CHINA BANKS GIVEN LIMITED CHANNEL TO INVEST IN FOREIGN

UNCLAS SECTION 01 OF 02 BEIJING 003316

SIPDIS

SIPDIS
SENSITIVE

STATE FOR EAP/CM
USDOC FOR 4420
TREASURY FOR OASIA/ISA - DOHNER/HAARSAGER/CUSHMAN
STATE PASS USTR FOR STRATFORD, WINTER, AND ALTBACH
STATE PASS CEA
STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON; SAN FRANCISCO FRB FOR
CURRAN/LUNG; NEW YORK FRB FOR DAGES/CLARK

E.O. 12958: N/A
TAGS: ECON EFIN EINV CH HK
SUBJECT: CHINA BANKS GIVEN LIMITED CHANNEL TO INVEST IN FOREIGN
EQUITIES

SUMMARY
--------------


1. (SBU) New rules allow banks with Qualified Domestic Institutional
Investor (QDII) quotas to invest in equities in addition to
fixed-income instruments, which are already permitted. Hong Kong
registered funds will for now be the sole beneficiaries, since no
other overseas regulatory body has yet signed an MOU with the
Chinese Banking Regulatory Commission (CBRC) covering QDII
supervision. A Hong Kong banker sees the change as valuable and of
interest to clients but does not expect a significant change in
outflows until the QDII quotas are expanded significantly and until
foreign stock market performance becomes more attractive relative to
the rapid appreciation underway among stocks traded on the mainland.
END SUMMARY


NEW POLICY
--------------


2. (SBU) The Chinese language May 10 China Banking Regulatory
Commission's (CBRC) policy circular broadening the scope of overseas
investment for commercial banks possessing a QDII license allows
banks to invest their quotas in equities, not just fixed-income
instruments. The circular states specifically that QDII investors
are not allowed to invest in commodities, derivatives, hedge funds,
or securities with a rating of less than BBB. Commercial banks are
allowed to invest in overseas stocks according to the following
constraints:

o The stocks purchased are listed on overseas stock exchanges;
o Up to 50 percent of existing QDII quota can be invested in
overseas equity markets; only up to 5 percent of the QDII quota can
be invested in one individual stock;
o A client of the commercial bank is required to invest a minimum
of RMB 300,000 (around $40,000) in QDII products;
o The client should have experience in stock investment;
o Managers of overseas investment should be approved by or
accredited to overseas regulators (e.g., the SEC) which have signed
an MOU with CBRC on cooperation in QDII supervision;
o Investment is limited to those stock markets whose regulators
have signed an MOU with CBRC on cooperation in QDII supervision.

LIMITED OUTFLOWS FOR NOW
--------------


3. (SBU) At present, only the Securities and Futures Commission of
Hong Kong has signed an MOU with the CBRC, so any QDII investments
will have to be made through funds registered in Hong Kong. (Hong
Kong's Hang Seng Index rose 2.5 percent Monday based on the news.)



4. (SBU) The China Securities Journal, summing up discussions with
local financial experts, suggested the CBRC circular should help
cool the heated Chinese stock market and reduce both RMB
appreciation pressure and excess liquidity. However, the
requirement that a client must invest at least RMB 300,000 (around
$40,000) and the relatively unattractive anticipated returns when
compared with the growth in the local A-share market have together
caused some experts to predict that the circular will have a limited
impact on China's A-share market.

HONG KONG: FIRST MOVER ADVANTAGE
--------------


5. (SBU) Hang Seng Bank Deputy General Manager Andrew Fung, who is
in charge of that Hong Kong-based bank's QDII operations, told us
during a May 16 visit to Beijing that the new rule is a "gift to
Hong Kong." In his view, the current QDII quota of USD 14 billion
remains largely unused because of anticipated RMB appreciation, high
relative returns in Chinese equity markets, and existing
restrictions on QDII investment funds managed by banks. The
circular has two purposes: 1) to provide more investment choices for
mainland investors currently focusing on irrationally overpriced
domestic stocks, and 2) to encourage Chinese investors to buy more
foreign exchange to reduce the growth of forex reserves.


6. (SBU) According to Fung, Hang Seng Bank will be allowed to invest
half of its USD 300 million QDII quota in funds that are managed in
Hong Kong. He expects initial client focus will be on the H-share
market (HKD-denominated shares of Chinese companies issued and

BEIJING 00003316 002 OF 002


traded in Hong Kong). Hang Seng will, however, have access under
the MOU to 2,000 managed funds that are already registered with Hong
Kong's Securities and Futures Commission. Fung predicted that
products based on investing QDII quotas in these funds will be
introduced first because equity funds on the Hong Kong Stock
Exchange already have authorization and prepared prospectuses,
making them easy to market. Since the equity funds available tap
into markets around the world, the QDII funds can be easily diverted
to stock markets beyond Hong Kong if future customers wish to focus
beyond H-shares, said Fung.


7. (SBU) In line with other media commentary, Fung does not expect
the QDII change to have any significant short-term effect on outward
capital flows. However, if QDII quotas are raised over time and the
relative performance of mainland markets declines, there could be a
significant demand for the new products, in Fung's view.

COMMENT
--------------


8. (SBU) The new rules potentially open up opportunities for
American and other foreign fund managers. They also appear to be
part of a three-pronged approach to addressing rapidly rising stock
prices through encouraging outflows, moral suasion, and increasing
the supply of local shares by pushing for new IPOs to be conducted
on the mainland. Still unaddressed, however, are low bank deposit
rates, which remain negative in risk-adjusted terms.

RANDT