SAFE issues new circular on the foreign exchange administration of fund management firms and securities firms making overseas investments: will it

Transcription

1 SAFE issues new circular on the foreign exchange administration of fund management firms and securities firms making overseas investments: will it open the floodgates to new investment quotas?

2 Further information If you would like further information on any aspect of this note please contact a person mentioned below or the person with whom you usually deal. Contact Shanghai Andrew McGinty T andrew.mcginty@lovells.com Anna Elshafei T anna.elshafei@lovells.com Beijing Thomas Man T thomas.man@lovells.com Liang Xu T liang.xu@lovells.com Hong Kong Jamie Barr T jamie.barr@lovells.com Tim Fletcher T tim.fletcher@lovells.com January 2010 This note is written as a general guide only. It should not be relied upon as a substitute for specific legal advice.

3 Contents 1. BACKGROUND 1 2. MAIN PROVISIONS OF THE NEW QDII FOREX CIRCULAR Overview Simplified application documents More efficient application procedures Restrictions on investments outside QDII Restrictions on outward remittances Ban on transfers or sales of Investment Quotas Effective use of the Investment Quota More stringent reporting requirements Special Accounts with Custodians Sanctions for violation of the New QDII Forex Circular 3 3. CONCLUSION 4

4 Lovells 1 SAFE issues new circular on the foreign exchange administration of fund management firms and securities firms making overseas investments: will it open the floodgates to new investment quotas? On 29 September 2009, the State Administration of Foreign Exchange ("SAFE") issued the Circular on Issues Concerning the Foreign Exchange Administration of Overseas Securities Investments by Fund Management Companies and Securities Companies 1 (the "New QDII Forex Circular"), which took effect the same day. The SAFE Circular on Relevant Issues Concerning the Foreign Exchange Administration of Overseas Securities Investments by Fund Management Companies 2 (the "Old QDII Forex Circular") was repealed at the same time. This note examines the main provisions of the New QDII Forex Circular and how it changes the landscape for fund management companies and securities companies investing overseas under the qualified domestic institutional investor ("QDII") programme. 1. BACKGROUND The QDII programme was launched by the Chinese government in 2006 to encourage the use of domestic capital to invest overseas by allowing Chinese investors to invest overseas. The QDII programme s reverse mirror image, the Qualified Foreign Institutional Investor ("QFII") scheme, began at the end of 2002, and opened the Chinese A share 3 and domestic bond markets to foreign investment for the first time. Together, these two schemes provide a two-way channel for capital to flow in and out of China via institutional investors. The QDII programme is the only official route through which Chinese investors 1 Hui Fa [2009] No Hui Fa [2006] No RMB-denominated shares issued by PRC companies that are listed on one of the two domestic stock exchange in Shanghai and Shenzhen. can invest in overseas securities markets (although it is common knowledge that many Chinese investors establish overseas securities trading accounts, particularly in Hong Kong). QDIIs are fund management companies, securities companies, trust and insurance and other financial institutions in China whose QDII status has been approved by the China Securities Regulatory Commission ("CSRC"). QDIIs can invest in overseas securities within the investment quota allocated to them by SAFE ("Investment Quota"), subject to any rules restricting their scope of investments, issued by their industry regulator. Up until 30 September 2009, China had approved 56 QDIIs, with a total issued Investment Quota of USD billion. Of these, 12 are fund management companies and securities companies with an aggregate Investment Quota of USD billion. 4 In contrast, up to the same date, the aggregate approved Investment Quota of the 78 QFIIs established in China was only USD15.72 billion - less than a third of the total Investment Quota issued to QDIIs. The Investment Quota that may be granted to any individual QFII is limited to USD1 billion, 5 whereas PRC law imposes no limit on the Investment Quotas that may be granted to a QDII. This means that SAFE can vary the Investment Quota granted to QDIIs according to variations in the foreign exchange reserves and other economic and political factors. Until very recently, the take up of QDII investment products by Chinese investors has been less than 4 See 5 Revised Measures on Administration of Foreign Exchanges for Securities Investment in China by Qualified Foreign Institutional Investors.. enthusiastic, due perhaps, among other factors, to increased uncertainty about international financial markets during the global financial crisis, and the commonly held view that the value of China s currency, the Renminbi ("RMB"), will likely appreciate against other major trading currencies, leading to lower RMB returns on overseas investments. Furthermore, between May 2008 and October 2009, apparently in reaction to the global financial crisis and to heavy investment losses suffered by some QDII funds, SAFE effectively put the QDII programme on hold by declining to approve any new Investment Quotas. The New QDII Forex Circular appears to turn this around. 2. MAIN PROVISIONS OF THE NEW QDII FOREX CIRCULAR 2.1 Overview The New QDII Forex Circular mainly deals with the administration of Investment Quotas, foreign exchange accounts, remittances of funds and statistical monitoring. It applies to both fund management company and securities company QDIIs (the "Relevant QDIIs") whereas the Old QDII Forex Circular only applied to fund management company QDIIs. In particular, New QDII Forex Circular: (a) (b) (c) simplifies the procedures and the materials required when applying for an Investment Quota applicable to Relevant QDIIs; provides that Relevant QDIIs may invest in any approved type of product up to the limit of their respective Investment Quotas; and imposes a "use it or lose it" principle, whereby, if a Relevant

