Accessing onshore China

Accessing onshore China Alan Yau Director, Institutional Client Management only intended for professional investors as defined by MiFID

Old Chinese proverb: When out of doors, never show your silver

Investing in China What is all the fuss about? The global investor search for yield China has been the global growth driver, even over the period of the recent financial crisis China s currency not fully convertible acceleration on RMB internationalisation This will pave the way for increased access into China s financial markets and new investment opportunities Paving the way for access into China s onshore financial markets and new investment opportunities

The need for internationalisation of the RMB Why? Three main reasons for the wider use of the RMB Playing catch-up Increasing share of world trade Trade settlements in RMB increasing - Current Account liberalisation Mismatch between size of economy and currency usage 1 A global trading currency China s new found confidence and growing world confidence in China Increasing will to open up financial markets to international investors RMB internationalisation facilitates opening up of domestic markets global index inclusion? Setting up RMB Centres in Hong Kong, Singapore, Taiwan, UK 2 A global investment currency China looking to diversify from USD as currency of trade USD liquidity squeeze during financial crisis Chinese companies using USD came to a standstill. PBoC stepped in with swap lines with central banks to offer RMB trade liquidity China wish to see RMB feature more in FX Reserves risk of USD depreciation 3 A global reserve currency Source: HSBC Bank.

Traditional way to acquire exposure to China assets Go offshore Equity markets Via listings in offshore exchanges eg Hong Kong: H shares, Red Chips, etc Number of stocks listed are limited in number eg H share listing represented by c.100 stocks Fixed income Via Dimsum market or hard currency issues Source: HSBC Bank.

Why Invest in onshore China? Preparing for the future 1. Well capitalised stock markets Onshore China (A and B share) capitalisation c.usd3.5 trillion (Sep2013) cf. UK, Japan Represented by over 2,400 company stocks exposure to sectors undergoing industrial upgrading 2. China fixed income RMB 29.6 trillion (USD5 trillion approx.) capitalisation Deep bond market for growing international investor base China s financial markets are sizeable and a source of new investment opportunities Source: HSBC Bank.

Accessing onshore China Key milestones of China market deregulation 1992 2003 2005 2006 2007 2009 2010 2011 2012 2013 B-share market opened to foreign investors A-share market opened to foreign investors under QFII scheme, with an initial quota of USD4 billion QFII quota increased to USD10 billion CSRC revised QFII rules and relaxed the eligibility criteria for long-term funds QFII quota increased to USD30 billion Domestic institutions allowed to invest overseas under QDII scheme SAFE relaxed QFII FX control rules China inter-bank bond market opened to foreign investors under CIBM scheme QFII allowed to trade index futures RQFII scheme launched, first batch being bond funds with total quota of RMB20 billion QFII quota increased to USD80 billion, and approval cycle shortened from 18 months to an average of 6 months CSRC and SAFE further revised QFII rules to relax controls and provide more flexibility RQFII scheme extended to A-share ETF funds, quota increased to RMB270 billion CIBM scheme extended to foreign insurance companies QDLP rules promulgated in Shanghai, allowing foreign hedge fund managers to raise funds in China and invest overseas CSRC Chairman Guo announced QFII/RQFII quotas to be expanded by 9/10 times and considered to pilot-launch the QDII2 program, the Qualified Domestic "Individual" Investors RQFII is extended to cover all financial institutions in HK with the asset allocation restrictions removed and repatriation rule confirmed PBOC released official circular to allow QFIIs to participate in CIBM Hong Kong/Macau/Taiwan residents living onshore in China allowed to invest into A-share and domestic securities investment funds Foreign residents living onshore in China allowed to invest into domestic securities investment funds Foreign banks allowed to provide custody service for domestic funds QFII quota increased to USD150 billion RQFII Scheme further expanded to Singapore(RMB50 billion) and London(RMB80 billion), Taiwan (pending) Source: CSRC, SAFE.

Accessing onshore China Access requirements Capital control to access onshore markets Three schemes open to investors: 1. QFII: Qualified Foreign Institutional Investors 2. RQFII: Renminbi Qualified Foreign Institutional Investors 3. CIBM: China Interbank Bond Market (limits to certain investors types eg central banks etc) An investor licence is required to tap China s financial markets

