Our panel discusses the rise of Hong Kong, the prospects for MFR, cross-border competition and the difficulties with distributors. Chaired by Nicholas Pratt.
Eddie Fong (MD & head of operations Asia Pacific, JP Morgan Asset Management)
Rakesh Vengayil (BNP Paribas IP, chief operating officer APAC & emerging markets)
Isaac Wong (director product management/investment funds, Euroclear)
Morris Chan (head of fund distribution services, Caceis Hong Kong)
Stanley Poon (vice president investment funds services, Clearstream)
Funds Global: How is Hong Kong developing as a China gateway?
Eddie Fong, JP Morgan Asset Management: Hong Kong is definitely a gateway for China. If we look at the evolution from clearing of renminbi (RMB), the Qualified Foreign Institutional Investor (QFII), and then the Shanghai Hong Kong Stock Connect, China is offering a sequence of products through Hong Kong progressively. Before it is going to Singapore, London, Taiwan, the first stop is Hong Kong.
Rakesh Vengayil, BNP Paribas IP: There has been speculation that the other big financial centres in China may take over Hong Kong’s role as a gateway to China combined with other locations engaging directly with China making Hong Kong’s role less relevant, but the dynamics won’t change too much. Hong Kong has the natural advantage of accumulating RMB, and plays a key role in the internationalisation of the RMB, is the world’s largest and most efficient offshore RMB business hub, with the world’s largest offshore pool of RMB liquidity. The geographical proximity and geopolitical stability makes it a proven financial hub. China has something at its doorstep through which it can control offshore fund distribution into China. All of the initiatives from Qualified Domestic Institutional Investor (QDII) to Mutual Fund Recognition (MFR) show that Hong Kong is a test lab for a concept to be proved and then taken forward. In our China strategy, Hong Kong will always play a very prominent role.
Isaac Wong, Euroclear: The opening of the Chinese capital markets and RMB internationalisation has been the grand vision of the Chinese government and it sees Hong Kong as part of it. So from that standpoint, it makes sense to use Hong Kong as the test ground. It has the proximity to China, the language, the infrastructure and everything seems to be ready. The MFR will be the next big thing in terms of cross-border arrangements but the Chinese are taking a very pragmatic approach, which makes perfect sense.
Morris Chan, Caceis: We thought Hong Kong would be the only gateway to China. As RMB internationalisation speeds up, many other markets are developing as an alternative. The once exclusive RQFII quotas are available in markets, such as France, the UK and Singapore. Hong Kong benefits from being the first mover in many initiatives, such as QFII, MFR and the upcoming Stock Connect. We believe Hong Kong has a competitive edge, but the gap is getting smaller as other options become available.
Stanley Poon, Clearstream: Hong Kong is well positioned but in terms of things like MFR, the devil is in the detail. We need to know how it’s all going to work, how banks and how fund managers will be connected.
FG: How far are you in terms of identifying issues for MFR, such as omnibus accounts versus nominee accounts, and then being able to solve them?
Poon: We’ve had close discussions with the respective infrastructures in Hong Kong and China and the marketplace. In China it’s all individual accounts, whereas in the rest of the world we operate on an omnibus status. So a solution needs to be worked out with the Chinese registries. We are well positioned to go into any type of market as long as there’s an agreed final solution which can streamline these operational inefficiencies and that should be understood by all the participants.
Vengayil: As in any initiative, there are challenges. There are known fundamental issues, which we are looking at and trying to address, like an omnibus versus segregated account. There could be a surprising number of minor market dynamics which impact the operational flow. So my concern is that while people are looking at all the fundamental blocking issues, there will be a lot more work to be done on the minor operational issues to have a seamless flow between Hong Kong and China.
Wong: The fundamental principle around all cross-border flows – funds or securities, stocks – is that RMB is not a fully convertible currency. The Chinese authority will implement a quota to control the flow. This gives rise to some complications, like the circulation of cash within the parameter of a given quota. As industry practitioners, we need to work these things out with the regulator and, before the final work is done, make sure that the model is robust.
