Following the successful launch in January 2014 of Irish UCITS using an RQFII licence to invest up to 100% of net assets in China A Shares, the Central Bank of Ireland has further expanded the range of investment opportunities available in China for UCITS with a fixed income focus.
It has done this by confirming that the board of an Irish UCITS may now make its own determination as to whether China’s Interbank Bond Market (the “CIBM”) is a regulated market for the purposes of the UCITS Directive. This confirmation followed a detailed submission to the CBI in relation to the CIBM outlining the manner in which it meets the requirements of the UCITS Directive. It offers a significant opportunity to investment managers who wish to combine the investment opportunities available in Chinese fixed income markets with the distribution possibilities and global reach of Irish UCITS.
The updates to the RQFII programme in March 2013 opened the door to the use of UCITS for RQFII investment for the first time and Irish UCITS were in the first wave of such products. To date, these structures have been structured as exchange-traded funds tracking China A Share indices, offering investors a broad exposure to the Chinese equity market.
However, it has been clear for some time that there is significant appetite amongst investment managers for a UCITS product which may invest primarily in Chinese bond markets and in particular the CIBM. The CIBM is an over-the-counter wholesale fixed income market, with a current market value of RMB 28 trillion, making it the third largest bond market in the world and accounting for almost 95% of all bond issuance and trading activities in China. Issuers on the CIBM include the Chinese Ministry of Finance, the Peoples’ Bank of China, Chinese development banks and corporate entities. The majority of investors on the CIBM are professional investment institutions and accounts and nearly all types of onshore bonds are traded on the CIBM, except for corporate and convertible bonds. The performance of fixed income instruments traded on the CIBM has compared very favourably in recent years with offshore renmenbi bond markets, including the Hong Kong dim sum market, and with Chinese A Shares. Accordingly, Chinese fixed income represents an attractive asset class for investors, with less volatility than has been seen in equity markets.
However, since the extension of the RQFII programme to UCITS in 2013, there had been an open question as to whether the CIBM would constitute a regulated market for the purposes of the UCITS Directive as set out in the Central Bank’s Guidance Note 1/96 - Permitted Markets for Retail Collective Investment Schemes (“Guidance Note 1/96). In particular it would be necessary to demonstrate that the CIBM is regulated and supervised by authorities duly appointed or recognised by the state in which it is located. Such authorities should have the power to impose capital adequacy rules, supervise directly members of the market, impose listing standards, ensure transparency in dealings and impose penalties where breaches of rules or standards occur. The market must permit investment by locally based retail collective investment schemes, have regular trading hours, suitable clearance and settlement systems together with custody arrangements necessary in order to allow the UCITS’ custodian to provide for the safekeeping of assets. The market must also be sufficiently liquid to allow a UCITS to meet any redemptions in accordance with the requirements of the UCITS Directive and the Eligible Assets Directive.
Update to the CBI's procedures in relation to regulated markets
The CBI has previously issued a list of markets deemed to meet the above criteria and had confirmed that it would consider on a case-by-case basis applications for the addition of further markets to this list following an assessment of the relevant market against each of the above requirements. In June 2014, following a submission made by Matheson in relation to the CIBM, with relevant input from service providers and contacts in Hong Kong and China, outlining the manner in which the CIBM met each of the above requirement. Following this submission, the CBI has updated its UCITS Questions and Answers document to confirm that:
§ The CBI will no longer review any submissions on whether any particular market constitutes a regulated market for the purposes of the UCITS regulations. Instead a UCITS may make its own determination of whether a particular market is eligible, following an assessment of the criteria referred to in Guidance Note 1/96.
§ The CBI will not object if UCITS and AIFs provide for investment of up to 100% of their net assets in securities and instruments issued or guaranteed by the government of the People’s Republic of China. Accordingly a Irish UCITS may now gain exposure to the Chinese market through investing in the CIBM if the UCITS itself determines that the CIBM meets the criteria referred to in the CBI’s Guidance Note 1/96.
The CBI may seek sight of such assessments at any time and UCITS should be in a position to explain their decisions in relation to these matters. This would include a documented assessment of the CIBM against the criteria outlined above. There are a number of investment managers currently working with members of the Irish funds industry and service providers in relation to the launch of Irish fixed income UCITS and we would be delighted to assist any investment managers who wish to further explore the opportunities available in relation to this strategy within an Irish product.
Shay Lydon Partner, Asset Managment Group Matheson Dublin Shay.Lydon@matheson.com