China Outbound Portfolio Investment: Fleshing Out Regulations for QDII Securities Institutions & Insurers

¡¤ The Trial Measures for the Administration of Overseas Securities Investment by Qualified Domestic Institutional Investors (合格境内机构投资者境外证券投资管理试行办法)(Securities Measures), effective on July 5 2007, issued on June 18 2007 by the China Securities Regulatory Commission (CSRC).

The greatest quantity of outbound portfolio investment by individual investors, at least in the near future, is likely to flow through securities institutions, which:

¡¤ May raise funds (in Rmb, USD or any other major currency) from either large or small numbers of individual investors who may make large or small investments;

¡¤ Enjoy the broadest scope of investment products; and

¡¤ May invest at present in more than 30 foreign countries and external regions, whose securities regulatory authorities have each signed a memorandum of understanding with the CSRC on regulatory cooperation (a Securities Regulation MOU).

In comparison, insurance institutions do not have the same flexibility or, at present, the same level of detail in issued regulations, as explained in the following summaries of the most recent legislation.

SECURITIES INSTITUTIONS

QDII securities institutions, including the separate categories of fund management companies and securities companies, are now governed by relatively comprehensive regulations, which specify qualification standards, retention of outbound investment advisors and domestic custodians, fund-raising, and investment restrictions.

Qualifications

QDII securities institutions, in addition to having the qualifications required of all QDIIs (such as good corporate governance, a risk control system, an experienced management team, no record of violations within the past three years and good financial conditions), must have the following qualifications:

For a QDII fund management company:

¡¤ Net assets of no less than Rmb200 million;

¡¤ Participation in the securities investment fund business for over two years; and

¡¤ Management of assets valued at or above Rmb20 billion (or equivalent in foreign currency) at the end of the preceding year.

For a QDII securities company:

¡¤ Net capital of no less than Rmb800 million;

¡¤ A ratio of net capital to net assets that is no lower than 70%;

¡¤ Participation in the collective asset management business for at least one year;

¡¤ Management of assets valued at or above Rmb2 billion (or equivalent in foreign currency) at the end of the preceding year; and

¡¤ Compliance with an "all-risks control index" standard that will be prescribed from time to time by the CSRC.

The Advisor

A QDII security institution may engage (upon conducting due diligence and more generally taking fiduciary precautions) a foreign investment advisor that has the following qualifications:

¡¤ Participation in the investment management business for over five years (or less if the advisor is an overseas branch of the appointing securities institution);

¡¤ Securities assets in the most recent fiscal year valued at no less than US $10 billion (or lower if the advisor is an overseas branch of the appointing securities institution); and

¡¤ Incorporation (and regulatory supervision) in a jurisdiction where the securities regulatory authorities have signed a Securities Regulation MOU, and maintain an effective cooperative relationship with the CSRC.

The Custodian

A QDII securities institution must appoint a qualified PRC bank as the custodian of its assets, and the PRC custodian may appoint, to hold custody of overseas assets, a foreign custodian agent that has paid-in capital of no less than US$1 billion, or assets under custody of no less than US$100 billion. The PRC custodian shall be jointly liable for any losses resulting from the foreign custodian agent's fault or negligence in performing its custodial obligations.

Fundraising

Both a fund management company and a securities company may raise funds (in Rmb, USD or any other major currency) from the public, through somewhat different methods subject to different restrictions, as summarized below.

A QDII fund management company may offer fund shares to individuals or organizations, provided that:

¡¤ The raised funds shall be no less than Rmb200 million (or equivalent); and

¡¤ The number of shareholders in an open-end fund shall be no less than 200, and in a closed-end fund shall be no less than 1000.

A QDII securities company may invite individuals or organizations to invest in a collective scheme, provided that:

¡¤ The raised funds shall be no less than Rmb100 million (or equivalent); and

¡¤ The number of shareholders in a collective scheme shall be no less than 2.

Investments

Permitted types of investment by a QDII securities institution include:

¡¤ Bank deposits, transferable certificates of deposit, bank acceptance bills, commercial papers, repurchase agreements, short-term bonds and other money market instruments (provided that all bank counter-parties meet CSRC requirements);

¡¤ Government bonds, corporate bonds, convertible bonds, mortgage-backed securities, asset-backed securities and securities issued by international financial organizations approved by the CSRC;

¡¤ Ordinary/common shares, preferred/preference shares, GDR, ADR and real estate trust receipts listed and traded at securities markets of countries or regions that have signed a Securities Regulation MOU;

¡¤ Publicly traded funds registered with the securities regulatory institutions of the countries or regions that have signed a Securities Regulation MOU;

¡¤ Structured investment products linked to fixed income, equity, credit, commodity indexes and funds; and

¡¤ Forward contracts and swaps, warrants, options, futures and other financial derivatives listed and traded on overseas stock exchanges approved by the CSRC.

Investment allocation restrictions for a QDII securities institution are:

¡¤ Deposits held with the same bank by a single fund or collective scheme shall not exceed 20% of the net value of the fund or collective scheme, except for deposits in the custody accounts of funds and collective schemes.

¡¤ The market value of securities held with the same institution (except for government and international financial institutions) by a single fund or collective scheme shall not exceed 10% of the net value of the fund or collective scheme, except for index funds.

¡¤ Where securities assets are listed or traded on securities markets of countries or regions that have not signed a Securities Regulation MOU, the amount of such securities assets held by a single fund or collective scheme shall not exceed 10% of the net value of the fund or collective scheme, and securities assets on the securities market of one country or region shall not exceed 3% of such net value.

¡¤ The market value of illiquid assets held by a single fund or collective scheme shall not exceed 10% of the net value of the fund or collective scheme.

¡¤ All the funds and collective schemes controlled by the same QDII, except for index funds, shall not hold more than 10% of voting rights in securities issuers, and their investments shall not be directed at controlling or influencing the management of securities issuers.

¡¤ The market value of overseas funds held by a single fund or collective scheme shall not exceed 10% of the net value of the fund or collective scheme, except for money market funds.

¡¤ If multiple funds and/or collective schemes controlled by the same securities institution hold interests in the same overseas fund, those interests shall not exceed 20% of that overseas fund.

Certain complex investment products are permitted by a QDII securities institution, subject to various restrictions, as follows:

¡¤ Investments in derivative products (not related to physical commodities) are permitted, including over-the-counter transactions with qualified counterparties, provided that the purpose is not speculation or leverage, and that aggregate exposure and costs do not exceed various ratios.

¡¤ Securities lending, repurchase and reverse repurchase transactions are permitted with qualified counterparties, subject to detailed restrictions on the terms of related agreements.

¡¤ Funds of Funds (FOF) may be created, and may invest in overseas funds no more than 20% of the FOF's net assets, but they are prohibited from investing in other FOFs, feeder funds or sub-funds of umbrella funds.

Prohibited activities by a QDII securities institution include:

¡¤ Purchasing real estate and mortgaging real estate, precious metals or titles for precious metals, physical commodities or securities with the raised funds