FOR the first time in history, China is radically opening its capital markets to far greater foreign participation.

In just a matter of months, the sole conduit for access - the Qualified Foreign Institutional Investor (QFII) program - has witnessed expansion, both in the number of forms approved to participate and in the total permissible quota, which more than doubled to US$80 billion. All of what has transpired, however, represents just the beginning of a process to bring about a more dynamic and robust QFII program. We now look into the likely near-term ramifications, with three of the more critical outcomes as follows:

Record quota issuance: While the untapped QFII quota is currently just over US$50 billion, we project that all of this quota will be fully deployed by no later than the end of 2015.

Death of the "quota rental": Far greater ease in applying for a QFII license will ultimately lead to the demise of the highly lucrative prime brokerage business of renting a QFII quota.

Two-tier QFII program: Demand among large global asset owners far exceeds the current QFII quota cap of US$1 billion per participant. This will likely lead to the creation of a two-tier QFII program.

With regard to actual demand for access to QFII, the ongoing issuance of licenses and investment quotas reflects the growing attractiveness that China represents, as pent-up global demand for emerging market assets increases in response to economic hardship elsewhere. To date, restrictions on in-flows to China have limited allocations to less than 1 percent of total worldwide allocations and skewed global portfolios in favor of China-correlated markets and regional neighbors.

Yet, broad exposure via BRIC funds, for example, will no longer suffice. The China market performance has decoupled from emerging market indices. Investors and managers alike need to consider China A-share allocations as an asset class of their own.

Entry liberalization

Proxy exposure will remain popular, but only until real exposure is more widely available. The possibility of entry liberalization via QFII (and its renminbi cousin RQFII) will allow global portfolio allocations to better reflect the economic realities of the Chinese mainland's 8 percent share of international market capitalization.

An ongoing expansion of QFII will minimize the appeal of investing in tangential sectors, such as upstream industries or currencies of major trading partners correlated with China's growth. Offshore IPOs offer premium share pricing but limited industry access. Most Chinese companies listed abroad are concentrated in just a few sectors: finance, telecoms and energy.

QFII's primary competitive advantage is - and will continue to be - direct access to a highly restricted market. However, it is important to recognize that the program's focus is now firmly on global asset owners, such as sovereign wealth funds, insurers and pensions.

Beijing now firmly views these institutions as playing a highly integral role in the QFII program, given both their interest and ability to invest large sums into the local market and do so with the longest time horizons.

Demand for quotas among large and liquid asset owners, however, is considered to be well beyond the current QFII cap set at US$1 billion per participant. In fact, both Norges Bank and the Hong Kong Monetary Authority recently received additional quotas, taking these two institutions to that upper limit.

Given such demand, along with the attractiveness of having such institutions operating in the QFII program, Z-Ben Advisors expects the QFII program to be expanded into a two-tier scheme.

There will continue to be the current program, open to all qualified parties but with a total quota cap at US$1 billion, and there will be a new premium-access tier open solely to large asset owners and a select group of investors, with a quota that exceeds the current US$1 billion cap.

Ongoing reforms will also continue, favoring the participation of global asset managers. Their ability to create well-structured portfolios and do so with relatively low portfolio turnover offers stability in a China market plagued by fickle investor behavior and higher rates of churn and redemptions.

That said, the one obstacle currently standing in the way of even greater QFII participation by asset managers is end demand. That's why asset managers should expect to receive no more than US$100 million in a QFII quota, at least initially. Demand for China exposure globally at the mass retail level - the primary focus of participating asset managers - has been negatively affected by questionable QFII performance to date, further complicated by ongoing concerns over China's economic outlook.

This has not been lost on the regulators overseeing QFII. In an attempt to make exposure to China more appealing, it was decided that QFII would be opened up to previously off-limit asset classes, including the interbank bond market and even the futures market.

Important basis

The allowance for asset managers to develop China products that have varying risk/return profiles - including dedicated fixed income QFII products - is nothing short of groundbreaking. It serves as an important basis for developing products to attract a much wider variety of dedicated, long-term investors.

No longer are all foreign institutions being as warmly welcomed to QFII as they once were. Although they were the first to gain entry nearly a decade ago, it is clear that in today's environment the sell-side and their prime brokerage units are being relegated to the sidelines.

The practice of "renting" a quota to anyone willing to accept abnormally high fees was never considered to be acceptable. Now it would seem that market forces will be unleashed to put an end to the practice once and for all.

It is clear that the QFII program is now entering an entirely new phase in its development.

There will certainly be greater opportunities on offer, but at the same time, a more open QFII program will result in increased competition. All participants will need to take this into consideration as QFII strategies are developed.

Z-Ben Advisors is a Shanghai-based consulting company, covering the Chinese asset management industry. Shanghai Daily has condensed the article. The opinions expressed are their own.