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RQFII won't deplete offshore yuan
By Nathan Chow |
March 25, 2013, Monday
|
Print Edition
Print Edition
ON March 6, the China Securities Regulatory Commission unveiled new rules for the Renminbi Qualified Foreign Institutional Investor (RQFII) scheme:
1. Financial institutions registered in Hong Kong and the Hong Kong units of Chinese banks and insurers will be allowed to join the Chinese brokers and fund managers in the program.
2. Participants will now be able to invest in the mainland stock-index futures, initial public offerings, convertible bond sales, and share placements. Previously, they were limited to equities and bonds.
3. Restrictions on the composition of investors' portfolios will be lifted. Prior to changes, investors were required to put at least 80 percent of their assets into fixed-income securities, with the remainder invested in stocks.
The revised RQFII scheme will allow the introduction of a broader range of yuan-denominated investment products offshore. The yuan use in Hong Kong as well as the circulation of funds between Hong Kong and the mainland will therefore be further enhanced.
Greater participation
Meanwhile, the expansion of the program will stabilize any abnormal fluctuations in China's markets to some degree. This is important because the mainland markets are currently dominated by local retail investors. They tend to have a shorter-term investment approach that contributes to market volatility. Greater participation of offshore institutional investors thus allows the markets to keep up with the international standards. That said, there are growing worries over the potential negative impact of the RQFII expansion on offshore yuan liquidity. We think these concerns are overdone.
The onshore bond market undoubtedly has its attractions, given its yield curve is about 100 basis points higher than its offshore counterpart.
The premium comes at a price, however. High concentration of Chinese issuers restrains investors from diversifying their portfolios. Investors are also exposed to higher credit risks due to the absence of international rating references and credit research resources. Such deficiencies may well counterweight the initial onshore yield advantage.
Likewise, lack of transparency and corporate governance surrounding Chinese companies also dampen foreign investors' appetite in mainland stock markets. Many still remain skeptical of the quality of the listed firms after several fraudulent accounting practices were spotted. These largely explain the tepid response of the program. The RQFII scheme, initially approved at the end of 2011, had its quota boosted to 270 billion yuan (US$43 billion). But only 70 billion yuan of that total has so far been utilized. This translates into about 5 billion yuan per month on the back of an untapped quota of 200 billion yuan.
Growing demand
Amid the increasing scrutiny of the Chinese companies and continued improvement in the macro conditions, the demand for RQFII products will likely be stronger going forward. Nonetheless, even if we assume the remaining quota comes in at a quadruple pace of last year's (20 billion yuan a month), the size is still smaller than the average monthly increase of yuan deposits in the fourth quarter of 2012 (30 billion yuan). In other words, the liquidity shrinkage caused by the RQFII should be more than offset by the increase in offshore liquidity.
If the demand for RQFII products is even stronger than the aforementioned assumptions, the regulators could divert more yuan flow to the offshore market under the capital account.
One of the policy considerations would be allowing Hong Kong banks to access the onshore interbank market for funding. Such a move would increase offshore liquidity and address a structural problem that has not been explicitly discussed in the yuan's internationalization roadmap hitherto.
Currently, offshore investors are allowed to hold various types of yuan-denominated assets such as deposits, bonds, and A-share exchange-traded funds (ETFs). The increased holdings of yuan assets by offshore investors suggested that China was borrowing from non-residents. This is counter-productive because China, given its enormous foreign reserves in excess of US$3.3 trillion, does not need to attract more foreign capital. Hence, a more balanced approach is needed by allowing offshore investors/business entities to raise yuan onshore and hold yuan liabilities.
Another plausible option is to allow mainland individuals to participate in the yuan-denominated version of Qualified Domestic Institutional Investor program (RQDII2). Indeed, the People's Bank of China recently stated that the authorities are actively preparing to launch QDII2. That sent a strong signal to the market that this new "through-train" scheme, which was originally proposed in 2007, should be principally readied and back on track soon.
On the other hand, the authorities can also boost offshore yuan liquidity by encouraging more yuan use in outward direct investment (ODI), the growth of which has been lagging behind the yuan-denominated foreign direct investment (FDI). In 2012, the yuan was used for merely 6 percent of China's ODI, compared with 36 percent for FDI.
Relaxing restrictions such as raising thresholds for project amounts subject to approval and simplifying application procedures could support yuan ODI growth. Other potential policies include relaxing the yuan daily conversion limits for Hong Kong residents and allowing yuan outward remittance for mainland individuals and corporates.