Fong: They will look for a solution which is scalable and cost effective and, if they prove the concept with the stock exchanges, with the Shanghai-Hong Kong Stock Connect, they can take reference. The straight-through processing (STP) rate in China is No 1. It’s over 99% for our joint venture in China. Our small team handles millions of investors. So it’s a very successful model. The STP rate in Hong Kong is low by comparison so if done right, MFR is a golden opportunity to promote automation.
Chan: The focus of the market has been on Stock Connect but MFR is similar. There are many operational issues to be resolved with MFR, such as the capital control, difference in Know Your Customer requirements and the operational models. Once Stock Connect is up and running, there will be some reference points for MFR and the roll out will encounter less uncertainty. There are lots of questions and not many answers, so it is important that we continue to monitor the situation and would be ready to support clients in the region when given more clarity.
FG: Now that Stock Connect has gone live will it be advantageous for MFR or will it take the momentum away from MFR?
Vengayil: Yes, there will be some lessons learnt in Stock Connect. Here again it was mainly on understanding and adapting different operating rules and marketing practices from a global fund perspective.
Fong: Chinese authorities are doing it gradually. They want flexibility to either adjust funding, change some of the requirements or control the flow through the quota system. If everything works the quota will increase.
Vengayil: That approach becomes a big problem if you want to apply some of these concepts for your global funds. For example, if you take stock on it for your Luxembourg fund, the positions of your funds are held by a clearing corporation in the Chinese market. Now, the legal standing of that isn’t robust. The presence of mechanisms to recover holdings or use omnibus accounts have not been articulated well. From a business perspective, large multinational organisations would normally like to have full visibility to the start-to-end process and risk involved in such an initiative, but that’s not always the case. However the organisations do understand that to take advantage of the opportunities in China, you have to be in the right place. So you may have to make certain moves without knowing what the results are going to be.
Wong: The bigger question is how these schemes will open up. Those cross-border schemes are initiated by the regulator but what’s in it for the whole industry, for the fund promoters, for the vendors, the custodian banks? You have to create enough motivation and economic incentive to make it work and to make it sustainable for long-term success. If you are taking a gradual stance and you do not have a timetable, then that makes it difficult for the practitioners to plan for the opening up. That is the awkward situation that we are facing.
FG: Do you expect the MFR to involve other countries?
Wong: It has to because Hong Kong domiciled funds are underdeveloped. Bringing in China is an exciting move but is it enough? Look at Ucits. It is large enough to have two competing domiciles in Dublin and Luxembourg. The bigger question is whether Hong Kong or Singapore will build itself up as the Luxembourg of Asia. Is China, in itself, sufficient to sustain a fund infrastructure or fund platform that is large enough? We need to open up China-Hong Kong further.
Vengayil: When you create a platform like this, the scale is of prime importance. Ucits is proven in some of the Asian countries. Even with fund passporting, many favour Ucits because it has the scale. Secondly, a few years ago there was an expectation that Luxembourg would be able to export Ucits funds into China. Now the distribution is limited to a few markets but access to China or Indonesia would make it much more successful. However, with MFR coming into play, Luxembourg Ucits funds getting access to the Chinese market will be more delayed than expected.
Poon: When you try to figure out which market is going to become the Luxembourg of Asia, you have to look at Luxembourg’s success and the expertise and experience it built up and the confidence it created in the Ucits brand. That’s something which needs to be replicated in the Hong Kong-China links and with the different regional passport links. That doesn’t come overnight. It needs months and years to build up that expertise to make it work.
Fong: In the EU there had to be agreements between the different national regulators and governments to create the passport structure so that cooperation and collaboration between countries is very important. The MFR will work because it is one country and two systems and the regulators are willing to talk and to compromise. But for the wider passport initiatives, like the Asean Collective Investment Schemes and the Apec Asia Region Funds passport, they can only succeed if regulators and governments compromise. However, getting compromises will be challenging because they each have agendas.
FG: Is that sense of competition healthy, in terms of promoting automation or is it more damaging because of agendas?
