Nicholas Pratt listens to international asset managers putting forward their argument for the adoption of automation in the Asian investment market.
International asset managers have long been the evangelists for greater automation in funds markets around the world, eager to see some kind of operational consistency in the industry. The battle to increase automation adoption and straight-through processing rates has been ongoing for many years and will continue for many more.
A more immediate development for asset managers in Asia has been the development of passporting and mutual recognition schemes, aimed at creating fund vehicles that are as portable as Ucits funds and lay the foundations for a truly cross-border market to grow across the heterogeneous region.
This could lead to more automation and operational standardisation, thereby creating some kind of virtuous circle.
In the meantime, asset managers are assessing the relative progress of each passporting initiative, the likelihood of success and the implications for market participants.
“We are clearly in the early stages of the creation of a region-wide environment for the sale and registration of funds, however, it is too early to evaluate the relative merits or likelihood of success of any of them,” says Jack Lin, head of Asia Pacific, India and Middle East at Pioneer Investments.
“The important issue is which ones will gain critical mass either in terms of the markets involved or the volume of funds. But the region is big enough to have more than one successful scheme, just like Europe has both Luxembourg and Dublin. That said, there are competing initiatives like the Asean and Apec passport schemes and if one gains that critical mass first, it will make it difficult for the other to gain any traction.”
On the exchanges side, the Shanghai Hong Kong Stock Connect programme has started, which has fuelled expectation that the China Hong Kong Mutual Fund Recognition (MFR) project will follow soon after but, says Lin, there have been similar initiatives before that have seemingly been set to succeed and then subsequently failed. “I have seen that movie before but the devil is in the detail.”
What is clear is that the development of a cross-border funds framework is much needed, says Lin. “The market has been waiting a long time for a cross-border framework and it will be good for the industry.”
Up till now, Asian investors have had to turn to Ucits funds run out of Luxembourg to make any offshore investment, which has created a somewhat absurd scenario. “Most Asians could not find Luxembourg on a map if their lives depended on it. So why is Luxembourg used as a processing centre? Once Asia creates a processing framework that is acceptable to all, then it can be in charge of its own affairs.”
One of the implications of having Luxembourg as the main centre for distribution is that there are often regulations and other operational issues that are not strictly relevant for Asia but it gets dragged into it because of the central role that Luxembourg plays.
For example, in 2003 there was a mutual fund scandal in the US involving illegal late trading and market timing where fund managers colluded with selected investors allowing them to trade more frequently than their prospectus allowed to profit from short-term market cycles. The New York attorney general at the time, Eliot Spitzer likened the practice to betting on a horse after it had crossed the finishing line and subsequently penalised a number of firms and introduced new laws to prohibit the practice.
“However the Asian mutual funds industry is still relatively unsophisticated and fickle in terms of investor behaviour,” says Lin. “They may see a bad news story about a company and then decide they want to pull their money out. And they are sent a letter accusing them of gaming the system.”
And when there is a public holiday in Luxembourg, then Asian investors are served by local providers.
“It highlights the absurdity of it all but it is within the power of the Asian funds industry to create something themselves to replace Luxembourg-based Ucits funds as the offshore vehicle of choice.”
Should this be the case, it will present a dilemma for many of the global operators that favour the status quo in terms of the dominant role of Ucits but if the various passporting schemes gain momentum and growth, then the global players will have to commit, says Lin.
Alternatively, Luxembourg may create a scheme aimed specifically at the Asian market. But Asia is growing fast and it is more likely that it will seek to create something from within its own markets. The majority expect MFR to be the most successful of these projects. Should it grow, Korea, Japan and even Australia may join. “All it takes is for these various trends to line up,” says Lin. “It may take two to five years but when or if it happens, it is likely to happen fast.”
Not all asset managers are as optimistic about the prospects of passporting. “I have been a big sceptic of passporting in the past,” says Mark Konyn, chief executive at Cathay Conning Asset Management.
“Passporting only addresses the regulation of funds, not the actual distribution practice. Current evidence suggests that the cross-border distribution issues will remain but with even more complexity. Passporting is dealing with yesterday’s issue. It may get overtaken by more technology-driven solutions.
“There are a number of changes that we are seeing in the market – the use of technology, relationships with distributors – that are affecting the way we try to distribute a fund. Passporting is just adding another layer of rules you have to clear to get a fund into the market. It is more complexity that requires upfront investment but with little chance to make money from it.”
