VZCZCXRO8195
PP RUEHCN RUEHGH RUEHVC
DE RUEHBJ #3316/01 1370944
ZNR UUUUU ZZH
P 170944Z MAY 07
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 7986
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC

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