5 Lovells 2 QDII does not "effectively use" its Investment Quota within two years of obtaining it, SAFE reserves the right to reduce it. This may be due to the fact that some QDIIs have been hesitant about investing due to the financial crisis, or are perhaps simply holding funds in RMB as a means of currency speculation. 2.2 Simplified application documents The New QDII Forex Circular significantly simplifies the application requirements for Investment Quotas. In particular, under the Old QDII Forex Circular, Investment Quota applicants were required to submit (among a long list of other items) a Foreign Exchange Business Securities Operating Permit ( in Chinese) (the "Forex Securities Operating Permit"). The Forex Securities Operating Permit itself had to be obtained through a separate application to SAFE requiring submission of a further set of application documents, as listed in the Old QDII Forex Circular. The New QDII Forex Circular has completely removed the requirement for a Forex Securities Operating Permit and the Relevant QDII s financial audit report for the previous year. Under the New QDII Forex Circular, applicants for an Investment Quota need only submit the following documents to SAFE: (a) (b) application letter; completed form Basic Information of an Institution in China Engaging in Overseas Securities Investments ( in Chinese); (c) (d) QDII approval document issued by CSRC; and any other documents as may be required by SAFE. 2.3 More efficient application procedures The New QDII Forex Circular requires that Relevant QDIIs to submit their applications for an Investment Quota to central level SAFE 6. Under the Old QDII Forex Circular, applications were made to local SAFE offices, which would then forward the applications to central level SAFE. Theoretically, this new procedure should speed up the approval process, given that one less stage is now involved, although in practice it may have the opposite effect, as central level SAFE will now have to deal with more applications and will presumably now need to carry out the task of preliminary checking of approval documents for completeness a task that was previously carried out at local level. Perhaps because of this (and in line with the traditional reluctance of central government bodies in China to commit to themselves to a processing timetable in new areas where they are unsure of the workload), the New QDII Forex Circular does not impose any time limits on SAFE making a decision to approve or deny applications. Under the Old QDII Forex Circular, central level SAFE was required to make its decision within 20 working days of receipt of the full set of application documents from local SAFE. However, in the absence of any express deadline, the default provisions of the People s Republic of China Administrative Licensing Law (the "Administrative Licensing Law") 7 will apply, such that SAFE must still render 6 See Article 3 of New QDII Forex Circular. 7 Presidential Decree [2003] No. 7 its decision within 20 working days of receipt of all application documents. If it cannot do so, it may, subject to the approval of its responsible officer, extend the deadline by 10 more working days, but it must explain the reason for the delay to the applicant. 2.4 Restrictions on investments outside QDII One of the most significant provisions of the New QDII Forex Circular is Article 5, which prohibits all investors in China from using foreign exchange cash to invest directly in overseas investment products 8 (i.e. without passing through a QDII). This may be designed to give SAFE a basis to punish those Chinese individuals with securities trading accounts in Hong Kong and elsewhere. Payments made by investors to Relevant QDIIs for overseas investment products must be made by way of transfer from banks in China 9 either in RMB or in foreign exchange. Under the Old QDII Forex Circular, the same prohibition applied only to individual investors in China 10 and not corporate investors. 2.5 Restrictions on outward remittances The New QDII Forex Circular expressly provides that Relevant QDIIs must not remit funds out of China in excess of its approved Investment Quota. 11 This is much clearer than the rule under the Old QDII Forex Circular, which allowed fund management companies to remit out the difference between subscriptions and redemptions of openended funds and not more than the 8 Article 5 of the New QDII Forex Circular. 9 Article 10 of the Old QDII Forex Circular. 10 Article 10 of the Old QDII Forex Circular. 11 Article 4 of the New QDII Forex Circular.

