That China is likely to soon open to hedge funds looks certain to generate some outstanding opportunities. Given the difficult trading conditions in markets and the reluctance of many non-US institutional investors to allocate to hedge funds, the China opportunity is a significant one for managers everywhere.

There are two things hedge funds can get from securing access to the Chinese market: allocations from investors and the opportunity to trade Chinese markets. At the moment it is access to domestic investors that is on the table whereby hedge funds will be able to apply to become a Qualified Domestic Limited Partner (QDLP).

It has been reported that only hedge funds with assets over $10 billion will be deemed suitable by the Chinese authorities to access domestic investors. The amount of domestic money that will be permitted to flow into foreign hedge funds remains unclear. But a figure of $20-40 billion in the first instance would hardly dent the estimated $50 billion per quarter, or more, that Chinese investors are already pushing into investment funds.

What’s clear is that there will be no shortage of demand among investors. With little in the way of a developed bond market and investors wary of stocks – the Shanghai Composite Index is off 60% from the 2008 peak – Chinese institutional investors need options.

The opening to hedge funds follows official moves to dampen speculative real estate development. Clearly, hedge funds can offer much needed diversification into asset classes outside of the country and, indeed, beyond Asia.

What is unclear is the timing of the opening to foreign funds. More optimistic China watchers see change happening in a matter of months. Others, however, caution that financial liberalisation in China moves slowly and that QDLP status for a handful of hedge funds won’t occur until well into 2013.

In the meantime, China will continue to mint cash with few obvious places to invest it. For all but a few officially favoured hedge funds, the opportunity in China will be delayed until domestic hedge funds have established themselves sufficiently to compete with foreign managers.

But the direction of travel seems clear. By allowing institutional investors more liberalised access to foreign investment opportunities the government shows it is committed to improving the functioning of capital markets. Together with bigger quotas for foreign institutions investing in China’s capital markets and an expanded RMB trading band making it a more flexible currency, the country is moving to a regime of more relaxed capital controls.

However, even bigger opportunities remain tantalizingly out of reach for now. With China’s futures markets the biggest on the earth and its equity market among the biggest, the real dream for hedge funds is to get licenced to trade in those domestic markets.

In developed markets, institutions, including hedge funds, account for the vast bulk of the trading. In China, they account for only a tiny minority of the action. Some day this will make China a very attractive environment for hedge funds to deploy capital, not just raise it from investors.