Evolving plans for cross-border funds distribution
Alternative Asian Funds Passport schemes are in the early stages of implementation. Their success is likely to depend on the country-level support in the region.
Official initiatives to create frameworks for distributing investment funds across international borders have been a major topic for Asia Pacific’s asset management industry during the past three years. Policy makers have mandated regulators to formulate ‘passport’ schemes that are consistent with broad objectives towards regional cooperation while also creating an environment for local fund managers to thrive.
These include the Mutual Recognition of Funds (MRF) between the Peoples’ Republic of China (PRC) and Hong Kong; the Association of South East Asian Nations Collective Investment Scheme (ASEAN CIS) connecting Singapore, Thailand, Malaysia; and the APEC Asian Regional Funds Passport (ARFP), whose signatories so far are:
- New Zealand
- South Korea
In addition, the Asia Fund Standardization Forum, led by Korea Securities Depository was set up in November 2015 to investigate the standardisation of posttrade processing of investment trust cross-border transactions.
Several factors prompted the introduction of these mutual recognition programmes. These include the growth of assets under management (AUM) in the region (local and foreign domiciled funds sold in the largest 10 domestic markets in the region have reached almost USD 5 trillion), moves towards closer economic integration among several Asia Pacific nations and the particular case of China’s policies of internationalising its currency and developing its financial markets.
Of course, the schemes are all at a promising stage of implementation, but recognition of their weaknesses as well as their positive potential has fuelled debate among professionals throughout the fund management industry about the best passport model for the region.
Divided views on merits of passport schemes
The opinions, criticisms and hopes of more than two dozen leading practitioners and regulators were shared at the Euroclear FundsPlace Asia roundtable in Hong Kong. Although different conclusions emerged about the relative merits of the schemes, especially the contrast between the MRF and ARFP, there was a clear consensus that the channels for cross-border fund distribution will open further – notwithstanding some skepticism about whether they would actually receive many flows.
The theoretical frameworks for the schemes might look impressive, but in practice the reality might be more muted. As Ivan Nicora, CEO Hong Kong Branch & Regional Head, Asia Pacific of Euroclear pointed out, although Europe’s adoption of the Undertakings for Collective Investments in Transferable Securities (UCITS) product has given a tremendous boost to the funds industry throughout the continent, distribution of domestic funds on the whole tends to be within rather than across national borders.
Yet, Nicora also recognises that there is strong momentum within many Asia Pacific countries to reduce the restrictions against foreign fund sales, and that organisations such as Euroclear have both the responsibility and incentive to provide them with the infrastructure for efficient order routing, settlement and custodial services.
Both the ASEAN CIS and the AFRP are motivated by a desire for closer economic integration: the former as part of the general lowering of trade barriers within the single market ASEAN Economic Community; the latter because of the desire for wider regional cooperation that could contribute to the development of financial markets and ease the path towards greater prosperity.
ASEAN CIS was launched in August 2014 with Singapore, Malaysia and Thailand as signatories. However, it has been slow to take off, with only 11 funds from Malaysia and Singapore and one Thai fund. The Philippines and Indonesia are welcome to join later, but have shown little sign of doing so.
Indeed, perhaps the future of ASEAN CIS lies in an eventual link up to ARFP. This would make sense, because ARFP has wider and more regional ambitions.
A long road to ARFP completion
ARFP is a major project of the Asia-Pacific Financial Forum (APFF) which is itself a policy initiative agreed by the finance ministries of 21 APEC countries. The APFF’s work covers all aspects of financial markets and treasury operations within the region, and its network embraces more than 150 organisations including government agencies, multilateral institutions, regulatory bodies and academic institutions.
In addition, leading international banks and consultancies contribute to the advancement of the ARFP by providing practical knowledge and expertise. So, a great deal of preparation and study has been expended on the scheme, while consultation and debate will continue for many years.
Neither the range and number of bodies involved in the process nor the expected lengthy time for implementation of ARFP is surprising. By trying to replicate the European UCITS scheme, the ARFP visionaries have aimed high.
However, there are several key challenges they have yet to address, as Steven Chan, Co-Chair of ARFP Task Force, APEC Asia Pacific Financial Forum concedes.