6 Lovells 3 amount of investment calculated on the basis of the SAFE-approved investment quota. 2.6 Ban on transfers or sales of Investment Quotas The New QDII Forex Circular expressly prohibits QDIIs from transferring or selling their approved Investment Quota to other parties. 12 This mirrors the provision in the QFII Forex Regulations, although it is unclear whether a whole industry has grown up around "quotarental" in relation to QDII as it had in relation to the QFII scheme (largely due to SAFE s parsimonious and erratic distribution of QFII investment quotas). The Old QDII Forex Circular was silent on this point. The basic position on licences and permits in China is set out in the Administrative Licensing Law; that is, they may not be transferred or assigned unless expressly permitted by another law or regulation Effective use of the Investment Quota A new provision allows SAFE to reduce a Relevant QDII s Investment Quota if it has not been "effectively used" within 2 years of being granted. 14 The provision does not explain the meaning of "effectively used", so presumably it is in SAFE s discretion to interpret whether or not an Investment Quota has been "effectively used". However, it is clearly intended to encourage full use of Investment Quota and to deter Relevant QDIIs from "sitting on" Investment Quota or using Investment Quota as a means of currency speculation. 12 Article 4 of the New QDII Forex Circular. 13 Article 9 of the Administrative Licensing Law. 14 Article 9 of the Administrative Licensing Law. 2.8 More stringent reporting requirements The New QDII Forex Circular imposes new reporting requirements on Relevant QDIIs and their custodian banks. A custodian bank is a bank which meets certain qualification criteria; they are given a number of responsibilities under the New QDII Forex Circular, including the safekeeping of fund assets; setting up separate accounts for different types of fund assets under its custodianship; keeping records and account books; and carrying out the clearance and settlement of transactions in accordance with Relevant QDIIs' instructions. The eligibility criteria for custodian banks are strict 15 : they must meet a number of stringent requirements relating to their ability to provide custodian services in relation to the assets of Relevant QDIIs. Consequently, there are relatively few of them, and they tend to be the very large-scale commercial banks (such as the Industrial and Commercial Bank of China and China's central bank, the People s Bank of China). 16 The New QDII Forex Circular requires Relevant QDIIs to report to SAFE within 7 working days of the end of each calendar month on the scale of the funds raised from investors for investment in overseas investment products, the sources of those funds, and the overseas investments made using such funds. Domestic custodians must, within 7 days of the end of each month, report to SAFE on the foreign investments made by the Relevant QDIIs for which they act. 15 Measures on the Administration of the Qualification of Securities Investment Fund Custodians (China Securities Regulatory Commission and the China Banking Regulatory Commission Decree No. 26). 16 A list of qualified custodian banks can be found on CSRC s website ( Forms for reporting purposes are appended to the New QDII Forex Circular. 2.9 Special Accounts with Custodians The New QDII Forex Circular provides that discrete custodian accounts must be opened by the custodian in China for RMB funds, foreign currency funds, and each new overseas investment product. As was the case under the Old QDII Forex Circular, custodians in China must report to SAFE and record file within 5 working days of opening a foreign currency account. 17 Where an overseas custodian is involved, the custodian in China is required to open an account (or accounts) for each of the Relevant QDII s products in the place where the overseas custodian is located. Where a Relevant QDII raises foreign currency funds from investors in China for investment in overseas securities products, it must open a foreign currency remittance account and a foreign currency settlement account for each such product. Where it raises foreign currency funds from investors in China through both direct and agency sales, it must open accounts for each type of sales Sanctions for violation of the New QDII Forex Circular SAFE may impose sanctions for violation of the New QDII Forex Circular pursuant to Article 48 of the People s Republic of China Administration of Foreign Exchange Rules 18 (the "Forex Administration Rules") and other regulations relating to foreign exchange. 17 Article 6 of the New QDII Forex Circular. 18 State Council Decree No. 532, issued by SAFE, revised on 5 August 2008.

