This article was written by Stanley Zhou, Minny Siu, Stella Wang and David Mu

We welcome the recent publication of the long-awaited rules for (R)QFIIs on 25 September 2020 (“New (R)QFII Rules”[1]) by the China Securities Regulatory Commission (“CSRC”) following its two consultation papers in 2019. The New (R)QFII Rules will take effect on 1 November 2020.

In our previous alert (R)QFII: 5 things you need to know after removal of investment quota, we identified 5 tips for foreign investors intending to access onshore capital markets investments through the (R)QFII regime. A critical outstanding question as highlighted in our previous article is the actual expanded investment scope for (R)QFIIs.  The New (R)QFII Rules have completed the latest reforms to the (R)QFII.

This article explains the “last piece of the puzzle” for the recent (R)QFII reforms.

Expanded investment scope for (R)QFIIs

We summarise below the current investment scope (in blue) and the expanded scope under the New (R)QFII Rules (in pink). Importantly, some of the current restrictions and qualifications on (R)QFII’s permitted investment scope will be lifted under the New (R)QFII Rules:

The key take-away points include:

  • Shares quoted on the NEEQ – national equities exchange and quotations (“NEEQ”) is also known as the “new third board” market in China. Companies listed on the NEEQ have been looking forward to capital investments by middle- and long-term foreign investors. With the latest expansion of (R)QFII investment access to shares quoted on the NEEQ, we expect to see further growth and developments in the NEEQ market with more (R)QFIIs and foreign strategic investors.[2]
  • Financial futures contracts on the CFFEX – (R)QFIIs are currently allowed to invest in stock index futures traded on the China Financial Futures Exchange (“CFFEX”) for hedging purpose only. The New (R)QFII Rules remove the requirement for “hedging purpose”, with expansion for (R)QFIIs to trade in CFFEX financial futures contracts beyond the stock index futures.
  • Commodity futures contracts on PRC futures exchanges – as of the date of this alert, only five types of onshore futures contracts (crude oil, iron ore, PTA, TSR20 and low Sulphur fuel oil) can be accessed directly by foreign investors through a direct access model, as opposed to the (R)QFII scheme. The (R)QFII New Rules prescribe that the list of eligible futures contracts available to (R)QFIIs will be approved by the CSRC separately. It is expected that such list would be significantly broadened in comparison with the current product list available under the direct access model.

KWM has provided extensive advice to foreign institutions in accessing the onshore futures market, covering netting, bankruptcy remoteness and regulatory issues.

  • Private securities investment funds – investment by (R)QFIIs in private investment fund category is not new in practice. The CSRC had clarified at informal occasions that (R)QFIIs may enter into privately placed asset management plans (“AMPs”) launched by onshore asset managers provided that the underlying investments of the AMPs fall within the permissible onshore investment asset scope set out in the (R)QFIIs rules. The New (R)QFII Rules have now codified this regulatory practice.
  • CIBM bond repos not yet opened to (R)QFIIs – notwithstanding the latest expansion to (R)QFII investment scope, bond repos traded in the CIBM will not be opened for (R)QFIIs. Foreign investment access to CIBM bond repos are currently limited to foreign sovereign entities, international finance organisations, RMB clearing banks and participation banks. It is worth noting that the New (R)QFII Rules do expand (R)QFIIs’ access to bond repos traded in the Shanghai Stock Exchange and Shenzhen Stock Exchange. We observe that some local securities firms have been preparing their service support in exchange traded repos for (R)QFIIs starting in November 2020.

Under the New (R)QFII Rules, an (R)QFII may engage an onshore private fund manager controlled by it or under the same control for onshore investment advice to that (R)QFII. (R)QFIIs with onshore private fund management wholly-owned foreign enterprises (“PFM WOFE”) may have a niche advantage under this relaxation, and this could also spur the business growth of the PFM WOFEs.

A more friendly account structure – from an omnibus account to a fully segregated account

(R)QFII – proprietary fund (自有资金);There are three types of funds injection into the Chinese financial markets under the (R)QFII regime, namely (i) the (R)QFII’s proprietary funds, (ii) funds raised from an open-ended fund managed by the (R)QFII and (iii) the funds entrusted by investor(s) in discretionary investment management agreements (“DIMA”). (R)QFIIs adopt the naming convention below for their corresponding onshore cash and securities accounts for these funds:

  • (R)QFII – [name of the China open-ended fund (具体开放式基金的名称)]][3]; and
  • (R)QFII – client money (客户资金)

Historically, an (R)QFII used to maintain only one “(R)QFII – client money (客户资金)” account to hold their client monies irrespective of the underlying client number or the number of DIMAs entered into with the (R)QFII. An “(R)QFII – client money (客户资金) ” account typically operates as an omnibus account to hold all onshore assets held for and on behalf of an (R)QFII’s offshore clients in the same account. Clients of the DIMAs would have to rely on the (R)QFII’s proper booking records to achieve a legal segregation effect. Such arrangement is akin to a “legally segregated; operationally commingled” approach in the offshore market.

