Spring 2013

DISTRIBUTION: Hong Kong in transition

Hong KongThe proposed mutual recognition of funds between Hong Kong and China could transform the island from a primarily fund distribution to a fund manufacturing centre. Muriel Oatham explores the opportunities. Proposals to allow mutual recognition of funds between Hong Kong and China were announced in late January by Hong Kong’s Securities and Futures Commission (SFC). While the exact details of the proposals and timescales remain to be seen, it is expected that funds domiciled and authorised in Hong Kong will become the first non-mainland China-domiciled funds to gain access to mainland Chinese investors. This would be the first stage of opening up the mainland Chinese domestic investment market to non-mainland Chinese funds. Angelyn Lim, a partner at law firm Dechert, says this could be transformational for the local fund industry in Hong Kong. “This could kick-start Hong Kong’s transition from a primarily fund distribution centre to a fund manufacturing centre. Hong Kong could become a fund manufacturing hub in Asia.” Marie-Anne Kong, a partner and asset management leader at PwC in Hong Kong, says increasing capital flows between Hong Kong and China, and eventually globally, will contribute significantly to the growth of the asset management industry in Hong Kong. “This will create Hong Kong as the gateway to opening China further. It is already the preferred offshore renmimbi centre and with the new RQFII [renminbi qualified foreign institutional investor] programme, we have seen good inflows already.” Lilian Wong, head of fund services, Asia Pacific at HSBC Securities Services, says while the details of the proposals are still unknown, she is cautiously optimistic. “The expectation is that funds in Hong Kong will be recognised in China and available for distribution there.” But she points out that the two markets are different: both in terms of maturity and their approach to regulation. While fund managers in Hong Kong are excited, she says there are a number of practical issues that need to be resolved, which will take time. “For example, the renminbi is still not fully convertible. Investors in Hong Kong can buy renminbi and transfer them into China, but investors in China cannot easily convert renminbi into Hong Kong or American dollars.” But the potential of domestic investment market in China is significant. Kong says $6.5 trillion are currently held in bank deposits. And there are still limitations on what Chinese domestic investors can invest in. Wong adds that Hong Kong funds will be attractive to Chinese investors, who can only access a small range of local mutual funds. She says the proposals that have been outlined give Hong Kong fund managers significant expectation that they will be able to sell into the mainland China market. Lim says the announcement has acted as a catalyst for further legislative and regulatory change aimed at opening up the island’s fund market. This was evident in February’s budget speech, in which the financial secretary announced further proposals that were welcomed by the fund industry. These included proposed changes to Hong Kong’s tax law to allow certain funds to claim exemptions. But, significantly, it set out the potential introduction of legislation to allow for the establishment of open-ended investment companies there. “Hong Kong does not have a mutual funds law. This is something the fund industry has been pushing for several years,” says Lim. The combined impact of these changes could radically change the overall composition of the Hong Kong retail fund market. More than 70% of retail funds are Ucits funds, domiciled predominantly in Ireland or Luxembourg. Only some 300 of the 2,000 authorised funds in Hong Kong are locally domiciled. While the criteria by which funds will qualify for mutual recognition have yet to be determined, Kong says she expects one of them to be fund domicile. She says this will exacerbate the trend for locally domiciled funds. These have grown over the past few years: first, through the success of the RQFII programme, and then further as asset managers have found it increasingly difficult to establish Ucits funds. “The Ucits fund authorisation process by Asian regulators is not as straightforward as it used to be,” she says, adding that the increased investment complexity that Ucits allow may not necessarily correspond to local requirements. Kong says that to get relevant products to the market quickly, asset managers began to launch locally domiciled products. OUT OF FAVOUR
In addition, she says the financial transaction tax means that some Ucits funds may not be viable products to sell in Asia, as they will be too expensive. “Fund managers need to have alternative products if they are no longer able to sell Ucits globally. And some, such as BlackRock, have publicly stated that they are looking to launch more locally domiciled funds.” Lim agrees that Ucits are beginning to fall out of favour with fund issuers because of the need to deal with multiple regulations and regulators. She says there have been few real alternatives. “But with the advent of more local Asia-domiciled investment funds which are able to be passported within Southeast Asia and the wider Asia Pacific region, this could change.”
But Wong disagrees, and says Ucits funds are still very much in favour. She says the products are well established, well regarded and understood by investors, and it would take some time for them to be threatened by the new proposals. But she does expect the number of Hong Kong-domiciled funds to grow as managers set up new funds to take advantage of the potential opportunity to enter China. Wong says a couple of fund managers have already started the process of setting up Hong Kong domiciled funds in anticipation of the Hong Kong China fund recognition. Kong agrees. While a number of international fund managers already have a presence in Hong Kong, she says there has been increased interest from large US fund managers recently which, so far, have focused more on the American domestic market. “For example, Vanguard had no presence in Hong Kong until two years ago.” MONITORING
Lim says the entry of Hong Kong funds into the mainland China domestic fund market will be monitored with anticipation by fund issuers globally. She says there has been a movement of personnel and resources eastwards to Hong Kong, which began after the global financial crisis of 2008, will continue and possibly even increase. She also anticipates new entrants from across the globe. “The attraction of potentially being able to tap into even a portion of the vast mainland Chinese domestic fund sector should certainly focus the thoughts of many offshore asset managers and fund issuers who do not already have a presence in Hong Kong or Asia.” Wong agrees that the market could see a number of new entrants. “Access to the Chinese investment market is limited. We would expect the proposals [for mutual fund recognition and open-ended investment companies] to drive increased competition in Hong Kong.” Wong spent the past two years building up HSBC’s asset servicing business there. While she says she is strongly supportive of the new proposals, she does not underestimate the challenge of implementation. “It is the right direction. But based on past experience, things do not always move as fast, or happen in quite the way you want them to.” But she is optimistic about the prospects for HSBC, which is increasing its presence in China. And she is anticipating new business opportunities as new entrants look to establish local funds. While the expansion of Hong Kong’s fund manufacturing capacity and the opening up of the mainland Chinese investment market are eagerly anticipated by the investment industry, there is potential for further expansion across Asia. Could these changes lead the way for the development of an Asia Pacific funds passport? “The Asia Pacific fund passport is the ultimate aspiration: an equivalent to Ucits. But in practice, there are a lot of milestones before we can get there,” says Kong. Wong says an Asia Pacific fund passport would be welcome. But she adds that practically it will be difficult. “Asia is a highly diverse region. The financial markets are at widely different stages of maturity, and individual tax and legal systems are very different.” Lim agrees there is significant work required before an Asia Pacific fund passport could be established. RIGHT DIRECTION
But she says there are encouraging signs that at least some Asia Pacific countries, such as the members of the Association of Southeast Asian Nations, which are heading in the right direction. Kong says the way to establish the passport is through starting bi-lateral agreements. “Hong Kong and China can be the first, and is critical. We need to ensure that is successful, and then can bring in more markets over time. Taiwan could be the next country to be included.” Lim agrees. She says given the wide differences between local funds industries across Asia, she would expect to see a number of smaller passporting or mutual fund recognition agreements between countries, which would be easier to achieve than a single Asia Pacific passport. ©2013 funds global asia

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