Money managers piling into China through RQFII program

A growing number of money managers are turning to the renminbi qualified foreign institutional investor program as their conduit of choice to provide clients with direct exposure to China's domestic stock and bond markets.

On Jan. 7, Ashmore Group, a London-based emerging markets bond and equity boutique, announced that it had become the first manager outside of Hong Kong to garner an RQFII license from China's regulators.

Two days later, Source — a London-based provider of exchange-traded products — and CSOP Asset Management, a Hong Kong money manager, announced the listing on the London Stock Exchange of the CSOP Source FTSE China A50 UCITS ETF, the first exchange-traded fund in Europe to offer investors direct exposure to China's domestic equity (A-share) market.

And on Jan. 16, Deutsche Asset & Wealth Management and Harvest Global Investments Ltd., the Hong Kong arm of Beijing-based Harvest Fund Management Co., listed their db x-trackers Harvest CSI300 Index UCITS ETF on both the LSE and the Deutsche Borse, two months after a New York Stock Exchange listing. The U.S. version now has more than $200 million, noted Marco Montanari, DeAWM's Hong Kong-based managing director of passive asset management, Asia Pacific, in an e-mail.

Launched in November 2011 as a first step in the internationalization of the renminbi, the RQFII program awards quotas to money managers — initially limited to approved affiliates of Chinese firms in Hong Kong — enabling them to directly invest offshore renminbi in China's domestic stock and bond markets.

Last year, the program was expanded beyond Hong Kong, adding RQFII centers in Taipei, London and Singapore.

The RQFII program effectively opened up a second door for overseas investors to China's closed capital markets, following the 2002 launch of the country's qualified foreign institutional investor program. With QFII, China's regulators extend U.S. dollar-based quotas to investment banks, asset managers and, increasingly, to big institutional investors such as central banks and sovereign wealth funds.

The pace of continued reforms lowering barriers to China's domestic markets will be key to determining when global benchmark index providers such as MSCI Inc. and FTSE International Ltd. add some or all of China's domestic “A shares” stock and bond markets to their indexes, accentuating what Jack Wang, CSOP Asset Management's head of sales, termed “extremely” underweight allocations by institutional investors to the world's second biggest economy.

According to MSCI data, the inclusion of domestically listed “A-shares” would boost China's weighting in the MSCI's global emerging markets equity index to 30% from roughly 18% now.

By the end of 2013, China's regulators had awarded 157.5 billion renminbi ($26.1 billion) of quota capacity to 52 RQFII license holders. Most were given to affiliates of China-based asset managers, but firms such as J.P. Morgan Asset Management, PineBridge Investments and Mirae Asset Global Investments have been joining their ranks in recent months.

Through the end of last year, China had awarded $49.7 billion in QFII quotas.

Market veterans say it's highly likely the two programs will merge at some point as China opens up its capital markets.

But that's unlikely to occur anytime soon, argues Chia Chin Ping, managing director of MSCI's Hong Kong office. The two programs were set up for different purposes, with QFII designed to swell the ranks of long-term institutional investors in China's volatile markets, and RQFII more focused on the eventual internationalization of the renminbi, he said.

For the time being, RQFII is clearly the program generating more buzz.

“We're just at the outset of what the RQFII program might bring,” said Jed Laskowitz, J.P. Morgan Asset Management's Hong Kong-based CEO, Asia Pacific.

In a Jan. 16 interview, Mr. Laskowitz said China's government is clearly determined to make RQFII “a very strong, robust” program, offering asset managers considerable room to maneuver.

J.P. Morgan, which has $525 million in QFII-related investments, with a mix of 85% retail money and 15% institutional, got an RQFII license in October, and has applied for a quota. Mr. Laskowitz said his Hong Kong-based team could look to bring an actively managed RQFII fund to market — focused on retail investors but open to small- and midsize institutional investors as well — within a quarter of getting its quota.

Ashmore, in its Jan. 7 new release, sounded similarly enthused about RQFII, saying the program will provide “unprecedented access” to China's markets for international investors, with advantages over the QFII program in areas such as liquidity, repatriation of funds and flexible investment guidelines.

For example, open-end funds under RQFII offer daily liquidity and no lockups, while funds invested using QFII offer liquidity on a weekly basis and have a three-month lockup. Private funds and segregated accounts invested in China's markets under RQFII, meanwhile, can repatriate their money on a monthly basis with no limits, while under QFII, prior regulatory approval is required and no more than 20% of investments can be withdrawn per month.

Those advantages are attracting growing interest in RQFII in the fifth year of a bear market for China's domestic stocks. The A-shares market has morphed from one of the priciest emerging markets to one of the least expensive.

RQFII is a “topic that everybody is talking about now,” said Frederick Laydon, Hong Kong-based chief operating officer of Principal Global Investors. Principal, which garnered a QFII quota in August 2012, is “looking closely at the RQFII space,” he said.

Wong Kok Hoi, founder and chief investment officer of Singapore-based money management boutique APS Asset Management, said his firm, which manages more than US$2 billion through the QFII program, is in the process of submitting an application for an RQFII license as well, attracted by the greater flexibility and expedited “application to approval process.”

Sarah Reeve, an associate with Shanghai-based Z-Ben Advisors, a strategic consultant to financial firms and investors looking to do business in China, said the pace of capital market reforms in the country has left money managers scrambling to make sure they're adequately positioned.

Managers with QFII licenses are asking whether they should have RQFII as well or transfer their unused QFII quotas to RQFII — an idea Chinese regulators have given no indication of being willing to entertain, she noted.

Market veterans say the end game will be a completely open market at some point, with QFII and RQFII likely to merge and eventually disappear. That process will be accompanied by an ever-greater share of China's domestic stock and bond markets being included in global benchmarks.

Z-Ben predicts that process of integrating A-shares into global benchmarks could begin by 2015, with MSCI — which announced it was studying the topic in mid-2013 — likely to lead the way, said Ms. Reeve.

MSCI's Mr. Chia declined to comment.

In its 2014 Asia equity market outlook released Jan. 15, Societe Generale pointed to just that prospect in arguing that while investors should continue to underweight China equities in the first half of 2014, they should be prepared to “reweight” in the second half as domestic market opening strengthens “the case for inclusion of A shares in the MSCI indices.”

Principal's Mr. Laydon predicts many investors will “want to get in ahead of that evolution,” which should fuel interest in QFII and RQFII alike as alternative routes to the same goal.

CSOP Asset Management's Mr. Wang agreed, noting institutional investors in Europe accounted for the $230 million in initial investments the CSOP-Source ETF garnered at its listing. A lot of institutional investors will try to allocate a bit more to China than before, convinced that if they don't start to look now, “it may be too late when the index is adjusted,” he said.