Under the New (R)QFII Rules, (R)QFIIs are encouraged to open multiple onshore accounts following the “(R)QFII – [client name (具体客户的名称)]” convention so that each client’s onshore portfolio held through the (R)QFII’s is fully segregated from the (R)QFII’s other onshore portfolios. If an (R)QFII continues to adopt the traditional “(R)QFII – client money (客户资金)” omnibus account structure, it will need to disclose the information of each end-investor to the relevant onshore exchanges, trading platforms and/or regulators.

We believe this account structure change will be highly welcomed by offshore end-clients, to better reflect the ring-fenced requirements for their respective investments through an (R)QFII. Importantly, the New (R)QFII Rules expressly recognise that the assets held in such “(R)QFII – [client name (具体客户的名称)]” or “(R)QFII – client money (客户资金)” belong to the underlying offshore clients.

A question frequently asked by (R)QFIIs was whether they should aggregate different clients’ positions held in the “(R)QFII – client money (客户资金)” account for complying their onshore disclosure obligations and monitoring foreign shareholding limit requirements. Now, the fully segregated account structure should facilitate (R)QFIIs’ assessment as to the persons responsible for the relevant disclosure of interest requirements (as well as the assessment of parties acting in concert).

KWM has assisted (R)QFIIs with respect to their offshore DIMA, participation agreements and/or custody agreement. We would be delighted to work with your institution to examine the changes and enhancement to your (R)QFII documentation to take advantage of the latest reforms to (R)QFII regime in connection with any proposed migration to a fully segregated account structure.

Other key changes

A more streamlined application process for (R)QFII licence – eligible foreign applicants can submit less and simplified application materials for (R)QFII licence and the notarisation / legalisation requirement has been removed. The prescribed period for the CSRC to issue its decision has been reduced from 20 business days (for QFIIs) / 60 days (for RQIIs) days (for RQFIIs) to 10 business days;Apart from the key points as highlighted above, the New (R)QFII Rules have included other important developments, including:

  • Relaxation on the number of onshore brokers – the PBOC and the SAFE have removed the limit on the number of onshore custodians that may be appointed by (R)QFIIs since this June. Similarly, an (R)QFII can now engage more than three onshore brokers for securities and futures investments. This relaxation could help (R)QFIIs fulfil the “best execution” obligations (if applicable) under their respective home jurisdictions;
  • Reporting of offshore hedging positions – the New (R)QFII Rules only require (R)QFIIs to report their offshore hedging activities upon the CSRC’s request (rather than on a quarterly basis as previously proposed in the 2019 consultation papers); and
  • Flexibility in off-market trades – there were uncertainties previously as to whether an (R)QFII may move certain positions from one portfolio to another in response to an offshore governance, structural or management adjustment due to the lack of clear regulatory guidance for off-market trades for (R)QFIIs. The New (R)QFII Rules expressly allow off-market trades of (R)QFIIs for the purpose of improving their investment efficiency and optimising their portfolio structures.

King & Wood Mallesons has advised many clients on structuring and legal issues relating to (R)QFII schemes, including the application for (R)QFII licence, appointment of global and PRC custodians, offshore fund-raising structures (including DIMA), ongoing regulatory requirements (including disclosure of interests) and complex cross-border transactions involving investments in (R)QFII assets and related arrangements.

Should you wish to discuss further on the implications of the latest (R)QFII regulatory developments on your business, please contact a member of KWM’s cross-border financing team.  In the meantime, we will continue to keep you updated on important Chinese financial regulatory developments through our regular client alerts and in-depth analysis.

[1]http://www.csrc.gov.cn/pub/newsite/zjhxwfb/xwdd/202009/t20200925_383649.html

[2]In this June, the Ministry of Commerce (“MOFCOM”) has published a consultation paper, proposing to attract foreign strategic investors to invest in NEEQ shares. Please see http://wzs.mofcom.gov.cn/article/n/202006/20200602975158.shtml.

[3](R)QFIIs could open multiple “(R)QFII – [name of China open-ended fund (具体开放式基金的名称)]” accounts, each for an individual China open-ended fund.