In short, given that there is a plenty of scope for regulators to expand offshore yuan, the drainage on liquidity caused by the RQFII should be manageable.
1. Financial institutions registered in Hong Kong and the Hong Kong units of Chinese banks and insurers will be allowed to join the Chinese brokers and fund managers in the program.
2. Participants will now be able to invest in the mainland stock-index futures, initial public offerings, convertible bond sales, and share placements. Previously, they were limited to equities and bonds.
3. Restrictions on the composition of investors' portfolios will be lifted. Prior to changes, investors were required to put at least 80 percent of their assets into fixed-income securities, with the remainder invested in stocks.
The revised RQFII scheme will allow the introduction of a broader range of yuan-denominated investment products offshore. The yuan use in Hong Kong as well as the circulation of funds between Hong Kong and the mainland will therefore be further enhanced.
Greater participation
Meanwhile, the expansion of the program will stabilize any abnormal fluctuations in China's markets to some degree. This is important because the mainland markets are currently dominated by local retail investors. They tend to have a shorter-term investment approach that contributes to market volatility. Greater participation of offshore institutional investors thus allows the markets to keep up with the international standards. That said, there are growing worries over the potential negative impact of the RQFII expansion on offshore yuan liquidity. We think these concerns are overdone.
The onshore bond market undoubtedly has its attractions, given its yield curve is about 100 basis points higher than its offshore counterpart.
The premium comes at a price, however. High concentration of Chinese issuers restrains investors from diversifying their portfolios. Investors are also exposed to higher credit risks due to the absence of international rating references and credit research resources. Such deficiencies may well counterweight the initial onshore yield advantage.
Likewise, lack of transparency and corporate governance surrounding Chinese companies also dampen foreign investors' appetite in mainland stock markets. Many still remain skeptical of the quality of the listed firms after several fraudulent accounting practices were spotted. These largely explain the tepid response of the program. The RQFII scheme, initially approved at the end of 2011, had its quota boosted to 270 billion yuan (US$43 billion). But only 70 billion yuan of that total has so far been utilized. This translates into about 5 billion yuan per month on the back of an untapped quota of 200 billion yuan.
Growing demand
Amid the increasing scrutiny of the Chinese companies and continued improvement in the macro conditions, the demand for RQFII products will likely be stronger going forward. Nonetheless, even if we assume the remaining quota comes in at a quadruple pace of last year's (20 billion yuan a month), the size is still smaller than the average monthly increase of yuan deposits in the fourth quarter of 2012 (30 billion yuan). In other words, the liquidity shrinkage caused by the RQFII should be more than offset by the increase in offshore liquidity.
If the demand for RQFII products is even stronger than the aforementioned assumptions, the regulators could divert more yuan flow to the offshore market under the capital account.
One of the policy considerations would be allowing Hong Kong banks to access the onshore interbank market for funding. Such a move would increase offshore liquidity and address a structural problem that has not been explicitly discussed in the yuan's internationalization roadmap hitherto.
Currently, offshore investors are allowed to hold various types of yuan-denominated assets such as deposits, bonds, and A-share exchange-traded funds (ETFs). The increased holdings of yuan assets by offshore investors suggested that China was borrowing from non-residents. This is counter-productive because China, given its enormous foreign reserves in excess of US$3.3 trillion, does not need to attract more foreign capital. Hence, a more balanced approach is needed by allowing offshore investors/business entities to raise yuan onshore and hold yuan liabilities.
Another plausible option is to allow mainland individuals to participate in the yuan-denominated version of Qualified Domestic Institutional Investor program (RQDII2). Indeed, the People's Bank of China recently stated that the authorities are actively preparing to launch QDII2. That sent a strong signal to the market that this new "through-train" scheme, which was originally proposed in 2007, should be principally readied and back on track soon.
On the other hand, the authorities can also boost offshore yuan liquidity by encouraging more yuan use in outward direct investment (ODI), the growth of which has been lagging behind the yuan-denominated foreign direct investment (FDI). In 2012, the yuan was used for merely 6 percent of China's ODI, compared with 36 percent for FDI.
Relaxing restrictions such as raising thresholds for project amounts subject to approval and simplifying application procedures could support yuan ODI growth. Other potential policies include relaxing the yuan daily conversion limits for Hong Kong residents and allowing yuan outward remittance for mainland individuals and corporates.
In short, given that there is a plenty of scope for regulators to expand offshore yuan, the drainage on liquidity caused by the RQFII should be manageable.
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