The so-called Qualified Domestic Individual Investors program, dubbed as QDII2, is aimed at promoting cross-border trading in the Chinese yuan, the People's Bank of China said at its annual working conference for 2013 early this year. The move will initially increase the flow of the Chinese currency between stocks in the mainland and Hong Kong, analysts said.
Under the proposed QDII2 program, mainland individual investors will be allowed to directly buy and sell securities on overseas stock exchanges for the first time. Market watchers predict Hong Kong will be the first testing ground for the pilot project before Beijing gradually expands it to other offshore markets.
Reviving "through train".
Financial regulators were giving priority to the implementation of QDII2 scheme, which could spark a multibillion-yuan outflow into Hong Kong's equity market. QDII2 is similar to an earlier proposal for a "through train" system, which never came to pass, would let mainland investors open accounts at brokerages in Hong Kong to trade stocks listed on the city's exchange.
In August 2007, the State Administration of Foreign Exchange announced that it would allow individual mainland investors to trade Hong Kong-listed stocks directly. But the proposal was delayed and officially scrapped in July 2010, as authorities worried that potential capital outflow would damage yuan-denominated A shares traded in Shanghai and Shenzhen.
Back in 2007, after the forex regulator announced that it would run an experimental program in Tianjin, a coastal city near Beijing, to allow Chinese mainland individuals to buy Hong Kong stocks directly, the Hang Seng Index in Hong Kong surged almost 60 percent in the three months, as investors there anticipated a huge inflow of funds from the mainland. However, the expectations were eventually dashed. The experimental program never materialized, and in 2010, the forex regulator said it had been scuttled. No reason was given.
As Beijing is determined to rev up the internationalization of the yuan, the QDII2 scheme would materialize as early as the middle of this year, industry sources said, adding that some mainland brokers have already been prepared for stock-account opening at their Hong Kong subsidiaries and are ready to conduct internal operation tests.
Mainland cities including Shanghai, Beijing, Shenzhen, Wenzhou and Tianjian have said that they hoped to become the locations for the trial run of the QDII2 program, which could help them gain an upper hand in the competition to be regional financial hubs.
Mainland investors have long complained that there were few channels for them to invest in overseas stock markets. Under the existing Qualified Domestic Institutional Investors (QDII) program, begun in 2006, individual investors on the mainland were allowed to invest in offshore capital markets only through funds offered by approved commercial banks, fund managers or securities firms.
As of the end of March, the foreign exchange regulator had approved a total quota of US$84.13 billion for QDIIs. The investment quotas for QDII2 may eventually exceed that of the QDII program as Beijing encourages more individuals to invest abroad.
The QDII2 quotas will likely be first issued to the Hong Kong subsidiaries of mainland brokerages, which will in turn distribute them to qualified mainland individuals. The asset threshold for individuals may be set at as high as 5 million yuan, some industry insiders said.
Technically, there are no barriers to the launch of the QDII2 project and there will be no about-face this time as officials have already drawn a lesson from the failed "through train" proposal.
"It's difficult for China to develop a complete trading system that enables its citizens to invest in all global markets because the yuan is not yet freely convertible and technical difficulties remain in terms of the opening of trading accounts and the repatriation of funds," Lin Jinghua, an analyst with Capital Securities Corp, said in an interview with business news agency ET Net. "It would be easier to start with Hong Kong, where subsidiaries of mainland-based securities firms can facilitate the program."
The QDII2 scheme is part of larger plans to ease the pressure and cost of dealing with the China's huge foreign exchange reserves. When the central bank purchases foreign exchange, it has to put an equivalent amount of yuan into the market and then carry out open market operations to hedge against excessive amounts of currency building up in the market. Encouraging the private sector to hold and invest with foreign exchange, which QDII2 will do, will help solve such problems.
With foreign exchange reserves that amounted to US$3.31 trillion as of the end of last year, as central bank data show, Beijing has been easing restrictions on the use of foreign exchange by Chinese nationals. In April of 2012, the forex regulator announced that the mainland will provide more channels for capital outflow and will gradually relax controls on overseas investment by its citizens.
Beijing hopes the QDII2 program could complement an existing Renminbi Qualified Foreign Institutional Investor (RQFII) plan, which allows institutions to pull yuan deposits in Hong Kong in order to invest in mainland-listed equities. Under such a scenario, there could be a two-way capital-flowing mechanism. Mainland investors to be attracted to investments in financial products that are less developed or not available on the mainland market, such as stock options or warrants.
"The QDII2 program could be limited to a size of around US$10 billion at the initial stage to limit its impact on the domestic market," said Zhao Qingming, a researcher with China Construction Bank. "It shows the gradual relaxing of China's capital account. Despite the slow pace, investors will eventually have an option to start direct trading of overseas stocks."
Mutual benefits.
Market observers noted that the emergence of QDII2, at least in concept, is once again reviving investor hopes in Hong Kong, which is striving to defend its status as the world's leading hub for offshore yuan trading and investment.
