The law firm Deacons has just released a summary and commentary upon recent regulations enacted by the China Securities Regulatory Commission regarding opening the fund management industry to foreigners, and it suggests in general that considerable progress has been achieved in clearing away the ambiguity. Fund management is at the forefront of new sectors foreign firms can participate in now that China has joined the World Trade Organization, and foreign players have been eager to get a concrete idea of what they can and cannot do.
Nonetheless, while foreign fund managers can now get a better look at what they need to do, they will find the process difficult and expensive. One point certain to cause chagrin at head offices is the huge cash capital required to be a foreign investor in a joint venture fund management company (FMC): Rmb300 million ($37.5 million). Deacons compares this to the HK$1 million ($130,000) that Hong Kong's regulators require.
The firm adds that in the case of a foreigner acquiring a stake in an existing FMC, there may be room to negotiate non-cash contributions, because this falls under a different law. But foreign fund managers now giving domestic partners free expertise and help in launching open-ended mutual funds will be disappointed if they try to use that as a capital contribution. Deacons says: "It seems unlikely that the 'free' know-how and technology already supplied by foreign institutions under technology cooperation agreements entered into with PRC counterparts will be recognized as part of their capital contributions."
For smaller fund houses that cannot find the cash, Deacons says it may be possible to clinch CSRC's blessing by providing a parent company's letter of support. Deacons believes the high monetary threshold is simply China's way of ensuring applicants are firms of 'substance', and that a sign of visible support from larger parent companies may do the trick. But this remains a matter of interpretation.
There is also a provision likely to prevent a foreigner from acquiring a plurality of shares, or from appointing a majority of directors in a FMC. Only a domestic securities company or investment trust company (an 'Itic') can have the highest capital contribution ratio or appoint the most directors.
Importantly, this precludes a domestic fund manager setting up an asset management JV with a foreigner. According to market participants, foreign fund managers in cooperation agreements with Chinese fund managers had explored the idea of creating a new JV, but the CSRC is concerned that this will create conflicts of interest. "They would be competing for the same products, for the same clients," says one. "It would make life too difficult for CSRC."
But the matter of a foreigner owning a plurality of shares is likely to be clarified further. China has agreed to open FMC ownership to foreigners at an initial 33%, which will rise to 49% after three years. This means foreigners trying to form JVs with fund management companies, as opposed to securities companies, seem to lose the option of creating a new JV from scratch, and will have to buy a stake in the existing FMC. But market watchers point out that the existing shareholders of these lucrative FMCs may not wish to sell.
Deacons believes that for a foreign asset manager looking for the quickest entry, acquiring an interest in an existing FMC will be much faster than establishing a JV from scratch. That's mainly because the typical FMC has at least four owners, all of which must face CSRC's scrutiny; it's not a matter of being a foreign player.
In addition to the onerous capital requirements that foreigners will have to demonstrate, they must also run a gauntlet of other requirements before winning approval to enter a JV. Among these is that the company's home regulator must have a recognized relationship with various regulatory bodies in China, and CSRC has not yet issued a list of 'suitable jurisdictions', says Deacons.
Other requirements include audit information, fund performance data, details about any B-share investments, reports on affiliated companies with a presence in China, and a research report on the development of the investment funds market in China.
There is also the issue of what regulatory bodies will be involved in this approval process. Deacons believes, however, that while fund managers will have to register with the Ministry for Foreign Trade and Economic Cooperation (Moftec), CSRC is the sole approval authority. Deacons further believes that over time Moftec's role will diminish, and that regulatory turf wars won't infringe on allowing foreigners to invest in FMC joint ventures.
Last, Deacons stresses that these are all draft rules from the CSRC, which remains open to comments from the industry.