China's securities watchdog is encouraging foreign pension and insurance funds to trade yuan-backed securities as part of its efforts to attract long-term investors to sustain healthy market growth.

"The (pension and insurance) funds are working well as long-term, steady institutional investors," said the fund supervision department of the China Securities Regulatory Commission, in a Website statement.

"They usually conduct medium- and long-term investments, which can help reduce market volatility."

Insurance capital holds 25 percent of stocks traded in the United States, 40 percent in European countries and 50 percent in Japan, the statement said on December 28.

No foreign insurer has yet to apply to invest in Chinese stocks "probably due to their conservative strategies," it said.

"But they are certainly the type of investors we want to lure as they have a large amount of assets under management and feature a steady operation style."

China started allowing foreign purchases of its yuan-denominated shares in 2003 under a license-and-quota system, as the country moves to shore up stock-market maturity with overseas expertise.

The CSRC issues licenses while the State Administration of Foreign Exchange grants quotas that specify how much stock each overseas investor can buy under the Qualified Foreign Institutional Investor, or QFII, scheme.

In August, China eased rules governing the QFII project, allowing a broader class of investors and slashing capital requirements for market entry.

Regulators allowed overseas trust firms, pension funds, charity funds and endowment funds to join the program. Authorities also halved the required amount of securities under management to US$5 billion for mutual funds and insurance firms.

"The regulator's position is to gradually open the capital market to overseas participation with priority given to long-term investors," said a source close to the commission.

"As domestic bourses are beefing up corporate governance and listing quality, the regulator deems it's the right time to welcome choosier investors."

The CSRC has so far granted a combined quota of about US$9 billion to 40-plus overseas institutions, mostly banks, mutual funds and brokers, for trading yuan-backed stocks and bonds.

Risk-averse institutions such as pension and insurance funds have yet to rush into Chinese securities because they believe risks are higher than they can shoulder, industry insiders said.

"China's market is more volatile and less predictable compared with Western bourses," said a vice chairman at a US-based medium-sized securities firm.

"That's why investors with long-term strategies won't plunge in at the initial stage."

The CSRC also cut the period under which foreign investors can't transfer their capital back home from a year to three months for pension funds, insurers and long-term mutual funds.

Chinese authorities should consider further lowering limits over capital flows to attract this type of money, the CSRC said.

Regulators should also support foreign securities firms and mutual-fund managers, which have partnerships with domestic players, to join the QFII program, according to the statement.

"These overseas financial companies, usually optimist about China's economic growth, will be ideal QFII candidates."

Mutual funds operated by foreign institutions investing in yuan securities grew 57 percent in size in the last quarter of 2006 to US$3.77 billion, according to regulatory data.

Their average return on investment reached 20.5 percent in December, outperforming a 17.9 percent gain for domestic equity-invested funds, according to Lipper, a Reuters fund-research unit.

"With China's sustained economic growth and improved corporate earnings, the local market will surely occupy a position in investors' global portfolios," said Li Zhi, a Hualin Securities Co analyst.

"In addition, the rebounding of the Chinese market has already brought foreign investors handsome gains and will continue to do so."