Global custodians and other international players are being inundated with enquiries from clients that see the mutual fund recognition scheme between Hong Kong and China as the next big opportunity. Nicholas Pratt explores at the issues that still remain unresolved.

International infrastructure providers are mainly concerned about the wider context of the mutual fund recognition scheme between Hong Kong and China, and the profound implications it could have, as opposed to operational issues.

This is largely because many details are still unclear, even though Hong Kong and China have reached the final stage of talks in preparing the mutual fund recognition scheme.

Alexa Lam, deputy chief executive officer and executive director of investment products, international and China, at the Securities and Futures Commission, says the project is now going through the final administrative procedures.

Lam is the driving force behind the agreement and was recently re-appointed for another one-year term, and says there are no further details to be announced.

MAJOR OPPORTUNITY
Meanwhile, global custodians and other international players are being inundated with enquiries from clients that see the scheme as the next major opportunity. Though there are operational and administrative issues still outstanding.

Will funds under the scheme be registered as omnibus accounts, as is the case in Hong Kong, or will they be registered according to each individual investor, as is the case in China?

Should it be the latter, the processing implications will be huge, especially for any transfer agents operating in the region.

Also, will processing systems have to be changed to process Chinese language funds rather than English language funds?

Will cash clearing be allowed? Will sub-advisors be allowed? And will it be possible to process any of these funds in offshore locations, such as in the Philippines or in Malaysia?

Or will the regulators insist that this work will be done in either Hong Kong or China, neither of which are especially cost-effective places to process funds?

“The idea of doing everything in Hong Kong as a result of [mutual fund recognition] would not be economically viable and fund expenses would be relatively high,” says Dean Chisholm, regional head of operations, Asia Pacific, Invesco.

There are also concerns that the regulator in China is looking closely at the administrative implications of the scheme, but that the engagement with market participants is limited to those that the regulator views as neutral.

For example, among those are distributors or infrastructure co-operatives, like Swift.

Chisholm says the experienced operations heads in Hong Kong’s asset management sector are not surprised by the slow pace of development.

“China has never traditionally been quick to introduce changes to the market.”

And even on the revenue side of Hong Kong asset managers, there is a realisation that the scheme will be a long, hard slog.

While this may theoretically be helpful in terms of easing concerns about a hastily established framework that neglects the operational implications, it could lead to a loss of a momentum that means the scheme turns into a non-event, says Chisholm.

Or else, operations teams could still be left rushing to make the operational changes needed, especially when one considers how the scheme will work alongside existing schemes.

“At the moment we are stuck between the two and it is hard to see how it will turn out,” he adds.

When the mutual fund recognition scheme was first proposed in January last year, the news was greeted by the international asset management community with optimism.

Their optimism was based on the presumption that the scheme will open the way for international managers to access the tens of trillions of renminbi of household savings in China.

CAUTION
Despite general optimism, there is some caution regarding the operational issues the scheme will create and the length of time it will take to resolve them all.

This is a concern that is exacerbated by the generally slow pace of legislative developments in China and the lack of transparency associated with the process.

Shanghai-based consultancy Z-Ben Advisors initially suggested that the scheme would be up and running early this year, albeit in pilot form initially.

Z-Ben estimates that China’s mutual funds industry could double in size by 2015 to 6 trillion renminbi ($971.6 billion), adding further to the attraction of the scheme.

Despite the various statements from ministers in Hong Kong, the reality is that there is still no confirmed agreement for the framework.

What the two main regulators involved – the Securities and Futures Commission in Hong Kong and the Chinese Securities Regulatory Commission in

China – may agree will still have to receive the approval of the state council in Beijing before it can be implemented.

“That has been the consistent line since December and no-one is giving any firm hints as to what is in there until there is state council approval,” says Chisholm.

The delay has raised concerns that the regulators are not quite in full agreement as to how the scheme will work, and are therefore not likely to send the proposal to the state council.

“Mutual recognition between Hong Kong and China is definitely a hot topic in the industry, as are the other co-operation initiatives in the region and the positioning of Luxembourg Ucits in that context,” says Tilman Fechter, executive director, head of sales and relationship management, investment funds services, Clearstream.

So far, it is known that this framework comprised six agreed guidelines: fund types; qualifications of the asset managers; application procedures; management of the funds; requirements for fund distribution; and an information disclosure and buyer protection mechanism.

The first funds to be approved for sale in Hong Kong and China are likely to be simple-structured, transparent products.

However, it is not yet agreed what the minimum size of the fund managers should be, nor the length of time they have to have been established, or the proportion of local investors in the fund products.

But how will the initiative progress in terms of take-up and adoption and how will it interact with other related initiatives that are all competing for investors’ money?

CHALLENGES
Many, if not all, of these questions will be answered much further down the line and once there is more clarity around the operational requirements for the mutual fund recognition.

Nevertheless, it means that these requirements and their implications in terms of systems development, or the challenges that will face asset managers selling into China, will all have to be considered in the wider context of these related initiatives.  

Fechter adds: “As a key market infrastructure already active in Asia since 1990, we are monitoring and analysing all the initiatives closely and are committed to bringing all funds to our investors in the same operational model as today whenever and wherever possible, shielding them from the complexities of the varying market models.”

He points out that Clearstream is already supporting international managers as well as Chinese banks investing into Hong Kong-domiciled funds today via its Vestima infrastructure and it aims to continue this support for funds within the mutual fund recognition scheme.

“We will ensure that all funds available to banks in China would also be available on our platform, regardless of whether these would initially be Hong Kong-domiciled or not, or with Ucits, to possibly follow at a later stage.”

Until there is more clarity, managers would be well advised to keep a close eye on the schedule of state council meetings.

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