Accessing onshore China Option 1: QFII scheme Qualified Foreign Institutional Investor (QFII) scheme Applicable Overseas asset managers, insurance companies, securities companies, commercial banks, others institutions (pension fund, charity fund, endowment fund, trust, government investment institution) Source funding Foreign Currency (converted to RMB onshore before investment commences) Exchange-listed or transferred A-shares, bonds and warrants Fixed income products traded in inter-bank bond market Available Securities investment funds instruments Index futures Subscription to IPO, additional issuance, rights issues, and convertible bond issuance Asset allocation No less than 50% in equity and no more than 20% in cash Foreign ownership limit 10% for individual foreign investor; 30% for all foreign investors Total approved QFIIs (as of 30 Nov 2013): 251 Total approved quota/available quota (as of 27 Dec 2013): USD49.7bn/USD100.3bn QFII market development (2003-2013) 1 700 1 775 2 100 12 15 7 3 400 18 950 3 398 3 347 3 050 1 920 24 18 12 15 803 12 258 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: CSRC, SAFE. Number of Newly Approved Institutions 29 72 45 Breakdown by number of QFIIs Asset management (62.15%) Insurance firm (6.37%) Securities firm (3.59%) Bank (13.15%) Others (14.74%) Advise to seek advice and help with an experienced Custodian bank in handling QFII application and documentation

Accessing onshore China Option 1: QFII scheme QFII eligibility criteria Type of institution Track record and operational experience Assets under management Paid in capital Ranking in world Asset Management 2 years or more Not less than USD500 million in securities assets in the last financial year Insurance companies 2 years or more Not less than USD500 million in securities assets in the last financial year Securities companies 5 years or more Not less than USD500 million in net assets and not less than USD5 billion in securities assets in the last financial year Commercial banks 10 years or more Not less than USD300 million in tier one capital and not less than USD5 billion in securities assets in the last financial year Others (pension fund, charity fund, endowment fund, trust company, government investment institution) 2 years or more Not less than USD500 million in securities assets in the last financial year Note: Only investors domiciled in countries or regions where the securities regulatory authorities have signed a Memorandum of Understanding with the CSRC are eligible to apply for QFII status. On 27 July 2012, the CSRC officially released the revised 'Circular on Relevant Issues Concerning Implementation of the Measures on the Administration of the Domestic Securities Investment of Qualified Foreign Institutional Investors' (the '2012 CSRC circular'). Source: CSRC, SAFE.

Accessing onshore China Option 1: QFII scheme application process QFII Custodian Application documents CSRC Obtain Investment License CDC: Central Depository Company SCH : Shanghai Stock Exchange CFETS : China Foreign Exchange Trade System Source: CSRC, SAFE. Exchange market Apply for opening of RMB account for securities investment Apply for the Investor ID at CSDCC SHH and SZN Report to Shanghai and Shenzhen Stock Exchange PBOC SHH CSDCC SSE QFII Starts Trading in Stock Exchange N SAFE CIBM Obtain Investment Quota and Approval to open RMB account Y CDC PBOC PBOC SHH CFETS SCH (optional¹) QFII Starts Trading in CIBM Interbank bond market Obtain quota approval to invest in CIBM Set up RMB account for CIBM Open bond account with CDC, SCH and filing with PBOC Apply for trading code with interbank trading center (CFETS)

Accessing onshore China Option 2: RQFII scheme RMB Qualified Foreign Institutional Investor (RQFII) scheme Hong Kong, UK, Singapore, and Taiwan subsidiaries of domestic fund management companies, securities companies, commercial banks, insurance companies, or Financial institutions registered and having its principal place of business in the respective RQFII Applicable institutions countries Obtained asset management licence issued by the respective securities regulator in country of RQFII centre and have already conducted relevant asset management business. Source funding Offshore RMB Exchange-listed or transferred A-shares, bonds and warrants Fixed income products traded in interbank bond market Available instruments Securities investment funds Index futures Subscription to IPO, additional issuance, rights issues, and convertible bond issuance Other CSRC-approved financial instruments Asset allocation On 6 Mar 2013, restrictions on asset allocation was removed ie Quota can be invested 100% bonds, equities etc Foreign ownership limit 10% for individual foreign investor; 30% for all foreign investors Allocated RQFII Quota in RMB (billion) Hong Kong Taiwan London Singapore Paris TBC Source: CSRC, SAFE. 50 80 100 0 50 100 150 200 250 300 270

Accessing onshore China Option 2: RQFII scheme application process Taiwan Hong Kong London Singapore RQFII Application documents Custodian CSRC SAFE Obtain Investment License Obtain Investment Quota and Approval to open RMB account Exchange market Apply for opening of RMB account for securities investment Apply for the Investor ID at CSDCC SHH and SZN Report to Shanghai and Shenzhen Stock Exchange PBOC SHH CSDCC SSE N CIBM Y CDC PBOC PBOC SHH CFETS SCH (optional¹) Interbank bond market Obtain quota approval to invest in CIBM Set up RMB account for CIBM Open bond account with CDC, SCH and filing with PBOC Apply for trading code with interbank trading center (CFETS) RQFII Starts Trading in Stock Exchange RQFII Starts Trading in CIBM Source: CSRC, SAFE.

