European investors still keen on China

Appetite remains, but it may be dampened by government measures to arrest fall in shares

European investors say they are still keen to invest in China's financial markets through the official quota system, although the recent stock market turmoil has made them more cautious.

The two major quotas that allow foreign investors access to China's controlled financial markets are the Qualified Foreign Institutional Investor and Renminbi Qualified Foreign Institutional Investor programs.

The QFII program, started in 2003, was raised to $150 billion in 2013 and the RQFII program, started in 2011, has been expanded to more than 10 international markets since inception, with each market given an individual quota.

Under the two systems, approved investors can invest in China's stock and fixed-income markets.

Robert Davis, a London-based senior portfolio manager at NN Investment Partners, said the RQFII has the great benefit of allowing foreign investors to access Chinese mainland equity markets, and offers wider opportunities compared with the H shares in Hong Kong.

"There are a greater number of companies to choose from, in sectors that are under-represented in the offshore Hong Kong market particularly in consumer, healthcare and industrial sectors, and some sub-sectors that for offshore investors are currently unavailable altogether－such as the distillery and wine sector," Davis said.

Gast Juncker, a partner at the Luxembourg headquarters of law firm Elvinger, Hoss&Prussen, said the RQFII "unlocked the door to the creation of full China (A-share and bond) products in a UCITS wrapper making that asset class available to investors worldwide".

UCITS, or the Undertakings for Collective Investments in Transferable Securities, are a set of European Union directives that aim to allow collective investment programs to operate freely throughout the European Union, on the basis of a single authorization from one member state.

Effectively it provides a single European regulatory framework for an investment vehicle, which means it is possible to market the vehicle across the EU without worrying about its country of domicile.

UCITS are popular in Luxembourg, which received its 50 billion yuan ($8.16 billion) RQFII quota earlier this year, making it the second European city to receive RQFII quota, after London was granted an 80 billion yuan RQFII quota in 2013.

Like Davis and Juncker, many European investors are positive about the long-term benefit of QFII and RQFII, because they give opportunities for higher return at a time when scope for high-return opportunities in Europe is limited.

Hong Kong, the earliest offshore market to trial the RQFII program and still the largest market for these investments, is in talks with Beijing to expand its 270 billion yuan quota, which was granted in 2011 and became exhausted late last year.

Fang Jian, a partner at the London-based law firm Linklaters, said both the QFII and RQFII plans had proved very useful for foreign investors to gain access to China's financial markets, particularly before the creation of the Hong Kong-Shanghai Stock Connect.

"Before the stocks link was established last year, QFII and RQFII schemes were the only channels for foreign investors to participate in China's high economic growth," Fang said.

Opened last year, the Stock Connect allows investors to buy a limited number of mainland stocks through their accounts in Hong Kong, which are not subject to mainland's capital control rules.

Fang said RQFII in particular also has wider significance, allowing institutional investors to gain exposure to the Chinese market－a crucial part in the renminbi's internationalization process.

"The RQFII scheme allows better connection between China's onshore and offshore renminbi markets because it allows renminbi in foreign markets to be put into use," Fang said.

However, Fang warned that foreign investors' appetite to invest in China's financial markets may be dampened by the government's moves to control the A-share market plunge, by imposing various price-control measures.

Since their June 12 peak, Shanghai stocks have fallen 30 percent in the space of three weeks. China's stock exchange regulator imposed severe limits on selling in an attempt to maintain stability, a key example being a newly imposed rule that shareholders and managers holding more than 5 percent of a company's shares could not reduce their holdings for six months.

"These measures may deter foreign investors, who believe fundamentally that the government should not intervene in the capital markets, and may lead to them becoming more cautious about investing in China," Fang says.