Experts in China’s qualified domestic institutional investors (QDII ) scheme say they believe the recently piloted Hua An International Balanced Fund will be used by the regulators to shape the scheme itself and is likely to lead to further such offerings.Angus Duncan and Yong Kai Wong, respectively partner and associate at Cadwalader Wickersham & Taft in Hong Kong, said in Legal Week, "While we await formalised regulations for an overarching QDII regime, the Provisional Banking QDII rules and the pilot launch of the Hua An Lehman transaction are major milestones in the liberalisation and modernisation of China’s capital markets.
“It is expected that the Chinese regulators will build on the Hua An Lehman framework and implement formalised regulations for future QDII investment fund offerings, to provide further guidance on the reporting obligations with regards to the domestic and international custodians and to liberalise the range of investments the QDII banks products could take part in."
The biggest difference between the Hua An Lehman transaction and earlier banking QDII offerings (this is the first fund-based offering) is the wider range of investment powers granted to funds to invest in fixed income and equity instruments.
Hua An International Balanced Fund will have a benchmark allocation of 45% to fixed income, 35% to global equities and 10% each to US Reits and commodities. Huaan will control asset allocation, while Lehman will manage the underlying funds on a CPPI basis. Both parties will cooperate on risk management and performance attribution.
The product has a double protection mechanism – both the CPPI and a five-year note carrying a Lehman guarantee. The authors said they expect this double protection may be a requirement in the immediate future as investors acclimatise to the sector.
The transaction uses an existing Lehman Brothers Cayman entity to issue the notes, which give indirect exposure to the underlying investments through the shares of a another Cayman-incorporated special purpose vehicle. The notes are purchased, structured and managed by Hua An and used for foreign investment through the QDII regime.
The authors said they expect the active participation of the Chinese party in investment allocation to be material. Huaan will control asset allocation, while Lehman will manage the underlying funds, said Hua An CIO Frank Yao as the fund was announced. Both parties will cooperate on risk management and performance attribution. Lehman Brothers is partnering the local fund manager on a project basis, and does not play a direct role in the Chinese investment management industry.
“This is a possible reflection of the Chinese regulators’ often articulated aim of increasing exposure of Chinese investment professionals and investors to world-class financial practice through cutting-edge investment transactions,” said the authors.
The Hua An Lehman transaction also uses a dual-custodian structure in which a domestic custodian (ICBC) and an international custodian (HSBC) coordinate to ensure proper monitoring, execution and investor reporting functions throughout the period of the transaction.
According to the authors, the total approved QDII investment quota of approximately $12bn is minute in comparison with China’s foreign exchange reserves and savings levels: “Viewed from this perspective, the potential for future growth and evolution in QDII offerings – particularly in QDII investment fund offerings which could be structured with greater flexibility in underlying investments – is massive,” they concluded.
