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One year after China opened the door to foreign institutions to trade renminbi-denominated A shares and bonds, it seems to be ready to open another gate, one that will free billions of foreign exchange funds for overseas capital markets.
"People have been talking about the impending launch of the qualified domestic institutional investor (QDII) scheme. We are excited about that, too," said Wang Hua, a fund manager of Yinhua Fund Management Co in Shenzhen, a bustling southern city bordering Hong Kong.
An outbound capital market has always been tempting to mainland institutions and individuals, who, with hefty savings and idle funds at hand, have been seeking new investment channels other than in the 1,300 or so listed companies in the mainland.
But the fact that yuan is still not fully convertible under the capital account has limited access to overseas markets, where market practices are more orderly and liquidity is higher, with more stocks to choose from.
Hong Kong, with its close links to the mainland and its rich financial resources, is generally regarded as a natural first choice for mainland funds once the official go-ahead is granted.
As a matter of fact, domestic capital has already crossed the border to enter overseas markets through underground channels, Wang said.
Instead of blocking such capital outflow, offering legal channels and setting new standards will actually make supervision much easier, he said.
The QDII is a twin to the qualified foreign institutional investor (QFII) program that was first introduced by Chinese authorities at the end of 2002 and formally kicked off last July. Both are transitional arrangements to facilitate cross-border capital investment before the yuan is fully liberalized.
More than US$1 billion of overseas capital has flowed into A shares and bonds over the past year through the QFII arrangement. While that infuses a fresh concept in the mainland securities industry, it also makes local businesses more eager to have equal access to the outside.
"QDII was a natural trend after the QFII scheme was allowed," said Chen Weihua, investment director of Southern Fund Management Co.
The steady entry of foreign capital has added pressure for foreign exchange regulators to keep the balance of forex inflow and outflow and maintain the stability of yuan, Chen said. Launching the QDII program can ease the pressure.
According to official statistics, China's outstanding forex deposits accumulated to US$149.8 billion by the end of May. Its capital account surplus in 2003 rose by 263 percent from 2002 to US$44.4 billion, largely driven by net capital inflow.
That helps explain the enthusiasm of the forex authorities in introducing QDII to encourage more domestic institutions to invest overseas.
"We are actively pushing the QDII program," said Ma Delun, deputy director of the State Administration of Foreign Exchange.
He said that the authorities had drafted a legal framework for QDII and rules of implementation to allow social security and insurance funds to invest overseas.
But it is not something that can be decided by a single department, he said. It requires the consensus of several departments.
Recently there have been rumors that it is hoped the new scheme will be launched in June or at the start of next month.
But Ma said the process is more complicated than many imagine.
"I don't think it will be so soon as some reports have predicted recently," he said.
In spite of the uncertainty about timing, QDII is obviously a core part of the legislation affecting the financial sector this year.
Regulators are busy with the design of the new system so that it will function well under efficient regulation and with standard practices.
The preparation of custodial banks, for example, has been put at the top of the agenda by banking authorities.
Liu Mingkang, chairman of the China Banking Regulatory Commission, said last week that after QDII takes off, it would need experienced banks to provide custody. Foreign banks, with more expertise in developed markets, have an advantage in this area, but mainland banks that have been trying for QFII custody do not want to lag behind.
Securities brokerages will also struggle for opportunities to offer broking services though, so far, only a few domestic securities houses have opened overseas branches.
How to set up the threshold for candidates for QDII itself is also a prime concern.
Apart from securities businesses, like investment banks and fund managers, other domestic companies are also hopeful of obtaining a QDII licence, including insurers, pension fund managers and trust firms.
Insiders said that to try to achieve a good start, the QDII scheme would be tried on a step-by-step basis. So, some qualified domestic institutions would be chosen as pilots to enter overseas markets and the authorities would still keep a close eye on capital flow. The result of the experiment would decide how soon the QDII scheme would be expanded to other companies.
The National Council of Social Security Fund (NCSSF), which operates nearly 140 billion yuan (US$16.9 billion) of strategic social security reserve funds, is a pioneer in the sector.
The NCSSF obtained State Council approval to invest in overseas capital markets in February and has been working with relevant departments to design detailed regulations to implement the plan, including the choice of fund managers and custodian.
Recently it acquired US$500 million of initial overseas investment quota.
A NCSSF official said that the council's march to overseas capital markets was only one way to seek appreciation of the assets that would be used to meet social security expenses in China in the future. And, as a special case, it is not equal to the formal launch of the overall QDII scheme.
After all, something that may have been disturbing the securities regulators is the impact on the mainland stock market when the overseas investment access is opened.
It is generally predicted that funds would be diverted to overseas markets, where the price/earnings ratio is still generally lower, which would weigh down stock prices of domestic companies.
The mainland authorities have to be careful if they want to open the gate to overseas investment when the domestic market still has many system flaws, said Qi Liang, director of the research institute of China Securities Co.
Investors will compare the prices and investment value in the two markets. Companies that have issued both A share and H share will be affected most, he said.
And China's B shares, traded in hard currencies now, would also lose ground to overseas stocks.
The impact on the Hong Kong market, however, is much more positive.
Since talks of an imminent launch of QDII spread in the first quarter, H shares and red-chips have staged bullish rallies several times, though none of them lasted for long, as lack of clarity about timing weakened the boosting effect.
Such stocks, as well as some large-cap bluechips, are preferred choices for QDII, analysts said.
(China Daily June 14, 2004)
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