Fund managers need to consider alternatives to mutual recognition as a way of gaining traction in China’s fast-developing funds market, says a consultant.
While asset managers pore over the details of Hong Kong-China mutual recognition, which launches tomorrow (July 1), it seems clear that many firms are waiting to see how the market evolves.
There are two divergent groups looking at their options for mutual recognition, according to Howhow Zhang, director of research at Shanghai-based consultancy Z-Ben Advisors.
“There are groups like JP Morgan, Invesco and Schroders. They have everything they need and they anticipate significant revenue within the first 12 months.”
The second group are the majority of smaller less well-resourced firms who will wait and observe what opportunities arise beyond the initial market opening.
Nonetheless, Z-Ben is predicting that the programme will see AUM of Rmb80 billion ($12.9 billion) flow to participants throughout 2015 and 2016. "Our most conservative estimates expect this number to approach Rmb1 trillion ($161 billion) by 2020," the firm said.
According to Z-Ben CEO Peter Alexander, “The vast majority of firms have made a decision to wait until the dust settles. Our argument to them is, what if the dust doesn’t settle for a long time?
“We are suggesting that what with fund recognition, the likely changes to be made by MSCI and whatever local regulators are doing with WFOE changes, it’s important to consider your positioning.”
The alternatives for asset managers interested in finding a niche are varied. The China Securities Regulatory Commission has proposed allowing foreign ownership of Chinese trust companies. The qualified domestic limited partnership (QDLP) programme for alternative investments is to be expanded to include traditional assets, and the People’s Bank of China has suggested a new qualified domestic institutional investor (QDII) scheme could be introduced, known as QDII 2.
The mostly widely-used vehicle, and one which groups such as BNP Paribas and Principal Global Investors have pursued, is the WFOE (wholly foreign-owned enterprise). A WFOE is a limited liability company that, unlike joint ventures in China, has the independence and freedom to run its own strategies and can convert renminbi profits to dollars for remittance to its parent company outside of China.
The first financial services WFOEs were set up 10 years ago up by UBS, Deutsche and other foreign institutions and were mostly used as a vehicle for managing real estate transactions on the mainland.
Alexander mentioned UBS and BNP Paribas as two firms which appeared to have an effective approach to China, both of whom have set up WFOEs. “UBS have been in the market from an early stage and were the first to set up a WFOE. BNP Paribas have been one of the most creative firms as well, setting up a WFOE last year and more importantly, getting RQFII quota in Hong Kong, Singapore and Paris. They were the first to show you can go across the globe and get as much as you want.”
In the context of fund recognition, Alexander said a WFOE allowed a firm to have a feeder fund available in China denominated in renminbi that is invested as part of the primary product domiciled elsewhere.
So if a firm had a Ucits product, in theory it could bypass the regulations and market it in China. Alexander says: “The people in the Grand Duchy [of Luxembourg] would love that to happen, but we have a rather different opinion.
“China is the fastest-growing funds market globally, and China wants to make Hong Kong into the Luxembourg of Asia. So the requirement to domicile funds in Hong Kong would only get stronger.
“We recommend that if firms want a piece of the China mutual fund pie, they should at least set up one or two funds in Hong Kong now. You don’t want to have to be scrambling to set these up when everyone else is doing it.
“The vast majority of others are starting to make their move. The Shanghai Financial Services Office is involved in a project to extend the QDLP programme beyond the alternatives space. So now we are seeing funds consider moving down the QDLP path. We are a little bit sceptical on that. QDLP is currently prohibited from marketing to mass retail, but it competes with mutual recognition in that you don’t have to worry about domiciling your funds locally."
Zhang says he expects QDLP to be expanded beyond the six pilot cities and may eventually be rolled out nationwide. But the restriction on mass retail marketing will not be lifted.
It’s not for everyone, he says: “For a Deutsche Bank, which has local infrastructure and a JV partner, it makes sense and will allow them to develop in the wealth management market."