The Mutual Recognition of Funds scheme between Hong Kong and China has had a slow start. Our panel discussed how it might evolve. Chaired by George Mitton in Hong Kong.
Stewart Aldcroft (managing director and senior advisor, Citi Markets and Securities Services, and chairman, Cititrust)
Tino Moorrees (chief executive and head of Asia sales, BNP Paribas Investment Partners, Hong Kong)
Stanley Poon (head of sales and relationship management, Asia, Middle East and Africa, investment funds services, Clearstream)
Richard Tang (chief executive, ICBC Credit Suisse)
Keith Yuen (managing director, Principal Asset Management Asia)
Funds Global: What do the volumes so far seen in the Mutual Recognition of Funds (MRF) scheme indicate?
Keith Yuen, Principal Asset Management: At the end of March, net inflows for southbound funds, going from China to Hong Kong, were about 45 million renminbi, while funds going from Hong Kong to China had net inflows of about 16 times that – about 720 million renminbi. So there’s a big difference.
The disparity is because Hong Kong is a small, mature and competitive market, while in China, because of the volatility of the A-share market and the renminbi depreciation last year, investors are looking for diversification, and these northbound funds provide a means for them to diversify. But remember that China is a huge market. These inflows are just a drop in the bucket in absolute terms.
One reason flows have not been larger is the homogeneity of the northbound funds, because of the restriction requiring the fund manager to be in Hong Kong. That pretty much restricts the funds to investing in Hong Kong, Chinese or Asian securities. None of the global managers have US equity managers in Hong Kong, for example, so they can’t get a US equity fund approved for northbound sale under the current regime.
Stewart Aldcroft, Cititrust: The volumes as at the end of March are pathetic. They are nowhere near what you should expect. The commentary we’ve heard, particularly by the SFC [the Securities and Futures Commission], is that it’s a long-term scheme, and there’s no great interest about what happens in the short term. But this is contradictory to the expectations of the fund companies that thought, ‘Wow, this is a great opportunity, we want to see billions and billions coming in.’
The total figure is just over $100 million aggregate between the two directions, which is nothing. Some companies are taking on that amount of money a day in this part of the world. And then for the northbound funds, it is understood that about 90% has gone to just one fund, the JP Morgan Asian Total Return Bond Fund.
Another Hong Kong fund, the first fund actually out on the street, was the Zeal Voyage China Fund. They got into the Alibaba online distribution platform, which was a great opportunity for them, and they took on thousands of new investors – many with just ten renminbi each. Which was not great.
The important issue is that, in the north, the choice of funds is China, China or China. You can either have it in bonds or in equities. What mutual recognition is beginning to do is to offer more choice. Although initially it will be predominantly Asian-focused, in time, as companies get better set up and create newer products, I suspect the multi-asset type of funds will start to become attractive. Multi-asset, because that’s capable of being managed out of Hong Kong, using information from around the world, and is a popular investment theme for retail investors.
Richard Tang, ICBC Credit Suisse: About two years ago when we talked about mutual fund recognition with CSRC [the China Securities Regulatory Commission], I was not a fan, especially for the southbound direction. As one of the top three mutual fund companies, I have to delegate some of my resources to it but, to be honest, if you look at the market we’re targeting, the Hong Kong retail market, the size isn’t there.
But, for the northbound route, I am more optimistic because I believe in three trends. First, the internationalisation of the renminbi. Second, the under-allocation by foreign institutional investors to Chinese assets. And third, the accumulated wealth of Chinese investors, who need diversification.
The need for diversification creates the opportunity for the long term, international fund managers with good branding. That’s why the number for the northbound route will grow faster than the southbound in the foreseeable future.
Stanley Poon, Clearstream: The launch of the MRF scheme was a notable step towards the opening of the Chinese market and towards a further internationalisation of the renminbi, which will benefit both the Chinese and international markets in the long term. The initial flows have been slow but given the scheme is the first of its kind, this was expected from the regulator’s timeline in preparing the market and approving funds for cross border distribution.
