China Continues to Open up its Markets

October 2020

Over the weekend, China announced a new set of rules simplifying the QFII mechanism and broadening its access, effective November 1, 2020.

 

We are excited to see continued capital market reform in China. This latest set of changes is likely to increase trading volumes and foreign institutional participation in China. We view these changes as a sign of increasing level of comfort that the CSRC has developed with foreign investment in Chinese equities. Further, it is also a sign of the increasing sophistication at CSRC and their understanding of the role of short selling activity in markets.

Nipun has been an early investor in Chinese A shares and has now traded over $9B in this market. We highlighted the size of the opportunity in China in 2016 and predicted its inclusion in the MSCI indices in 2018. Further, we correctly predicted that MSCI would go beyond the large caps to include the mid-caps in their indices.

This recent set of changes brings the QFII mechanism closer to the HK–Connect route as a way to access Chinese A shares. We had predicted this convergence of the two mechanisms in our note published in April 2019. In our note, we wrote “We see Connect as being the dominant mechanism in the near future with growing convergence between the QFII and Connect.” This has proven to be correct and Chinese A share holdings over the Connect are now twice of those on QFII, as summarized in the chart below.

 

 

 

That said, the new regulations significantly widen the scope of QFII while also vastly simplifying the application process. The following is a summary of the rule changes, effective November 1, 2020:

  • QFII holders are now allowed to lend their long inventory to other investors for short selling.
  • CSRC removed the restriction that stock futures/options can only be traded for hedging purposes. This is interpreted as allowing QFII holders to short sell and borrow securities as well.
  • QFII holders are now allowed to invest in commodity futures, treasury bond futures and FX derivatives.
  • The QFII application process has been simplified removing the restrictions on size/assets of the applicant, length of history etc. Further, the number of documents required with the application has been cut in half. The authorities are expecting to turn around applications within 10 days, as compared with the current process that can take years or months.

Despite all the uncertainty in the financial markets and the turmoil in the world-at-large, China is sticking with its agenda of long-term capital market reform. The Chinese understand that attracting foreign capital improves the functioning of their markets, lowers volatility and ultimately lowers the cost of capital for their companies. We have always maintained that China will continue to advance its capital market reform agenda, at its own pace and with its own controls. The recent change in regulations has proven us correct. If you would like to learn more about our research and capabilities, please reach out to us at info@nipuncapital.com.

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While many of the thoughts expressed in the attached materials are stated in a factual manner, the discussion reflects only Nipun’s beliefs about these investments and the related markets.  These materials may contain forward-looking statements based on Nipun’s expectations and projections about these investments.  Those statements are sometimes indicated by words such as “expects,” “believes,” “will” and similar expressions.  In addition, any statements that refer to expectations, projections or characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements.  Such statements are not guaranties of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict.  Therefore, actual returns could differ materially and adversely from those expressed or implied in any forward-looking statements as a result of various factors.  The attached information was prepared as of the date hereof, and may be different as of the date you review it.  Nipun and its affiliates undertake no obligation to revise or update any statement in these materials for any reason.