Our panel discussed exchange-traded funds, regulatory overdrive and whether mutual fund recognition has been a failure. Chaired by George Mitton in Hong Kong.
(managing director and senior advisor, Citi Markets and Securities Services)Andre Durand
(managing director, Societe Generale Securities Services)Rosemarie Kriesel
(managing director, global client coverage, Hong Kong, RBC Investor & Treasury Services)David Li
(chief executive, Caceis Hong Kong)Ian Stephenson
(global head of fund services, HSBC)Fanny Wong
(head of custody, Bank of China HK)
Funds Global: What are the biggest challenges facing your business this year?
Ian Stephenson, HSBC:
The uncertain regulatory environment is a big challenge for us. Having gone to a lot of effort to implement US regulation, we’ve now got to look at the implications of some of that legislation being changed.
However, we see regulation as having peaked in terms of its impact on our business. If we look at how much we spend in terms of technology supporting regulation, it’s relatively small. A lot of the effort is ink time and people time, and a lot less than you might imagine in terms of technology.
Technology plays an important role in offsetting the increased costs of doing business. The industry needs to start a process of self-reflection, looking more broadly at the way it does business. There’s been a lot of investment in automation in HSBC, offshoring and process optimisation across the global businesses, operations and technology.
David Li, Caceis:
Market uncertainties definitely impact us – look at the effects of Trump, Brexit or the upcoming elections in France, for example. Regulation also remains a major factor in our day-to-day work. We are having to fight on many fronts, both complying with existing regulations and ensuring that we are up to speed with regulatory developments and ready to implement the next initiative for our clients.
However, on the positive side, we are seeing strong opportunities in areas such as fintech [financial technology]. Caceis has recently finalised an innovative partnership with Europe’s first Bitcoin exchange, Bitstamp, and is taking part in initiatives to ensure our clients benefit from fintech opportunities such as distributed ledger technologies.
Fanny Wong, Bank of China (Hong Kong):
We see higher costs with a lower margin, higher transparency but lower certainty, more service requirements but less manpower, a bigger business pie, but more competitors. It’s not an easy game.
We are facing difficult regulatory requirements. As custodians we inevitably have to invest a lot of time, effort and money to make sure we are all compliant, so that’s a big challenge.
The second one will be about new, disruptive technology. We have to catch up with these new technologies to ascertain whether, when and also how they can be of help to us. At this stage, the likes of blockchain and crypto-currencies and are still premature. It takes time and cost to make them mainstream and get them commercialised.
The third challenge will be cyber security because that’s a top priority for regulators when they look at our business.
Politics is also a challenge. In less than two weeks’ time, Hong Kong will have a new leader. We have to work out how to measure these risks and build them into our business. [On March 26, Carrie Lam was elected chief executive of Hong Kong.]
Rosemarie Kriesel, RBC Investor & Treasury Services:
The biggest challenges are the evolving regulatory landscape and disruptive technologies. Our asset management clients are having to enhance efficiencies, reduce costs and embrace innovation. Our approach has been to take a hard look at technology. We’ve invested in a multi-year technology strategy. We are taking the data we hold for clients and transforming it so they can get at that data quicker and more efficiently. Our objective is to help them reduce their costs and achieve efficiencies.
Andre Durand, Societe Generale Securities Services:
There’s a lot going on in automation. Today, if we look at the transfer agency business in Asia, most of us are around 60% to 70% automated, which is good news. The problem is that there is still 30% non-automated and my fear here is the black swan. Over the last six months, with elections in various countries, we’ve seen that uncertainties are growing. If it goes bad and suddenly everybody decides to redeem, I’ve got a challenge because I’m still 30% manual. That’s my fear.
Stewart Aldcroft, Citi Markets and Securities Services:
I don’t agree that the regulatory peak has been reached. Regulators, globally, to my mind are in overdrive. My question to the regulator these days is, ‘Who is giving you a mandate to increase the volume of regulation?’ It’s not the end investor. For example, in Hong Kong we have four or five regulatory consultation pieces going through at the moment from the SFC [Securities and Futures Commission] that are all impacting the asset management business. In the UK it’s the same.