Chan: Any competition will be healthy. It will only benefit and bring best practices to the whole industry. Different countries have their own areas of focus. For example, Hong Kong has its advantage in distribution in North Asia, while Singapore is very strong in distribution in southeast Asia. It would be hard to say there will be a single Asian passport as in Asia we have fragmented markets, whereas Europe has a single regulator. Fund passport initiatives are welcome developments. MFR, Asean and Apec will facilitate more discussion among regulators at a later stage about a truly Asian passport. The MFR may be the first step in that direction. If it works, they can move forward and map that same programme into Japan, Singapore and other markets.
Poon: It’s an evolution and each country needs to look after its interests before worrying about regional initiatives. So it’s going to take some time. When I go to Taiwan, Korea, Singapore and Hong Kong, each country is doing its own thing. But there will come a time when the different national regulators will sit down and say, “we need to do something on a regional passport”.
FG: In terms of the momentum for promoting back office automation and in the fund processing side, is there more momentum now or less than 12 months ago?
Fong: The distributions are realising the benefit of automation in Taiwan. Almost 50% of the distributor, more than 20 of the major ones, have signed up to the Taiwan Depository & Clearing Corporation (TDCC) platform and gone live. And every month we see one or two more go live. So we are happy with the progress. It has given us a double-digit increase in our STP rate for the last two years.
Chan: We received many enquiries on automation and we are positive about the initiative, however, it takes time to achieve automation. In terms of RFPs and STP rate, we don’t see significant increase in demand for automation. From distributors’ perspective, strong financial incentive is necessary to convince them given the relatively low cost in Asia and diversified financial products they are distributing. They can function with the existing model and top priority may have been given to other projects like regulatory requirement that will have a significant impact.
Vengayil: When we talk about STP, we talk about cost and operational risk but Taiwan is a special case because it deals with high volume but low value transactions. That’s why the free concept came in, to make it attractive for distributors to participate. As a fund promoter, we incur large costs when we support high volume and low value markets. So there are more mutual benefits in Taiwan. There is also a case to support some of the early adopters for longer because they are the ones that gave the momentum to the market by taking the lead and showing others that this concept could work in the Taiwanese market.
Fong: Yes, and also, on top of risk and cost, there is one very important benefit – scalability. The challenge for a transfer agency (TA) business is that you don’t know when the volume will go up. When you have too many resources, you will be challenged with the cost and, if you do not have enough resources, you have to work overtime, hire temporary staff. So scalability is very important.
Wong: The TDCC had a big role in convincing the distributors to sign on. And the idea of starting with the automation of order routing only makes perfect sense. It fits very well with the Taiwan model of high volume, low value transactions and it creates an economic incentive for the distributors to pursue. But the bigger question is what happens next in Taiwan? Should it end there with order routing or should we position ourselves to enter into a full service model with settlement and asset servicing? The market is not ready yet. Everybody is busy with signing on to order routing and they are not looking beyond that. But it will be more relevant for us as an infrastructure service provider when they do. Taiwan will be moving into a second phase much sooner than we anticipated.
Fong: I always compare the funds automation evolution with the securities market automation evolution. We had paper-based settlement for securities 25 years ago and then we introduced Swift messages for securities settlement and trade confirmations. Now we are in the progress of automating funds dealing.
Poon: Clearstream’s approach has been a little bit different in Taiwan. We understand order routing is a key concern, and that’s why offering it free to the distributors did create the initial momentum. The real cost savings and reduction in operational risk on the distributor bank side is when you start looking into cash settlement, reporting and custody services. When they realise this, that’s when they need to pay a little bit extra to get that service. That’s why we’ve held back from providing only order routing because we believe our full service model works globally for all bank distributors and should work in Taiwan in the future.
Vengayil: This is a perfect demonstration of a collective effort from all industry participants. So that’s the remarkable thing in Taiwan – regulators are involved, service providers are doing their best, fund promoters are pushing and distributors are participating. That’s why I feel this will be always seen as a reference point in Asia and a case study for how you can collectively promote automation.
FG: Is the role of the regulator essential for automation projects or does it hinder automation in the long term because it is not coming from market demand?
