When Hua An's QDII fund ceased redemption activity on September 18 last year, it promised Chinese investors that it would fully indemnify their losses. Though, nearly a year after Lehman Brothers' bankruptcy, the jury is still out as to how much Hua An will ever recover from the bankrupt Lehman entity for its currently frozen QDII.

Hua An was the first test pilot QDII project launched in China in September 2006, and later it became the first to witness its issuing house and its foreign investment advisor go to court.

On June 15 and 16, the Shanghai high court heard the case Hua An filed against Lehman Brothers International for breaches of contractual duties over its QDII product. However, as one week drifts into another in Shanghai, the court has been unable to arrive at a verdict over whether Hua An shall receive damages from the now bankrupt Lehman entity.

The damages will most likely be funded by frozen assets held under Lehman Brothers International, the defunct European entity of Lehman, within the Chinese jurisdiction. These assets had been impounded by court orders to stay in China when the Shanghai court accepted the filing of the Hua An case on September 27, 2008. An unverified claim asserts that part of these assets involved foreign investors' investments into China through the Lehman QFII quota.

Whatever becomes of this case, will set a precedent for the future of QDII. It has already had an impact on the regulatory environment in China, with the China Banking Regulatory Commission issuing rules on July 30 that clamp down on delta-one, back-to-back structured product sales, as seen in the Hua An design, to institutions in China.

As reported by AsianInvestor on September 17, 2008, the Hua An QDII fund raised assets in China and invested the proceeds into guaranteed notes issued by a Lehman special purpose vehicle (SPV) named Lehman Brothers Special Financing. In turn, the vehicle received a 100% guarantee provided by Lehman Brothers Finance.

Under a complex structure, the SPV invested the proceeds passed on by Hua An into seven mutual funds managed by Lehman's asset management arm. These include the Lehman Brothers Anti-Benchmark Euro Equity Fund, Lehman Brothers Alpha Fund-Global Value Fund, Lehman Brothers Alpha Fund-Straus US Equity Fund, Lehman Brothers Global Bond Fund (Offshore), Lehman USD Liquidity Fund and the Strategic Commodities Fund.

How-how Zhang, an analyst at Shanghai research house Z-Ben Advisors, believes Hua An will eventually recover only about 40% of the original value, from the portion of assets held in guarantee in the fund. However, he says the asset recovery is unlikely to happen soon. Zhang expects the case will drag on indefinitely.

As stated in the last available fund report published at the end of the second quarter in 2008, the guarantee is backed by Rmb97 million ($14.2 million) in assets -- made up of Rmb784,946 in cash ($124,594), with another Rmb96 million ($14.1 million) in a Lehman Global Multi Strategy Fund and zero coupon swaps. As of June 30, the fund's total assets stood at Rmb97.77 million ($14.3 million).

Some might say Hua An is responsible for setting a precedent for the break-up of QDII relationships. Since its schism with Lehman in September, two more QDIIs have had marriage difficulties: ICBC Credit Suisse split ways with Credit Suisse in February this year after Credit Suisse decided to sell its long-only platform to Aberdeen; and, in July, China Southern ditched BNY Mellon for Wellington over what Southern insiders claimed to be lack of support from Mellon.

Word is that the new QDII pipeline is expected to restart soon, and many of the original nine QDII foreign advisor contracts are about to fall due for renewal. There is growing concern among industry sources that more split-ups and horse-trading between foreign advisors will ensue.

Bizarrely, one legal counsel interviewed for this story said many of these foreign advisor contracts only carried two-year terms with little mention of exclusivity or lock-ins for the Chinese partners.

There are now 10 fund management houses fighting for the chance to launch a QDII ETF with the Shanghai Stock Exchange. Z-Ben says only three will be short-listed.

The names that are known to be parading in the beauty contest with the SSE include: ChinaAMC, China Southern (with S&P), Harvest (with Deutsche's db x-trackers), Guotai (with Nasdaq), Fortune SGAM (piggybacking ETF capabilities from SGAM's Lyxor arm), Fortis Haitong with Taiwan's Polaris and BoC International (Blackrock's China JV speculated to launch with the newly acquired BGI entity.)