New CSRC Guiding Opinion on QFII inspectors

The Lehman Brothers QFII fund became the first QFII to face possible liquidation by the relevant PRC regulatory authorities. The Lehman bankruptcy has led the CSRC to realise the importance of further supervision of the market and its participants, in particular QFIIs. As such, the CSRC issued its Guiding Opinion on Inspector of Qualified Foreign Institutional Investors (CSRC No.40 [2008]) (Guiding Opinion) on October 17 2008 in order to strengthen compliance control of QFIIs and to regulate the management of QFII inspectors. The Guiding Opinion came into effect on October 20 2008.

Requirements and duties of QFII inspectors

A QFII Inspector shall be familiar with the Measures for the Administration of Securities Investments in China by Qualified Foreign Institutional Investors (合格境外机构投资者境内证券投资管理) and relevant PRC laws and regulations and shall have good work ethics (Article 4 of the Guiding Opinion).

The duties of an QFII inspector shall include, but are not limited to (Article 7):

(a) making a compliance report regarding the operation of funds to the CSRC;

(b) carrying out compliance examination on clients;

(c) reviewing relevant application documents, product reports and business reports of the QFII, which shall be submitted to the CSRC;

(d) conducting daily supervision over transactions of the QFII together with relevant departments of the QFII and focusing on unusual transactions;

(e) carrying out regular and irregular inspections of QFII transactions;

(f) supervising the information disclosure activities of the QFII in relation to onshore securities investments; and

(g) arranging training on QFII laws and regulations for the relevant departments.

CSRC requirements on QFII inspectors

Pursuant to Article 8, an inspector shall avoid conflicts of interests and the QFII shall in the meantime make relevant arrangements to ensure the effective performance of such inspector. The QFII shall submit an annual compliance report to the CSRC within 30 days of the last day of the first half-year (Article 9). A QFII inspector shall prevent the QFII from violating local laws and regulations and shall report such matters to the CSRC within 10 working days thereof (Article 10). An inspector shall make objective and fair judgements on the compliance and risk control of the QFII (Article 11).

CSRC supervisory system

Before the Guiding Opinion was issued, the CSRC had issued the Measures for the Administration Chief Inspector of Securities Investment Fund Management Company (Measures for Chief Inspector). These Measures set out the duties, requirements and nomination procedure of the chief inspectors.

The Guiding Opinion provides a similar system. However, taking the existing organisational structures and operation cost of QFIIs into consideration, the Guiding Opinion does not specify (i) that the QFII should employ a full-time inspector (instead, it conditionally permits an employee of the QFII to be nominated as a part-time inspector); (ii) the detailed internal nomination procedure of the QFII inspector; and (iii) stringent requirements on the QFII Inspector similar to those specified in the Measures for Chief Inspector.

Significance

As QFIIs are now permitted to invest in a wide range of domestic financial products such as stocks and bonds listed on the local Chinese stock exchanges as well as securities investment funds, further supervision of QFIIs is required.

QFIIs are established and exist under different laws, regulations and regulatory systems and may exercise different standards on compliance control. Although QFIIs usually have a compliance department and professional operators who exercise fund investments, foreign professionals working for the QFIIs may have difficulties in understanding PRC laws, regulations and regulatory systems, thus resulting in their breach.

The Guiding Opinion strengthens supervision on the internal operation of QFIIs. This prevents QFIIs from engaging in non-permitted activities such as over-proportional investments or untimely information disclosure acts. It also strengthens the supervisory powers of regulatory authorities on the QFII products, compliance examination on clients, transaction procedures and information disclosure system.

Before the Guiding Opinion was issued, most supervisory functions of QFIIs were exercised by the stock exchange and custodian bank according to the Measures for QFIIs. Under this Guiding Opinion, such functions are extended to the inspector to further regulate the compliance control and effectively prevent violation.