Recent years have seen calls for the continued opening-up of Chinese individuals’ investments overseas grow louder and louder. Together, with both the arrival of global asset diversification, and the development of private funds in China, domestic funds are already following a trend towards investing in the global market by issuing overseas funds, using global strategies.
Generally speaking, the function of overseas funds is to avoid risks in the domestic market and to grasp opportunities in the global market so as to assist clients in their global asset allocation. As for the so-called Chinese Overseas Fund, in reality, it refers to hedge funds and products registered in foreign countries (including Hong Kong, Macao and Taiwan) by Mainland Chinese institutions. These hedge funds are commonly used for investing in stocks, derivatives, foreign exchange in Hong Kong or overseas markets, and the scope of such products covers more than those offered by China’s “Sunshine Equity Funds”. Therefore, overseas funds have considerable appeal for investors who are looking for overseas asset allocation.
Any institutions who issue overseas funds are unable to avoid certain fundamental questions, such as how can fund managers attract more and more investors? How can they set up a proper investment structure for the operation of overseas funds? And how can they offer the necessary and suitable tax planning opportunities for both Chinese investors and overseas funds? But firstly, those who offer solutions to attract Chinese investors under the current legal framework and administrative structure would have to achieve an effective marketing reaction from China’s domestic investors.
In accordance with the Regulation of Foreign Exchange Administration of China, any domestic institutions or individuals who invest directly overseas or issue or deal in overseas securities, portfolios or negotiable securities and derivatives shall process the registration at the Foreign Exchange Administrative Authority under the State Council. In the event that prior registration or filing is needed by law, such registration or filing is required to be done before the application of approval or filing at the Foreign Administrative Authority. In other words, domestic individuals (like domestic institutions) are required to undergo proper approval and filing processes before launching an overseas investment.
Under the current Foreign Exchange Administration, domestic individuals’ overseas investments may be divided into three categories: Overseas Direct Investment (ODI), Overseas Portfolio Investment (OPI) and Other Overseas Investment (OOI). Other than in a situation where individuals’ ODI has been supported by a clear ruling system (i.e., The Circular on Relevant Issues of Foreign Exchange Administration Towards Domestic Individuals Using Special Purpose Companies (SPVs) for Investment and Fund-raising Overseas and for Round-trip Investments, Circular Hui Fa [2015] No. 37 or Circular 37), policy-making and operations for domestic individuals’ OPIs are all still part of a pilot scheme, with only the Qualified Domestic Individual Investors Scheme (QDII) launched so far, which allows QDIIs to participate in the examination and potentially qualify.
The QDII Scheme is an arrangement that is suitable for a market which is not fully opened-up for free currency exchange and free foreign capital exchange, and such an arrangement provides a bridge which allows domestic investors to invest in the overseas portfolio market. In China, the QDII scheme was launched by the People’s Bank of China in April 2006, and allows financial institutions including banks, funds, securities traders, and insurance companies to apply for QDII status.
The QDII Scheme developed very quickly after its launch. By 27 February 2015, the institutions which have passed the examination and qualified as QDIIs had reached 131 institutions with an accumulated quota of USD87.593 billion, while QFIIs reached 265 institutions with an accumulated quota of USD69.723 billion, and RQFIIs reached 103 institutions with an accumulated quota of RMB311.5 billion, with the good news being that quotas for QFIIs and QDIIs are expected to be eased within 2015.
In 2013, the People’s Bank of China suggested commencing preparations for an experimental QDII2 scheme, aimed at individual OPIs. Since then, the first series of six pilot QDII2 cities (Shanghai, Tianjin, Chongqing, Wuhan, Shenzhen and Wenzhou) was launched. Its policy rules that for domestic individuals who have reached the age of 18 – whose daily net assets balanced within the three months before application, who have passed the test for overseas investment and anti-risk capability, and who have negative financial credit records and have no previous judicial orders – could apply for qualification as an QDII2. In early June, the State Council further approved and circulated its Opinion on Top Tasks in Deeply Reforming the Economic System in 2015 to support the previous PBOC commitment. This means that the limitation of a quota of USD50, 000 per person per year that was enforced from 2007 could be lifted soon. Such a liberalization might release billions of RMB into the overseas portfolio and securities markets.
