December 01, 2009

Provisions on Foreign Exchange Control in Connection with Domestic Securities Investments by Qualified Foreign Institutional Investors

Issuing Body: State Administration of Foreign Exchange
Issuing Date: September 29, 2009
Effective Date: September 29, 2009


Seven years after China first allowed Qualified Foreign Institutional Investors (QFIIs) to invest domestically in securities, the State Administration of Foreign Exchange (SAFE) has finalized the regulations governing foreign exchange for QFIIs.

Enacted on September 29, 2009, the Provisions on Foreign Exchange Control in Connection with Domestic Securities Investments by Qualified Foreign Institutional Investors (2009 QFII Foreign Exchange Provisions) made several important changes from the 2002 version of these regulations, the Provisional Rules on Foreign Exchange Control in Connection with Domestic Securities Investments by Qualified Foreign Institutional Investors, which were simultaneously repealed.

In addition to the 2009 QFII Foreign Exchange Provisions, QFIIs remain subject to the Administrative Measures of Domestic Securities Investments by Qualified Foreign Institutional Investors (QFII Administrative Measures), which were jointly enacted in 2006 by SAFE, the China Securities Regulatory Commission (CSRC) and the People's Bank of China. The QFII Administrative Measures more broadly regulate the activities of QFIIs in China.

Compared with the provisional 2002 foreign exchange rules, the 2009 QFII Foreign Exchange Provisions raise the upper limit of the investment quota for individual QFIIs 25 percent, forbid the transfer of rights to a QFII's investment quota, and establish lock-up periods during which a QFII cannot withdraw its investment principal from China.

Administration of QFII Investment Quotas

Under the 2009 Foreign Exchange Provisions, a QFII is defined as an asset management firm based outside China (such as a funds management firm, insurance company or securities firm) that is approved by the CSRC to invest in China's securities markets and is granted a certain investment quota by SAFE for its domestic securities investments.

The 2009 QFII Foreign Exchange Provisions raise the maximum investment quota that a single QFII can obtain from US$800 million to US$ 1 billion. The minimum investment quota, meanwhile, remains the same as was previously allowed, US$50 million.

A QFII must pay in its investment principal within six months after its quota is granted. If US$20 million or more of principal, but less than the full quota, is paid within the prescribed time period, the actually paid-in amount will be the QFII's investment quota. As news reports have noted, in practice this clause effectively enables a QFII to enter China with an initial US$20 million investment quota, though the failure to invest the full US$50 million quota will likely have other consequences: The QFII will need to secure SAFE approval before paying in the remainder of its original allocation, and it will not be allowed to apply for an increase in the original quota within a year of the original approval.

Generally, the lock-up period for a QFII's investment principal is one year (meaning the QFII cannot withdraw its principal from China during that period).

For certain QFIIs, however (such as pension funds, insurance funds, mutual funds, charity funds and foundations), the investment principal lock-up period is shortened to three months. This rule reflects SAFE's intention to encourage and support medium- and long-term investments by QFIIs. During the lock-up period, investment principal cannot be remitted out of China. The lock-up period will be calculated from the date on which the investment principal is fully paid in.

In contrast to the provisional 2002 rules, the 2009 QFII Foreign Exchange Provisions contain no clauses relating to the transfer of investment quota usage rights and proscribe the transfer or reselling of a quota as an illegal use of foreign exchange, which means QFIIs cannot engage in the previously lucrative "quota rental" business.

Bank Account Currency Exchange Management

Each QFII should open one foreign exchange account and one corresponding RMB special account at its custodial bank. Both the foreign exchange account and the RMB special account should be registered at the local SAFE branch.

Capital in the foreign exchange account and the RMB special account cannot be used for purposes other than domestic securities investments.

If a QFII's cumulative paid-in principal is less than US$20 million, the QFII cannot exchange its foreign currency principal for RMB (meaning the money cannot be invested in the securities market, since that can only be done with RMB).

The 2009 QFII Foreign Exchange Provisions also simplify the approval procedures for inbound and outbound remittance of capital, which should make it somewhat easier for QFIIs to operate in China.

Conclusion

By allowing more foreign capital to flow into China's securities markets, the 2009 QFII Foreign Exchange Provisions are expected to increase foreign investment in China and the size of at least some Qualified Foreign Institutional Investors. The new rules meanwhile tighten control over how QFIIs actually use their allotted investment quotas. This is expected to benefit the development of China's capital markets in the long run by encouraging productive investment rather than the speculative sale of quotas.

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