By Michelle Chen HONG KONG, Jan 30 (Reuters) - Higher quotas, fewer regulatory restrictions and clearer tax guidelines are needed to give foreign investors greater access to China's markets through a pilot investment scheme.

Despite worries about China's shadow banking sector and a slowing economy, the Renminbi Qualified Foreign Institutional Investor (RQFII) scheme, which allows overseas funds to buy onshore assets in yuan, has made huge strides in recent months thanks to buoyant demand from investors looking for chunky yields and a stable currency.

The first yuan exchange-traded fund (ETF) under the RQFII scheme was listed in London in January while a Chinese government bond ETF and the second yuan ETF listed in the United States. under RQFII is expected to launch shortly.

The RQFII scheme, launched in 2011, allows financial institutions to use offshore RMB to invest in the Chinese mainland securities markets, including stocks, bonds, and money market instruments.

Regulatory restrictions are also being eased.

RQFII applications in Singapore and London are likely to quicken. The China Securities Regulatory Commission (CSRC), the market regulator, sent a notice last week to custodian banks, confirming that license application and investment operations in those two places would be the same as in Hong Kong, a source told Reuters.

The simple procedures to obtain licenses bode well for a strong pipeline of diversified RQFII products available to investors beyond Hong Kong, boosting the use of the renminbi in global trade.

But relatively small quotas and a pending withholding tax issue means global funds investing in China will find it a slog for now.

"RQFII quotas are still too small for institutional investors who won't bother to allocate assets in China unless $100-200 million can be distributed to them," said Ding Chen, chief executive officer at CSOP Asset Management, the largest RQFII products provider with total quotas of around 34.1 billion yuan ($5.63 billion).

At present, most of the quotas granted to an RQFII product by the State Administration of Foreign Exchange (SAFE) are no more than 2 billion yuan ($330.53 million) and thus the share each institutional investor finally gets is even lesser.

In Ding's view, all global investors have so far held an underweight position on China, because Chinese stock indices have not been adopted in international benchmarks, but also due to lack of channels and quotas to invest into China.

Taxes are another headache.

The current regulations have not specifically stated if RQFII and its older cousin the Qualified Foreign Institutional Investor (QFII) programme are subject to taxes in China or if they are totally exempted.