The QDII & New Bond Effects

Industrial and Commercial Bank of China, China's largest commercial lender, has raised 4.45 billion yuan (HK$4.56 billion) for its first qualified domestic institutional investor scheme product that targets overseas equities and related assets. ICBC's open-ended fund will invest half its assets in mainland-related stocks in Hong Kong and the other half in high- yield bonds and money-market products across Asia to hedge against yuan appreciation.

The Beijing-based bank completed sales of the new fund in less than a month, with the 4.45 billion yuan subscribed as of Friday representing the maximum it can raise. That makes it the largest equity fund so far for investments in overseas markets. The bank intends to offer another QDII fund specializing in overseas stocks soon. ICBC has a US$2 billion (HK$15.6 billion) QDII quota granted by the People's Bank of China.

The central bank of China allowed commercial banks to invest overseas under the QDII scheme on May 14 in an attempt to channel hot money out of the overheating domestic stock market. The banking regulator is revising QDII terms and plans to allow banks to invest up to 70 percent of their quotas, from the 50 percent allowed at present, in equities to boost interest in such products.

The CSI 300 Index has fallen 12 percent since hitting a record high on June 19, trimming its gains for this year to 84 percent. The CSI 300 is valued at 41 times the reported earnings of its member companies, about twice as much as indexes in Japan and India, Asia's next most expensive markets. As Chinese mainland stocks rallied, the securities regulator said on June 20 it would also allow brokerages and fund management firms to buy shares abroad, effective Thursday.

Funds must raise at least 200 million yuan to qualify for the program and they can invest in equities traded in 33 jurisdictions, including the United States, Hong Kong, Japan, Britain and Germany. Domestic investors may buy up to US$100 billion of stocks and bonds overseas in the coming year as China removes barriers on capital. Investors must put in at least 300,000 yuan into the fund.

This significant move by ICBC will spur other banks to follow rapidly. The developments itself should be sufficient to puncture a few holes in the equity bubbles in China for a while. Now that there are outlets for liquidity, investors will have to reassess the situation. The move bodes very well for China shares listed in HK, the H shares. Of particular interest to local investors, PetroChina, China Mobile and even ICBC are looking better by the day as predicted beforehand.

As if the QDII effect was not enough, the Beijing chiefs leaked out details that it will proceed in stages to sell 1.55 trillion yuan (HK$1.59 trillion) in special domestic bonds to finance the fledgling overseas investment agency. The special agency was akin to the Temasek model for Singapore. The special agency was an excuse to run down the reserves in USD to exploit better opportunities, and to lessen holdings in straight USD. The stock market has been hit by the planned bond issue as investors fear it will pull funds from the market.

"The plan will be carried out gradually according to its monetary policy," Yi Gang, assistant governor of the People's Bank of China said. Yi reiterated the Finance Ministry's view that the bond issue would have only a neutral impact on the economy.The Finance Ministry would issue the bonds directly to the central bank in exchange for part of the US$1.2 trillion (HK$9.36 trillion) in foreign currency reserves under the PBOC's control.