Submission to IBA Committee I Newsletter: Update on China

With China's accession to WTO in December 2001, China presents enormous opportunities for the international asset management industry, as the domestic financial market and players develop increasing sophistication. The financial regulators in China are pushing ahead with financial market reforms and regulations, across the equity and bond markets, over banks, insurance companies, securities companies, securities investment fund management companies, trust investment companies and other financial institutions. The Qualified Foreign Institutional Investors Scheme ("QFII") was introduced since 2002 and has attracted much interest and foreign investments in A-shares of domestic listed companies and bond market. All of the US10 billion investment quota has now been used up.

On the outbound investments from China, the much anticipated Qualified Domestic Institutional Investors Scheme ("QDII") was introduced in April 2006. However, the QDII scheme is less successful in that it was reported that only less than 5% of the US$14 billion quota granted has been invested. Chinese domestic investors are hesitant to invest offshore through the QDII scheme due to the anticipated appreciation of Chinese currency Renminbi ("RMB") and restrictive investment scope of QDII products.

In the institutional investors space, Chinese insurance companies and the National Social Security Fund, the national pension fund, have now appointed international fund managers to invest their foreign currency funds globally.

Global players in the asset management industry may seek opportunities in China by forming joint ventures in China. There are now 25 joint ventures since 2002 out of a total number of 59 fund management companies in China. For a newcomer to this market, the first step may be to establish a representative office in China or explore any possibility to benefit from the QDII scheme or mandates from Chinese institutional investors before establishing any actual presence in China.
 

QDII Update

The QDII scheme was officially announced in April 2006 by the People's Bank of China, the Chinese central bank, which contains the principle policies for the financial services sector on outbound investments in overseas markets by Chinese nationals and corporations. The policies are summarised as follows:

• Mainland and foreign commercial banks in China may conduct discretionary asset management business in overseas investments where RMB funds may be raised from corporations and individuals, which funds will be converted into foreign currencies and invested in overseas fixed income products;
  

• qualified fund management companies or securities companies may raise foreign currency funds from individuals and corporations, which funds may be invested in overseas investment portfolios including equities;
  

• qualified insurance companies may conduct overseas securities investment by converting RMB funds into foreign currencies and invest in fixed income products and money market instruments.
  

Numerous QDII products had been launched by banks in China and often with aprincipal guaranteed features, but the interest from Chinese investors was low.

It is worth noting that the State Administration of Foreign Exchange ("SAFE") announced in January this year an increase in the permitted amount of foreign currency fund conversion by a Chinese individual to USD50,000 per annum (from USD20,000). Such funds may be used to purchase QDII products.

On 10 April 2007, a memorandum of understanding was signed between the CBRC and the Hong Kong Securities and Futures Commission ("SFC") regarding QDII scheme which allows the two regulators to exchange information. This significant regulatory development paved the way for QDII money to be invested in securities listed on the Hong Kong stock exchange and mutual funds authorised by the SFC. Currently, there are over 1,800 SFC authorised funds and over 70% of which are UCITS funds.

On 10 May 2007, the CBRC issued its "Notice on the Adjustments to the Overseas Investment Scope of Overseas Wealth Management Business of Commercial Banks on behalf of their Clients". This Notice widens the investment scope permitted under the QDII scheme applicable to commercial banks (including Chinese banks and approved foreign banks in China). When the QDII scheme was announced a year ago, the QDII investment products (which accept Renminbi denominated subscriptions from local Chinese investors and convert them into foreign currencies before investing offshore) offered by onshore banks were limited in exposure to bonds and fixed income instruments. Commercial banks are required to apply for QDII investment quotas before issuing QDII products. It is reported that about US$14 billion in investment quotas have been granted to date.

The amended QDII scheme may have a significant impact on the Hong Kong stock market and on mutual funds authorised in Hong Kong, with the effect spreading to other markets gradually when the QDII investment quotas are increased. Global fund managers can now also act as investment managers for the QDII products which invest in equities. The key points of the new scheme are summarised below:
 

To date, the Hong Kong SFC is the only regulatory authority which has signed an MOU with the CBRC. Other overseas regulators may be expected to enter into an MOU with the CBRC.

