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* Banks return $800 mln in QFII quotas from April-Sept 2015
* Banks "rented quota" to clients without access to China
* Clients can now use routes such as Stock Connect, own QFII
* Banks' quota renting fees tumble from 200 to 20 basispoints
* Falling yuan adds currency costs to quota renting business
By Michelle Price
HONG KONG, Jan 17 (Reuters) - Global banks have started tohand back investment quotas used to buy Chinese stocks and bondsbecause alternative channels for investment in China and thesliding yuan are making this once lucrative businessunprofitable.
While China's move to open up its capital markets and allowits currency to trade more freely has created opportunities forglobal banks, these developments are also threatening to killoff niches where they have acted as middlemen to give previouslyexcluded foreign investors backdoor access to the mainland.
Several banks, including Barclays, Commerzbank, Norway's SEB and the Netherlands' ING, handed back just over $800 million in quota granted byChinese authorities under the Qualified Foreign InstitutionalInvestor (QFII) scheme between April and September 2015, publicdata shows.
Other banks are considering following suit, according toindividuals familiar with the discussions.
The move does not reflect a waning appetite for investmentin China, however, despite its slowing economy; overall quotasfor QFII have quadrupled to about $81 billion since 2010.
But banks' share of the quotas, which they repackage intoderivatives such as p-notes and sell on to investors who don'thave access to Chinese markets, a practice known as quotarenting, has dwindled to just 14 percent from 37 percent overthat period.
That means more foreign investors such as asset managers andindex funds, the biggest users of such products, have access toChina through QFII or new alternative avenues for investmentsuch as the Hong Kong Shanghai Stock Connect scheme and the moreflexible yuan-denominated RQFII - so fewer need the banks asgo-between.
"Renting quota allocations is a dying business due to theaccess available through Stock Connect," said Brendan Ahern,chief investment officer of New York-headquartered KraneShares,which runs an exchange-traded fund for mainland shares.
Because banks had the best access to China stocks, they wereable to charge as much as 200 basis points on these syntheticproducts up until just over a year ago, according to investors,but this figure has plummeted to around 20 basis points inrecent months as funds have gained direct access to China stocksthrough Stock Connect and their own quotas.
GETTING WORSE
Things are expected to get worse when the Shenzhen stockmarket joins the Connect scheme sometime this year.
"The cost of warrants or p-notes to access China have comedown in line with Stock Connect costs, and with Shenzhen comingonline that is going to challenge the economics of that businesseven more," said David MacKenzie, Asian equities product managerat investment management firm Schroders.
Public data and regulatory filings show that some of thebiggest China index funds, including BlackRock's $5 billion FTSEA50 China Index ETF, are increasingly using their own newlygranted QFII quotas and Stock Connect in place of syntheticproducts.
Barclays and Commerzbank declined to comment. A spokeswomanfor SEB said the bank handed back its quota because it was moreefficient to use Stock Connect wherever possible. ING did notrespond to requests for comment.
For banks, declining client demand has been compounded bythe depreciation of the yuan, which has lost about 5 percentagainst the dollar since August. This is because QFII isdenominated in dollars, which are exchanged onshore for yuan andthen back into dollars when holders want to sell up.
In the past, banks generally benefited from the appreciationof the Chinese currency, but are now exposed to currency riskamid expectations the yuan will decline further.
In a bid to help cover the currency costs, some banks arenow renting out QFII free of charge to big clients, according totwo people with knowledge of the banks' businesses.
Some of the biggest providers of synthetic China accessproducts, including HSBC, UBS, Credit Suisse, Citi andMacquarie, declined to comment for this article.
Handing back quota might once have put Beijing's nose out ofjoint, but the government looks unlikely to raise strenuousobjections under the changed circumstances.
"The Chinese authorities understand the issues, so banksdon't need to worry so much about offending the authorities,"said Keith Pogson, senior financial services partner at EY inHong Kong. (Reporting by Michelle Price; Editing by Will Waterman)
