The China Securities Regulatory Commission and the People's Bank of China, the central bank, said last Thursday in a joint statement that China will allow foreign investors into its US$500-billion stock markets under a qualified foreign institutional investor (QFII) scheme.

The policy allows for the first time overseas fund managers, insurers, brokerages and commercial banks to invest in China's A shares, Asia's second-largest equity market by capitalization.

Fund managers and analysts have welcomed the plan. They say foreign capital is key to improving backward markets dominated by volatile domestic retail punters that rarely reflect company fundamentals.

"China's market remains expensive, and there are a lot of issues with corporate governance which foreign investors are not comfortable with," said Joe Zhang, head of China research at investment bank UBS Warburg in Hong Kong.

"But China is a fast-growing market. Many foreign investors don't want to miss out," he added.

But no one had forecast a rush of money into China's 1,200 A shares, as some of China's top firms had already listed in Hong Kong.

News of the scheme may help stem a slow, steady decline in prices due to a crackdown on financial corruption, poor liquidity and frequent share offerings.

"We do not expect a flood of foreign investment in China's A-share market, mainly because of high valuations, with the average price/earnings ratio at more than 40 times," said Zheng Weigang, a senior analyst at Shanghai Securities.

And foreigners - who had largely shunned the small, hard-currency B-share markets and their 112 largely poor-quality companies - would be cautious, said investment analyst Martha Wang of First State Investments in Hong Kong.

"The A-share market is so deep, so large, we can't just blindly put our money into this market," she said.

According to the rules, qualified investors must entrust their money to banks in China and appoint a domestic brokerage to trade A shares on their behalf.

Foreign investors must keep their money in the country for at least one year.

The rules have disappointed some fund managers, who had hoped for more flexibility, especially during a 17-month market downturn that has wiped 30 per cent off A-share prices.

"It's quite a lot more limited than what we've expected. So in that respect it's disappointing," said Hong Kong-based Stewart Aldcroft, managing director of Invested Asset Management Asia.

"Some of the restrictions, such as locking up the money for three years (for closed-end fund), are certainly a very unattractive proposition, particularly given current market conditions and the type of companies that would be available to be purchased," Aldcroft said.

"There will be a short-term emotional response. It will give investors the confidence they have lacked recently, instil new hope in the markets because long-term, QFII is bound to help the markets become more mature and sophisticated," said Yan Xiaoqing, Shanghai chief representative of Fortis Investment Management.

Fortis plans to set up a joint venture fund management company with Haitong Securities to tap China's markets.

Foreign investors could help raise China's speculative markets to international standards.

An inflow of capital would help backward State enterprises restructure, and foreign funds' longer-term investment strategies would stabilize prices.

But Yan and other foreign fund managers said while China's economy was expanding, they were reluctant to dive into A shares, as most were overvalued compared with Hong Kong-listed China players.

(Business Weekly November 19, 2002)