Chan: For automation we have to define whether it’s just one country or across Asia. We talk about the increasing automation in Taiwan’s market and the highly automated China’s local fund market. But across Asia we have not seen huge progress. In Taiwan, the platform has been promoted by the regulator, just like what we saw with the Central Moneymarkets Unit (CMU) in Hong Kong for clearing and settlement. To promote automation across Asian borders, you need more collaboration among stakeholders.
Vengayil: The problem we have in these markets is that it is hard to sell the concept of operational risk. Most of the market has labour intensive processes to ensure there is zero tolerance on error and that has been working. The error rates are less than 0.05%. So they do have mitigating process and it’s not expensive in some of these markets. Until there is some big breach, it will be an unbeatable combination. The key priority of the regulators in automation has been to reduce the transaction cost for the end investor rather than mitigating the operational risk. Regulatory involvement isn’t a hindrance, on the contrary, it accelerates the process. It has been proven in Taiwan’s case as participants got more comfort from this programme being sponsored by a regulatory affiliated body rather than us going and pushing a proprietary solution.
Fong: When the government works together with the industry to explore a solution, all parties will benefit. Taiwan is a great example. When AFAC was approaching Taiwan distributors back in 2007, it was a very slow progress. But the TDCC platform has been a great catalyst. You need the support of a regulator or central body for these financial infrastructure projects, similar to building an airport. How could they work if they were not supported by the central authority or an appointed vendor?
Vengayil: Normally people understand the benefit of these concepts but from a priority perspective, they see this as something which is nice to have and go down the priority ladder. The moment the regulator starts getting involved then it becomes mandatory to respond. We have seen that in Taiwan and we are seeing that in India for its own Mutual Funds utility platform.
Fong: To secure IT resources, the primary criterion is regulatory requirement. The second criterion is supporting business. If you have a wonderful product, idea and forecasting, that it will raise $5 billion and you will get approval for IT development. Pragmatically, that’s the situation.
Wong: Regulators are part of the integrity of the financial infrastructure. Who else is better positioned to manage that or to promote it? If it is driven by the regulator instead of the sell-side or the service vendor who might be seen as simply wanting to make money out of it, it will certainly help. I take it as a positive sign.
FG: Many distributors in Europe are reassessing their business models and the role of automation. We’re also seeing the likes of Alibaba.com bringing e-commerce to the distribution chain. Will there be a shake up in Asia and will it be a driver for more automation?
Vengayil: It’s an absolutely valid point. There are two things driving this. There are a lot of markets in Asia where regulators are pushing for direct access for investors who do not want to pass through a distributor. For small investors there should be a consolidated platform through which they can get access. And for investors that are capable enough to make their own choices, they can access the market directly. In India this is mandatory – fund houses need to have a direct investment share class, with a benefit of higher net asset value and that is driving a wave of automation. The second point is the transformation happening on the distribution side. They are focusing on high-end investors to make it more efficient and profitable so there will be a whole group of clients that will be left out and will need a platform to provide access to the market.
Poon: What I am seeing is definitely a move up the value chain, across the region. In the past banks looked at automating faxes as the be all and end all of automation. But now we are moving into the wider scope of funds processing. There is also a competitive dynamic where the big players are recognising the value of automation in terms of operational risk and cost reduction and are getting smarter about automation and using it for more than just order routing. They’re going to benefit from that in the longer term and the ones that are going to be left out are those just doing simple automation work and happy just to automate a single process.
We are seeing this in Singapore where the banks are willing to adopt a more one-stop shop service. Hong Kong is sort of latching on. In the last two or three years the big four banks have taken an interest in the long-term benefits of automation and are trying to quantify them so that in five years they can see the benefit on their bottom line.
Wong: Korea is a much better case than Taiwan for the benefit of the full service model. In Korea the bulk of the business is fund of funds whereas in Taiwan it’s direct investing so Taiwan has much more volume and a greater incentive for automation. The second point is how the local central securities depositaries (CSDs), the Korea Securities Depositary (KSD) and the TDCC, promote the model to the trustee banks, the distributors and the commercial banks there. As the infrastructure, as the backend engine or the connector to the offshore world, we rely on KSD to promote a service to banks that have direct connections with them.
