; it must have been in the securities investment fund business for more than two years; and the amount of funds it manages by the end of the latest quarter, must not be less than RMB 20 billion;.
- For a securities firm, its registered capital must not be less than RMB 800 million; the ratio of its registered capital and net asset must not be lower than 70 percent; it must have been in the collective investment schemes (the “collective schemes”) business for more than one year; and the amount of funds it manages by the end of the latest quarter, must be at least RMB 2 billion; and
- Other requirements related to its financial conditions, internal control system and management employees with qualified experience.
After obtaining QDII qualification, a fund management firm or a securities company must submit its fund raising documents to the CSRC for approval.
In addition, a QDII must also file required documents with the State Administration of Foreign Exchange (“SAFE”) in order to obtain a foreign exchange allocation from SAFE.
2. Hiring of Overseas Investment Advisor
A QDII can hire a foreign investment advisor to help it with overseas securities investment. A foreign investment advisor must meet certain requirements, including, among other things, having operated an investment management business for more than five years, and having securities assets under management for the latest fiscal year of not less than US$ 10 billion. Additionally, the foreign investment advisor must be incorporated in a foreign jurisdiction whose securities regulatory authorities have signed a memorandum of understanding for the regulation of securities with the CSRC, and have maintained an effective co-operative relationship with respect to such regulations3;
The CSRC QDII Regulations also provide that when an investment advisor is authorized to make investment decisions by a QDII, the investment advisor is liable for losses incurred by a fund or a collective scheme as a result of the investment advisor’s own mistakes, negligence or failure to fulfil its obligations. It remains to be seen, however, how this provision is to be enforced. It is not clear if the CSRC will require that such provision be included in the investment advisor agreement.
3. Hiring a Bank as Custodian
When carrying out overseas securities investment business, a QDII must hire a qualified Chinese bank to serve as the custodian of the assets for a fund or a collective scheme. The Chinese custodian bank can hire a qualified foreign asset custodian to act as custodian of overseas assets. Among other qualifications, the foreign custodian’s paid-up capital for the latest fiscal year can not be less than US $1 billion, or the assets under custody can not be less than US $100 billion;
The custodian shall be liable if the assets of a fund or collective scheme suffer losses as a result of the overseas custodian’s own fault or negligence when carrying out its obligations. Again, it remains to be seen, how this provision will be enforced. It is not clear whether the CSRC will require such provisions in the custodian agreement.
4. Raising Fund in China by QDIIs
Under the CSRC QDII Regulations, a fund management firm may offer its fund products through offerings to the public pursuant to existing regulations and use the proceeds to invest in overseas securities markets. Similarly, a securities company may use collective investment schemes to raise funds in China and use the proceeds to invest in overseas securities markets. The CSRC QDII Regulations permit a fund or collective investment scheme to raise funds in the Chinese market in RMB, U.S. Dollars or other major foreign currencies. However, the CSRC has not specified the maximum amount of RMB that a fund management firm or a securities company can convert to hard currency. Rather, the regulations require a domestic institutional investor to asses its own specific needs and set a reasonable cap on foreign exchange needs. Such cap shall be filed with CSRC.
5. Eligibal Products for Investment
The CSRC QDII Regulations provide a list of overseas financial products and instruments into which QDIIs may invest their domestically raised funds. They include :
- common or preferred shares listed and traded on a stock exchanges (only from a jurisdiction whose securities regulatory authorities have signed a memorandum of understanding with regard to cooperation in securities regulation with the CSRC);
- bank deposits, transferable deposit receipts, bank’s acceptance bill, commercial paper, repurchase agreements, short-term treasury bonds and other currency market instrument;
- treasury bonds, corporate bonds, convertible bonds, residential mortgage backed securities and assets backed securities and securities issued by qualified international financial organizations;
- public funds registered in a jurisdiction which has signed a memorandum of understanding on bilateral regulatory cooperation with the CSRC;
- certain structured investment products; and
- derivatives, including forwards, swaps, options, warrants, futures and other financial derivatives listed and traded on overseas exchanges approved by the CSRC.
Although the list of products is long, CSRC has set a number of limits which regulate how much of the assets of a fund or a collective scheme may invest in each of the products. Some of the limitations are:
- bank deposits held by a single fund or collective scheme in one bank shall not exceed 20% of the net value of the fund or collective scheme;
- the market value of securities issued by one issuer (excluding government and international financial organizations) held by a single fund or collective scheme shall not exceed 10% of the net value of the fund or collective scheme;
- securities assets listed and traded on securities markets in countries and regions which have not signed a memorandum of understanding with the CSRC held by a single fund or collective scheme shall not exceed 10% of the net value of the fund or collective scheme, and securities assets of any one of such countries or regions shall not exceed 3% of the net value of a fund or collective scheme;
- funds or collective schemes must not purchase securities to control or influence the issuer of the securities or its management. All the funds or collective schemes managed by one domestic institutional investor shall not hold more than 10% of the total number of issued voting shares issued by the same entity.
- the market value of illiquid assets held by a single fund or a collective scheme shall not exceed 10% of the net value of the fund or collective scheme;
- the aggregate market value of an overseas fund held by a single fund or collective scheme shall not exceed 10% of the net value of the fund or collective scheme; and
- the total holding of an overseas fund held by all the funds or collective schemes managed by a single domestic institutional investor shall not exceed 20% of the total units of the overseas fund.
Purchase of the following categories of assets are prohibited:
- real property;
- real estate mortgages;
- precious metals or certificates representing precious metals; and
- commercial products.
The following transactions are prohibited:
- borrowing of cash except for redemption, transaction clearance, or other temporary use;
- using borrowed funds to purchase securities except for investment in financial derivatives;
- participating in short-selling transactions when not holding the underlying securities; and
- securities underwriting business.
6. Information Disclosure
Under the CSRC QDII Regulations, a domestic institutional investor is required to file a report with CSRC and make an announcement within 5 days upon the occurrence of certain events, including: (i) the change of custodian or overseas custodian; (ii) the change of investment advisor; and (iii) events involving overseas litigation and other material events. In addition, when a change of custodian or overseas custodian occurs, the relevant domestic institutional investor shall also file a report with SAFE.