(Yicai Global) Oct. 11 -- China's recent decision to scrap its quota system for Qualified Foreign Institutional Investors, a program that grants eligible overseas investors access to mainland-listed stocks and bonds, is part of a general opening-up strategy and will lead to an unprecedented wave of foreign inflow into the country's capital market in the next few years.
The State Administration of Foreign Exchange abolished the overall USD300 billion ceiling for QFII participants in September. The QFII program started in 2002.
The decision shows China's commitment to opening its capital market to the world. While it will take time for the effects to be seen, the removal of the quota system will gradually allow for more flexibility in capturing a rapidly expanding volume of inbound capital.
Demand is already piling up with more and more global indexes including Chinese assets in their portfolios. Close to USD100 billion of capital inflow is expected from passive investors this year.
Many asset managers have already begun discussing the possibility of carving out China as a standalone asset class by major index providers, similar to Japan. This would translate into significant further inbound capital, as global institutional investors such as pension and insurance funds increase their allocations in China.
In addition, the removal of the quota is likely to accelerate growth in the country's capital markets. In the past, the real economy raised funding largely through indirect sources, such as bank deposits or shadow banking channels. However, this has posed enormous hidden credit risks to the financial system and is becoming increasingly unsustainable amid slower economic growth.
Hence, policymakers are proactively driving the development of the local capital market. The capital market-trading environment in China will improve over time and move closer to international standards. Chinese policymakers have been proposing different measures to increase the width, depth and transparency of the capital market.
The opening-up and development of China's capital market, together with an increased number of interconnecting programs, will make Chinese investments more accessible to foreign investors. In the long run, the move will allow global players to bring their expertise to the local market to create more variety and a better quality of onshore investable assets as well as eventually support a wide range of investment strategies.
Having a more meaningful onshore presence also means that global asset managers can enjoy better synergies between onshore and offshore businesses. For example, the payoff for global asset managers to develop tailored investment strategies for China would become higher, as such strategies can be deployed both in onshore and offshore businesses. This also creates the case for smaller managers to consider inorganic acquisitions targeting smaller fund management companies in the market, with a view to exporting Chinese investment capabilities to their global operations in the case where global investors are stepping up on Chinese allocations.
To take advantage of the growing opportunity, we see a five-pronged agenda for global players aspiring to enter or double down on China.
First, global players should calibrate an appropriate level of ambition for their China franchise to determine the most suitable type of active versus passive play. Second, they should be aware of the complicated licensing requirements and ensure that their business proposition and application progress hand-in-hand from an early stage. Third, they need to identify the most effective 'base' operational entity, due to separate operations in China's regulatory environment. Fourth, they should consider embracing partnerships as a means to achieve scale. Lastly, we suggest that global players take green-field opportunities to build future-proof infrastructure in a modular way.
Ray Chou is a Partner in Oliver Wyman's Shanghai Office. Ray has 15+ years of consulting and industry experience in Greater China and Asia.