Old RQFII still popular despite new China investment channels
Many observers predicted the demise of China’s old renminbi qualified foreign institutional investor (RQFII) scheme when newer, more efficient mechanisms providing access to mainland capital markets came along to replace it.
But now it looks set to remain a popular channel for foreign investors, its importance apparently underlined by the decision this week to almost double Hong Kong’s quota for the scheme.
The emergence of new access mechanisms such as the bond and stock connects, and the China interbank bond market alongside the old RQFII, some analysts say, risks creating fragmented domestic capital markets with duplication in certain areas, or simply confusing foreigners trying to evaluate the best investment channel to use.
Launched in 2011, the RQFII programme allows financial institutions to buy yuan-denominated securities in the mainland, including stocks, bonds and money market investments.
This week’s decision to increase Hong Kong’s RQFII quota to 500 billion yuan (US$73.5 billion) from 270 billion yuan shows the importance of the quota system to China’s notoriously cautious policymakers, at least for now.
The separate schemes allow regulators to more easily monitor and control flows pending a potential inward surge as the nation further liberalises its capital markets. But more importantly, policymakers worry that any resulting capital outflows could be detrimental to China.
MSCI’s decision last month to add mainland Chinese A-shares into its key emerging market indices may draw US$400 billion of inflows in the coming decade while potential inclusion of yuan-denominated bonds into global bond indices could also bring in US$1 trillion in the same period, analysts estimate.
“The increasing number of access channels into domestic market shows China’s drive to open up its capital markets to attract foreign investment, and policymakers may want to consolidate all the schemes only when these operations run very smoothly,” said Nathan Chow, an economist at DBS Bank.
Meanwhile China also made RQFII less restrictive last year, awarding approvals to foreign investors based on asset size, rather than allocating a set amount as before. This way, if the overall size of assets under management by a foreign institution grows, the quota will rise accordingly.
Barnaby Nelson, head of greater China and north Asia at Standard Chartered Bank, said 30.8 per cent of investors who are already invested in China say they are likely to continue using the QFII and RQFII channels already in place for future investments, despite the new investment opportunities on offer.
The absence of easy transferability across the access schemes means existing users can only switch to the newer schemes by reducing their RQFII holdings to zero then re-buying those positions through the Stock and Bond Connects. That incurs extra legal, compliance, operational, and management costs, Barnaby said.
Users of the Stock Connect also need to abide by daily quotas. A major reason for exchange-traded funds using the RQFII mechanism is so that when they have reached their daily limit in the Stock Connect, they can still add to investments to avoid a tracking error with the FTSE China A50.
Although RQFII quotas are generally sufficient for large institutions, they have run out for many smaller funds and ETFs, forcing them to free up quotas from other products to support their ETFs or turn down new orders from clients.
Hong Kong had exhausted its 270 billion RQFII quota by late 2014 but had to wait until now for it to be replenished amid headwinds to the internationalisation of the yuan.
Heavy-handed official intervention to shore up a near-meltdown in China’s equity markets in 2015 and strong yuan depreciation pressure last year due to slowing economic growth had lead to wariness among foreigners buying mainland securities.
However, both macroeconomic and regulatory factors are now converging to create a positive environment for the onshore bond market, according to Chi Lo, senior greater China economist at BNP Paribas Asset Management.
The forced sell-off by domestic players due to a crackdown on financial misconduct has, arguably, made the onshore yields attractive now, as have fading capital outflows, improving Chinese fundamentals and the possibility that the yuan will appreciate later this year, Lo wrote in a research note this week.
“We have used the Bond Connect on top of our RQFII quota this week as the surge in Chinese yields made them attractive,” said Raymond Gui, managing director at Income Partners, which was the first non-bank asset manager globally to receive an RQFII licence from the Chinese government in 2013.
The top five holdings of the Income Partners’ RMB bond fund-class 2 are Asian Development Bank (13.9 per cent), China treasury bills (13.8 per cent), China National Petroleum Corp (11.8 per cent), Guangzhou Metro Corp (7.5 per cent) and Zhejiang Geely Holding Group (7.5 per cent).
Eighteen countries have been granted RQFII quota for 1.74 trillion yuan, including 250 billion yuan for the US that is second to Hong Kong.