China opens up to foreign hedge funds

As the money flows out, where will it land?

China's capital reforms are slow but progressing. Photo: Getty Images

China has given foreign hedge funds permission to use funds from Chinese residents in investments abroad.

This reform, called the Qualified Domestic Limited Partner programme, is the latest and boldest in a series of reforms to open the capital account and integrate China into international markets.

This reform will allow domestic capital to flow abroad, and will also provide an opportunity for Chinese institutions to seek funding through a new investment option. Prior to this reform investment options open to these institutions were limited to a domestic stock market – which is commonly seen as a casino – under developed capital bond markets or incredibly limited foreign investment.

It is hoped that the hedge fund reform will help to work against the effects of this limited investment, which had caused an unsustainable property bubble throughout the past decade. Other reforms have included allowing foreign institutions larger quotas when investing in capital markets and expanding the renmimbi’s trading band to give greater currency flexibility.

The hedge fund reform will mimic other Chinese reforms, starting cautiously. Licenses to operate in China will be issued in Shanghai only to firms controlling over $10bn in assets, and there will a limit of $5bn of total assets which can be raised collectively by licensed funds.

Hedge funds are already queuing to apply, as this $5bn will not be split evenly between funds but divided competitively.

There had been concerns about the increase in capital outflows from China. These reforms show an increase in confidence and a recognition of the need for healthier capital markets. With the Chinese State Administration of Foreign Exchange having a final say on all capital leaving the country, these reforms are a cautious but concerted push towards modernisation.