* Rule stymies foreign investment in small-cap stocks -group
* Risks heightened after Han's Laser buy orders halted
* Short-term profit limits hamper large asset managers -group (Adds details from ASIFMA policy paper)
By Samuel Shen and Noah Sin
SHANGHAI/HONG KONG, March 20 (Reuters) - An industry body representing global asset managers in Asia has urged China to lift foreign ownership caps in listed companies, two weeks after the restrictions disrupted overseas buying of a Chinese stock and just as foreign inflows are set to swell.
In a policy paper released on Wednesday, financial lobbyist ASIFMA called on regulators to abolish the 10 percent individual and 30 percent aggregate foreign ownership ceilings in a China-listed company.
"If these limits are not removed, we are afraid that foreign institutional investors may not be able to invest in some of the listed companies, particularly the small cap companies," ASIFMA said.
Fang Xinghai, vice-chairman of the China Securities Regulatory Commission, said this month China is not considering relaxing the foreign ownership restriction.
His comments came after regulators halted foreign share purchases in Han's Laser Technology as offshore ownership of the firm neared the 30 percent cap. Index provider MSCI then deleted the Shenzhen-listed stock from its global benchmarks.
MSCI is expected to quadruple China's weighting in its emerging markets index later this year. Rival index publishers FTSE Russell and S&P Dow Jones Indices also plan to add Chinese stocks to their global benchmarks.
"With the inclusion factor increasing further, instances of foreign ownership reaching its limit will likely become more commonplace if local regulation does not change," said Charles Sunnucks, fund manager for emerging markets at Jupiter Asset Management.
The index weight adjustments triggered by foreign ownership rules "could be incrementally negative for market sentiment" if it makes rebalancing more volatile for fund managers, said Laura Wang, chief China strategist at Morgan Stanley.
The immediate risk is small, however, since only 18 of China's 3,500-listed companies currently have foreign investors that control more than 13 percent of the company's market capitalization, said Wang.
That risk could rise in tandem with foreign ownership in China and its weight in global indices.
China could draw up to $456 billion from global investors, if and when all A-shares are incorporated into MSCI's benchmark index, J.P. Morgan said in a report this month.
ASIFMA also urged regulators to exempt global asset managers from the so-called short swing profit rule.
The rule, designed to prevent insider trading, bars shareholders owning more than 5 percent of a listed company to profit from selling or buying its shares within six months of the original purchase or sale, according to the ASIFMA report.
But it could also constrain large international investment firms that are not necessarily insiders but can manage hundreds of funds with each owning a small piece of a listed company.
"That surely is not the original intent of these rules," said Eugenie Shen, head of ASIFMA's asset management group.
China's securities regulator should explain the circumstances in which affiliates could be treated as the same unit, or 'acting in concert', ASIFMA said, calling the current lack of clarity "the biggest obstacle for larger foreign institutional investors".
In its policy report, ASIFMA, which also represents investment banks and law firms, recommended enhancing two-way access between global and mainland markets, which would mean allowing greater outbound investment flows.
Beijing last year unofficially suspended quota approvals for outbound investment schemes such as QDLP and QDII amid fears of capital flight.
Starting next month, Chinese bonds will be included in Bloomberg's flagship bond index, as China's policymakers open the door wider to foreign investment in the country's $13 trillion bond market.
"While it is desirable for China to have an influx of capital into the country, it is equally important to allow capital outflows to support the desire of domestic investors to have a legal channel through which to diversify their investments abroad," ASIFMA said. (Additional reporting by Andrew Galbraith; editing by Darren Schuettler)