A recent study conducted by my colleague Tilman Fechter confirmed this. By interviewing 21 senior decision makers from leading international asset managers, he found that all survey participants rated China as an important or the most important market, and his evaluation suggests that MRF will be used by many international asset managers. The research also indicated that MRF will probably be more of a longer term success story rather than a quick win. Some of the reasons for this are the time needed by domestic investors to gain familiarity and comfort with the new products, competition from local players and restrictions of the investment profile in the MRF programme.
The regulators have currently approved 32 southbound funds compared to six northbound funds. Even if it might take a few years for MRF to come to full fruition, international players are advised to start or continue their strategic positioning and devise concrete market entry strategies, as it is not so much a question of “if” there will be a stronger demand for such products in China, but more of “when”.
Tino Moorrees, BNP Paribas Investment Partners: For the northbound funds, although it is disappointing to see how much has been raised so far, if you look at the numbers in March compared to January, it has increased thirteen-fold. So there’s clearly a significant rise in cash in the northbound route. Also, we’re only talking about six months so far. The awareness of the distribution channels in China is not there yet. A recently conducted study showed that if you go to a distributor of the northbound products in China, nobody even knows about it.
Given that there are only six northbound funds, and unawareness at the distributor level, I think the numbers are not too bad. Regarding the inequality between southbound and northbound flows in volumes, how long is that going to be sustainable? Will Chinese asset managers, at some point, raise the question of ‘what’s in it for us’?
Funds Global: Are the mainland wealth management distribution networks interested in MRF?
Aldcroft: Not a lot, no. From talking directly to a number of mainland distribution networks, it seems that they have set up offices in Hong Kong to service the needs of their predominantly high-net-worth customers, who either have money in Hong Kong already, or have plans to have money in Hong Kong – we don’t ask how, but we know the routes.
The wealth managers don’t have to worry about there being only four or six funds approved for northbound sale. They are more worried about the nearly 2,000 funds that are already authorised here in Hong Kong. Plus, if the customers are sufficiently high-net-worth, they can invest in anything anywhere in the world, because they would be regarded as a professional investor.
These people represent more than 30% of all fund sales in Hong Kong, as shown by Hong Kong Investment Funds Association statistics. For them, MRF means nothing. It’s pointless. These same firms are really more interested in talking to fund managers here in Hong Kong, and then taking those fund managers around their branches in China, talking to frontline sales staff and doing presentations, sometimes to the customer. So long as there are no actual fund sales done at that circumstance, that’s fine.
That’s what the mainland firms are doing. There are a number of insurance companies, IFAs [independent financial advisers] and others here in Hong Kong, who are not mainland, who are doing more or less the same.
Funds Global: How do you expect the MRF scheme to evolve in future?
Aldcroft: Clearly we have to assume this is going to go in phases. It’s only when CSRC is comfortable with what’s happening that they will release a little bit more. Everything is in the control of the Chinese government and the CSRC, and all we in Hong Kong and all the SFC can do is to react once there’s a little bit of leeway given.
Exchange-traded funds (ETFs) will be in the scheme probably very shortly, because they are not going to be part of Stock Connect. Although ETFs are traded on the stock exchange, ETFs are authorised as if they were funds first, so that would make them natural for MRF. There’s an expectation that the next development under MRF will be the inclusion of ETFs. That’s what the stock exchange is pushing for.
What are the other developments? Well, you could include Chapter 8 funds, for example [a fund category defined by the SFC]. A Chapter 8 fund could be a feeder or a fund-of-funds product, so long as the end fund has been authorised in Hong Kong. It would allow a fund that is probably getting its investment management carried out in Europe or North America or Japan to form a part of MRF.
Chapter 8 also includes specialist schemes, hedge funds and the like. I’m not talking about those, just the feeder variety, and funds of funds.
As for extending MRF into Europe, there’s almost no chance of that. We’ve had Alfi [the Association of the Luxembourg Fund Industry] coming here and talking about how they are in discussions with China about having mutual recognition for Luxembourg funds. Well, the word mutual doesn’t exist in Luxembourg’s dictionary. Mutual means both ways. Luxembourg has spent most of the last five years building a fortress to prevent foreign funds coming into Europe. This isn’t going to work.
The interesting speculation is that if Brexit occurs, and the UK comes out of Europe, could the UK then immediately have mutual recognition with China? There’s a lot of discussion between London and China on this and a London-Shanghai Stock Connect as well.