The problem with blockchain is that none of us understand it. We’re all fearful of it and think it’s going to be the solution to all our ills. I disagree again because I don’t see the way in which blockchain will improve our business.
The growth of the business is a challenge. Here in Hong Kong, it’s hard to get the right staff because there aren’t enough of them. Right now, it’s looking positive in the markets, but if we start to see a lot of turbulence, there could be disruption.
One thing I’d add is that our clients face significant challenges and we are seeing a trend towards more outsourcing. Our hottest market at the moment is Taiwan. Everyone is looking to outsource technology people. In China, the regulations now encourage outsourcing for fund managers. This is the beginning of an observable trend.
Funds Global: How is the mutual recognition of funds (MRF) scheme developing and what could be done to boost take-up? How does MRF compare with other regional funds passporting schemes?
MRF is quite different from the other initiatives in the region. What the Hong Kong government wants to achieve is a co-ordinated strategy. If you look at MRF in combination with Stock Connect, it’s designed to give them more tools with which to open up the market.
I don’t see MRF as competing with the other initiatives in the region. It is designed to help local funds compete with Ucits. The size and strength of the Chinese onshore market makes MRF an interesting proposition for a lot of people. I always describe China as the land of opportunity for fund managers.
There were 48 southbound funds approved so far and only six approved northbound, but those six have sold like hot cakes and some had to stop subscriptions because they reached a 50% limit. The concern of the regulator is that the imbalance is too much to be bearable, so they are hesitant about approving more funds because of the disparity, which at times can be more than 80 times in terms of assets.
The root cause is the depreciating renminbi. People are hesitant about the performance of all those southbound funds. They also need more confidence about the regulatory regime in China.
To encourage the take-up, we have to wait until the currency is more stabilised and we need to do more with investor education. From the industry’s perspective we would like to see more different types of funds being approved under the scheme. Meaningful reference can be made to the Switzerland MRF, because under the Switzerland MRF you can have funds of funds, structured funds, feeder funds and whatnot.
I don’t believe the renminbi is the issue. When you invest abroad, you are ready to get some currency exposure. The limits, however, are a problem, because if you want a product to be successful, you have to be at the right place at the right time. The problem with these limits is that Hong Kong is a developed market and China is an emerging market. How can you design a product that caters for the needs of Hong Kong investors and Chinese investors at the same time? The distribution strategy needs to be different as well, but you have only one product.
Yes, it has taken several years to get MRF off the ground. However, we’re applauding the industry that it’s finally come to fruition, while also recognising the current frustration because of the amount of time it’s taking northbound funds to get approved. But, stepping back, it’s early days, and it’s part of the whole opening up of China’s capital market along with some of the other passporting schemes.
I understand that the Hong Kong regulator is also talking to other countries such as France, so probably the next step will involve an MRF between Hong Kong and France. That would be a key development because France is one of the biggest markets in Europe, and currently, French funds are not very widely distributed outside of France.
I have a strong feeling about this: MRF is a failure so far. Fanny said about the concern of the regulators on the imbalance. That is wrong, because the agreement is that you’ve got 300 billion renminbi of quota in both directions allowed. In any event, if you’re trying to sell funds from Hong Kong into the mainland, the purchase is a loop system. The money never goes out of the mainland, it is only the investment value. So it’s not as if the money is lost to China. SAFE [the State Administration of Foreign Exchange] seems to have a misconception about this too. It’s an agreement, and clearly one side isn’t playing the game, and that is patently unfair. The SFC should be working much harder on this on behalf of the Hong Kong industry.
I’ve got some figures. The net sales of southbound funds, which means northbound money, since the start is just 74 million renminbi. The net sales for northbound funds, southbound money, is 7.7 billion renminbi, not a big number. That’s less than the weekly aggregate fund sales in Hong Kong.
