Mutual fund recognition offers a new route into China â but as our panel explains, this route is untested and asset managers must feel their way with care. Chaired by Nick Fitzpatrick
and Alan Chalmers
in Hong Kong.
(head of sales and relationship management, investment fund services, Clearstream)Peng Fei
(chief executive and co-founder, Winsight Global Asset Management)Andrew Gordon
(managing director, Asia, RBC Investor & Treasury Services)Curtis Tai
(vice president, CSOP Asset Management)Eleanor Wan
(chief executive, BEA Union Investment Management)Fanny Wong
(head of custody, Bank of China, HK)
Funds Global: Does the recent volatility in the Chinese stock market have the potential to derail the mutual fund recognition scheme or is it irrelevant? How close is mutual fund recognition to launching?
Andrew Gordon, RBC Investor & Treasury Services:
We’re close and the industry is excited. Commentary from the regulators leads us to believe mutual recognition will be launched before the end of the calendar year. What that means is the first round of approvals will be made. Funds may not be sold before the end of the year, but we are close.
Curtis Tai, CSOP Asset Management:
From a rules and regulation standpoint, the volatility hasn’t derailed anything. From a demand standpoint, it has made the timing good. A lot of Hong Kong-based managers want to distribute their funds in the mainland market. In the past, these kinds of international funds have not been popular, especially since the QDII [qualified domestic institutional investor] scheme was opened at an inopportune time in 2007, followed by the financial crisis in 2008. But after the recent market volatility, we’re seeing a lot of demand for international assets from mainland investors. The mainland market has been isolated from the rest of the world, with high yields and great returns, for several years. Now we’re starting to see a diversification effect.
Fanny Wong, Bank of China (HK):
The fact that both SAFE (the State Administration of Foreign Exchange) and the central bank announced implementation guidelines in November shows they are committed to the scheme. The market rout, instead of derailing the whole thing, diverted the attention of the regulators to the marketplace, but now they’re trying to resume a normal path. In a way, the volatility has helped, by giving more time for the industry to conduct connectivity and back office testing.
Eleanor Wan, BEA Union Investment Management:
I wouldn’t use the word ‘derail’, but when you look into mutual fund recognition, it has two streams. One is the northbound, which is Hong Kong funds coming to China, then there is the southbound, which is the Chinese managers bringing their products down to the south. The market volatility has caused some resistance in the investment appetite for Chinese equities at the moment.
We all agree there is a lot of opportunity in China. In the long term, a lot of global investors are increasing allocations to Chinese assets. The challenge for the Chinese managers is that global investors like to look deep into the process, not just the numbers.
Tilman Fechter, Clearstream:
It’s close. The Hong Kong asset managers are ready, although not ready with all of the distribution agreements and all of the access into the market. But they are ready to go there. What I am questioning is if the other side is ready. Are the Chinese asset managers ready to sell in Hong Kong and elsewhere?
Peng Fei, Winsight Global Asset Management:
In terms of action, mutual fund recognition is close, but in terms of how significant it will be, it is still in question. The volatility impacts sentiment. When I did marketing in China, I felt investors there were scared of markets – scared of Asian markets at first, but now they are afraid to invest in overseas markets as well.
Funds Global: How important is it for international asset managers to have a partner in China, through a joint venture for instance, as they seek to distribute under the mutual fund recognition scheme? Can they succeed without one?
Finding a partner in China is important because it is such a big country and your partner is your guide. The joint venture needs to be built on trust and it needs to be about the mindset of growing the business together. The other thing is that new entrants are not always aware of the Chinese regulations.
We recently submitted our application in China. We worked with a local lawyer and when we received the comments back from the CSRC [the China Securities Regulatory Commission], we did not understand the content of the questions. Regulators in China ask high-level questions, which can be hard to answer. You need your local partner to help you.
The regulations have been constructed in such a way that a manager from Hong Kong doesn’t need to have an onshore presence in order to take advantage of mutual recognition of funds, but I agree that you need to have a partner to help you, whether that’s your own office or, more likely, the master agent. Joint ventures are not the only way of getting into China these days: there is the arrival of the WFOEs [wholly foreign-owned entities]. But, so far, the master agent route is the one global managers are taking to get into China for mutual recognition.