But how long will it take? It could be another year before we see any further development such as ETFs, and maybe another two or three years before we get to the next phase after that.
Funds Global: How do you see order processing in the MRF scheme evolving?
Poon: All the flows going in and out of China are still very ad hoc. Either a sub-TA [transfer agent] sends it to China using their own methods, or they utilise the CMU [Central Moneymarkets Unit] platform, or they’re sending it directly to China. Everything is quite manual between Hong Kong and China. We are also trying to streamline the flows but it will take time to completely automate the full trade cycle.
Currently, the account opening documents to gain access to Chinese funds are all in Chinese. These need to be translated, and somebody needs to understand it on both sides of the fence. This will take time to evolve and for the industry to adapt.
As stated earlier, the unanimous conclusion of our last year’s survey with fund managers around Hong Kong was that MRF will go through a phased development. Most survey participants agreed that in the first phase, they’re not going to make money out of it. It’s an evolution to something which may look totally different in two or three years’ time.
Morrees: I was hoping for Ucits to be recognised in MRF, but Stewart made a good point. A mutual scheme must be implemented in two ways. There are Ucits funds which are registered in Hong Kong, and maybe they would be the first step.
The problems are similar in a lot of the Asian fund passporting schemes. It’s often to the benefit of the happy few. It’s not for nothing that several countries are hesitant to join certain schemes. There’s little to win for them.
Funds Global: Will MRF and the other access schemes evolve to the extent that access to China is fully open?
Tang: The thing you need to understand about Chinese culture is that, although they will give you flexibility to satisfy the market needs, there will always be a limit. There is no absolute freedom, only relative freedom.
Every mechanism, every quota, allows the authorities to control the channel, so they can limit the damage from outside. It’s like the ocean. If it’s peaceful in the ocean, you are welcome to come. If anything is dangerous, I have the mechanism to protect the inland. That’s the mentality.
These kinds of quotas will be there for a while. They won’t disappear for the foreseeable future.
Aldcroft: Quota is an important issue. The SFC were more than a little enthusiastic about the fact that the size of the quota that was given for MRF in both directions was much bigger than any of the other schemes in China such as Stock Connect, QDII [qualified domestic institutional investor], etc. And yes, superficially that sounded really good. Until you worked out that, at $46 billion each way, it represented about twice the size of the aggregate assets under management of all eligible (for MRF) Hong Kong-domiciled and authorised funds. So clearly there was no prospect of Hong Kong authorised funds hitting that quota, given the 50% restriction on the value of mainland-owned assets per fund.
But the second aspect of the quota, which people really didn’t focus on, is that in MRF, the money never leaves China. The transactions always go through ChinaClear [the China Securities Depository and Clearing Corporation], which ultimately holds the assets. As an investor, you haven’t got your money out of China, only the “investment value”. So, to me, the quota is irrelevant, and should not be seen as a limiting factor for MRF.
Funds Global: What must international asset managers consider when building a business in mainland China?
Aldcroft: You can’t go straight to China, set up and do business. A few have tried and not done at all well. And that’s what Hong Kong is here for. It’s been here for more than 100 years. It is the world’s expert at doing business in China.
If there’s a mistake to be made, Hong Kong has made it in the past, and will know how to get past that. And it’s so easy to make many mistakes in China, because it’s very opaque in some respects. So my advice is, come to Hong Kong, set up in business, build up a bit of experience, hire a few people, then start to think about going to China.
If you’re going to do it with the funds business, at the retail funds level, you clearly do have to set up Hong Kong-domiciled funds. And then only 12 months after they’ve been up and running, and raised sufficient money, can you then think about taking them into China. If you are thinking about starting today, it would be at least two years before you can start raising any money, because it will take you the best part of six months to get your first fund into the SFC after getting a licence, and then once you’ve set up, 12 months to run, then another six months to get your fund approved to go in to China. That means the second half of 2018, from today.
Moorrees: You have to have stamina. You need to be willing to invest. Regulation changes so often that you need optionality. We established a WFOE [wholly foreign-owned enterprise] in China at the end of 2014. We have our joint venture with Haitong Securities for more than a decade. We are doing several other things as well. It’s basically about getting oneself ready in order to seize the right opportunity when it arises. As the window of opportunities usually is time-bounded, you simply have to be prepared on several fronts to hit the bullseye.
