China approves new yuan ETFs in Hong Kong

SHANGHAI, April 19 Thu Apr 19, 2012 4:14am EDT

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SHANGHAI, April 19 (Reuters) - Chinese regulators have started licensing domestic funds to create new yuan-denominated exchange-traded funds (ETFs) for sale in Hong Kong, hoping to attract fresh investors to use yuan they have accumulated offshore to invest in mainland markets.

Within two weeks of announcing a 50 billion yuan ($7.9 billion) increase in the quotas for the Renminbi Qualified Institutional Investor (RQFII) programme, China's market regulator has already issued licenses for the Hong Kong subsidiaries of some domestic fund management companies to create new funds, according to sources and media reports.

The speed with which Beijing is ramping up approval of fresh quotas shows its determination to stimulate interest among overseas investors for putting their offshore yuan into the Chinese market. The initial batch of funds on offer, which were limited largely to buying Chinese bonds, have faced challenges attracting demand in Hong Kong.

"We know that the fundraising has been mediocre," said Winnie Deng, an analyst at Z-Ben Advisors covering the offshore yuan fund market.

She said that of the 21 fund companies granted a portion of the original 20 billion yuan ($3.2 billion) in RQFII quotas, only China Asset Management Company Ltd (China AMC), Harvest Fund Management Co and E Fund Management have publicly claimed to have met their fundraising targets.

The fresh 50 billion yuan in quotas is meant to be used for investment in Chinese equities through passive index-linked ETF products, industry sources say.

Local media have reported that between four and seven fund companies have already received approval from the China Securities Regulatory Commission (CSRC) to create new ETF products that will be denominated in offshore yuan (CNH) but will trade on the Hong Kong stock exchange.

A source at one fund said the CSRC had given approval to create an index-linked ETF but said that permission from the Hong Kong Securities and Futures Commission (SFC) was still pending. The source said the CSRC had not yet specified how much of the new quota the fund would receive.

The 21st Century Business Herald, a prominent financial newspaper, quoted an anonymous fund manager as naming four companies as having received approval to launch index-tracking ETFs: Harvest Fund, China AMC, E Fund Management and CSOP Asset Management.

The report said the funds would track the CSI100 index , the CSI300 index, the FTSE Xinhua China A50 index, and the MSCI China A Index but did not specify which fund would track which index.

The four funds did not respond to requests for comment.

COMPLEXITIES OF ETFS

The first round of RQFII fund approvals issued in January was also initially limited to four funds but quickly expanded to 21. But it is unlikely that all 21 of the original funds will receive shares of the new quota.

For one, the Hong Kong Securities and Futures Commission has published strict criteria specifying that applicants seeking to launch new ETFs in Hong Kong must have prior experience operating ETFs in mainland China.

Renault Kam, director of GF Asset Management, said that while his firm launched a bond-based RQFII fund in March, his team is still considering whether to try for an ETF license.

"We have a security house background. The fund management houses will have an easier time. We don't have any ETF products at the moment," Kam told Reuters.

Chi Lo, CEO of Hong Kong-based HFT Investment Management, told Reuters on the sidelines of an industry conference on Wednesday that there would also be many technical and regulatory issues to be sorted out.

"We are talking about a Hong Kong firm buying into A shares listed in China, but then the ETF will be listed in Hong Kong. So there's a lot of back- and middle-office issues, compliance, regulatory, foreign exchange issues ... There is some major work ahead," Lo said.

BAD TRACK RECORD

The decision to add ETFs to the RQFII portfolio is probably due in part to concerns about the lukewarm reception afforded to the current batch of RQFII products, which are required to invest 80 percent of their portfolio in fixed-income products.

Deng at Z-Ben Advisors attributed that mostly to the lack of differentiation among the various funds on offer and their distribution channels.

"There is very little distinction between offerings ...(and) about 80 percent of them use Bank of China Hong Kong to handle their distribution," she said.

This time around it appears the CSRC is ensuring that each fund house has something unique to sell by granting funds monopoly rights over a given index.

"What we understand is, there will be one index per manager," said a source at one of the funds.

But Lo of HFT said that the shortage of indexes poses a challenge for the next wave of applicants: "You've only got two or three key indices for Chinese A shares."

"The challenge for the firms that want to get into the ETFs is, if they can't get into these big indices, what are they going to do? Can they do a fund of funds? Create a synthetic index that outperforms the major indices yet at the same time is still A shares? It depends on the creativity of the firms." ($1 = 6.3015 Chinese yuan) (Additional reporting by Yixin Chen; Editing by Jason Subler & Kim Coghill)

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