Shanghai-based Huaan Fund Management is working with Lehman Brothers in the United States to develop what could be China's first mutual fund that invests overseas, according to market sources in Shanghai, Shenzhen and Hong Kong.

This would represent the official start of a much-talked-about programme for qualified domestic institutional investors (QDII), although the fund would be open to retail investors as well.

Officials at Huaan confirmed they are working on such a product, but would not comment on Lehman's involvement. They said at least 10 other Chinese companies are also working on similar products.

Funds executives and analysts agree, however, that Huaan is pushing this the most aggressively. Huaan has a history of pioneering new products in China; one of the country's "Old 10" mutual fund houses, it was the first to offer an open-ended fund, in 2003.

Sources believe that any pilot scheme approved by the government will have to invest very conservatively, and will likely be structured to provide a guarantee. Although QDII was originally conceived as a way to bolster the Hong Kong Special Administrative Region's economy in the early 2000s, the pilot is now expected to invest globally.

Timing is uncertain, and there is a history in the Chinese media of proclaiming QDII programmes only to see them sidetracked. The central bank is said to be keen on QDII because it will represent a modest step toward liberalizing capital controls and help relieve pressure on the renminbi's appreciation. The China Securities Regulatory Commission is said to be nervous that a QDII programme will send the wrong signal regarding the attractiveness of the domestic stock market.

There are also tremendous regulatory hurdles. All of China's regulations concerning the fund management industry assume the activity is onshore, in renminbi, so a pilot programme will require a lot of exemptions and fudges, with the tacit support of the regulators.

Finally, a QDII programme may be held back if market conditions don't look right. The pilot must succeed for others to follow. Global equity markets have enjoyed a good run so now is not a good time to take a big position; the appreciation of the renminbi means an investment needs to outperform local markets by 2-3% just to stay even - and that will be hard to achieve in today's global fixed-income environment with its flat yield curves and low volatility.

If all goes well, the pilot could emerge by summer. But if it doesn't, then the media has just announced yet another false dawn for QDII.

The May edition of AsianInvestor magazine includes a China report that analyses QDII, domestic M&A and other topics in the Chinese funds industry.