This content is from: China (PRC)

PRC tightens control over foreign investor access

Pre-approved foreign institutional investors can access China’s financial market in a controlled manner, in compliance with securities regulatory and foreign exchange control requirements

Pre-approved foreign institutional investors can access China’s financial market in a controlled manner, in compliance with securities regulatory and foreign exchange control requirements

Inside China
Inside China, written by FenXun Partners’ Xusheng Yang and Sue Liu, is an insight into aspects of the China market that often elude the naked eye.

Yang is a specialist in China’s financial markets and institutions, having started his career at the China Securities Regulatory Commission and then co-founding FenXun in 2009. Liu’s practice focuses primarily on the asset management industry, and has previously worked as an associate at Skadden Arps Slate Meagher & Flom in New York.

The qualified foreign institutional investors (QFII) programme is a specialised regulatory platform offering approved foreign institutional investors direct access into China's securities market under a complementing foreign exchange quota system. It is administered by the China Securities Regulatory Commission (CSRC) for regulatory supervision purposes and the State Administration of Foreign Exchange (Safe) for foreign exchange control. While QFII investors are expected to remit foreign currency, a similar programme has been implemented for foreign institutional investors remitting offshore renminbi (RMB), the RMB qualified foreign institutional investors (RQFII) programme. Since their introduction in 2002 and 2011, respectively, the QFII and the RQFII programmes have grown steadily in size. As of the end of October 30 2017, 287 investors have been approved under the QFII programme with a total investment quota of $94.49 billion, and 192 investors under the RQFII programme with a total investment quota of $88.92 billion.


The QFII programme has been developed to open up China's securities market to foreign investment in a controlled and orderly fashion for both securities regulatory and foreign exchange control purposes. Under China's foreign exchange control regime, capital inflow and outflow, as well as associated currency conversion, are subject to regulatory review and registration. Prior to the implementation of the QFII system, securities publicly traded on China's securities exchanges were largely off limits to foreign investors. A limited number of listed companies do issue so-called domestically listed foreign investment shares (B shares) that are open to foreign investment. B shares are denominated in US dollars on the Shanghai Stock Exchange and in Hong Kong dollars on the Shenzhen Stock Exchange. However, due to significantly reduced volume and liquidity, B shares routinely trade at a discount compared to A shares. Investment in A shares was and continues to be the main attraction under the QFII programme though approved investors may now also invest in bonds and warrants traded on stock exchanges, fixed income products traded in the interbank bond market, securities investment funds and stock-index futures. QFIIs are also allowed to subscribe to initial public offering of stocks, issuances of convertible bonds, subsequent stock issuances and share placements on securities exchanges. For international investors with a global asset allocation, the Chinese A share market is too important to ignore. Such investors would find the QFII programme desirable and necessary for capital deployment into China.

The QFII programme was designed to attract stable long-term capital from credible investors that would expand the capital pool for China's securities market without causing undesirable disturbance to the market or the capital exchange control regime. Foreign institutional investors are also expected to exert positive influence on China's capital market by potentially diversifying the individual dominated investor structure, encouraging a long-term investment approach based on value, and nudging listed companies towards enhanced corporate governance and social responsibility practices.

A selective platform

As such, the QFII programme is selective of its candidates. Permissible institutional investors encompass an array of financial institutions, including asset management companies, insurance companies, securities companies, commercial banks, and other institutional investment vehicles such as pension funds, charitable foundations, endowment funds and sovereign wealth funds. To qualify under the QFII programme, an applicant will need to demonstrate that they have:

  • an established operating history (for a minimum of two to 10 years dependent upon its categorisation);
  • a sound financial status and good credit standing (eg having proprietary assets or assets under management (AUM) meeting required thresholds);
  • an adequate human resource person meeting professional qualification requirements applicable in the applicant's jurisdiction of origin; and
  • a sound corporate governance and compliance structure, as well as clean compliance records for the most recent three years.

In addition to the previous criteria, the jurisdiction of origin of the applicant should have well-developed legal and supervisory systems, and its securities supervisory bodies shall have entered into a memorandum of understanding for cooperative supervision with the CSRC.

The QFII programme was designed to attract stable long-term capital from credible investors without causing undesirable disturbance to the market

Over the years, the QFII programme has developed in the general direction of alleviating procedural burdens and relaxing trading restrictions. Potential participants, however, need to go through an application and approval process, obtain QFII quotas and set up appropriate banking and securities accounts prior to making any investment, in each case, following prescribed routes and formulas. In addition, the trading activities of approved foreign investors remain subject to the rules and requirements prescribed in the QFII regulations, as well as laws and regulations generally applicable to securities investors.

Investors planning to obtain QFII quotas first need to obtain approval from the CSRC, which involves the filing of an application with the regulator and the provision of relevant supporting documents. Notably, on top of financial statements and supporting documents of factual matters, an applicant is also required to submit an investment plan. The CSRC will review the application materials and determine whether to approve the applicant's QFII status.