Then the issue of choice. JP Morgan are suitably embarrassed because all the money goes to their fund. [The JP Morgan Asian Total Return Bond Fund has been the bestselling product in the scheme so far.] They would love to see more choices out there rather than all the pressure being put on them. So again, here’s another reason why SAFE and CSRC [China Securities Regulatory Commission] have got this wrong, because if they gave more choices, it would help give JP Morgan more competition and maybe become less embarrassed, if anybody wants that to happen of course.
I was thinking back to the first of these that I attended, and we talked about passporting, because MRF hadn’t happened. Most of the people there were from Chinese banks or similar, and the consensus was that the point-to-point passporting relationship would be more effective, if nothing else than because of politics. The fate of multi-country passporting has a big question mark against it.
Funds Global: Has the addition of Shenzhen to the Stock Connect programme led to a rise of investment flows under the scheme?
It has been successful, but it hasn’t reached its daily quota level. The number I hear is 20% of the daily limit, but that’s been rising steadily. It opens up another channel to invest into China without the quota regime around funds that currently exists.
The Shenzhen Exchange has a market capitalisation of $3.2 trillion. It’s the third-biggest in the region after Tokyo and Shanghai. While Shanghai is experiencing a steady decrease, Shenzhen’s market capitalisation is rising continuously, and we are keen to see what the next steps in its strategic development strategy will be. ETFs, for instance, are probably in the pipeline and then initiatives like IPO Connect.
In a way, Shenzhen is more attractive than Shanghai, because Shanghai is so similar to Hong Kong, whereas Shenzhen represents a completely different market.
Judging from the new accounts made just for the sake of Stock Connect, we indeed did have some exponential growth, because fund managers are trying to package some Stock Connect funds or products like that, so it’s helpful.
People keep comparing the launch of the Shanghai Connect with the Shenzhen Connect, and they find the Shenzhen Connect less promising, but we must recognise that there is a lot more QFII and RQFII quota being dished out today [the qualified foreign institutional investor scheme, and its renminbi equivalent, allow foreigners to invest in mainland assets]. Institutional investors have a lot more channels to go into China, not like three years ago when the Shanghai Stock Connect was initiated.
Some funds are still trying to amend their offering documents to include Stock Connect, and I have learned that Luxembourg and Ireland are allowing their Ucits funds, and even alternative investment products, to invest into China through Stock Connect. So there are some bright spots going down the road.
[At almost the same time as the roundtable was held, China’s premier Li Ke Qiang announced the plan to roll out Bond Connect.]
It’s just one part of the overall liberalisation of the capital account in China. We see it as part of that longer-term trend. The actual take-up, similar to other providers, has been quite modest among our traditional client base, but what it’s doing is providing another avenue for access into China, and that’s creating excitement among foreign investors who are positive about increasingly favourable market entry opportunities.
Aldcroft: I was interested to hear from a client a couple of weeks ago why they are not doing more with the Shanghai or Shenzhen Stock Connect.
‘Because our fund managers don’t find the China story very compelling right now.’ To me, this is a wrong answer. In a way, as a fund manager, they are denying clients access to something that clients might want to buy.
Fund managers have become extremely cautious over the last five or ten years and they’re not willing to take on an ambitious opportunity, which is what Shenzhen represents. More than half of them underperform benchmarks, they’re under massive pressure from regulators to stop being closet index trackers, they’ve got to bring their fees down, so why take on an extra risk? That’s the attitude the fund manager is showing.
It is this caution that is prevailing in the fund industry right now.
On Shenzhen, is there expertise in the fund houses? Shenzhen was closed to global investors for years. Who invested in getting to know that market? Who knows the companies that are listed there? They are difficult companies to analyse, closed companies, huge price-to-earning ratios, risk of fraud, whatever. There’s a learning curve.
Funds Global: Globally, passive investment products are capturing a larger proportion of assets under management than ever before. How are tools such as exchange-traded funds (ETFs) developing in Asia?
The ETF has been a disruptive product in the asset management space. Today we’ve got something like $3.6 trillion sitting in ETFs, which is greater than the entire hedge fund industry worldwide. Asia’s slice of that is about $300 billion, of which over half is in Japan. The predicted growth rate in the region is significant, something like 18% a year.