“These include tax treatments, distribution methods, data privacy/protection and cross-border data transfers, and standardisation of languages, notification processes and regulatory framework, just to name a few,” he told the roundtable.
Nevertheless, a Statement of Understanding was issued in September 2015 by Australia, New Zealand, Japan, the Philippines, South Korea and Thailand, and a final agreement is likely to be signed in 2016.
Singapore dropped out from the signatory list because the Monetary Authority of Singapore was concerned about the absence of a tax neutral statement – although a tax reference sub-group has been set up to address those concerns.
Critical mass is important, so the inclusion of Australia and Japan is especially important. The size and maturity of their markets should encourage cross-border fund distribution, giving fund managers greater access to larger pools of savings and investors more diversification options. In fact, Australia’s fund industry is already bigger than the country’s stock market capitalisation, which might be a significant reason why Australia is a keen promoter of ARFP.
Just as important are cost reductions due to economies of scale and competition, and also the employment opportunities created by a more developed regional fund management industry. APEC estimates that ARFP might save the industry USD 20 billion and add 170,000 jobs.
However, in order to achieve its objective of creating a multi-jurisdictional arrangement ARFP needs active participation from existing signatories and to enlarge its membership to create scale. Chan says ”A priority this year is to encourage Singapore to sign on to the ARFP, and reach out to Chinese Taipei, Hong Kong, China and Malaysia to join the passport scheme. India, Indonesia and Vietnam also have indigenous mutual fund industries that would be beneficial to include in the ARFP.”
That said, the future inclusion of the PRC and Hong Kong are less certain. They launched their bilateral MRF scheme in July 2015 (having announced it two years earlier) and, arguably, they have a separate agenda tied to the PRC’s policy of renminbi internationalisation, capital market liberalisation and financial services development.
Alternatively, the MRF model of providing Hong Kong and PRC investors with streamlined access to each other’s market could evolve into a ‘hub-and-spoke’ framework for Greater China and even for other Asia Pacific countries.
MRF’s positive intentions
The advantages of MRF for Hong Kong should include building asset management skills, acquiring more ‘added-value’ jobs, and leveraging its range of financial service providers for securities, foreign exchange and banking. Its fund managers also have the opportunity to gain access to a growing USD 1 trillion Mainland mutual fund market and offer alternatives to wealth management products sold by local banks that are worth around USD 3 trillion.
The benefits to the PRC could include providing domestic investors with more product choices, increasing competition within the fund management business and among distributors, improving investment management standards and the ability to sell more China-invested products outside the Mainland through various distribution channels.
The MRF scheme provides more or less identical structures and criteria for Hong Kong domiciled and PRC funds; they are pretty much mirror images of one another.
Briefly, Northbound funds must be established, managed and operated in accordance with Hong Kong laws, receive SFC authorisation and be a unit trust, ETF or other type of collective investment scheme that is domiciled and operating in Hong Kong. They must also appoint a Mainland representative, qualified by the China Securities Regulatory Commission (CSRC).
In addition, no more than 20% of their assets can be invested in Mainland China markets and not more than 50% of a fund’s AUM can be sold to investors in China. Their minimum size must be RMB 200 million or equivalent and they can only invest in vanilla equities, bonds or ETFs.
A Southbound fund needs to be registered as publically offered securities investment fund with the CSRC under the Securities Investment Fund Law of the PRC, and it must also gain Hong Kong Securities and Futures Commission (SFC) approval and appoint a Hong Kong representative who complies with Chapter 9 of the Code on Unit Trusts and Mutual Funds.
The same percentage distribution and allocation restrictions imposed on Northbound funds also apply to Southbound funds; both directions have been awarded generous initial quotas of RMB 300 billion (USD 46 billion).
Review of MRF’s restrictions
There are some suggestions among fund practitioners for fine-tuning the system as there are certain limitations that are unnecessary and could prevent the introduction of successful funds which would be a prerequisite for the MRF scheme to gather momentum.
