On the face of it, China’s recent move to scrap two important quotas limiting foreign investment in the country’s equities was a major step towards market liberalisation. But in reality it will make very little difference because the programmes under which the caps operated were already becoming somewhat redundant, according to analysts. In fact, the quotas that have been removed had been in no danger of being breached for at least a decade. China announced on September 10 that it would removed the quota limits on the qualified foreign institutional investors (QFII) scheme, and the renminbi qualified foreign institutional investor (RQFII) programme, a gesture that would further open its capital markets to the world. China scraps QFII and RQFII investments quota to allow unrestricted access to world’s second-largest capital market However, analysts said both equity and bond investors had been relying more heavily on other cross-border channels with better arrangements in place to allow easier access to trade in China. It was not the quotas that were constraining them from investing more through QFII and RQFII. “SAFE [China’s foreign exchange watchdog] has never refused the quota applications since 2007, especially on the back of local currency depreciation, so [even with the quotas scrapped], capital inflows will not jump in the short term,” said Xing Zhaopeng, an economist with ANZ. In particular, foreign investors have been turning more and more to the so-called stock connect schemes that allow them to buy and sell equities in Shanghai and Shenzhen, and similar channels for bond trading. “Rather than using QFII and RQFII, in recent years most foreign investors have been utilising the stock connect, bond connect and the CIBM [China Interbank Bond Market] channels to buy into domestic listed China A-shares stocks and onshore bonds,” said Anthony Wong, Portfolio Manager of Allianz Global Investors. QFII lets foreign funds invest onshore in China’s yuan-denominated A shares. The RQFII programme gives investors access to offshore yuan to buy mainland-traded stocks. As of September 11, 292 foreign institutions had applied for QFII investment worth US$111.3 billion, only 37 per cent of the total quota, which was doubled to US$300 billion at the beginning of this year. A total of 222 institutions applied for RQFII worth 693.3 billion yuan, just a third of the 1.99 trillion yuan quota. Delivering on a promise it made as a condition of joining the World Trade Organisation in 2001, Beijing introduced the QFII scheme in 2002 as a way to open up its capital market to international investors. It introduced RQFII, a similar scheme giving investors access to offshore yuan to buy mainland-traded stocks, nine years later. UBS and Nomura were the first banks to win licences to handle QFII investment from the China Securities Regulatory Commission (CSRC) in May, 2003. A few others including Morgan Stanley and Citi joined later. Foreign investors were initially subject to strict rules ranging from investible targets to capital remittance. For example, during the early days of the QFII scheme, eligible closed-end funds could only repatriate capital out of China after three years, and for each remittance the amount was not allowed to exceed 20 per cent of the total principal. The frequency for repatriation was capped at once a month. The rules were relaxed gradually. By last March, China had fully scrapped the lock-up requirement for the investment principals, and also removed the cap on capital repatriation. However, there are still thorny issues with the scheme that make it arduous to use, said Xing. Investors under the QFII and RQFII schemes still need to fill in an application form from the tax authority before transferring funds to offshore, even though they are exempt from paying tax. Secondly, their custodian banks are subject to supervision of their capital levels by the People’s Bank of China and SAFE. Sometimes it is not easy to transfer capital from onshore to offshore accounts, Xing said. Repeat of 2015 China stock market turmoil will shatter global investors’ confidence, says FTSE’s Jessie Pak By contrast, the stock connect programme, kicked off in 2014 and later expanded to the bond market, enables investors to buy and sell on a “first come, first served” basis, and has much easier settlement rules. Unsurprisingly, it has gained in popularity among investors. Statistics from the stock exchanges show average daily turnover under stock connect trading Shanghai and Shenzhen-listed stocks reached 20.1 billion yuan in August, up by 171.6 per cent from 7.4 billion yuan per day in the first half of 2015. Similarly a bond connect channel introduced in 2016, together with the China Interbank Bond Market (CIBM) which opened up to foreign investors a year earlier, have been channelling more capital inflow than QFII and RQFII, said analysts from Goldman Sachs in a report issued on Wednesday. “Given that CIBM and bond connect did not have quotas, they became the preferred market access routes since their introduction,” the report said. Jing Ning, a portfolio manager at Fidelity International, said she did not believe the scrapping of the caps alone would bring significant liquidity into domestic financial markets. Rather, the move is important symbolically. “The current QFII utilisation rate is low, while stock connect and other mechanisms offer equally easy market access,” she said. “Nonetheless, it indicates Chinese regulators’ determination to further sweeten the infrastructure for foreign investors to get access to Chinese stocks.” In January, Beijing doubled the QFII and RQFII quotas, opening the way for global funds to get a bigger bite of its domestic stock market as the government extended an olive branch to the US amid talks to end the trade war. China has been introducing more financial opening up measures since last year, as its trade dispute with the United States has heated up. The world’s largest economy is demanding fairer trade policies, greater market access, intellectual property protection, and a more level playing field for foreign companies. Now well into its second year, the trade war has seen Beijing and Washington locked in an escalating battle of tit-for-tat tariff increases on each other’s imported products. Beijing has promised that within three years it will fully scrap restrictions on foreign ownership in the financial service industry, including in banking and insurance. China now still imposes restrictions on domestic individuals investing in securities overseas. They need to go through the Qualified Domestic Institutional Investor (QDII) scheme, in which banks and asset management firms invest on behalf of individual investors after getting quotas from the government. More foreign capital has been flowing in to China’s capital markets as onshore bonds and equities have been increasingly included in popular global indices. China has recently been added to JP Morgan’s GBI-EM bond index which, according to Goldman Sachs, could bring around US$3 billion a month into the bond market from February 2020 onwards. That is in addition to its inclusion in the Bloomberg Barclays Global Aggregate index in April, which should prompt inflows of around US$6 billion a month. Because of higher foreign demand for Chinese assets, FTSE and S&P will both decide whether to expand or shrink their weighting on September 23. Global index provider MSCI will further raise the inclusion factor from 15 per cent to 20 per cent and add mid-cap stocks in November. The Chinese yuan weakened by 3.8 per cent against the US dollar in August, as trade war tension between Washington and Beijing escalated. But many investors dismissed the profit erosion brought by a weaker yuan, and are still hoarding their holdings of Chinese shares and bonds, betting on long-term growth of value in Chinese assets. “Despite the trade tensions, we remain positive on Chinese equities in light of upbeat results for the first half of 2019, government policy support and attractive valuations,” said strategists with UBS, in a report issued this week. They favoured stocks in consumer staples, e-commerce and health care. “The interim results of Chinese equities were better than expected, driven by the internet, financial and consumer sectors. While downside risks from trade linger, we remain constructive on the asset class given the government’s policy support and above average earnings growth,” said the report. Moreover, the analysts preferred Chinese onshore stocks to those listed in Hong Kong. “The former should outperform the latter because of government policy support and superior earnings growth,” they said.