ANALYSIS: China’s New Investment Channel For Qualified Foreign Institutional Investors
By TieCheng Yang and Mark Shipman, of Clifford Chance LLP.
On May 4, 2011, the China Securities Regulatory Commission (CSRC) promulgated the Guidelines for Investment in Stock Index Futures by Qualified Foreign Institutional Investors (Guidelines). The Guidelines officially announce that Qualified Foreign Institutional Investors (QFIIs) may trade in stock index futures in China with immediate effect, yet at the same time impose investment restrictions on such trading activities (see WSLR, June 2011, page 14).
In fact, before the Guidelines were officially promulgated, the CSRC had published a consultation draft of the Guidelines in January 2011 (Consultation Draft) along with an explanatory note (Drafting Explanation) to elaborate on certain issues under the Consultation Draft. No material changes were subsequently introduced to the Guidelines and their provisions remain almost identical to those of the Consultation Draft. As a result, this article refers to the Drafting Explanation in understanding the application and implications of the Guidelines.
The Guidelines are aimed at regulating the participation of QFIIs that participate in stock index futures trading.
In essence, QFIIs may invest in stock index futures only for “hedging purpose” in accordance with the relevant rules of the China Financial Futures Exchange (CFFEX). In doing so, they must comply with specific thresholds, open separate accounts and apply to CFFEX for trading codes with respect to each account.
CFFEX is responsible for regulating QFIIs’ hedging quotas and trading activities and to report to CSRC and the State Administration of Foreign Exchange (SAFE) regularly on the status of the QFIIs’ hedging quotas that it has approved.
The Guidelines explicitly restrict QFIIs to engage in stock index futures trading in accordance with CFFEX’s rules for “hedging purpose” only. The Drafting Explanation adds detail to this requirement, in that a QFII must adhere to the rules under the Administrative Measures on Hedging of the China Financial Futures Exchange (Hedging Measures), such that it must submit a hedging plan and other supporting materials when applying for the hedging quota from CFFEX. This is necessary for CFFEX to examine the trading activities of the QFII and monitor how the QFII uses the approved hedging quota.
Unfortunately, the Guidelines, the Drafting Explanation and the Hedging Measures do not define what hedging is or what activities might constitute hedging. As a result, many QFIIs are unclear as to how they should design their hedging plans or trading models precisely. This has also led to uncertainty as to whether hedging quota applications would generally be approved and the basis upon which CFFEX would determine that the participation of a QFII in stock index futures trading is only for hedging purpose.
Another point worth noting is that, while both the Consultation Draft and the Guidelines are silent on whether a QFII may utilize stock index futures to launch offshore derivatives, the Drafting Explanation explicitly prohibits a QFII from doing so as a result of the hedging principle. This is because a QFII may trade stock index futures to hedge its exposure and, hence, there appears no need for it to launch offshore derivatives. The prohibition is therefore deemed as an implicit requirement under the hedging purpose limitation…