Yuen: We’ve been a joint venture partner with China Commercial Bank (CCB) for over ten years now. They have some 14,000 branches, so the distribution network is important, as people in China buy funds largely through banks. Our northbound funds are not approved yet, so how well they sell is still an unknown.
We have been the investment adviser for all of the QDII mutual funds from our joint venture in China. However, QDII got a bad start and some retail investors got burned. It will take some time to rectify that. I hope MRF can give people a fresh start to look at foreign funds.
Poon: As a Luxembourg-based organisation, we have a strong connection to the Ucits brand. Why was Ucits so successful? We think it’s about the trust. People could have four or five different products on the shelf, why do they choose a Ucits product? It’s the brand. They want to put their money in that product and get a return out from it. It’s about having the confidence that this product will make money for them. So the same would apply if you are an international fund manager wanting to establish in China. You need the trust and brand to compete at least on equal footing with the local players who have been established for some time.
Funds Global: How long will it take before a Chinese asset manager becomes one of the top global asset managers?
Tang: One of my colleagues is very positive. He mentioned about five years, but I think it would take one to two decades. It really depends on two points. One is the internationalisation of the renminbi – how many people want to hold renminbi-denominated Chinese assets. Second is, how bad a job the US and Europe does, and how much investors want to allocate away from those markets. This shift will not be determined only by the Chinese asset manager, it depends on many other factors.
You see, US financial institutions can be global because the dollar became the global currency. The same thing could happen to Chinese financial institutions. But they are still young to the game and it depends on how much money will be transferred from non-renminbi assets to renminbi assets outside of China.
Poon: I would see this sooner rather than later, especially with industry consolidation and acquisitions. Richard would probably have a better feel. Would you see a Chinese asset manager acquiring a big foreign name in order to be number one in the world?
Tang: ICBC Group have asked me the question several times. They have a department called the Strategic Investment Department that looked into the opportunity five or six years ago after the financial crisis. I gave them several suggestions. First, you always have to have your niche market. When you are a Chinese asset manager, you have to remember your competitive advantage.
If you introduce yourself as ICBC and ask for European equity investment or US equity investment, investors won’t buy it. But if you claim you are a Chinese expert, you can naturally become one of the biggest asset managers by helping people manage their total Chinese solution, from cash to fixed income to equity.
The problem when you acquire is the cultural integration. When you buy an asset management company, can you retain the clients? Can you make it become better, based on the difference of culture, based on the different mentality? I don’t know.
People in China are considering acquisitions, but I’m not sure the Oriental culture can adapt to the financial institutions located in Paris or London. These kind of guys can sell their stake to you for a very handsome price and then walk away. They can retire, and what have you got? Especially for private banking asset managers. I’m very cautious when I give suggestions to my top management in Beijing.
Funds Global: Do the Chinese asset managers need to acquire abroad in order to grow?
Aldcroft: If you look at the history of the largest global fund management companies, with the exception of Vanguard they’ve all acquired to grow. They’ve all spent serious amounts of money to buy others, they’ve incurred debt, and paid it back as asset growth has occurred. Vanguard haven’t done that, except that they’ve bought business by being the lowest fee on the street.
How do you get to be one of the top managers, particularly if you’ve got a trillion dollars under management, let us say? Well, it’s not going to be that difficult, if you focus only on the China market, to get to a trillion dollars in the next five to ten years, because there is about $5 trillion of money floating around looking for a home in some way or another within China.
The question Chinese fund managers need to think about, in their domestic market, is whether or not they start to offer more non-Chinese products. If the government is willing to allow more development and SAFE [the State Administration of Foreign Exchange] allows more money to go out, then ICBC, for example, could set up a US growth fund, or a European income fund. Their chances of succeeding to sell products to customers in China is far greater than even the biggest foreign fund managers would have in China.
They have the branding. They have thousands of branches and maybe more than 100,000 potential “front-liners” able to sell products to customers. They have every opportunity to sell all the products that every possible client would like to have. But they haven’t got these products in China at the moment. And of course that’s what mutual recognition, to some extent, is aiming to do. It aims to provide alternative products to the China-only diet that currently exists.
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