The QDII2 scheme is believed to be linked to the B-H share conversions proposed by the mainland securities regulator. Beijing is encouraging companies with B shares - traded in US dollars in Shanghai and Hong Kong dollars in Shenzhen - to relist in Hong Kong amid a lack of liquidity and buying interest in the B-share market. A QDII2 scheme could let former holders of B shares trade stocks in Hong Kong after the firms are relisted in the city.
"Although several requirements may be set to select qualified domestic private investors in the initial stages, indicating that incremental liquidity from domestic funds may not be very significant at first, the Hong Kong market could still benefit from boosted market optimism," Guotai Junan Securities (Hong Kong) Ltd said in a report.
Although some concerns have been raised that the plan to give individual investors direct access to Hong Kong equities or other offshore markets may drain capital from mainland stock markets, key industry players don't think that will be the case.
"The outflow of renminbi to Hong Kong is unlikely to affect the A-share market because private capital has already been flowing to overseas markets through other means," Investment consultancy Z-Ben Advisors said in a note to clients. "Additionally, H shares are not trading at a large discount to A-shares, being less attractive than they once were."
Mainland investors are more worried about a flood of A-share initial public offerings that could siphon hundreds of billions of yuan from the market while diluting the prices of the existing stocks, according to Z-Ben Advisors.
The Hang Seng A-H Premium Index, a barometer of the price premium of mainland-listed A shares to their corresponding H Shares listed in Hong Kong, was at around 100 recently, down significantly from the high of 167.1 in 2009, after the A-share market suffered a three-year losing streak.
Guotai Junan Securities pointed out that undervalued class A shares in the banking, insurance and infrastructure sectors would benefit from stronger two-way flow of yuan funds between the mainland and Hong Kong.
"QDII2 could be considered another significant step in renminbi internationalization," the broker said. "We expect the same shares on the mainland and Hong Kong markets to gradually trade at an equal price, or at least the valuation difference to gradually narrow in the future."
Meanwhile, Hong Kong, as a well-established financial hub, hosts a wider range of investment tools than available in the mainland, such as stock options and warrants. In such a sophisticated market, QDII2 could offer mainland investors access to more financial products and enable them to spread risk and improve the effectiveness of asset allocation, according to Tan Fei, analyst with Shenyin & Wanguo Securities Co.
Risk-control mechanism.
Risk control could one of the top priorities for QDII2 as mainland investors lack experience in investing in overseas markets. Lu Zhengwei, chief economist with the Industrial Bank, said the timing may not be right to unveil the pilot project, especially if Hong Kong is to be used as the first testing ground.
"Hong Kong's stock market has gained a lot since 2009 because of the booming economy of the Chinese mainland and easing monetary policies in the US," Lu said. "Currently, it has little room left to rise. The economic recovery on the mainland remains flabby, and the US Federal Reserve is considering an early end to its bond-buying stimulus."
He added, "It would be unwise to open the Hong Kong market to mainland individual investors at this time, especially considering that they are generally less skilled in risk management."
However, other industry insiders said that despite the challenges, the program should be carried out as it is positive in the longer term in terms of yuan globalization and capital-account opening. But they expect Chinese regulators to take risk into consideration.
Xiang Songzuo, chief economist at Agricultural Bank of China, said only individuals with a certain scale of liquid assets may qualify for the new program. He suggested that the asset threshold could be US$5 million or US$10 million.
"Applications would also need to be of good reputation, with long-term investment experience and the ability to bear risks," Yuan Junping, managing director of Guotai Junan Assets ?Asia?, was quoted as saying in Hong Kong's Standard newspaper.
Opportunities for institutions.
It is understood QDII2 will extend the quota from institutions to high-end mainland investors. They will likely to be required to open special purpose investment accounts in financial institutions in both the mainland and Hong Kong to keep capital flow under control.
The arrangement will benefit Chinese brokerages, which have subsidiaries in Hong Kong, as well as financial consulting agencies, which have already served high net-worth individuals in the mainland.
"Definitely, it opens a new platform for businesses," said Sky Wu, a Shanghai-based independent consultant and former investment manager at Bank of China. "Brokers can earn extra commissions from helping investors to trade stocks in Hong Kong. In addition, wealthy Chinese may seek advice from investment consulting agencies with experience in analyzing the Hong Kong market for asset allocation and stock picking."
Besides, rich mainlanders may have to pass certain tests before being allowed to trade stocks directly in Hong Kong. That would provide chances for intermediaries in terms of investor education.
Although mainland individuals are increasingly aware of investment rules and products available in offshore markets like Hong Kong, direct trading could bring about risks without solid due diligence and reviewing processes.
"We've already started to gauge clients' responses on investing directly in Hong Kong-listed shares and many of them seem enthusiast about it," said Stephen Chen, a manager with Shanghai Fuga Investment Consulting Co, a firm specializing in providing advice in trading stocks. "Apparently, they need more information about stocks listed overseas, not just prices and fundamentals, but also latest developments and industry updates. We plan to start a business on that once the QDII2 program is unveiled."
