TAIPEI, Taiwan -- China is opening up its over-the-counter market to foreign investment funds, though it may be a while before these funds decide to wade into this murky, thinly traded market.
The China Securities Regulatory Commission thinned down its rules this month on 4,200 traded over-the-counter via an obscure, illiquid but fast-growing board called the National Equities Exchange and Quotations.
If the liberalizations work out, foreign investment funds such as the UBS Lux Equity Fund-Greater China and BlackRock Global Funds-China Fund would be able to trade the board more safely.
The exchange trades shares of ambitious companies that are too small for China's major exchanges. Tech, tourism and health care make up much of the 3-year-old OTC board, which raised total capital of $2.1 billion last year.
Despite the risks, there is a lot of investor interest in these stocks.
"The biggest question that I get as I travel around and talk about China is 'How do I invest in Chinese companies?'" said Jack Perkowski, managing partner of merchant bank JFP Holdings in Beijing. "I think that many international investors would love to consider investing in those 4,200 companies if they had access and information."
The board's companies include -- just to name a random but representative few -- social networking firm Zhengzhou Zoneyet Technology, field safety-monitoring equipment supplier Geokon Instruments and the Suzhou Xizhijia Maternal & Infant Care Service.
New rules will let companies like those move to ChiNext, a full-blown exchange for startups, on a trial basis and cancel a restriction on the number of qualified investors needed when companies try to offer new shares, state-run China Daily reported. The regulator is also asking securities firms to open subsidiaries that offer OTC-tailored services.
Those measures should raise trading volumes and liquidity, the state paper said, adding that "institutional investors such as mutual funds" were particularly welcome. Liquidity and volumes happen to be top concerns among foreign investors.
"The only way foreigners would start trading this exchange would be in there was much higher liquidity as they do not want to be in a position where they are stuck holding a position," said Nitin Dialdas, chief investment officer with Hong Kong-based fund manager Mandarin Capital. "Therefore, there would need to be a big pickup in domestic activity before we start seeing foreign fund managers trading it."
Individual foreign investors cannot legally trade Chinese shares, but may buy into funds offered by many of the 277 offshore institutions with government-approved investment quotas. That includes fund companies UBS (UBS - Get Report) , BlackRock (BLK - Get Report) and individual offerings like the Morgan Stanley China A Share Fund (CAF - Get Report) .
Relaxation of OTC board rules comes as the government goes all out to bring in offshore investment. Chinese officials want foreign funds in stocks to capitalize up-and-coming firms that would form the foundation for a new economy based more on consumerism and clean investment rather than manufacturing.
Foreign funds lost confidence in mid-2015 year because the major exchanges tumbled after a record increase over the previous year. The benchmark Shanghai Composite Index lost about 40% from June through August.
Prices have come up 24% from the August low, and analysts point to government intervention, from currency liberalization to a state stock buying program, as a reason for the comeback.
Foreign investors believe stocks moved from the OTC board to ChiNext will eventually be accessible to investors in Hong Kong following more liberalization. Foreigners without Chinese investment quotas can freely trade the Hong Kong exchange, and last year China opened that route to 568 Shanghai-listed shares.
"There certainly are quite a few interesting stocks on the board, for instance, stocks of investment management companies, which were largely cut off from access to China's main boards," said Denis Suslov, an analyst at research and consulting firm Kapronasia in Shanghai.