With the CSRC's approval in hand, an applicant can then go ahead and obtain foreign exchange quotas from Safe. The exchange quota permits a QFII to convert, within the granted quota amount, foreign currencies remitted from outside of China into onshore RMB for investment inside of China, and convert RMB into foreign currencies for repatriation purposes. QFII quotas are categorised into a basic investment quota and an excess investment quota. Basic investment quotas can be obtained through record filing with Safe, the size of which correlates to the size of assets or AUM of an approved investor, and ranges between $20 million and $5 billion. Investment quotas in excess of the basic levels need to be reviewed and approved by Safe on a case-by-case basis.

Custodian banks

It is worth noting that custodian banks are essential to the QFII programme. All QFIIs are required to retain a qualified custodian bank. The CSRC has so far only approved 19 commercial lenders to act as custodian banks of QFIIs. Under the QFII programme, a custodian bank plays a much larger role than a provider of banking and custodian services. A custodian bank also handles, in respect of each QFII, regulatory filing, regulatory as well as tax reporting and foreign exchange and remittance matters. As such, a custodian bank should be appointed prior to starting the application process since both the CSRC and Safe require that applications and other filings be submitted via custodian banks.

Reporting and compliance

Successful applicants are bound to utilise QFII quotas within specific regulatory parameters. Investors are generally expected to start deployment of capital within one year following obtaining the QFII quota, although more specific time frame and percentage requirements were removed in 2016. QFII investments are generally subject to a three-month lockup period, during which a QFII is prohibited from repatriating its investment principal abroad. The lockup period commences on the day on which the cumulative amount of investment principal remitted into the PRC by a QFII reaches $20 million. Upon the expiry of the lockup period, the cumulative monthly amount of net capital outflows (principal and investment returns) of a QFII may not exceed 20% of its total assets within the PRC as of the end of the preceding year, and a minimum balance of $20 million in the QFII's account is expected to be maintained.

Continued reporting obligations apply to QFIIs following successful application for QFII status and investment quota. A QFII shall report to the CSRC and Safe within five business days upon the occurrence of:

  • a replacement of its trustee;
  • a replacement of its legal representative;
  • any change in its controlling shareholders;
  • any adjustment to its registered capital;
  • any involvement in significant lawsuits and other major events; or
  • the imposition of material penalties by foreign authorities.

As previously discussed, such reports should be filed through the custodian bank.

In addition to QFII regulations, the investment activities of QFIIs in China's securities market are subject to generally applicable trading rules and regulations. With China A shares investment for example, a foreign investor is prohibited from holding more than 10% of the outstanding shares of a listed company, and the aggregate amount of shares of any A share listed company held by all foreign investors shall not exceed 30% of the outstanding shares of such listed company. Strategic investment in a listed company is exempted from such caps. In addition, any investor holding five percent or more of the outstanding shares of an A share listed company becomes subject to augmented disclosure requirements and trading restrictions. Generally speaking, unless a QFII intends to actively exert influence on a listed company, it would have a much easier time in term of compliance to stay below the five percent threshold.

Tax treatment on QFII investment income is favourable. In principle, income derived from securities investment may be subject to enterprise income tax (EIT) and value added tax (VAT). In addition, securities transactions are subject to stamp duty. However, incomes derived from transfer of stocks and other equity investment assets by QFIIs after November 17 2014 are expressly exempted from EIT, provided such income is not received or generated by onshore entities established by QFIIs. Effective May 2016, income from the transfer of securities obtained by a QFII is exempt from VAT as well. Where a QFII obtains income such as dividends, bonuses and interests from sources in China, such income is subject to EIT withholding at a rate of 10% (as compared to the regular EIT rate at 20% for non-resident enterprises). The EIT withholding rate may be further adjusted in accordance with bilateral tax treaties (if any). The obligation to withhold such EIT has been imposed on parties that pay out the dividends, bonuses or interests. In general, QFIIs are obligated to settle all outstanding tax obligations before repatriating funds abroad.

What's in store for the future?

The QFII programme, by definition, serves but a small portion of foreign investors interested in China's capital market. The RQFII programme supplements the QFII programme in respect of well-established foreign institutional investors investing with offshore RMB, which also serves to boost internationalisation of the RMB. The QFII and RQFII programmes, however, follow very similar regulatory strategies and operate under very similar rules. The Stock Connect scheme introduced in 2014 and expanded in 2016, on the other hand, is far more inclusive. Through collaboration between the Shanghai, Shenzhen and Hong Kong stock exchanges, international institutional investors and qualified individual investors may trade selected Shanghai and Shenzhen listed stock through the trading and clearing platforms of the Hong Kong stock exchange. The move signals a major step in the liberalisation of China's capital market. With minimum qualification requirements and regulatory restrictions, the Stock Connect offers direct and easy access to A shares to a much larger variety of investors. Although international investors do not need to obtain foreign exchange quotas prior to trading mainland listed stock, a market-wide daily trading quota applies. Of course, stock connection also permits mainland investors to trade Hong Kong listed stocks through Shanghai and Shenzhen exchanges. The Stock Connect programme, to a degree, unifies the three stock exchanges into a much larger and accessible securities market.

The QFII programme, as well as other specialised market access platforms, is expected to be a temporary measure operating under otherwise impenetrable restrictions. As the economy of China becomes more open and liberal, the QFII programme will continue to evolve until it retires from the stage.

By Sue Liu, partner at FenXun Partners (Beijing)

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