In December 2013, Maples and Calder advised on the first Irish authorised UCITS with full access to the Chinese equity market via a Renminbi Qualified Foreign Institutional Investor ("RQFII") licence. Since then, Maples and Calder has established both UCITS and Irish alternative funds for RQFII managers and sees significant interest in both of these products for housing an RQFII strategy and accessing European investors.
Historically, Irish and other European domiciled funds were restricted to accessing the domestic China investment markets through the Qualified Foreign Institutional Investor (“QFII") programme. This has been in place since December 2002 and allows foreign institutional investors to invest (in the local currency) in China securities – in particular, China A Shares listed on the Shanghai Stock Exchange and the Shenzhen Stock Exchange. The return on the investment, including dividends and capital gains, can be legally exchanged into foreign currency and repatriated.
The RQFII regime was introduced, initially in pilot phase, on 16 December 2011. Until recently the RQFII regime was confined to Hong Kong based entities. In January 2014, the first RQFII licence was granted to an entity from outside China or Hong Kong – a UK based entity. The requirement for the RQFII quota to be used through a Hong Kong domiciled fund was also removed. This opened up the RQFII market for the first time to investment funds domiciled in other jurisdictions such as Ireland.
Irish fund options
Ireland offers a range of regulatory structures that can accommodate a China access strategy. In the context of a QFII licence, the Qualifying Investor Alternative Investment Fund ("QIAIF"), a fund within the scope of the Alternative Investment Fund Managers Directive ("AIFMD") regime, is best suited for this. The QIAIF provides great flexibility as no investment, borrowing or leverage restrictions apply. In addition, the QIAIF offers a pre-launch authorisation without prior review and MiFID equivalent investor eligibility criteria (i.e. a €100,000 minimum subscription).
In the context of an RQFII licence, a manager has the option of using an alternative fund, the QIAIF, or a UCITS fund to house its RQFII strategy in Ireland.
UCITS funds are pan-European investment fund structures designed primarily for retail investment and Ireland is a key jurisdiction for the establishment of UCITS funds. UCITS are suitable for investment by institutional investors and can be sold on a public offering basis across the EU on a passport basis, as well as outside the EU on a country-by-county basis. Irish domiciled UCITS represent 3,442 funds (including sub-funds) and assets of approximately €1.2 trillion as at July 2014 and are distributed in over 70 countries around the world.
Increasingly UCITS are being viewed as key cross-border products for alternative investment strategies.
Ireland clears the way for UCITS investing into China
A QFII is subject to an initial three month lock-up of assets in the China securities and cash accounts. This commences at the later of: (a) the date the full quota granted under the QFII licence is taken up; or (b) six months after the QFII quota was approved if it is initially taken up only partially. For a fund that trades any more frequently than monthly, this would present challenges, at least in theory, in the event of a large redemption. While a monthly dealing QIAIF should be capable of meeting the liquidity challenges this initial lock-up presents, it has been a barrier for UCITS which are required to deal at least twice monthly.
Ongoing monthly repatriation limit
Generally repatriation out of China by a QFII is only permitted on a monthly basis on the net level of subscriptions/redemptions and is subject to China's State Administration of Foreign Exchange's approval being granted in the event the repatriation amount sought exceeds US$50 million in any given month.
The absence of both an initial lock-up restriction and any monthly repatriation limit for RQFII is why it is suitable for use in a UCITS.
The tax position of the fund as regards China will be an area to examine. All regulated Irish funds benefit from a range of attractive tax features.
- They are exempt from Irish tax on their income and gains;
- Non-Irish resident investors are exempt from Irish tax in respect of distributions from the fund or redemptions of units in the fund (provided either an appropriate investor declaration or certain procedures at fund level are put in place)
- No Irish stamp duty arises on the issue, sale or transfer of shares or units; and
- Certain services which the fund receive, such as qualifying investment management services, are VAT exempt.
The entitlement of an Irish regulated fund to avail of the Ireland / China double tax treaty needs to be examined on a case-by-case basis. This issue is subject to the particular investment structure and to Chinese law and the Chinese State Administration circulars regarding treaty entitlement. Where access to the Ireland / China treaty is available, the treaty can relieve an Irish resident company from Chinese capital gains tax on sale of shares in a Chinese company (other than a company which consists principally of Chinese land).
How does the custody element operate?
Irish funds are required to appoint an independent custodian or depositary located in Ireland with primary responsibility for safekeeping of the fund's assets. This entity will engage the local custody provider in China by way of a sub-custodian arrangement. On a day-to-day basis, the investment manager will engage directly with the local sub-custodian on the trading side.
Assets (held in a securities account and a cash account in China) will be fully segregated and recorded in the joint names of the QFII/RQFII quota holder and the fund. In the event of insolvency of the local sub-custodian or the QFII/RQFII, the fund's ownership of the assets is thus assured. An opinion from counsel in China on the specific arrangements may be necessary for the Central Bank of Ireland to be assured of proper safekeeping arrangements.
Access to European Investors
Over the past nine months Maples and Calder has established both UCITS and alternative Irish funds, the AIFMD QIAIF fund, for Hong Kong managers with RQFII quotas and this is now a well-tested route for Asian managers targeting European investors. The Central Bank of Ireland is now very familiar with these products and provides an excellent regulatory environment within which to operate.
It is also worth highlighting the memorandum of understanding entered into in 2008 by the Central Bank of Ireland and the China Securities Regulatory Commission and the China Banking Regulatory Commission. This formalised the relationship and co-operation between the two jurisdictions.
Gaining access to Chinese domestic markets is increasingly becoming a key priority for asset managers and European investors. Now that RQFII has opened up to UCITS, the opportunities promise to increase further.
For further information on the topics covered in this update or generally, please contact the following lawyers or your usual Maples and Calder contact:
Michelle Lloyd Head of Irish Asia Desk, Investment Funds, Maples and Calder, Hong Kong.
Daryl O'Brien Associate, Investment Funds, Hong Kong, Maples and Calder, Hong Kong. firstname.lastname@example.org