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QFIIs Permitted to Trade Stock Index Futures

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11 May 2011

On 4 May 2011, the China Securities Regulatory Commission (CSRC) issued the Guidelines for Qualified Foreign Institutional Investors' Participation in Stock Index Futures Trading (the Guidelines).

The Guidelines, which came into force on the same day, allow qualified foreign institutional investors (QFIIs) to trade onshore stock index futures for hedging purposes.

The Guidelines do not differ substantially from the consultation paper circulated by CSRC for public comment back in January 2011. The following points may be of interest:

Stock Index Futures

The term "stock index futures" (SIFs) is defined as a financial instrument based on a stock index, which is authorised by CSRC to be traded on the China Financial Futures Exchange (CFFEx). Currently, only the CSI300 index is traded on the CFFEx. Onshore participants including licensed securities firms and fund managers began trading in April 2010.

Futures Brokers

Trading of SIFs can only be done via a CFFEx member. Currently, CFFEx members are limited to PRC licensed futures brokerage companies. Each QFII may appoint up to three such futures brokers in order to execute trades on CFFEx. This is similar to the existing rules allowing a QFII to appoint up to three securities firms for trading A shares.

Hedging

According to the Guidelines, a QFII may only trade SIFs for hedging purposes and shall comply with the relevant CFFEx rules.

Hedging quota

QFIIs are required to apply to CFFEx for a hedging quota. To this end, CFFEx may require the submission of a set of documents including, without limitation, incorporation documents of the applicant, audited financial reports for the last two years, spot trades in the last six months, and proposals for hedging transactions. According to the existing CFFEx rules, the hedging quota is valid for a period of six months. CFFEx shall report to CSRC and the State Administration of Foreign Exchange (SAFE) the hedging quota granted to the relevant QFII.

The Guidelines are not clear as to whether and how a QFII's hedging quota is related to its investment quota as approved by SAFE. It is understood that CFFEx has the discretion to determine a QFII's hedging quota in proportion to its investment quota.

Daily hedging and investment quota

According to the Guidelines, the hedging activities of a QFII shall also comply with the following requirements:

  • At the end of each trading day, the total position held cannot exceed the QFII's investment quota. According to CSRC's commentary on the consultation paper relating to the Guidelines, the total position held shall be the aggregate of the QFII's long position and short position without netting.
  • During each trading day, the total trading value (excluding closing position) cannot exceed the QFII's investment quota. This seems to restrict the frequency of trading in a trading day.

If a QFII's day-end position breaches the restriction as a result of price fluctuations, it is required to cure such breach within 10 trading days.

Notably, the "investment quota" referred to above is different from the hedging quota approved by CFFEx. The Guidelines define the term "investment quota" as "the investment principal amount approved by SAFE which has actually been remitted into China or the investment principal adjusted and confirmed by SAFE".

Under the QFII regime, before a QFII can invest in the onshore market, it is required to apply to SAFE for an investment quota. Within the investment quota granted by SAFE, the QFII can remit funds in foreign currency and convert the funds into RMB for the purpose of trading A shares and other permitted RMB instruments (which have now been extended to also include SIFs). If the actual amount of remitted funds is less than the quota originally granted by SAFE, such remitted amount will be deemed to be the investment quota. A QFII may apply for an increase in its investment quota. On the other hand, SAFE retains the power to adjust the investment quota according to financial market conditions and/or the international balance of FX payments and receipts. The definition of "investment quota" seems broad enough to cover various situations of the above.

Offering derivative products offshore

Under the Guidelines, SIFs are basically a tool for hedging QFIIs' investments in the PRC. Therefore, a QFII is not allowed to use its hedging quota for offering of derivative products offshore. This restriction is not expressly provided in the Guidelines. However, CSRC specifically mentions this restriction in the commentary on the consultation paper relating to the Guidelines. This restriction, if implemented by CSRC, will prevent QFIIs from providing their clients with synthetic exposure to the onshore SIFs market.

Other provisions

According to the Guidelines, where the QFII has more than one RMB special account, the QFII shall apply a separate trading code for each RMB special account. This is in line with the account segregation requirement under the QFII regime.

The Guidelines require a QFII to fulfil its information disclosure obligations in accordance with the relevant laws and regulations and CFFEx rules. The custodian bank and the futures broker appointed by the QFII are each obliged to report to CSRC the investment and trading activities of QFIIs.

Practical Considerations

QFIIs interested in trading SIFs will now need to consider the following:

  • to appoint futures brokers and negotiate futures brokerage agreements (we understand that some QFIIs started this some time ago);
  • to apply to CFFEx for a hedging quota with the assistance of a custodian and futures brokers; and
  • the custodian agreement may need to be amended to reflect new rights and obligations arising from the new trading activities and involvement of futures brokers.