Historically, most of the products were in equity. We’ve seen a move towards fixed income and also leveraged and inverse products being launched, initially in Taiwan and now here. That’s giving investors a greater product choice.
The market is becoming more sophisticated and there’s going to be more money invested. People are better educated in investment products. Almost every magazine has something around the historic performance versus benchmark of alpha funds.
Recently I read a survey done by Source UK Services on ETFs. It says that in the next five years from 2016 to 2020, the ETF business is likely to double. It’s a huge market, but right now it’s dominated by the US players because they take up more than 70% of the global market share while those in Asia account for less than 10%. But, given the accumulation of wealth in Asia and the ageing population, there is the potential for ETF growth in Asia.
Asset managers are gearing up to develop their products to meet that rising demand. Traditionally, demand for ETFs in Asia-Pacific has not been as much as in the West, but developments such as the creation of custom portfolios or establishment of custom indices demonstrate that managers are trying to have a range of products available for investors. It’s healthy for the industry to offer more choice and part of the maturing process that we’ve seen in Asia-Pacific as it moves more towards the trends we’ve seen elsewhere.
ETFs are being adopted because of their cost-efficient nature and we are seeing a lot of innovation around smart beta. This is a positive trend and regulators are very happy to see this.
Many firms are offering different kinds of low-cost ETFs in Hong Kong, such as Vanguard and Amundi.
In Asia, ETFs are heavily used by institutions, sovereign wealth funds, pension and insurance companies. They’re even being used by MPF [Mandatory Provident Fund] managers to give them access to some parts of the world.
But the missing element is the retail investor, who is not being given access to ETFs because the typical funds distributors won’t get paid to sell ETFs. A natural phenomenon which the UK adequately demonstrated with the RDR [retail distribution review] was that when you put a commission ban in, ETF sales go up.
That’s not going to happen in Hong Kong, Singapore, Taiwan and China any time soon. An RDR needs to be an agreement between these four regulators because fund sales and the booking centres are fungible within the region as a whole.
You’re already getting some big private banks booking in one country where they’ve made sales in another country, and where they book is where they get their commission. It becomes difficult from a regulatory point of view to stand alone. We’ve not seen any great examples of Hong Kong’s SFC and the MAS [Monetary Authority of Singapore] agreeing on things, and that’s what needs to happen here.
Some people say the low take-up in Hong Kong is because there aren’t enough ETFs listed here, but I don’t agree. If we look at the range of ETFs available in Hong Kong it has increased, slightly below 200 at the moment.
Investors have choices. However, what we’ve seen is that the first ones for external markets that were brought to market were regional ones, so you can buy virtually any country in the region on the Hong Kong stock market. The ones that were not were the ones that are the most useful ones.
Hong Kong and the UK are tied together, we’ve got a common history, but I checked recently and there’s eventually one ETF offering the FTSE 100. It’s less than £5 million. The problem for retail clients is not any more the fact that the products are not available.
Funds Global: The US and Europe have seen an increase in interest in alternative investment vehicles in recent years. Are you seeing this trend in Asia as well?
Yes. The large public funds, just like other funds in the world, are investing a proportion of their assets in alternative asset classes. It’s driven by their yield requirement, because they’ve not been able to get it with the risk profile they need from fixed income and other asset classes.
Coming from China, private equity firms are queueing up to come to Hong Kong. Over the world, you see subsidiaries opening, obtaining licences, setting up their offices in Australia and so on. It’s a confirmed trend. There are large amounts of capital to be invested, and firms are actively seeking global providers like Caceis to partner with in order to achieve their business development ambitions.
In Asia, institutional investors have access so they can make allocations to the alternatives asset class. But there remains a lack of available product for retail investors. There isn’t the same breadth and number of funds available for them to invest into alternative asset classes, so that’s a bit of a disservice in that sense. If that’s where the money wants to go and that’s the demand, we expect to see asset managers cater to this. And of course, there is still some residual lack of appetite, particularly among retail investor, for any asset class that could be seen as too exotic.