Accessing onshore China Option 3: CIBM scheme China Interbank Bond Market (CIBM) scheme Applicable Type 1: Foreign central banks or monetary institutions authorities Type 2: RMB clearing banks in Hong Kong SAR and Macau SAR Type 3: Overseas participating financial institutions engaging in RMB cross-border settlement Type 4: Foreign insurance companies (since March 2012) Type 5: QFIIs and RQFIIs Source funding Available instruments RMB (generated from central bank reserve/currency swap, cross-border trading or RMB investment business or premium from RMB insurance products) Fixed Income instruments in interbank market Government bonds, PBOC bills, financial bonds, commercial paper and mid-term notes, etc Number of foreign institutions approved under the CIBM scheme (as of 26 Dec 2013): 105 Among them, 68 are foreign banks, 11 are foreign insurance companies, 21 are RQFIIs and 5 is QFII Note: The number does not include foreign central banks and monetary authorities as this is not publicly disclosed, the number is the total foreign institutions which are allowed to participate in CIBM market including those under CIBM scheme as well as RQFII scheme. Breakdown by number of institutions Banks (65%) Insurance Companies (10%) RQFIIs (20%) QFII (5%) Source: CSRC, SAFE.

Who can invest? And what can be invested in? Asset class Market Market size (USDbn) Who can invest? RMB Equity A-share market 3,393 QFIIs RQFIIs RMB Fixed Income China interbank bond market (CIBM) 4,448 QFIIs RQFIIs Central banks RMB clearing/settlement banks Supranational institutions Foreign insurance companies Exchange traded bond market 261 QFIIs Note: For those institutions having on-shore subsidiaries or JVs, they actually have the option to invest through their onshore subsidiaries/jvs. Source: CDC as of 30 Jun 2013; SCH as of 1 Jul 2013 and CSDCC as of 30 Jun 2013. Source: HSBC Bank. RQFIIs

Comparison between QFII and RQFII Differences between schemes relate to (i) asset allocation (ii) liquidity (iii) quota increase

Products and solutions: Offshore RMB versus onshore RMB Payments and cash management Offshore RMB products 1 Onshore RMB products (China) 2 No restriction on account opening No restriction on account opening Custody/fund admin RMB Custody and Funds Administration Services RMB Custody and Clearing (QFII only) Exchange services and risk management products Spot FX (for trade/general purposes) Deliverable FX Forward, FX Option and FX Swap Deliverable Interest Rate Swap, Cross Currency Swap and Interest Rate Swaptions Non Deliverable Forward Non Deliverable Option Spot FX (QFII only) Forward FX (QFII only) FX swaps (QFII only) Interest Rate Swap and Cross Currency Swap (QFII only) Credit Risk Mitigation Agreement/Warrant (QFII only) FX options (QFII only) Borrowing/financing products Trade financing facilities and commercial loans Issuance of offshore RMB bonds/certificate of deposits (CDs) Investment products Time deposit, CDs Primary and secondary RMB bonds trading FX linked structured deposit Interest rate linked structured deposit Equity linked structured deposit Gold linked structured deposit RMB investment funds RMB equities RMB RQFII funds RMB gold ETF Trade financing facilities and commercial loans (QFII only) Money Market (QFII only) Time deposit (QFII only) Call deposit (QFII only) Structured deposit (QFII only) Bonds (QFII and CIBM) Onshore RMB money market funds RMB mutual funds (equity fund, bond fund and MMF) Notes: 1. Representative offshore RMB products currently available in Hong Kong. Products may vary in other regions. 2. There are certain restrictions on the types of clients to which the products can be offered.

CIBM, QFII and RQFII A cautionary note on taxation Exchange market Withholding tax, subject to 10% income tax Coupon Interest Coupon Interest of Government Bond (issued by MOF) is tax exempted Stock/Cash Dividends Deposit Interest (including interest from RMB cash balance, Clearing Reserve Fund, Warrant Collateral Fund) Business tax Coupon interest are subject to business tax but currently, they are not collected as there are variances among the different tax authorities Capital gains tax Capital gains tax is not collected as the SAT is yet to announce the rule regarding the capital gain tax Interbank bond market Withholding tax, subject to 10% income tax Coupon Interest Coupon Interest of Government Bond (issued by MOF) is tax exempted Currently no standard tax withholding practice is adopted by the bond issuers Deposit Interest Business tax Coupon interest are subject to business tax but currently, they are not collected as there are variances among the different tax authorities Capital gains tax Capital gains tax is not collected as the SAT is yet to announce the rule regarding the capital gain tax Please seek specialist tax advice before proceeding! Note: Since there is no standard practice of tax collection in the market, you may want to seek your own professional tax advice from your tax adviser. SAT - State Administration of Taxation in China.

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