China’s ‘Closed’ A Market – How To Get In

by | May 6, 2014

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Dominic Clabby from Source ETF Suggest Another Innovative Way to Use Exchange Traded Products

China is one of the world’s largest equity markets, yet it doesn’t feature in every investment portfolio. Why not? Partly because, until recently, China’s ‘A shares’ market – the one that caters for the domestic investor – has been accessible only to the largest international investors.  But since January 2014, European investors have been able to buy and sell exchange traded funds that invest directly in Chinese A shares.

A Little History

As recently as 2003, the ‘A shares market’ (shares of Chinese companies listed in mainland China) was completely closed to foreign investors. Investors looking for Chinese exposure could only buy ‘H shares’ (Chinese companies listed in Hong Kong) and some other offshore share types. However, these actually represent only a small slice of the Chinese equity market.


The A shares market is far larger and more diverse, with over 2,000 companies and a greater focus on domestic and consumer-oriented companies. Currently, A shares alone represent over 4% of global equity market capitalisation. The instrument of choice for investors looking for direct Chinese equity exposure has always been A shares.

The A shares market first started to open up to very large foreign investors in 2003, with the introduction of the Qualified Foreign Institutional Investor (QFII) scheme, which allowed banks, insurance companies and other large financial institutions to set up branches in mainland China, apply for a QFII licence, and then request a quota to invest in A shares.

QFII quota has grown from US$ 4 billion in 2003 to US$ 150 billion in 2013. But how has this helped the average investor, who doesn’t have resources or scale to apply for QFII status?


New Opportunities

ETFs and other investment products offering exposure to China A shares have emerged. But, until very recently, an ETF offering exposure to China A shares could still offer only indirect exposure via derivatives – the ETF relied on a counterparty with QFII status to deliver its performance. Demand for QFII quota is high, and there are also restrictions on the transfer of funds in and out of China under the QFII scheme, so fees on these products have tended to be high.

So what has changed? In 2011, the Chinese government introduced a new quota scheme, for “Renminbi Qualified Foreign Institutional Investors” (RQFII).  Generally, under the QFII scheme, foreign investors bring US dollars or other currency into China and convert into Chinese renminbi (RMB) to buy A shares. And the RQFII scheme extends to foreign investors who are typically in Hong Kong, although the scheme is expanding to the UK, Singapore and Taiwan. Because the movement of foreign currency in and out of China is still controlled, the RQFII quota offers greater liquidity and is more flexible than the QFII quota.

The Revolution reaches Europe

This greater flexibility lends itself to ETFs. The point being that RQFIIs can apply for an investment quota for a specific ETF. That ETF can then buy and sell A shares, up to its allocated quota, and can offer the daily liquidity and high transparency that ETF investors expect. Since 2012, Hong Kong-listed RQFII ETFs have already grown to around US$ 5.8 billion. And in January 2014 the first RQFII ETFs arrived in Europe.


What does this mean for investors? RQFII ETFs allow all investors – not just large institutions with their own investment quotas – to invest directly and efficiently in one of the world’s most important equity markets. Of course, China is still widely viewed as an emerging market, with potential for high volatility and currency risk. But, for investors who accept those risks, Chinese equities have never been more accessible.


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