China Expands Investment Scope for Offshore Wealth Management

Recently, China’s financial regulatory authorities have expanded the range of permissible investments that mainland financial institutions may offer to their clients to now include offshore equity securities. This expansion is part and parcel of a key financial program in China, known as the Qualified Domestic Institutional Investor (QDII) program, which was established to promote and regulate the movement of Chinese financial investments offshore. Under the expanded QDII program, Chinese financial institutions will be able to create investment’pools’ in which their clients may invest that include a variety of offshore securities. The first notable expansion of the QDII program was announced in May 2007, when the China Banking Regulatory Commission (CBRC) issued a notice expanding the investment scope for offshore wealth management services provided by commercial banks in China to include offshore equity investments, subject to certain conditions discussed below.¹ Pursuant to Notice no. 114, commercial banks are now permitted to invest in a wide range of asset classes, including offshore equities and funds that invest in offshore equities. Before the issuance of Notice no. 114, the only offshore investments such banks could offer to investors through their investment pools were those in certain fixed-income securities.

Mainland commercial banks wishing to take advantage of the expanded QDII program must meet or abide by certain requirements. Most notably, these banks may purchase equity securities only through a stock exchange whose regulator has entered into a Memorandum of Understanding (MOU) with the CBRC. Alternatively, when purchasing offshore equity fund products commercial banks must select public funds that have been approved, registered, or confirmed by a foreign regulator that has entered into an MOU with the CBRC. In either scenario, if the bank works with a foreign investment manager to make offshore investments, the foreign investment manager must also be regulated by a supervisory authority that has signed an MOU with the CBRC. Currently, foreign regulators in Hong Kong, Japan, Singapore and the United Kingdom have signed a MOU with the CBRC. As a result of these legislative changes, mainland commercial banks are now able to purchase publicly traded equity securities and shares of equity funds in these jurisdictions.²

A commercial bank’s direct investment in such securities, although no longer prohibited, still must meet the following criteria: (i) investment in such securities should not exceed 50% of the net value of the total assets of the relevant financial product and investment in a single security should not exceed 5% of the net value of the total assets of the relevant financial product; (ii) the minimum investment in such product by a single client should not be less than RMB300,000 (or its equivalent in a foreign currency); and (iii) the target client should have sufficient investment experience in public securities. In addition to these requirements, banks must also, inter alia, (i) give their clients appropriate and timely disclosures with respect to such offshore investments; (ii) strictly monitor the sales activities of sales personnel; (iii) give due regard to an investor’s investment objectives and instructions; and (iv) maintain the requisite policies and procedures applicable to banks with respect to internal compliance and risk management. Notice no. 114 has not changed the current prohibitions on foreign investments by mainland commercial banks in the following types of securities: structured products,³ derivatives, hedge funds, securities rated grade BBB or below by an internationally recognised rating agency, or any high risk, speculative investments.

Investing in Overseas Securities

In addition to the expansion of the QDII program discussed above with respect to mainland commercial banks, the China Securities Regulatory Commission (CSRC) has adopted rules permitting mainland brokerage houses and fund management firms to invest their clients’ money in a wide range of overseas securities. These new rules, issued by the CSRC in June 2007, give such entities the ability to create investment pools in which their clients may invest that consist of overseas fixed-income, equity, and derivative securities. In contrast to mainland commercial banks, which despite their expanded investment scope are prohibited from investing in certain, higher risk securities, qualified brokers and fund managers have now been given greater flexibility to invest in a variety of equity investment products including swaps, warrants, options, and futures. As a result of this new legislation, several mainland fund firms have received the CSRC’s approval to invest in various developed and emerging overseas markets as well as the well-established Hong Kong markets. Unlike the CBRC, however, the CSRC has already entered into MOUs with regulators in several different countries, thus allowing for greater investment choice for those mainland financial institutions that are regulated by the CSRC.⁴

Despite this increased flexibility, mainland brokerage houses and fund management firms are still subject to certain investment restrictions. In particular, investments in derivatives are only permitted for hedging purposes, not for speculation or leveraged trading, and investments in property, mortgages on real property, commodities or precious metals are not allowed.

The most recent expansion of the QDII program applies to Chinese insurance companies. In July 2007, the China Insurance Regulatory Commission (CIRC) issued a regulation extending the investment spectrum for mainland insurance companies to include investments in overseas equities. These insurance companies may now make investments (up to 15% of their assets) in stocks, stock funds, and other equity derivative products from established capital markets outside of China, in addition to already permissible investments in offshore fixed-income and money market securities. It should be noted that offshore investments made by any Chinese financial institution must be made in accordance with an investment plan that is approved by the appropriate Chinese regulator, and such plan cannot be changed without the regulator’s approval.

The QDII program has expanded significantly over the past year, and is expected to continue to grow and evolve to meet the needs of the developing financial community in China. To date, approximately two dozen banks and insurance companies had been granted QDII licenses with aggregate investment quotas reaching US$20bn. Through the expansion of the QDII program, individual Chinese investors will be offered a diversified array of investment opportunities from various established and emerging markets throughout the world to complement their existing domestic investment portfolios.

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