QDII licences could be more lucrative as rules are eased
China has granted its first qualified domestic institutional investor (QDII) licences to three banks, which are now allowed to invest abroad on behalf of their clients.
Do not expect financial fireworks any time soon. The first licensees are limited in what they can buy and for the time being the prospective returns offer little inducement to invest overseas.
That may change in the future. If the State Administration of Foreign Exchange (Safe) allows asset management firms to invest abroad, things could become much more interesting. In fact, for those lucky enough to get it, QDII status could amount to a low-risk licence to print money.
Right now, it is doubtful whether the onshore customers of Bank of China, Industrial and Commercial Bank of China and the mainland subsidiary of Bank of East Asia are jumping up and down with excitement. Between them, they can invest up to US$4.8 billion on behalf of their mainland clients. Unfortunately, there is little that they are allowed to buy that looks attractive.
Under the regulations, banks are restricted to buying fixed-income bonds rated as investment grade; that is, BBB or better.
Initially, at least, mainland investors in search of diversification are likely to adopt a conservative stance. That means buying only the debt of trusted issuers, typically the US Treasury or US government agencies and perhaps reputable issuers closer to home, like the Hong Kong government or MTR Corp.
At the moment, AAA-rated 10-year US Treasury bonds are yielding a fraction over 5 per cent. By staying at home, an investor would earn only 3 per cent in equivalent Chinese bonds, so venturing abroad would return a 2 percentage point yield advantage.
Unfortunately, however, our investor would also be running a currency risk. Right now, the offshore market in non-deliverable currency forwards is pricing in a yuan appreciation of 3.5 per cent against the US dollar over the next 12 months. That is more than enough to wipe out all the yield gains of buying US Treasury bonds. Suddenly, being a QDII looks a lot less attractive.
Investors could bump up their yield by buying riskier bonds. Holding Hong Kong government or MTR paper would get them an extra 0.7 per cent a year. Buying A-rated US corporate debt would earn them an extra percentage point. But investing in bonds as a QDII still looks like a money-losing proposition.
But if the authorities grant QDII status to asset management companies, who under Safe's regulations would be allowed to invest in overseas equities and derivatives, holding a licence would become much more attractive. For example, licensees would be able to arbitrage between mainland-listed A shares and Hong Kong-listed H shares.
Consider the price movements of BOC shares. Since their Shanghai listing three weeks ago, BOC A shares have appreciated by 12.34 per cent. Over the same period the H shares have dropped by 5.83 per cent in yuan terms.
If an investor had been able to buy the A-share issue and simultaneously sell H shares short, he would have earned a total return of 18.5 per cent in just three weeks. That is not bad for a trade which - in theory at least - eliminates the overall market risk of equity investment.
Holding a QDII licence could become even more lucrative if ICBC goes ahead with plans for a simultaneous A-share and H-share issue at a single price. With the authorities keen to attract international finance professionals as long-term investors, the issue price will be determined by conservative global institutions buying into the larger Hong Kong tranche.
That figure is likely to look cheap to less price-sensitive investors in the onshore market. As a result, the sheer weight of onshore demand could send the A shares sharply higher relative to the H shares on listing.
For investors able to trade in both markets, it should all make for a very tasty free lunch.
