The Bill and Melinda Gates Foundation, Lehman Brothers and Yale University would not seem to have much in common. But all three are found on a list of foreign organizations certified as Qualified Foreign Institutional Investors (QFIIs) by the China Securities Regulatory Commission (CSRC).
As of mid-January, 76 foreign groups, mostly financial firms, had access to China’s capital markets via the QFII program. What should be these investors’ best chance to get China exposure, however, is being undermined by a lack of operational freedom.
Last year, the cap on total investments made under the program was increased from US$10 billion to US$30 billion. Once an institution has been given QFII approval, it must then wait to be allocated a share of the US$30 billion quota. This is where the problems begin.
"Existing QFIIs find it extremely difficult to get new quota, even though there is now effectively US$20 billion of space approved by the State Council," said Fraser Howie, the author of a book on China’s stock markets.
Best intentions
When the scheme was set up in 2003, it was hailed as a crucial step in the global integration of China’s capital markets. At a stroke, the country could atract foreign capital while simultaneously soaking up foreign investment expertise.
That goal has not changed, according to Qiu Yanying, chief strategist at TX Investment Consulting. The restrictions exist because QFII is still in a testing stage, he said, and the regulators want to limit any potential negative impact on the market. Qiu notes that foreign investors have a greater influence on the market than their relative size – QFII transactions account for less than 5% of A-share market capitalization – would suggest.
That is little comfort for the QFIIs themselves, particularly since some basic issues remain unaddressed. Chief among these is taxes: While taxes for domestic institutional investors are clearly defined, regulations have yet to outline what foreign investors are meant to pay.
"Just get it out of the way, stop messing around," said Chris Ruffle, co-chairman of Martin Currie and director of the China Fund, which has about US$1.2 billion invested in A-shares. "We opened up the market in 2002. Here we are in 2009 and we still don’t know what tax we’re going to pay."
Unable to pay taxes, QFIIs investing in China’s markets are effectively prevented from taking their money out of the country. Investors are also unable to make investments through a secondary account or through different brokers.
QFII may be suffering, ultimately, from a lack of interest combined with regulatory caution. Many experts maintain that stable development should, in the short term, be given precedence over the roll-out of a true market system.
"Higher degrees of capital market development can lead to market fluctuations," said Yin Zhongli, a professor at the Institute of Finance and Banking at the Chinese Academy of Social Sciences. "For QFII, we should be patient."
The waiting game
Patience may be hard to come by among potential foreign investors. In January, the Hong Kong-listed H-shares of mainland companies approached the same levels as their A-share equivalents, widely seen as a sign of foreign enthusiasm for China-based investments despite global economic weakness.
For now, though, foreign investors will have to make do with H-shares. That may placate some, but Ruffle remains convinced of the importance of QFII’s role in China’s restricted markets.
"I really believe that QFIIs have a positive influence on the markets in bringing an international perspective to bear, and bringing an institutional way of looking at the market," he said.