But, a more important point is the requirement that investment management of approved funds cannot be delegated to third parties operating outside the Hong Kong or PRC domicile. The proscription is logical – the intention is to improve local investment management skills – but critics argue that it is an overwhelming disincentive for global fund managers to participate in the scheme.
Besides, there are many alternative routes for Chinese investors to deploy their cash internationally, and at least 30% of fund sales in Hong Kong are to Mainland China investors, who are pouring savings into global funds, according to the Hong Kong Investment Funds Association.
“Most Mainland cash isn’t interested in MRF; instead it flows straight into one of 1,200 authorised Hong Kong funds to get international exposure,” argued Stewart Aldcroft, Chairman of Cititrust Ltd at the Euroclear FundsPlace Asia roundtable.
Furthermore, Hong Kong, Singapore and Taiwan are major users of European UCITS, with between them more than 4,500 registrations for authorisation. Consultants PwC estimate that these three locations combined have in excess of USD 200 billion in AUM in UCITS, equating to about 4% of the world’s total Funds.
Nevertheless, so far more than 40 Southbound funds have submitted to SFC approval, and 32 funds from 17 Mainland managers have been approved for distribution in Hong Kong.
On the other hand, the process from authorisation to fund launch for Northbound fund managers within MRF can take several months, and rejection rates are high. For instance, of 17 Northbound funds submitted to the CSRC, only four have actually launched and it is estimated the majority of investor flows has gone to one of them: the JP Morgan Asia Total Return Bond Fund.
Renminbi internationalisation drives MRF exceptionalism
Esmond Lee, Executive Director (Financial Infrastructure) at the Hong Kong Monetary Authority (HKMA) is convinced that more funds operating in both directions within MRF will be approved and launched soon and managers and distributors need to be patient.
“The MRF must be seen in the context of Mainland China internationalising its currency. There will be a complete opening up of the current account, gradual opening of the capital account and more worldwide usage of RMB in commercial and financial transactions,” he told panelists and delegates at the Euroclear roundtable.
This narrative underpins the perspective of Jessie Lam, Executive Director, Head of European Business E Fund Management (HK) Co Ltd, the third largest asset manager in the PRC.
Timeframes are shortening between announcement and implementation of market opening schemes to and from the Mainland, as evidenced by Stock Connect. But, the funds industry needs to be patient. The Chinese authorities want stable markets and a steady currency, and it is essential to view their actions from their perspective.
“Chinese regulators throughout the managerial chain are quite rule-bound. Officials and administrators have limited power to innovate, nor are they willing to take chances. Instead, they tend to follow a one-to-one, case-by-case logic rather than act in multi-directions,” she told the roundtable.
On the other hand, “regulators seem to be more open to new ideas if they are likely to work and as long as they are not too aggressive. In addition, the mutual fund industry in the Mainland is young and quick to adopt new technologies.”
Examples of this regulatory flexibility and the energetic response of the Mainland’s promising funds industry include the online distribution methods of Baidu, Alibaba and Tencent which tap into the vast data bases built up from their core businesses.
In contrast, Hong Kong regulators have been reluctant to embrace the convenient, cheaper and faster tool of online distribution, perhaps wary of another Lehman-type mis-selling scandal.
However, it is important to recognise that the MRF scheme is only in its first phase: as the SFC has emphasised, it is a long-term programme and phases two and three will probably be introduced in the next three-to-five years. These might include use of UCITS Chapter 8 funds, which would allow investment into funds-of-funds, implying a degree of international management control and direction.
However, whether or not MRF will evolve into a hub-and-spoke passport model for the region is uncertain. The HKMA’s Lee argues that MRF can’t be replicated elsewhere because of the unique cultural, linguistic, political and economic ties between Hong Kong and Mainland China.
Perhaps the most important reason why it won’t is that it is not intended to be. Instead, Hong Kong is the centre and conduit for two-way capital and investment flows specifically for Mainland China as it opens up its markets and internationalises its currency.
Ideally, all 17 Asia Pacific countries would participate in a common passport programme similar to the European UCITS scheme, but that’s unrealistic. Instead, for the time being at least, MRF, ARFP and ASEAN CIS will likely coexist as part of individual nations’ broader political and economic objectives.