8 China's Capital Markets-The changing landscape The role of ofll The Chinese government introduced the Qualified Foreign Institutional Investor (QFII) system in 2002 to permit overseas institutional investors to buy into domestic-listed equity and debt markets. Prior to this, foreign investors were only flowed to invest through the B-Share market. as a gateway into the domesti market, the system currently allows more than 100 international institutions comprising banks, trust companies, insurers, asset managers, securities firms sovereign wealth funds, pension funds and endowment funds to invest in Chinas securities markets. It is understood that another 100 or more applicants are waiting At the end of 2010, the total quota approved by the state Administration of Foreign Exchange (SAFE)had reached USD 19.7 billion, and the government has pledged to expand the quota to an eventual total of USD 30 billion In terms of actual investment, QFll funds traditionally implement a relatively stable investment performance, QFlls in general underperformed as a whole -though at the same time, slightly less volatility was also evident. The average annual return on QFll funds for the past 4 years was 124 percent, -65 percent, 78 percent and-11 percent respectively, compared to 163 percent, -64 percent, 103 percent,-4 percent for the benchmark FTSE China a All-Share Index over the same period The market share of QFlls has been increasing since the beginning of 2011 due to quota holders optimistic view of the A-Share market. Though QFll holdings still only account for less than 2 percent of total stock market holdings, their influence fa outweighs their relative size. They are watched closely by many domestic investors due to the depth of their fundamental research and relatively sophisticated approach to risk management and selection Shanghai International Board Overseas companies are not yet able to list directly in China, although several have expressed a desire to be among the first to list on Shanghai's proposed International Board Before launching the International Board, China's regulators need to formulate listing rules and market regulations addressing the preparation of financial statements, management discussion and analysis, and audit requirements. The following are some of the key points to be clarified Accounting Standards approach: In particular, will non-Chinese entities need to use Chinese GAAP, will a reconciliation approach be required if other GAAP are accepted, and how do Chinese market regulators plan to enforce the interpretations of IFRS if IFRS are accepted? The role of non-Chinese audit firms: Will the regulators establish criteria for non-Chinese accounting firms to audit non-Chinese companies listing in the PRC? Disclosures, management discussion and analysis: For example, will non-Chinese entities be required to meet the disclosure requirements as domestic listed entities and be subject to the same review methodology on their IPO prospectuses? Will Chinese language prospectus and disclosures be required? Once the rules for an International Board are released, we expect to see a number of companies seeking to tap the quidity of China s savings market through local listing. As these issues are clarified, there could be many implications to non-Chinese entities looking to raise capital on China s equity markets 0 2011 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG international"), a Swiss entity. All rights reserved.The role of QFII The Chinese government introduced the Qualified Foreign Institutional Investor (QFII) system in 2002 to permit overseas institutional investors to buy into domestic-listed equity and debt markets. Prior to this, foreign investors were only allowed to invest through the B-Share market. As a gateway into the domestic market, the system currently allows more than 100 international institutions comprising banks, trust companies, insurers, asset managers, securities firms, sovereign wealth funds, pension funds and endowment funds to invest in China’s securities markets. It is understood that another 100 or more applicants are waiting for approval. At the end of 2010, the total quota approved by the State Administration of Foreign Exchange (SAFE) had reached USD 19.7 billion, and the government has pledged to expand the quota to an eventual total of USD 30 billion. In terms of actual investment, QFII funds traditionally implement a relatively stable and high equity allocation strategy. Under normal circumstances, QFII positions are maintained at levels of 70 to 90 percent in A Shares. With regard to actual investment performance, QFIIs in general underperformed as a whole — though at the same time, slightly less volatility was also evident. The average annual return on QFII funds for the past 4 years was 124 percent, -65 percent, 78 percent and -11 percent respectively, compared to 163 percent, -64 percent, 103 percent, -4 percent for the benchmark FTSE China A All-Share Index over the same period. The market share of QFIIs has been increasing since the beginning of 2011 due to quota holders’ optimistic view of the A-Share market. Though QFII holdings still only account for less than 2 percent of total stock market holdings, their influence far outweighs their relative size. They are watched closely by many domestic investors due to the depth of their fundamental research and relatively sophisticated approach to risk management and selection. Shanghai International Board Overseas companies are not yet able to list directly in China, although several have expressed a desire to be among the first to list on Shanghai’s proposed International Board. Before launching the International Board, China’s regulators need to formulate listing rules and market regulations addressing the preparation of financial statements, management discussion and analysis, and audit requirements. The following are some of the key points to be clarified: • Accounting Standards approach: In particular, will non-Chinese entities need to use Chinese GAAP, will a reconciliation approach be required if other GAAP are accepted, and how do Chinese market regulators plan to enforce the interpretations of IFRS if IFRS are accepted? • The role of non-Chinese audit firms: Will the regulators establish criteria for non-Chinese accounting firms to audit non-Chinese companies listing in the PRC? • Disclosures, management discussion and analysis: For example, will non-Chinese entities be required to meet the same disclosure requirements as domestic listed entities and be subject to the same review methodology on their IPO prospectuses? Will Chinese language prospectus and disclosures be required? Once the rules for an International Board are released, we expect to see a number of companies seeking to tap the liquidity of China’s savings market through local listing. As these issues are clarified, there could be many implications to non-Chinese entities looking to raise capital on China’s equity markets. © 2011 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2011 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 8 | China’s Capital Markets - The changing landscape