The Renminbi Qualified Foreign Institutional Investor (“RQFII”) pilot program allows non-PRC institutional investors from certain jurisdictions that have officially implemented the RQFII (the “Relevant Jurisdictions”) to deal in People’s Republic of China (“PRC”) domestic securities using offshore Renminbi (“RMB”). Additionally, because of special RQFII rule provisions, the RQFII program affords broader investment possibilities in some contexts and much greater flexibility not found in its predecessor pilot program, the Qualified Foreign Institutional Investor (“QFII”). Currently, only Hong Kong, London and Singapore (the “Relevant Jurisdictions”) have been announced as eligible jurisdictions under, and have officially implemented, the RQFII program locally—although Taiwan and Paris have also been announced as recipients, they have not yet locally approved the program.
The RQFII program is potentially attractive to non-PRC investors keen to deal directly in the PRC onshore securities market as it provides direct access to:
RQFII versus QFII Before the introduction of the RQFII program, a non-PRC entity that wanted to deal in securities issued in the PRC domestic market would have required approval as a QFII under the QFII program. The RQFII has not eliminated the QFII program, which is still a useful avenue into the PRC domestic securities market for certain types of institutional investors, but the programs differ in significant ways that are material to certain investors, among them (i) currency of settlement; (ii) investor eligibility parameters; and (iii) suitability considerations, including flexibility of investments and repatriation of proceeds.Table 1 shows a summary comparison of the key requirements of the RQFII and QFII programs.
RQFII Application ProcessTable 2 sets out the timeline for a typical RQFII application process through to listing. As the RQFII program and uses of it in the form of open-ended funds and listed vehicles is still fairly new, it is an optimistic timeline and draws substantially from its practice and use in Hong Kong, which is the only one of the Relevant Jurisdictions to have both authorized and listed such funds.
Potential Uses of RQFII in an International Investor’s Portfolio
Considerations in the Choice of a Relevant Jurisdiction for a RQFII License Applicant
Where should you apply for your RQFII license—Hong Kong, London or Singapore?
Need for innovative investment thesisSimply having access to the PRC domestic securities market will not ensure the success of an RQFII applicant. Fund managers need to identify and/or develop specialized investment products tailored to clients’ needs.
Potential Impact of PRC-Hong Kong mutual fund recognition and mutual stock market access Some observers believe these developments may actually enhance PRC fund managers’ interest in the RQFII program because in order for the RQFII program to work successfully, offshore RQFII managers would require the specialized investment skills and techniques of onshore PRC investment professionals with expertise in PRC assets. In any event, these issues are currently moot as the Hong Kong-PRC mutual fund recognition program has been announced as imminent for the better part of a year but has yet to be implemented, while the Hong Kong-PRC mutual stock exchange access is slated to go live by the end of year at the earliest.
Lack of clarity in interpretation and application of the RQFII program rulesWith PRC laws in general, much needs to be derived from observation, repeated practice without adverse reaction and general public consensus. Some specific areas of uncertainty have been discussed above, and there are many other areas in which knowledgeable practitioners’ advice is a necessity.
Among other things, there are questions as to the definition of “principal place of business” in a Relevant Jurisdiction (a key requirement for RQFII eligibility). On another note, what exactly is an RQFII open-ended fund since no specific definition has been provided, and why the distinction between QFII open-ended China funds and RQFII open-ended funds? The practical way to deal with such uncertainties has been to watch other RQFII applicants in action or to take the leap with fingers crossed. So far, there has been no indication otherwise from the PRC regulatory authorities and as the RQFII program gains traction, more clarity and certainty will surely arise.
Withholding taxAnother stumbling block had been the taxation of profits, especially that on capital gains, which has now been clarified by the PRC regulators to some extent. Earlier this year, China Asset Management Company announced that it had obtained a Hong Kong Resident Tax Certificate from the Inland Revenue Authority of Hong Kong which exempts its China AMC CSI 300 Index ETF from a 10% withholding tax on unrealized and realized capital gains derived from all its disposals of China A-shares other than those A-Shares in “land-rich companies” in China. As a result, the fund reversed all provisions it had made for withholding tax since the date of inception of the fund in respect of its trading in non-land-rich A-shares although, as a small proportion of its holdings were in land-rich companies, it would continue to make the necessary 10% withholding tax provision for those holdings only and, going forward, would cease to make any provisions for its trading in non-land-rich A-shares and would apply this position retroactively from the date of the inception of the fund. It is anticipated that the China Securities Regulatory Commission (“CSRC”) and SAT will likely address this issue formally in the coming months.
