The plan is as follows: starting with Hong Kong, renminbi deposits held offshore are channeled into domestic equities, thereby further opening up China’s long-isolated capital market and – hopefully – stemming the ugly losses suffered by the Shanghai Composite Index (SCI) recently.
Though innovative, it remains to be seen whether the scheme is enough to drive up domestic equities. Markets remain uncertain, both at home and abroad.
The program, which might be launched as early as this year, has been dubbed “mini-QFII” as it will complement the existing Qualified Foreign Institutional Investor project, which lets overseas institutions trade renminbi-denominated equities in Shanghai and Shenzhen.
Just like the QFII scheme, institutions wanting to participate in mini-QFII will be required to apply for investment quotas. It has been suggested that the Hong Kong subsidiaries of five to six mainland brokerage and fund houses may be involved in a trial run. They would issue renminbi-backed funds in the city to individuals – as opposed to the likes of private equity firms – and invest the money in A-shares.
More than 20 mainland brokerages operate in Hong Kong, accounting for 9% of the market, and nine fund houses have received approval to set up there.
The initial size of the fund pool is expected to be about US$1.5 billion but analysts say this could rise to US$15 billion in coming years. The overall QFII quota currently stands at US$30 billion.
The initiative has two major underlying purposes. The first is to boost the international status of the Chinese currency. It’s no secret that Beijing hopes to promote international use of renminbi and thereby reduce its reliance on US dollar in trade settlement. To this end, the State Council last month extended a pilot program allowing conduct cross-border transactions to be conducted in renminbi.
The second purpose of the initiative is to shore up liquidity in the mainland stock market. It is interesting to note that regulators announced mini-QFII at least half a year before it can be put in place – and the announcement coincided with a slump in mainland shares and lukewarm turnover.
Commenting on the new plan, Yao Gang, vice chairman of the China Securities Regulatory Commission, said in a recent forum that his agency “has been trying to launch more such pilot programs to accelerate the mainland’s financial market opening-up process.”
The SCI is down by more than a quarter so far this year, making it one of the world’s worst performing indexes. The losses are tied to worries about government tightening and an economic slowdown. Renewed fundraising efforts by banks and other companies, tougher austerity measures to rein in inflation and action to slow property price growth may continue to weigh heavily on the mainland market.
In these circumstances, the launch of mini-QFII is intended to boost investor confidence by creating a potentially big source of liquidity rather than bringing immediate cash to the market.
Many foreign firms have complained that they lack channels through which to deal with local currency derived from trade transactions. Under the new arrangement they will be able to access the A-share market via mainland money managers.
But let’s not get ahead of ourselves. Should this development come to pass, it does not necessarily mean a flood of investment in new products, despite the fact that mainland financial institutions are more familiar with the local market than their QFII counterparts.
Foreign investors have applied for and been granted only half of the existing QFII quota, and not all of the individual quotas have been used, partly reflecting concerns about A-share volatility.
It may be even harder to build up overseas investors’ confidence in Chinese money managers who have been plagued by a slew of market-manipulation scandals in recent years and usually don’t have consistent investment styles.
Foreign investors may also be uncomfortable with the close ties that many mainland brokerages and fund houses have with various levels of government or large state-owned enterprises. The issue is whether mini-QFII funds would able to operate in a truly independent, commercially driven way.
In this sense, index-based products that track key mainland stock gauges will likely be favored by investors.
In the long haul, the mini-QFII mechanism will facilitate arbitrage activities between the mainland and Hong Kong markets, further narrowing the valuation gap. Due to the heavy slump in A-shares, many mainland-listed banks or other heavyweights are now trading at a discount to their Hong Kong-listed counterparts.
There is, however, still a long way to go before China’s capital market is opened to full foreign participation – a development that is ultimately dependent on currency convertibility. Only then could the country become a key presence in the portfolios of overseas investors.
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