A roundup of the reformed QFI rules – what is next?

It has been 18 months since the reformed Measures for the Administration of Domestic Securities and Futures Investment by Qualified Foreign Institutional Investors and RMB Qualified Foreign Institutional Investors (in Chinese《合格境外机构投资者和人民币合格境外机构投资者境内证券期货投资管理办法》) and its implementing rules (collectively, the New QFI Measures) were issued in September 2020. Please see our recent write-ups and webinars here and here on QFI.

The New QFI Measures have seen more than 180 new applicants obtaining their QFI licence through an application procedure that has been significantly streamlined, including more than 50% being hedge fund houses or prop trading firms. Meanwhile, the market has also been long awaiting the next breakthroughs, which have been written down in the black letter law but are still pending the final greenlights from the relevant regulators and exchanges.

It is indeed difficult to ascertain with certainty when these breakthroughs will take place given the many moving pieces, geopolitical or otherwise. With that being said, the opening up of China’s financial market will be a trend irrevocable to China, and the dynamism of the Chinese economy is likely to continue to foster and present opportunities as a result.

We have set out below the key breakthroughs that are likely to take place in the foreseeable future:

Investment in futures

Previously, without setting up a PRC entity, foreign investors could only invest in stock index futures under the previous QFII/RQFII scheme and a few specific types of commodity futures available for direct investment by foreign brokers and investors (which as of late include crude oil, TSR 20 rubber, low-sulfur fuel oil, iron ore, purified terephthalic acid (PTA), copper and palm olein). Under the New QFI Measures, a larger variety of commodity futures and financial futures will eventually also become available to foreign investors for investment.

In order to boost confidence, on 13 October 2021, China’s financial regulator CSRC further announced that starting from 1 November 2021, QFIs will be allowed to trade commodity futures, commodity options, and stock index options, of which trading in stock index options shall be limited to the sole purpose of hedging, but not speculation.

It should be noted that the exact categories to be made available to foreign investors are subject to the announcement of the relevant exchanges. While it is said that exchanges are ready for their infrastructures to be put in place, given the roiling commodities market, there has been a delay in the relevant exchanges issuing the final announcement.

It is worth noting that although there are many ways in which the futures trading process in China is similar to those in the western markets, there are also certain notable differences that arise due to PRC laws and market practices.

For example, in China, futures trading is structured as an agency model, rather than the principal-to-principal model as in some of the European markets. This means that the broker acts as an agent on behalf of its client, with the exchange acting as the central clearing counterparty as well as the trading counterparty. On that basis, the counterparty’s defaulting risks will be very low.

Another example is the concept of margin. Unlike western markets that have the concept of settlement margin, in China, margin is primarily posed for collateral purposes. Therefore, in China, sufficient margin must be posted prior to, rather than after, a trading taking place.

Typically, the fund manager will open a futures margin account with a third party bank, into which margin will be transferred by the fund. By operation of law, margin will be held by such margin depository bank, as opposed to the broker, and ringfenced as the fund’s assets.

More details can be found via our write-up on futures trading.

Margin trading/short selling

Under the New QFI Measures, QFIs are expected to participate in margin trading and securities lending, ie, to borrow money or securities from brokers for securities trading in the same way as domestic market participants. This is particularly meaningful given China does not currently allow same-day trading for A stocks. Having the ability to borrow money or securities in the way mentioned above would effectively narrow the gap, and achieve an effect similar to buying and selling shares on the same day.

During the stock market crash in 2015, many Chinese trading firms, under the pressure from the government, halted all stock-shorting activities, and at the same time CSRC discontinued the practice of same-day transaction settlement (ie, T+0 was changed to T+1). A few years later, margin trading was back in business, but the total capacity for brokers to carry out such business was capped to the amount of which all the qualified brokers can lend.

Furthermore, since the beginning of 2021, CSRC has provided guidance to QFI custodian banks, stating that hedge fund/investment bank QFIs are no longer allowed to engage in securities borrowing (ie short selling). However, CSRC has not stated that other QFI investors are prevented from doing so.

Investment in bond repos

The expanded investment scope of QFIs also includes bond repos, although exchange traded repos are not yet available for QFIs in practice. We understand that exchanges are actively promulgating exchange level implementing rules, and once those are issued, QFIs would be allowed to invest in exchange traded repos. The timeline is not yet clear but it is likely to take place within this year.

CIBM repos, on the other hand, are only available for QFIs that are commercial banks and foreign reserve institutions, but not otherwise. We are unaware of any foreseeable changes to such rules and regulations on CIBM repos.

Summary

Lacking access to the above-mentioned asset classes has led to the non-ability to realise some of the investment strategies for QFI applicants, for example managed futures or convertible bond arbitrage. That said, given those asset classes are explicitly addressed in the New QFI Measures, it would be eventually a matter of timing as to when those are made available to QFI investors.

Please note that this article is produced by jointly Simmons & Simmons and Shanghai YaoWang Law Offices.

Should you have any questions or require further assistance regarding any of the above, please do not hesitate to contact us.

Melody Yang
Co-Head, Partner
Shanghai YaoWang Law Offices
T +86 21 8013 5022
M +86 135 2105 2486
melody.yang@yaowanglaw.com