We hear that some of these joint-venture entities operate quite independently from the joint-venture partners. Some firms are used to being independent. It’s still a new process for them to work on mutual fund recognition and to learn as they go, because it means operating in a new environment. But, if there is trust, and an existing collaboration, it will shorten the preparation period, because at least you are comfortable that you have a partner to resort to. It will help you with a quick start but it does not necessarily mean a sure success.
I surveyed international asset managers and found that distribution or market access was rated the most important aspect, because funds are still a product which needs to be sold, not bought. But the managers also said this area was their weakest point. The good news is that the Chinese banks are going to sell the products. If you have access to the banks, you have a good chance of success.
If you are cut out from the big banks, you need to be innovative, perhaps by using online channels, if the regulatory environment allows. And if you don’t have an innovative channel, the best chance you have is with a joint venture and to put your funds in the same product range with your joint-venture partner.
If you have none of these three, the only chance you have is to align yourself with the global banks which sell your funds around the world. If you have a strategic partner like UBS, you could ask UBS to sell your funds in China.
I would add that the cost of doing business in China is quite high. I have been working on the whole process, and we haven’t yet got the physical business, but already we are spending significant sums on legal costs, translation costs and service providers. You have to work with a lot of service providers because the two systems are so different.
If you’re going into Europe, you can put together a project plan, you know exactly what you need to do and you can evaluate almost to the day how long each piece is going take. China is not like that.
No, you have to feel the stones to be able to cross the river.
Exactly. That is a Chinese phrase. This is the business strategy: to make your own bridge.
Funds Europe: How does mutual fund recognition fit in with the other regional fund passporting schemes in Asia such as the Association of Southeast Asian Nations (ASEAN) passport? Is there room for all or does one dominate?
This is the billion-dollar question because you are talking about a scenario five or ten years down the road. Nobody knows what will happen. But for a scheme to be successful, it has to meet certain needs. You have to harmonise the regulatory framework, the tax, the market practices, the pricing norms, the distribution models – a lot of things. Without a commitment, you won’t have any hope. But that would also be determined by how much each of the major stakeholders expects to gain.
There will be some winners and some losers, but to make it successful, you need the population to use the passport. At the moment, the ASEAN passport is too small. Some people will be successful, local players, but I have doubts overall because there are too many challenges. You saw it when Singapore pulled out – it was a significant signal of why it doesn’t work.
Ucits was successful because it enabled the industry and any participant in the industry to build scale. What we have now is fragmentation. We’ve got three different schemes that require managers to do things differently to qualify for the different schemes. The competition is one of resources. There are few managers who would set themselves up with a range of products especially for each scheme. It’s not that they never see the ASEAN passport succeeding, but the priority for pretty much everyone I talk to is Hong Kong/China mutual recognition of funds.
I agree that the ASEAN passport is too small right now. The macro-environment for those three markets is attractive over the long term but there hasn’t been much activity so far. Will Indonesia join? It would be transformative, but I don’t think they will, because there’s not enough upside for them and the complexity of the funds passport is formidable.
If the ASEAN passport can get away from all the technicals in terms of tax, in terms of structure, then it will be successful, it will be powerful. But it won’t be easy because tax is such a challenging area all across the world.
It’s not only tax. Asia is such a fragmented market. Distribution is one of the most difficult things to do because if you go to Taiwan, Korea or Japan, you find different cultures, different investment mentalities, different languages, different regulations.
The question then becomes, will Asia follow the Ucits European method or will it follow the North American method where basically everybody goes to the US and invests into the US through the SEC [Securities and Exchange Commission] regulations there? The success of mutual fund recognition may determine whether other countries are willing to unify or whether China will continue to do its own thing and everybody will just have to go into China.
I agree that we have to see whether there is demand. Why would an investor from Thailand invest into Singapore, or a Singaporean invest in a Thai fund, where they don’t know the country, they don’t know how the system works, and maybe they don’t know how they are taxed? The biggest thing they need is trust.
In February, I remember saying mutual fund recognition could become a role model to showcase how a bilateral linkage can be done, and that if you start small or bilateral, then there is the potential for it to be linked up with fund markets in other jurisdictions to make it multilateral.
We seem to find the other passporting schemes not promising at the moment, but at least for the Hong Kong fund industry, they are fortunate to have gone through the learning process for mutual fund recognition.
Funds Global: Most if not all of the Chinese asset managers with qualifying funds under the scheme already have a subsidiary in Hong Kong. Does this mean mainland domiciled managers are better placed to benefit from the scheme than Hong Kong-based funds?