On 18 July 2015, the Guideline on Promoting Healthy Development of Internet-based Finance (hereinafter referred to as the Guideline), an administrative document which has been addressed as the “Basic Law” of China’s Internet-based Finance, was implemented jointly by ten ministries and committees of the State Council. The ten ministries and committees include the People’s Bank of China (PBOC), the Ministry of Industry and Information Technology (MIIT), the Ministry of Public Security (MPB), the Ministry of Finance (MoF), the State Administration of Industry and Commerce (SAIC), the Legal Affairs Office of the State Council (LAOSC), the China Banking Regulatory Commission (CBRC), the China Securities Regulatory Commission (CSRC), the China Insurance Regulatory Commission (CIRC), and the State Internet Information Office (SIIO). Even though this Guideline is only a kind of outline – leaving all sorts of details to be announced at the same time by each authority in charge of specific administration – and even though the schedule of progress of such detailed rules are all pending further confirmation by specific authorities mainly including the CBRC and CSRC, one element that has been applauded by industry players is the four basic orientations in sixteen Chinese characters for administration with the Guideline, namely: encouraging innovation, preventing risks, drawing on advantages and avoiding disadvantages, and developing in a healthy manner.
Inside the Guideline, the ten administrative authorities confirmed five supervising principles, namely, to supervise (the market) by law, to supervise (the market) moderately, to supervise using categories, to supervise synergistically, and to supervise using innovative methods. Meanwhile, the authorities also clarified the distribution of administrative powers, that is, the PBOC shall be in charge of the supervision and administration of internet payment businesses, the CBRC in charge of online lending and trust as well as internet consumption finance including individuals’ online lending and borrowing, and minor online lending activities; the CSRC in charge of equity financing, and internet-based sales of funds; and the CIRC for internet insurance, etc.
Obviously, this Guideline has demonstrated that the supervision of China’s internet-based finance shall not only define the market’s borders, but also preserve space and room for its future development. Such a demonstration is regarded as good news for those institutions and individuals who are keen to engage themselves in global asset diversification and allocation or outbound investment. In other words, for those financial institutions offering domestic individuals portfolio investment services, using internet-based product marketing fully and adequately would be the most exciting point of this basic law for China’s Internet-based finance.
According to recent statistics, internet-based finance in China has been developing dramatically, with the overall size of the industry reaching RMB 1 billion by the end of the first quarter of 2015, and it is expected to cover 48.9 million domestic users by the end of 2015 with the permeating rate reaching 70 percent. For QDII2s, among the six pilot cities, if 50% of the individuals with personal assets over RMB 1 million make outbound investments, such a policy would create an overall investment quota of approximately RMB 4.1 billion.
Nevertheless, there are also some problems and hidden dangers in China’s previous and existing market for internet-based finance. These include the absence of tariffs, rules and supervision. Some hidden risks for customers’ funds have already led to run-away cases by some operators; incomplete internal control schemes for institutions have led to operational risks; neither credit-rating systems nor financial consumers’ protection schemes are complete; and the level of information security for participating institutions is awaiting upgrades, to name a few issues.
One may read from the eight requirements inside the Guideline that PBOC has already announced the organization of a State Internet-based Finance Association to strengthen self-ruling and self-management, and shall offer additional piloting opportunities to institutions participating in QDII2 services in the current situation of supervision measures not being realized. Also, it is imagined that by adopting and implementing three measures including information announcement, protection of investors’ rights, and internet and information security, institutions in QDII2 service could gain solid advantages in marketing and set up a survey in order to win the first series of customers or investors.
Firstly, for those participating institutions who could manage information disclosure for customers and announce their business and operational activities together with their fiscal status to investors in a timely manner, attracting and maintaining investors would not be a problem.
Secondly, in order to stabilize investors’ confidence, participating institutions should educate consumers by providing them with the terms and conditions of contracts, and dispute resolution schemes that match the requirements of strengthening internet and information security for the protection of consumers’ rights.
Thirdly, participating QDII2 institutions who could upgrade their internet and technology and thereby better maintain their customers’ information could easily occupy a leading position for bargaining with administrative supervisors by sharing their advantages in collecting first-hand information and alerting customers of risks.
Finally, the launch of QDII2s may satisfy domestic individuals’ demand for global asset diversification, ease the pressure of increasing foreign exchange reserves, and speed up the RMB’s internationalization, and the institutions represented by sound commercial banks will certainly play a key role and gain a competitive advantage in the industry’s future.
Jeffrey Chen
Partner Lawyer
Shanghai Chen He Law Firm Member of Shanghai Lawyers Association, Hong Kong, Marcau and Taiwan Legal Research Committee
