China’s regulators could further elevate the country’s qualified domestic institutional investor (QDII) quotas, which along and the recent announcement that retail investors can put money into overseas assets promises more market liberalisation. But experts caution that it is unlikely to lead to a major outflow of offshore investing by Chinese asset owners.

The steps were covered in an article published on the WeChat account of the State Administration of Foreign Exchange (SAFE) on Friday (February 19). The article stated that Chinese residents will be able to conduct overseas insurance and securities investments as part of the $50,000 maximum annual quota for foreign exchange purchases by individuals this year. In addition, more Chinese fund managers and asset owners could gain permission to invest more assets offshore. It did not offer a timeline for these changes. 

 

If introduced, these steps would allow more of China’s institutional and retail funds to invest offshore and help to better internationalise the renminbi. There are currently $125.72 billion in QDII quotas outstanding for 171 institutions, a total most recently increased in January.

Liu Shichen, head of research at Shanghai-based Z-Ben Advisors, told AsianInvestor that the easing possibilities “have been on the table for discussion for a long time, given it involves many regulators and foreign exchange reserve consideration, we may not see anything confirmed this year”.

He predicts that once they are implemented they could increase investment flows towards equities listed in Hong Kong and the US, also renminbi-dominated fixed income assets listed overseas.

Liu Shichen, Z-Ben Advisors

However, Liu cautioned that the overall rules changes are unlikely to have a major effect on the investing behaviour of China’s largest investment institutions, noting that even a full cancellation of QDII quotas would be unlikely to greatly ramp up offshore investing.

INSURERS’ DILEMMA

Were the rules to be eased, China’s life insurers would likely be best placed to take advantage of them. However, they currently lack overseas investing experience, Liu noted.

“For Chinese [insurance] players, it is not easy to allocate as much as they want into offshore markets since they have to equip themselves with more overseas experience first,” he said.

Chinese insurers can already invest up to 15% of their overall assets into offshore market, subject to regulator permission. But most only have exposure of 2% to 3%. 

An easing of the rules and permission around overseas investing would be unlikely to greatly change this cautious investing approach, Liu said.

Benjamin Deng, chief investment officer of China Pacific Insurance Company, told AsianInvestor in January that despite his optimism about Hong Kong’s equity market, his company has yet to substantially allocate new funds to H-shares. Deng said this was due to a government limit on investments that can be made via QDII.

Under QDII rules, insurers are only allowed to invest their foreign exchange funds in overseas market products (such as bank bills, negotiable certificates of deposit), fixed income products, depository receipt, and certain equity products.

Deng added that CPIC is paying close attention to whether Beijing will grant a new quota for insurers, which could potentially allow it to invest more offshore. Such investments might be into equities such as H-shares; Deng declined to state exactly what its stock exposure is, but said it is quite very small when compared with its Rmb2.3 trillion ($360 billion) of assets under management (as of June 2020).

Liu added that big insurers are unlikely to see offshore investments as increasing their overall level of returns. “Onshore assets have many choices for a satisfied return, offshore exposure is for diversification only.” 

China's SSE Index rose as much as 18.8% in a year while Corporate Bond Index rose 4.2%. In comparison, S&P 500 index recorded a 20.3% increase in the past 12 months. However, that is largely seen as having been an exceptional year of performance, and Chinese insurers are not familiar with most of its companies. 

 

QDII acts as the main quota-based system through which Chinese mainland institutions can invest overseas. Unlike the Qualified Foreign Institutional Investor (QFII) and RMB Qualified Foreign Institutional Investor (RQFII), the channels by which foreign investors an enter China’s capital markets, QDII continues to retain a strict quota management system, while China removed the quota for QFII and RQFII in September 2019.

However, there have been signs of QDII being expanded. In January SAFE issued new quotas of $9.02 billion QDII, taking the total amount of QDII quotas to $125.72 billion. Before this latest round, SAFE last awarded QDII batches in September and November last year, respectively.

Sources: PBoC, SAFE, Morgan Stanley

INDIVIDUALS’ INTERESTS

According to SAFE’s article, individuals might be more likely than institutions to invest into offshore equities, properties, and wealth management products. The country is considering raising the annual FX quota, to provide more options for individual investors under their current amount.

Under China’s current foreign exchange rules, individual citizens can exchange foreign currencies equivalent to $50,000 each year, but only to make direct overseas investments under regulations' criteria.

Currently, some Chinese investors have already bought into Hong Kong equities under the Hong Kong-Shanghai/Shenzhen Stock Connect scheme, mostly using renminbi to trade for a higher fee. An expansion of their annual FX exchange quota and their investment scope within it could help boost their offshore investing interest and lower their trading costs. 

There is already a sizeable business in Hong Kong share trading by Chinese organisations and individuals. On a single day of February 24, investors from Shanghai and Shenzhen traded over HK$100 billion worth HK equities under the Stock Connect Scheme, almost accounting for 30% of Hong Kong bourse's daily HK$354 billion trading volume. 

“Many high net wealth individuals have already been granted many different ways to invest offshore, such as the Stock Connect scheme between Shanghai and Hong Kong,” Liu said.

That means they are more comfortable doing so, and as such an easing on the restrictions may lead more of them to directly invest into Chinese companies listed in the US bourse, particularly. Currently, individual investors in China can only invest in offshore assets through qualified third parties such as fund houses and banks.

In addition, they may also be attracted to cross-border wealth management products, an area of focus by China's authorities. On February 5, Hong Kong, Macau, and mainland Chinese regulators signed a “Memorandum of Understanding on the Launch of the Cross-Boundary Wealth Management Connect Pilot Scheme in the Guangdong-Hong Kong-Macao Greater Bay Area (GBA).” 

The scheme is designed to link mainlanders and Hong Kongers with more financial products. Hong Kong’s regulators have said they will launch Wealth Management Connect as soon as possible, but Liu believes the scheme may need more time to receive active feedback.

“We will see a comprehensive restriction and the currency exchange will also be adopting a strict method between areas.” he said.