(Yicai) Dec. 3 -- Over the past decade, as Shanghai worked to build itself into an international financial center, the city has faced numerous challenges but has resolutely made steady progress. In November, the 10th anniversary of the Stock Connect Scheme marks another milestone of Shanghai's role as a 'super connector' of domestic and foreign capital.

The Qualified Foreign Institutional Investor (QFII) scheme invited international capital into China's capital markets, and the launch of the Stock Connect program in 2014, including the Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect, acted as a critical propeller. The program paved the way for China's A-shares being included in the MSCI Emerging Markets Index and accelerated the internationalization of China's capital markets.

In 2018, the policy raising the foreign shareholding ratio limit to 51% attracted a large number of global asset management giants and investment banks to set up entities in China's onshore market, mostly in Shanghai. Firms including BlackRock, Fidelity International, and Schroders now have wholly-owned mutual funds headquartered in Shanghai. 

Meanwhile, programs like Qualifed Domestic Limited Partner(QDLP), Mutual Recognition of Funds (MRF), and Wealth Management Connect are steadily bolstering Shanghai's position as a global asset management hub and advancing its transformation into an international financial center.

This year, the 35th edition of the Global Financial Centers Index (GFCI 35), jointly released by UK's Z/Yen Group and the China Development Institute in Shenzhen, rated New York, London, Singapore, Hong Kong, San Francisco, Shanghai, Geneva, Los Angeles, Chicago, and Seoul as the top 10 global financial centers.

Despite the fact that China is still some distance away from full capital account liberalization, reform is a gradual process, especially for a market as vast as China's. Setting a timetable for capital account liberalization is not advisable, Yu Yongding, an academician at the Chinese Academy of Social Sciences (CASS), told Yicai in an interview. Research also indicates that China's financial opening-up has four dimensions: financial market liberalization, market-based formation of the Chinese yuan exchange rate, internationalization of the yuan, and full capital account liberalization. Each dimension has its ultimate goal, and more importantly, there is a priority order, with full capital account liberalization being the final step of the process.

Stock Connect Hastens Internationalization of China's Capital Markets

Shanghai first proposed to become an international financial center in the early 1990s. After over three decades of growth, the city has largely succeeded in establishing a financial center reflecting China's economic strength and the yuan's international status. Shanghai is now entering a new phase focused on comprehensively enhancing its capabilities.

Data show that last year, the added value of Shanghai's financial industry reached CNY864.7 billion (USD119.4 billion), up 5.2 percent from the previous year. In the first quarter of this year, the figure reached CNY209.7 billion (USD29 billion), up 5.1 percent from the same period last year. The total number of licensed financial institutions in Shanghai has reached 1,771, of which 548 or over 30 percent are foreign-owned institutions.

Notably, the Chinese mainland is the world's second-largest capital market, and Shanghai is a key hub for inbound and outbound capital. In the past decade, the Connect program, setting sail from Shanghai, has been promoting the internationalization of China's capital market. This year, the Shanghai-Hong Kong Stock Connect celebrated its 10th anniversary.

"The Shanghai-Hong Kong Stock Connect, as one of the most successful financial innovations globally, has played a series of exemplary roles in the opening up of China's financial markets," said Thomas Fang, head of China Global Markets at UBS. “The 10-year development of Connect has been a gradual process, including the growth in the number of included stocks and the gradual diversification of products. We believe that this model will continue to grow in the future.”

Specifically, in terms of trading volume, the average daily turnover of northbound and southbound trading increased by 21 times and 40 times, respectively, in the first three quarters of this year from the same period in 2014 when the program was launched, according to data from Hong Kong Exchanges and Clearing's (HKEX). As two-way capital inflows steadily rise, the two markets have been better integrated with regard to investment philosophies and trading strategies.

The Stock Connect between the Chinese mainland and Hong Kong is an excellent mechanism that has been tested by the market in recent years, Henry Fernandez, MSCI's chairman and chief executive officer, told Yicai.

Shanghai Ramps Up Efforts to Become a Global Asset Management Hub

Shanghai is also speeding up its transformation into a global asset management center, which is a key move in the process of becoming an international financial center.

In the past two years, dozens of leading global asset management firms, including BlackRock, Neuberger Berman, Fidelity International, Schroders, and UBS, have established a presence in Shanghai. Data show that more than 60 renowned international asset management institutions have set up nearly 90 types of foreign-funded asset management companies in Shanghai's Lujiazui, accounting for over 90% of the national total. Nine out of the top 10 global asset managers by assets under management have built footholds in Lujiazui.

The asset management business has a natural tendency to attract capital, summoning investment banks, law firms, auditing and rating agencies, and other financial service institutions.

The opening-up of China's asset management industry "has gone through three major stages, and each stage was coordinated and progressive," Liu Song, Neuberger Berman's head of Asia Pacific, told Yicai.

During the first stage, Chinese regulatory authorities officially issued relevant policies to relax standards in 2003. Foreign asset management giants such as Invesco, Schroder BOCOM, BlackRock, Morgan Stanley, and JPMorgan Chase entered China and acquired stakes in Chinese fund companies as non-controlling shareholders.

In the second stage, the QFII program was introduced, and foreign capital was able to participate in Chinese capital market investment. In August 2005, the QFII quota was increased to USD10 billion. Today, the QFII quota limitations have been completely canceled, and the Bond Connect and Shanghai-Hong Kong Stock Connect have become new mainstream investment channels.