Some of the sovereign funds are setting up special purpose vehicles to do this sort of business, buying into real property, private equity and whatnot. The private sector is robust, which is why there are a lot of fund houses coming into Hong Kong and applying for a type 9 licence. They start off with private funds normally, long-short strategy and private equity. Last year, there was 15% growth in type 9 corporate licences in Hong Kong, and the year before it grew by 10%.
Funds Global: What do you predict will be the future of Ucits funds in Asia in an environment where many regional regulators favour supporting onshore asset management as the expense of offshore funds?
Ucits won’t die out. Yes, there’s a lot of focus on domestic funds, and asset managers who have come into this part of the world have the mindset to set up domestic funds – not only because of pressure from Taiwan but because local funds are more sellable in a number of markets. But Ucits is a strong brand, and I don’t see that going away.
Ucits will continue to be the product of choice for the region. Hong Kong, Singapore and Taiwan, the three big overseas markets, between them have nearly $350 billion of assets in Ucits products across Luxembourg and Dublin. It represents over 5% of the aggregate size of all Ucits assets. The interesting thing is that if you look across the region you’ve got Malaysia, Thailand and now the Philippines all taking Ucits products to use within feeder or fund of funds products for domestic funds, which enables the companies that offer them to bypass any local passporting schemes to get into the market.
Passporting obviously isn’t working so this is the best way to give access to global markets but retain control of the costs and finances as a local business. It also enables the local industry to develop and grow without encouraging the big international players to come and dominate.
One of the key factors for those of us who’ve been around the last 25 years in the funds industry has been the trust and credibility that Ucits have attained in this part of the world. That’s not going to go away any time soon. If asset managers start to set up a local product, they’re going to have to invest really heavily to get the branding out there for that trust to build up.
From a fund manager’s point of view, Ucits is one of the best tools, the most cost-efficient way to access 80 countries. This is more than just trust in the brand, it’s Ucits’ accessibility. You look at Ucits’ dominant position today in Hong Kong – more than 80% of assets in the retail market. Singapore is close to 90%. You cannot switch to something else overnight.
My prediction on Ucits is that it will be a smaller share of a larger pie. The problem with predictions, as we all know, is that they are particularly difficult when they are about the future.
Funds Global: How optimistic are you about the development of the funds industry in Asia in the next 12 months?
Despite what we’ve said about passporting, things are going to happen in the second half of the year, so that will be interesting. Whether or not it’ll be exciting, I don’t know. China will always be interesting, and not only for the funds industry but for people servicing the funds industry. Asia continues to grow, people continue to earn money – the demographics are supportive. The question is, what kind of products does the money find its way into? That is important.
Local governments are seeking to promote their domestic funds industry and it will be interesting to follow the developments surrounding this kind of initiative. China’s growth rate may be slowing but it remains one of the highest in the world. Renminbi depreciation actually helps, in a way, because it drives investors to seek investment opportunities outside of their currency zone. The main concern for the fund industry is the continued uncertainty. We hope there are no other major political upheavals, in the wake of events such as Brexit and Trump.
Technology is driving growth. If the players embrace innovation and look at better ways to distribute their products, better ways to improve efficiency and reduce operational risk through increased automation, better ways to handle data for their clients, then we believe the positive growth trend is going to continue.
Aldcroft: The industry has fantastic opportunities, but the opportunity set needs to be defined. Associating funds with the pensions industry has the most opportunity going forward because Asia is vastly under-pensioned and governments from north to south are working on the problem. The natural use of funds is for pensions.
There is a continued need for the industry and the government to work together to enhance investor education, to tell them that for pensions you can’t just rely on one pillar. We are talking about three pillars altogether to sustain you in retirement. On fund investment behaviour, we need to promote long-term investment and not hopping from one to another. There’s still a lot to be done, but Hong Kong has made some inroads.
Final word from me is a quote: ‘Pessimists are sad morons and optimists are happy morons.’ So let’s be happy.
©2017 funds global asia