The new policies on QDII products will initially benefit the Hong Kong stock market, the mutual funds and the fund managers regulated in Hong Kong. Global fund managers who already have mutual funds authorised in Hong Kong will have indirect access to Chinese investors. By buying QDII products which invest in mutual funds and structured products, the Chinese domestic investors will also have indirect access to global markets and securities. The new scheme introduced by the CBRC Notice provides commercial banks with potential for innovative QDII product design.

In March 2007, the China Banking Regulatory Commission ("CBRC") had issued measures to allow trust investment companies to conduct QDII business, adding to the list of players who may offer QDII products in China. To date, there have been very few reported foreign joint venture cases in trust investment companies, where such joint ventures are allowed.

The China Securities Regulatory Commission have just issued a consultation draft on the rules relating to QDII fund products promoted by fund management companies and securities companies. These developments present significant opportunities to international fund managers in managing these assets offshore or to play a sub-advisory role.
 

Update on insurance companies QDII

Early in 2007, the China Insurance Regulatory Commission ("CIRC") introduced the draft Regulatory Measures on Offshore Investment of Insurance Assets ("Draft Measures"). These rules seek to replace the provisional rules issued in August 2004 and give a wider investment scope of insurance companies' assets investing overseas, as well as establish an independent registration regime for foreign managers seeking to manage such assets.

The proposed new regime will primarily have the following impact on international investment managers acting or intending to act for Chinese insurance companies:

• managers will be required to seek approval from CIRC independently before they may act for insurance companies;

• the CIRC proposes to supervise such approved Managers on continuous basis and to conduct annual appraisal on the qualifications of such Managers; and

• the permitted investment scope of insurance funds has been broadened to include global equities and investment funds (previously investment in equities were limited to those issued by Chinese companies).
  

Under the existing rules, foreign investment managers are required to meet certain qualifications and must have paid-up capital and net capital of not less than US$60 million respectively, and assets under management of not less than US$50 billion.

Update on NSSF

In late 2006, China's National Social Security Fund Council for the first time granted overseas mandates to 10 global investment managers to manage in total USD 1 billion of the National Social Security Fund ("NSSF"). It is reported that the NSSF, China's national pension fund of last resort, has total assets worth of around USD30 billion.

The 10 managers are AllianceBernstein, Allianz, AXA Rosenberg, BlackRock, JanusINTECH, Invesco, PIMCO, State Street Global Advisors, T. Rowe Price and UBS/CICC who will respectively manage mandates in Hong Kong equities, US equities, Non-US equities, global bonds and foreign currency cash products.

QFII Update

The China Securities Regulatory Commission ("CSRC"), People's Bank of China ("PBOC") and the State Administration of Foreign Exchange ("SAFE") jointly issued new regulations effective 1 September 2006 that govern the regime allowing qualifying foreign institutions approved by the CSRC as Qualified Foreign Institutional Investors ("QFIIs") to invest in China A shares and other RMB-denominated securities in the People's Republic of China ("PRC") subject to the grant of investment quotas by SAFE.

Key relevant changes for fund managers under the New QFII rules include the following:

• The qualifying criteria for fund management institutions in terms of assets-under-management has been reduced from US$10 billion to US$5 billion for the most recent financial year. The requirement for five years operating history remains.
  
  
• QFIIs may now operate multiple securities sub-accounts with the PRC clearing and settlement house and have corresponding multiple RMB special accounts. The sub-accounts may be opened as direct accounts or nominee accounts. Where a QFII establishes a securities account for mutual funds, the account may be opened in the direct name of "QFII+fund". It is expressly provided that assets in such account belong to the relevant fund and are independent of the QFII and the custodian.
  
  
• The new regulations no longer set out the specific requirements with respect to remittance and repatriation, but instead provide that remittance, repatriation and any lock-up period shall be as adjusted by SAFE based on the economic and financial situation of the PRC, foreign exchange balance of payments and according to arrangements set by the PBOC. SAFE has yet to issue any supplemental regulations that specify the remittance and repatriation requirements. However, based on current practice, the lock-up period may be reduced to three months for open-ended mutual funds and similar investment bodies, and further the three months lock-up period may start to run from remittance of a certain minimum amount of the QFII quota (rather than the full QFII quota) and thereafter, remittance and repatriation may generally be made freely according to subscription and redemption requirements of such mutual funds.