Yes, but they probably will not benefit too much compared to the Hong Kong-based funds because of the lack of products. What they can offer are mainly RQFII [renminbi qualified foreign institutional investor] funds or China-orientated funds. For global funds, they have much less experience and skill and even if they have many representatives here in Hong Kong, they probably need to find some partner to offer these kinds of strategies.
Figures suggest there are some 40 funds coming southbound and 17 funds going northbound. So it seems like the mainland Chinese fund managers are getting more benefit than the Hong Kong managers. Of those 40 funds, we don’t know how many have subsidiaries in Hong Kong, but if you do have a subsidiary in Hong Kong, for those mainland Chinese managers, it wouldn’t be a difficult decision for them to come south because Hong Kong, after all, is an open market.
What is also critical is the fiduciary duty. When you are being appointed as a master agent for registration for a Chinese fund, we put ourselves in front of the regulator that we are representing a partner which is not stationed here. If we are going to get independent relationships, we need to be a bit cautious because we need to represent our brand in the market and, most importantly, it is in front of the regulator that we are representing them. So we need to do due diligence.
Mutual fund recognition will help with the issue of trust. Once everybody gets more familiar with the regulations on both sides then, globally, people and investors, pension funds, institutions and so on, will feel more comfortable investing in and out of China.
We are seeing more institutional investors globally looking for different strategies to invest into China, but one of the biggest questions you get is what strategy, and do they trust the numbers? And not only the numbers, but do they trust the asset manager?
One of the interesting things for me is the view that the Chinese asset managers are going to use Hong Kong as their offshore jurisdiction. The idea is that they will put funds into Hong Kong to then distribute them internationally. But this is going to be a challenge, because Hong Kong funds are not distributable outside. If they want to have an international base, they need to go to the established domiciles, Luxembourg, Ireland and so on. And how are they going to distribute? The Chinese asset managers may need to form partnerships with the big Western banks.
That’s long term, though. The important thing about mutual recognition is that it is ‘mutual’... It’s right and proper that Hong Kong can be comfortable with China and that China can be comfortable with Hong Kong. It will take a long time for the European Community to acknowledge that investor protection standards in China are equivalent to Europe, and without that mutual recognition and mutual respect I can’t see it happening. It’s a long-term project.
Funds Global: Will the trend for renminbi internationalisation help international firms gain investors from mainland China, or is this trend mainly going to benefit Chinese managers as they expand globally?
It is not one-sided. For renminbi internationalisation to be successful, all the stakeholders will have to play a part. Mutual fund recognition is one of the ways to engage international fund managers, because they are being encouraged to consider introducing a renminbi share class into their own product. If they agree to do just that, renminbi will be used for subscription and redemption purposes.
And if international fund houses decide to introduce a renminbi share class, they have to consider the hedging strategy, how to manage one more share class, what sort of tools to engage and whatnot. Gradually, it will beef up their understanding and expertise. It is a virtuous cycle.
Everybody will benefit. The renminbi is an important trading currency already but it’s still not opened up. There are so many opportunities. What is needed is for the Chinese managers to understand global practices, and then the foreigners can benefit from the big market. But I still believe China will remain a controlled economy. Business opportunities will be governed by the different government initiatives, and with a quota.
All of the various initiatives, QDII, RQFII, mutual recognition, are aligned to renminbi liberalisation or internationalisation. They go hand-in-hand. It’s clear the Chinese want to use it as a trading currency but also as a reserve currency. There will be winners on both sides.
Without the government promoting renminbi internationalisation, there is little chance for international firms to get investors from China. But by committing to internationalisation, the government have to accept global standards, they have to be available to be regulated globally and they have to do central reforms. That pushes the Chinese financial markets to open further. Maybe China may benefit first, but eventually both sides will benefit.
There is no doubt that China wants the renminbi to play a more important role in the international financial system and that covers almost every area of the financial services businesses. The asset management industry stands to benefit enormously.
Internationalisation is extremely important. China is still an emerging market and the renminbi is not a widely available currency. Currency hedging is still expensive. When we have huge inflows and outflows of RQFII products, sometimes the renminbi can be tight. Trade settlement has to take at least T+1 or T+2 before you can get out of a currency that you need. Renminbi internationalisation would help make the market more efficient. From an operational standpoint, the trend is beneficial for both foreign and onshore managers.
The second thing is innovation. You could do a lot of currency hedge products, or long-short and other types of strategies. Given its size and the interest in China, there are massive opportunities.
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