Poon: Korea has been an excellent case where the KSD has done a great job, even without a real regulatory push from the government. It spread the word and made it a market infrastructure which the banks around Korea can believe in. They’ve adopted a model which works for the banks with order routing, settlement and custody. It is about getting volumes on to the infrastructure to make it work, which is the easy job.
FG: Have we seen automation move beyond order routing to include custody and settlement in any of the Asian markets?
Poon: In Hong Kong or Singapore, we’ve seen demand for the full settlement models and they have been key markets for us. But most of the other markets in Asia are taking on board the idea of a full service model. Taiwan adopted order routing first but it had to do that to get the big players involved and address the inertia.
Fong: It doesn’t mean that it cannot emerge further. No one says that you have to stop. You can move on.
Vengayil: Taiwan is slightly different. If you go to Singapore and talk about order routing, it will not make any sense for anyone, because it doesn’t mean anything. It’s big value, small volume.
Fong: But then you look at Hong Kong and Singapore, apart from private banks, the retail business from the bank is still fax-based. I don’t know why Hong Kong and Singapore, as financial centres, are still receiving faxes. When my colleagues from Europe come here, they don’t believe it. But contrary to that, I point out in China STP rate is 99%.
Wong: Hong Kong has been selling funds for 20, 30 years and it is pretty concentrated in a few commercial banks, and they have built up their own legacy structure.
Poon: For the IT heads at those big four distributors, making those connections to different platforms and TAs is a really complicated process. Things change every day in the funds business. It’s not like equities or bonds. And when we speak to those big four, they usually report the same issues. We don’t understand why they don’t change but we know the industry is extremely complicated, something which you can’t standardise into one format for everybody.
Vengayil: The good thing though is that in the current market scenario, everyone is realising that you need to go for a structural change to have your costs under control. They are moving beyond some of those small-scale, tactical measures to real strategic or structural change. In the past, funding these projects was an issue but if you have a good business case, where you can do this in a one or two year payback, the business is willing to fund it. I’m talking about a big number, which has been dedicated for operational efficiency, which has never happened. These structural changes are essential because margins are dropping and markets are becoming more competitive so the automation has to happen.
Chan: As a services provider, we see that there’s quite a long way ahead for automation. We will be happy to provide information on different platforms to distributors that want to have more knowledge about automation, but we also believe it will take time to spread the knowledge. We are on one hand connected to different automation platforms, and on the other well prepared to serve the manual processes. We have to take care of all the different counterparties and their processing needs – this is of utmost importance – because we are not distributing in just one country, it’s across the regions.
FG: The service providers in Asia have different strategies and business models. Will these approaches still work in Asia?
Poon: For us it works. The willingness of distributors to take on more automation higher in the value chain, not just order routing but settlement and custody, is increasing every year. Clearstream’s approach of a one-stop-shop for these banks in the region has helped create momentum and will be successful for us in the future just as other providers’ models will probably be successful for them as well.
Chan: Asia is very unique. Having exposure to and experience in handling different business models across Europe, we can meet various clients and countries’ specific requirements. Our operational model in Europe could be extended to Asia when more requests for automation from this region are seen.
Wong: Euroclear and its fund settlement platform is a vision from Europe and the Asian office has been set up to link the Asian investor and the distributor to the Ucits world. That remains the majority of our business. But we are seeing European investors investing into Hong Kong or Singapore domiciled funds and we have the development of the MFR and other passport arrangements so there will be more connectivity within Asia. We believe in the full service model. This is the end goal. There may be adaptations and differences, in terms of the players and driving forces between Korea and Taiwan and China and Singapore, but the ingredients of a successful model remain – to rely on the infrastructures in Europe and to extend into servicing Asia.
Vengayil: Local market forces and dynamics will drive such approaches. Hence, we do not have a one-size-fits-all approach. Each market has its own advantages and challenges. It is the business that will stand to gain from automation and increased efficiency.
We operate in 14 markets in Asia Pacific and what we have observed is there is nothing like one size fits all. The thing about finding solutions unique for each market is that there should be interoperability. As long as that is kept in mind, we should let it respond the way it is required by the market and evolve to where it should get.
Fong: We are committed to working with all vendors and regulators.
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