In 2016, the WFOE PFM program was launched, allowing foreign asset managers to take 100 percent ownership and directly raise funds and invest in the Chinese market.

By April 2020, the third stage allowed foreign firms to submit applications for public mutual funds, enjoying the same level of opportunities as domestic firms.

Establishing public mutual funds is no easy task and comes with significant costs. A public mutual fund requires at least 60 employees and has a relatively complex corporate structure. Foreign firms need to build new and independent internal IT systems in China and cannot share data with their overseas parent companies. This process involves extensive communication with both the parent company and Chinese regulatory authorities.

QDLP and MRF Quotas Await Expansion

Because of the volatility in the domestic capital market and the widening interest-rate differentials between China and the US, Chinese yuan-denominated assets have not been well-received. But overseas investment has been popular, partly due to the continuous expansion of innovative mechanisms, such as QDII, QDLP, and MRF, which also offer new opportunities for foreign investors.

Data from China's State Administration of Foreign Exchange (SAFE) shows that QDII quotas have been expanded again. By the end of May, a total of 189 financial institutions had been approved for a cumulative investment quota of USD167.8 billion, up by USD2.3 billion from the end of April.

With the rising willingness of Chinese investors to allocate assets globally, institutions have been actively issuing products through the QDLP channel. Shanghai was the first to launch a QDLP pilot program in 2013. In the same year, it attracted participation from several foreign firms, including Bridgewater Associates and Oaktree Capital Management, creating conditions for Shanghai's development as an international asset management center. QDLP is a key business for foreign private equity firms in China, as the funds they raise through QDLP can be invested in their overseas parent company's funds, thereby leveraging the strengths of the foreign institutions.

Since July this year, several foreign fund managers with businesses in the Chinese mainland have launched multiple QDLP products, including Barings' international credit bonds, Morgan Stanley Asset Management's equity market neutral strategies, Abrdn's global investment grade bonds, and Wellington Management's global opportunities multi-asset fund, Yicai learned from relevant channels and insiders. Many other foreign institutions are applying for new investment quotas.

"The QDLP scheme has long served as a valuable supplement to the cross-border investment framework," Ge Yin, partner with Han Kun Law Offices and expert on cross-border investment management, told Yicai. “It is a preferred choice for many global asset management firms planning to set up asset management entities in China. This has contributed to the development of Shanghai as an international asset management and financial center.”

Yicai learned that the QDLP quota usually ranges from USD50 million to USD100 million, with some foreign fund managers receiving quotas of over USD300 million. Once the quota is used up, institutions can reapply for additional quotas. The largest cumulative QDLP scale for a single institution has exceeded USD600 million, becoming a significant source of business for foreign firms operating in China.

At present, both domestic and foreign institutions are looking forward to the MRF expansion. Chinese authorities are considering relaxing the cross-border sales limit to 80 percent from 50 percent, according to a draft policy on the recognized Hong Kong funds released by the China Securities Regulatory Commission on June 14.

"QDII quotas are often quickly exhausted after each approval," said Freeman Tsang, head of intermediaries for Asia except Japan at Pictet Asset Management. “The MRF launched in 2016, and the Cross-Boundary Wealth Management Connect introduced in recent years served as an effective supplement, helping mainland investors better understand the overseas market and diversify risks.”

A Journey Toward High-Level Openness

Opening up is just the first step. More profound work toward high-level openness is underway.

Regarding the Stock Connect, "we expect greater breakthroughs in entry conditions and trading models," Fang noted. For instance, institutions are looking forward to greater diversity in asset categories, including government bonds, futures, and options, to widen the possibilities for overseas investors to allocate assets in China. Also, as overseas investors gradually increase their investments in China, they need more tools and products for risk management.

International financial institutions based in Shanghai face numerous challenges, such as difficulties in raising funds domestically, uncertainties regarding cross-border data security, and insufficient Qualified Domestic quotas.

"After attracting foreign capital, ensuring their smooth operations and achieving high-level opening up are other crucial tasks," Ge noted. “The predictability of policies, such as the timeline for obtaining licenses and the implementation time for cross-border data-related regulations, remains a key factor for foreign managers to operate effectively, and it is also vital for optimizing the business environment.”

There is room for improvement in multiple aspects for Shanghai to enhance its capabilities as an asset management hub, such as the business environment, law-based governance, product innovation, and interconnectivity, Zhao Xinge, executive deputy director of the CEIBS Lujiazui International Institute of Finance, told Yicai.

For example, in terms of product innovation, the trend of sustainable finance is waning in the US, and innovating related products, such as carbon-neutral bonds and cross-border green ETFs, will help Shanghai attract more international capital. To boost interconnectivity, in addition to broadening capital inflow channels through five capital market cooperation measures with Hong Kong, Shanghai can also actively collaborate with capital markets in Southeast Asia and Europe, exploring new Connect mechanisms to bolster the city's international influence.

Zhao also suggested further relaxing institutional entry requirements, such as allowing the establishment of independently qualified offshore subsidiaries, expanding the range of applicants for the QDLP program in Shanghai, increasing cross-border investment channels, and setting up negative lists for MRF sales. These can be gradually achieved by building Lingang New Area into a cross-border asset management demonstration zone.

Editor: Lin Jiechen, Futura Costaglione, Chen Juan