The possible emergence of new ways to access mainland Chinese equity markets could drastically change the trading environment of Hong Kong, says Oliver Ng, head of financial institutions partnerships for broker Bank of China (BOCI) Securities, a wholly owned subsidiary of Bank of China, of the People's Republic of China (PRC).
The credentials for trading into or out of the PRC – Qualified Foreign Institutional Investor (QFII) and Qualified Domestic Institutional Investor (QDII) respectively – are hard earned and facilitating access either way is BOC Securities core business. The bank is incorporated in Hong Kong, but has both clients from mainland China with QDII status and overseas clients that with QFII status.
According to Ng, a new method of accessing the Chinese market could be opening up in the near future. Talk is of a new status, unofficially known as mini-QFII, which could allow the licensing of Chinese fund managers to trade into the Chinese markets from Hong Kong.
“There is speculation, with no formal rule from the Chinese Securities Regulatory Commission, the mainland securities regulator, that overseas firms that are subsidiary of PRC companies, ie mainly Chinese fund houses, will be eligible to apply for mini-QFII status,” explains Ng. “Once approved, they will be allowed to invest in mainland China. Then they will be able to offer mutual funds denominated in reminbi to overseas investors.”
Chinese investment houses typically send orders to exchanges through a broker's gateway, like DMA, and Ng says this basic process would continue for mini-QFII firms. “For these funds, their traders, although based in Hong Kong, are under secondment from China. When they place orders for the China markets, they would use Chinese terminals to connect through a network to the broker's gateway at the Shanghai and Shenzhen exchanges. So they are, in essence, moving the trading desk from China to Hong Kong.”
The implications of this development are intriguing. If overseas pension funds and other asset owners are able to invest in Chinese-owned fund houses trading out of Hong Kong, the process for investing in China could bypass firms that have attained QFII status, such as Aberdeen Asset Management, which was approved on 12 August. Depending on the products offered and regulations imposed, mini-QFII funds could see a significant flow of capital from investors that are losing faith in other equity markets.
In a recent speech referring to the ”flash crash' event in which the price of major US equities plummeted sharply and then rebounded, chairman of the US regulator the Securities and Exchange Commission Mary Schapiro said, “According to mutual fund data, every single week since 6 May has seen an outflow of funds from equity mutual funds.”
Comparatively the Chinese markets – both mainland and Hong Kong – are performing well, says Ng. “In Hong Kong, we've had exceptional turnover, up to HK$70 billion traded on some days. If you look at the Shanghai and Shenzhen markets combined, it's substantially higher than what we've had in Hong Kong,” he notes. “In that sense, I feel the turnover in China is quite healthy, especially given that it's a closed market dominated by retail investors.”
The potential increase in funds under management of Chinese buy-side firms from overseas sources could also lend a traditionally retail market a more institutional flavour. That could potentially lead to use of more complex execution strategies. “In mainland China, basic DMA trading is available and common as most trades are done by electronic means. On the other hand, algo trading is limited to very simple and basic strategies such as VWAP and TWAP,” Ng says.
For the moment, overseas investment firms still require a broker to act as a liaison into China. BOCI Securities offers a solution for QFIIs involving its mainland affiliate BOC International (China) Limited as an execution broker in China and its parent Bank of China which as a local custodian for QFIIs.
It also offers QDII firms a route to diversifying their portfolio via outside markets. Mainland QDII clients typically pass their non-domestic orders to brokers who manage the overseas part of the transaction. Having had their fingers burnt during the financial crisis, many Chinese investors are cautious about trading overseas.
Whatever the future holds, Ng says that the current volume restrictions of trading via QFII and the dual-listing of some of the largest companies in China on the Hong Kong Stock Exchange means that for overseas investors who wish to have good exposure into China, Hong Kong is the best route to market.