There are many conflicting views about how distribution will evolve, says Konyn. Distribution in Asia is based on a retail banking architecture. This creates smaller fee shares for fund managers because the distributors control so much of the landscape. It also puts fund managers at the mercy of the distributors when it comes to the use of automation, hence the long-term campaign to encourage greater adoption of straight-through processing policies.
“We hear more about investor education but that is a very expensive process,” says Konyn, who points out that efficiency for fund managers and administrators will be key as the Asian market develops and mutual funds face greater competition from the likes of managed-account services and exchange-traded products.
“But we are also seeing new distribution channels, the growth of insurance funds and the growth of the population, especially in markets like the Philippines where assets under management have gone up by four times since 2008.”
There is also the impact of technology as a disrupter of distribution channels, says Konyn. “An increasing number of investors are subscribing to funds online. We have seen the success of Chinese online platforms like Alibaba.com and now it has a $65 million money market fund. Right now this trend may be unique to China bit it will point the way for other regions in China.”
However it does throw up some regulatory concerns, says Konyn, not least because it is putting unregulated products into a regulated world, but there is clear evidence of the potential for online platforms.
For global asset managers that are used to highly automated markets in other parts of the world, much of the Asian market can be operationally challenging with disappointingly low STP rates. Dean Chisholm, regional head of operations at Invesco, is clear about where this low rate emanates from. “Local distributors are the problem. They do not know how to get an order out and they cannot justify automation from a cost perspective.”
There have been some regulatory-led initiatives in the region. The Hong Kong Monetary Authority launched its own automation platform but only the Bank of China group and BEA got involved in a significant manner.
In contrast, Taiwan and the Taiwan Depository & Clearing Corporation have been very successful in encouraging local distributors on to its platform.
However, Chisholm is somewhat uneasy about having regulators play too prominent a role in promoting automation.
“I’m a free market man. Regulations are very difficult to push automation. The main point is that we are all trying to make more money from mutual funds but I don’t think distributors get the economics.
“HSBC are rumoured to be doing something in terms of automating their distribution and this may lead other banks to automate, not because they have worked out the economic benefits of automation but because they are copying what another bank is doing.”
The various passporting initiatives in Asia, most notably MFR, have been cited as a possible catalyst for more automation but Chisholm claims this is unlikely. “MFR will not be the trigger for more automation in Hong Kong because the volumes will be too small,” says Chisholm.
There is also the concern that MFR will create operational challenges that were unforeseen and have still not been resolved. “There is still no whitepaper on how MFR is going to work,” suggests Chisholm.
Whether or not omnibus accounts will be eligible for MFR fund processing is still unknown although indications are that they will be accepted in China.
If that is the case it will make MFR much more straight-forward, especially given that the initial volume is likely to be Hong Kong-based investors (where omnibus accounts are used) investing into China (where nominee accounts are used). But one operational issue that has not been fully appreciated is the cut-off time for an MFR fund, says Chisholm.
“For Hong Kong funds, the cut off is from the TA that receives the order. For Chinese funds, it is between the client and the distributor, not the TA and the distributor. So that is what needs to be sorted out. The time delay between omnibus or client orders is two to three hours which is a considerable time.
“It should be the same cut-off time between China and Hong Kong. It was not something that was immediately apparent but it has been subsequently pointed out.”
While the operational issues of MFR are ironed out, there is the possibility that other faster-moving developments will have more of a role in promoting automation in the Asian funds industry, says Chisholm.
“The possibility of exchange-traded mutual funds puts a whole different dimension on how you trade a mutual fund. You need a market-maker to price them in real time but it will mean you can buy and sell funds like securities. It changes the access channel and the cost of buying funds. And ETFs are already available in China.”
It will also make it easier to trade funds electronically, as is being done in Thailand which could promote more automation at the back end as electronic trading will require real-time processing rather than end-of-day batch processing commonplace in many Asian markets.
One of the biggest development in Asian financial services in the last year has been the growth of e-commerce and this may have a profound influence on the growth of the Asian funds industry and the promotion of automation, says Chisholm, echoing the views of Conning Cathay’s Konyn.
“E-Commerce could be the jump forward. It opens up opportunities but whether the industry can capitalise on them is another thing.”
Chisholm cites the dizzying growth of smartphone usage in Asia as a reason why a lot of new e-commerce providers will get into the distribution market for funds, however, he thinks it is still some time before we get new manufacturers through e-commerce. “Can Google or Facebook make a mutual fund? An ETF is a lot easier to make than a mutual fund.”
©2014 funds global asia