MINI-QFII Programme

A so-called mini-QFII scheme is expected to gain regulatory approval by China’s National Day on Oct. 1^s,t, setting the stage for the internationalisation of yuan.

China-based fund managers and banks are opening offices in Hong Kong as they seek to secure mini-QFII licenses, which allow qualified foreign institutional investors to channel overseas yuan deposit into investments in China. Guotai Junan, CICC, Haitong Securities, Da Cheng International Asset Management Company and Harvest Global Asset Management are tipped to be among the first batch of such qualified institutions to provide yuan-denominated A-share and bond products to global investors in Hong Kong.

The initial quota of mini-QFII will be small, rumoured to be within 10 billion to 20 billion yuan, but the breadth of the Greater China Market – Shanghai, Shenzhen, Hong Kong and Taipei, which is of a combined market capitalization of over $6 trillion and two times that of Tokyo’s, is a big asset class people could hardly dismiss.

In just 11 business days after the inception of the expanded yuan programme, yuan deposits in Hong Kong surged to 104 bn, up 86% yoy, suggesting a even faster yuan deposit growth going forward.

The full process of yuan internationalization will proceed in five steps:

· Yuan leaves the mainland

· Yuan circulates offshore

· Yuan re-enters the mainland

· The width and depth of the offshore yuan market be enhanced

· Finally, full opening of the capital account

The roadmap:

· Beijing kicked off the first of the five steps on July 9^th, 2009

- a pilot scheme was launched in July, allowing direct settlement of yuan transactions for cross-border trade between Shanghai and four cities of Guangdong province on the one hand and Hong Kong, Macau and ASEAN countries on the other hand.

· The pilot scheme was expanded on June 10^th 2010

- the expanded scheme allowed yuan settlement between 18 additional mainland provinces and all countries. The scope for yuan trade settlement was expanded to cover not only trade in goods, but also services trade and other current account transactions.

- Between July 2009 and June 2010, the amount of yuan cross-trade settlement totalled 71 bn yuan. Of such, 87% traded in HK and Singapore and 56.4 bn yuan was used for goods import and 6.5 bn yuan was for goods export, meaning 50 bn yuan was flowed out of China through net imports.

- Yuan deposit went from 35 bn to 90 bn in a year, in line with the growth of china net imports settled in yuan.

· The Amended Clearing Agreement on July 19^th, 2010

- Bank of China (HK) has been playing a special role in controlling the circulation of yuan in Hong Kong – as the clearing bank for all transactions in the territory, a de facto “central bank for yuan in Hong Kong”, the bank is the lender of all yuan transactions while all yuan held by other banks is deposited with BOC (HK).

- Under an amended agreement, corporate are now allowed to open yuan accounts and transfer funds across accounts for any purpose (instead of just trade-related deals). Banks are also allowed to launch yuan-linked products, such as CDs, deliverable forwards, mutual funds and insurance products.

- The first interbank yuan deposit and yuan deliverable forward deals traded on July 20^th.

- The SFC approved Haitong Security Asset Management to issue the first yuan mutual fund in Hong Kong, raising 5 bn yuan to invest in offshore yuan bonds, CD as well as convertibles. Haitong can do so when the Mini-QFII scheme is approved.

- Any people, regardless of their countries of domicile can do yuan business in Hong Kong as long as they open a settlement account with BOC (HK).

· The third step: letting the yuan re-enter into the mainland via Mini-QFII and allowing offshore yuan to buy onshore yuan bonds

- Chinese security firms, asset managers and insurers are to launch yuan funds to invest in A-share and yuan fixed-income securities.

- On Aug. 17^th, the PBOC announced that 1) central banks 2) yuan clearing banks in HK and Macau and 3) overseas banks who are the participants in yuan cross-border trade settlement are allowed to take part in the China interbank bond market. The bond investment needs an approval from the PBOC, a quota will apply (unknown at this stage) and the source of yuan should be from 1) currency swaplines with PBOC ( a total of 800 bn yuan with 7 central banks since 2008), 2) cash from yuan cross-border trade or 3)proceeds from investing in yuan business. This scheme, the first tentative step toward an eventual opening of the capital account, has limited impact for now as it takes time to setup operations. For the long run, it will act as a bridge between onshore and offshore, improving the circulation of yuan.

· Going forward, yuan deposit rates in Hong Kong are likely to exceed that of the mainland.

- Since 2007, Chinese banks and corporate were allowed to issue yuan bonds in Hong Kong. So far, there is 29 bn yuan outstanding in 17 issues.

- Yuan bond buyers in Hong Kong have demanded higher coupons than comparable onshore bonds due to the scarcity of deposits: 2-yr bonds issued by CDB, HSBC and BEA are in the range of 2.45-2.8%, some 20 bps above onshore 2-yr bond yields.

- After July 19^th, more banks and companies mull yuan-bond issuing in Hong Kong – CDB, EXIMB, BOC have applied for 5 bn yuan issuance each, while IFC eyes $50 mn while ADB aims for an unknown size of issuance.

- Deliverable USD/yuan spot has been in a range of 6.68-6.73 in Hong Kong, about 100 bps below that of onshore, again, due to scarcity of yuan in Hong Kong (banks need to borrow yuan from BOC (HK) at a rate of 86.5 basis points). Volume wise, daily turnover has risen from $5 mn initially to some $15 mn.

- The first deliverable forward went alive in Hong Kong on 20^th July, with the first trade carrying out between two Chinese names. The one-month FX swap worth $60 mn was done at 27 pips, compared to 13 pips onshore and 22 pips for NDF.

Issue date	Name	Coupon	Maturity	Amount (mln yuan)
19/8/2010	McDonald	3	2013	200
13/7/2010	Hopewell Highway	2.98	2012	1380
10/7/2010	CITIC Bank	2.68	2011	500
22/9/2009	BOC	3.25	2010	2000
28/9/2007	BOC	3.35	2010	1000
22/9/2008	BOC	3.4	2011	1000
23/7/2009	BEA	2.8	2011	4000
11/9/2008	CCB	3.24	2010	3000
27/10/2009	MOF	2.25	2011	3000
27/10/2009	MOF	2.7	2012	2500
27/10/2009	MOF	3.3	2014	500
24/8/2007	EXIMB	3.2	2010	1000
4/9/2008	EXIMB	3.4	2011	3000
14/12/2007	FUNG Choi Media	0	2011	190
13/7/2009	HSBC China	2.9778	2011	1000
14/9/2009	HSBC China	2.6	2011	2000
20/8/2009	CDB	2.2497	2011	1000
20/8/2009	CDB	2.45	2011	2000