7 Lovells 4 The Forex Administration Rules provide for fines of up to RMB300,000 and, in cases of serious violation, withdrawal of the Investment Quota in the event of a breach of the New QDII Forex Circular. 19 Where a violation by a custodian in China is considered serious, SAFE may order Relevant QFII to cease using that custodian s services. 3. CONCLUSION China s high levels of foreign currency reserves are putting upward pressure on the value of the RMB, but increases in the value of the RMB impact negatively affects China s export sector which has already been hit hard by the global financial crisis. The Chinese government is therefore actively looking for ways to increase outflows of foreign currency from China into overseas markets. However, it appears willing to do so only through governmentcontrolled systems - its key policy consideration seems to be to keep foreign currency outflow under its control and subject to its approval. At the end of October 2009, less than a month after the New QDII Forex Circular took effect, SAFE approved Investment Quotas for two Chinese fund management companies to launch products under the QDII scheme (the "October Allocation"). The October Allocation was SAFE s first approval of new Investment Quotas in 17 months. The New QDII Forex Circular and the October Allocation seem to indicate a change in policy away from the previous position of freezing new allocations of Investment Quotas. These recent developments apparently indicate that the Chinese government is now actively encouraging investment in 19 Article 11 of the New QDII Forex Circular. overseas securities again. This may be because China believes the worst of the global financial crisis is over and there are now opportunities for Chinese investors, or it may be to relieve some of the pressure to allow the RMB to rise against other currencies. The PRC regulatory authorities have declared their aim of keeping the inflow and outflow of foreign exchange balanced, but, in practice, they seem to be more interested in encouraging Chinese investment in overseas securities than foreign investment in the domestic securities market. In 2009 (up to 30 September), SAFE approved new QFII qualifications for only 12 foreign investors, and granted only USD2.277 billion of Investment Quota to the 5 existing and 12 new QFIIs. Clearly, the Chinese government s greater concern is to control the amount of foreign funds in the domestic market. It seems that there is continuing appetite in the domestic market for overseas investments: according to some commentaries, as at October 2009, around 20 firms had obtained CSRC approval to launch QDII products but were being held up by lack of quotas from SAFE, and since the October Allocations were announced, asset managers in China have been swamped with requests from investors in China for overseas investment products. That said, SAFE seems to be taking a relatively cautious approach: the amount of Investment Quotas allocated in the October Allocation, despite being much greater than the amounts approved for QFIIs, is not very significant (USD3 billion) relative to the size of China s foreign currency reserves (estimated at USD2.27 trillion in September 2009). It therefore remains to be seen whether the relaxation of the application requirements in the New QDII Forex Circular is simply a "tweaking" of previous policy on overseas investment rather than a fundamental policy change, or whether it means SAFE has been given a green light to "turn on the tap" and to allow a flood of new Investment Quotas to QDIIs.

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