For a fuller discussion on the changes under the new QFII regulations, please refer to our article entitled "Revised China QFII Rules" available from Deacons website: http://www.deacons.com.hk/eng/knowledge/knowledge_268.htm

In June 2006, the first authorised China A-shares open-ended mutual fund was launched in Hong Kong which provides the retail market with direct access to China A-shares market through the QFII scheme. This open-ended fund was made possible due to the changes to the QFII rules that have evolved to address concerns raised by fund managers. There has been notable demand in A-Shares fund products internationally.

Fund management JVs and representative offices

Foreign fund managers may find potential opportunities of business in China through establishing joint venture fund management companies.

A. Fund Management Companies(minimum registered capital of RMB100 million) . Since 2005, foreign fund managers may take up to a 49% stake in a Chinese fund management company and this may be done through acquisition or green field options). The scope of business of a fund management company in China includes:-

• promote and manage domestic retail mutual funds, QDII funds
  
  
• as adviser to foreign managers or mutual funds
  
  
• manage mandate for National Social Security Fund's domestic assets
  
  
• manage enterprise annuity funds (voluntary pension schemes)
  

Qualification requirements for foreign shareholders of joint venture fund management companies include (i) with more than RMB 300 million (US$36 million) in paid-up capital; (ii) no regulatory violations over past 3 years and reputable and financially sound; (iii) home regulator has signed Memorandum of Understandings with the CSRC; and (iv) experience in asset management (public funds),)

B. Representative Office

Rather than holding a stake in a PRC fund management company, a foreign player may prefer to establish a representative office in China:

• The permitted scope of activities of a representative office may include "information and communications, liaison, market research and other activities not involving the operation of a business".
  
  
• Fund management companies may apply to establish a representative office in China under the Administrative Measures on Representative Offices in China of Foreign Securities Related Enterprises.
  
  
• Bank or other financial institutions may apply to establish a representative office in China under the Administrative Measures on Representatives in China of Foreign-Funded Financial Institutions.

Taiwan private offerings

Regulations are in place permitting private offerings of offshore funds to be made to (i) banks, securities firms, trust companies, insurance companies or such other legal persons or organisations as may be approved by the supervising authority, where the number of offerings are unlimited; and (ii) such natural persons, legal persons or funds that meet conditions prescribed by the supervising authority, the persons to which a private offer is made under this second limb not to exceed 35 in number.

In (ii) above, a "natural person" means (a) an individual who has net assets exceeding NT$10 million in value or an individual whose net assets when combined with his/her spouse exceed NT$1.5 million per annum or whose income during the past 2 years, when combined with his/her spouse's income during the past 2 years, exceeds NT$2 million. A "legal person or fund" would need to have a total assets exceed NT$50 million in value or a trust created pursuant to a trust deed and holding assets in excess of NY$50 million in value. The relevant regulations also impose an obligation on the offshore fund entity to conduct due diligence on its potential investors and obtain sufficient evidence from such investors in order to certify to the supervising authority that such investors are qualified investors.

There are two ways to conduct a private placement of an offshore fund in Taiwan. The first way is for the offshore fund entity to conduct the private placement by itself. Alternatively, the offshore fund entity may engage a local bank, a trust company, a securities firm, a securities investment trust enterprise or a securities investment consulting enterprise as its agent for the purpose of conducting the private placement (i.e. through a local agent).

The practical difference between an offshore fund entity conducting the private placement by itself and engaging a local agent to conduct the private placement is evident in two areas, namely: (a) foreign exchange implications on the investors' investments; and (b) who submits the required filings to the supervising authority. A filing must be made to the Securities Investment Trust & Consulting Association with a copy to the Central Bank within 5 days after the initial closing of the offshore fund entity. Any changes in the investors and /or their investment amount after the initial closing should be documented in a variations report and must be filed with the authority by the 5th day of the month immediately following the month in which a change took place.