One must also bear in mind that amendments to the rules and “practice” of the RQFII program may not necessarily be reflected in the actual rules or legislation themselves as they would be elsewhere, but may end up being “accepted” by virtue of repeated usage or announcements and press releases.
Time lagThe technical details for London’s RQFII have still to be clearly ascertained—and the only truly tried-and-tested model is the Hong Kong model, which requires funds to be domiciled in Hong Kong. This puts foreign managers at a distinct disadvantage to Chinese asset managers which are able to obtain approval and launch their products immediately, irrespective of demand. However, the target market for RQFII products is different from that for direct Chinese fund products, which foreign investors could not access by themselves so this is, perhaps, an unfair comparison and is, in any event, better than no access at all. That RQFII ETFs have been listed in New York, Ireland and Luxembourg indicates that this is merely a temporary blip that can be overcome and as the program develops, the timing issue will resolve itself.
Time limits for investmentsWhile the RQFII license is granted by the CSRC to the fund manager itself, the quota is obtained from the State Administration of Foreign Exchange (“SAFE”) on the basis of the relevant product that the fund manager wants to launch. At the same time, the SAFE requirement is that a quota be obtained within one year of the RQFII license being obtained. This creates an issue of developing an RQFII product, obtaining regulatory approval for that RQFII product (if an RQFII open-ended fund) and obtaining a quota before the year expires, failing which the SAFE has the right to revoke or reduce the quota. However, the SAFE has reportedly approved an amendment to its RQFII quota policies as a result of which an RQFII now has the flexibility to allocate its RQFII quota across different fund products under its management. It is understood that, following the amendment, the SAFE will not grant a specific quota to a specific fund product – although this is very recent, it is likely to ease the time limit concerns of RQFII managers.
Requirement for RMBThere is a presumption that a steady supply of offshore RMB is necessary for RQFIIs to purchase PRC assets. However, since the introduction in March 2012 of RQFII ETFs, virtually all RQFII ETFs are traded in two or more currencies; a Hong Kong-managed New York-listed ETF would trade in U.S. dollars on the New York Stock Exchange, which are then converted into RMB in Hong Kong before the ETF purchases the PRC securities in the PRC. The continued need for currency conversion and hedging in the meantime will require that RQFII funds consider the application of financial markets regulations such as the European Markets Infrastructure Directive and the U.S. Commodity Exchange Act.
On the basis of these uncertainties, it becomes doubly important that interested parties contact advisers, such as legal advisers familiar with the process on their intentions, and work closely with such advisers to ensure that they do not misinterpret current practice and provisions or inadvertently run afoul of practice (especially when this is changing on a regular and very rapid basis) and to ensure that the RQFII process flows smoothly and possible issues can be anticipated and dealt with efficiently and seamlessly.
ConclusionAs China pursues efforts to internationalize the RMB, there are expanding opportunities for international investors to obtain exposure to onshore PRC assets and funds and hedge their exposures in offshore RMB markets. The RQFII program marks a potentially important step in that internationalization and would appear to be the way to go, as opposed to the QFII, as recent announcements as to the incentives to be offered for the RQFII program would indicate. The CSRC, the SAFE and the People’s Bank of China are aware of the need for investors’ confidence and have indicated that they are addressing the issues affecting the RQFII program, among them, taxation, repatriation and access to the fixed-income markets as a top priority, and are likely to resolve them shortly. The RQFII application process has been very much streamlined and clarified with the CSRC announcing an unprecedented 60-day performance pledge in the processing of RQFII applications. The speed in quota issuance for the RQFII and QFII programs and the liberalization of access to these programs has left observers in no doubt as to the PRC regulators’ intentions. Market participants need to start planning their involvement in the market and mastering the technical complexities attached to the RQFII program now so that they are not left scrambling for a position when demand hits.
Notes: Hong Kong currently has the largest RQFII quota of RMB 270 billion, followed by the UK and France with RMB 80 billion each and Singapore with RMB 50 billion. Taiwan is expecting RMB 100 billion.
This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer. Any views expressed herein are those of the author(s) and not necessarily those of the law firm’s clients.