"The QFII is a tremendously significant move in the reform, especially the opening-up, of China's capital market," said Fred Hu, managing director of Goldman Sachs (Asia) L.L.C.

China unveiled its long-awaited qualified foreign institutional investor (QFII) scheme last Thursday, allowing foreigners to trade its A shares and bonds that were previously only available to Chinese investors. The government had been prudent with the move, given the partial convertibility of its currency, renminbi, on the capital account.

Hu said the primary significance of the move, rather than drawing in much-needed foreign capital, is that the foreign institutional investors, valuing long-term returns rather than reaping profits from speculation, could help listed companies improve their performance and bring about a more mature investment philosophy.

However, Hu said China's QFII rules are unnecessarily stringent, and that, coupled with other long-standing concerns including a lack of transparency, is likely to keep major international investors from coming in, in the near term.

Hu had extensively consulted major international investors and fund managers about the scheme and they reacted, he said, with caution. "Most of the international investors welcomed the QFII, there's no doubt," he said. "But the vast majority of them are waiting on the sidelines. They are unlikely to enter the market immediately, nor would they flood in."

International investors have largely found three areas of the QFII rules too strict, he said. They include the long investment periods required before repatriation is allowed - a minimum one-year and a three-year period for close-end funds - overly complicated repatriation procedures, and a stipulation that the investor can choose only one domestic securities firm as its agent.

The regulators had probably been overprudent, he said, as foreign capital is predicted by Goldman Sachs to account for only 10-15 percent of total funds trading in Chinese shares in three to five years, should all the "basic factors," including improved transparency and more reasonable price-to-earnings ratios, fall into place.

"There should be a further loosening (in QFII rules) to realize the expected goals of the reform," Hu said.

A few overseas financial institutions, however, had expressed interest in a role in QFII. The BOCI Securities Co Ltd, 49 percent-owned by the BOC International Holdings Co Ltd, the Bank of China's (BOC) Hong Kong-based investment banking arm, said last Friday that it would try for the first QFII licence. And the Standard Chartered Bank announced later that it would apply for a trusteeship in the scheme.

The news of the move has largely exerted downward pressure on the stock market in the past few days as it stoked fears that the hard currency-denominated B shares, available also to foreigners, may eventually lose their importance.

The managing director said he also saw the move as the start of China's liberalization process of its capital account, which still imposes strict controls on cross-border capital flows. "The QFII broke through the forbidden area," he noted.

(China Daily November 15, 2002)