The credit crunch is forcing investors, regulators and financial service providers to revisit many of their assumptions. Another idea that may no longer look so certain: that ChinaÆs first moves to allow cross-border investment flows will soon lead to much greater liberalisation.

That was the message from a panel discussion from MondayÆs conference organised by the Hong Kong Investment Funds Association, which represents the retail funds industry.

For global fund-management companies, one of the biggest challenges to doing business in China is the lack of clarity regarding what is actually allowed, or an idea of what will be allowed, and when.

This was already the case even when China was enjoying strong economic growth and a bullish stock market. ôWeÆd like more clarity,ö says Eleanor Wan, Hong Kong CEO at Allianz Global Investors, adding that law firms interpret the rules and regulations differently.

Nonetheless, many global fund executives were excited by last yearÆs (short-lived) rush among Chinese investors to put money into the new qualified domestic institutional investor (QDII) programme opened to domestic mutual-fund companies, who launched QDII funds with global playersÆ help as sub-advisers.

This move, following the older qualified foreign institutional investor (QFII) regime, indicated that China was gradually opening its border to flows in both directions, albeit in a tightly controlled fashion.

For many fund houses, that seemed to point inevitably toward further liberalisation, including their ultimate goal of being allowed to sell their offshore funds to local clients.

But now that goal looks less likely. ôQFII and QDII are all about a transition, but toward what? To free markets?ö wonders Carl Hinze, associate at Eversheds in Shanghai. He says the expectation of continuing liberalisation of Chinese cross-border markets is now in question. ôA year ago it was easy to assume that QDII would evolve to the point of direct marketing of offshore funds; ChinaÆs policy has changed in reaction to the credit crisis, but we donÆt yet know how.ö

The important thing will be to understand Chinese policy, not its actual written rules, to know what the China Securities Regulatory Commission and other government entities will allow. But the only clear goal is to strengthen ChinaÆs funds industry and capital markets.

Peter Alexander, principal at Shanghai consultancy Z-Ben Advisors, says this should not mean the end of QDII; on the contrary, he notes that both QDII and QFII have been subject to alternating rounds of euphoria and despair.

He suggests that global fund houses hoping to sell very niche or exotic asset classes and products via QDII arrangements will be disappointed; and in light of the credit crisis, derivatives-based products and hedge funds look like non-starters. The government wants QDII to ensure Chinese people have access to a range of core asset classes û from Australian resources to US growth stocks û whose risk/reward characteristics are presently unattainable at home. He still believes QDII will account for 25-33% of total domestic fund AUM within five to seven years.

AGIÆs Wan says QDII relationships are challenging anyway. Global fund managers in that industry have quickly learned that the all-important major Chinese commercial banks, which dominate fund distribution, require a sustained effort in time and (Mandarin-speaking) human resources when they carry out nationwide marketing campaigns û for very low fees.

Taxes, product structure, and a clear understanding of who is responsible for what remain challenges in China, Wan says. Perhaps most importantly is managing customer expectations, which are incredibly demanding, and trying to determine who is ultimately responsible for their education û and the education of distributors. (Although this is hardly unique to China.)

This lack of clarity is unlikely to be resolved soon. The government was meant to propose a new version of its Securities and Funds Law this spring, which at present bars local institutions from investing overseas and is therefore in dire need of modernising. But such talk has died out, as regulators deal with more immediate priorities and absorb the unfolding lessons of the credit crunch. In any event, laws tend to condone practices already taking place on an experimental level.

As the credit crisis plays out, then, the only thing that companies trying to operate in the Chinese funds market should realise is not to cling to easy assumptions.