Japanese investors are eager to use the Asia Region Fund Passport (ARFP) scheme to benefit from long-term investment opportunities in the region, such as ones linked to China’s Belt and Road Initiative, experts have told AsianInvestor.
In December 2017, Japan moved one step closer towards granting such access after the Financial Services Authority (FSA) issued domestic guidelines for asset managers to apply under the ARFP.
The ARFP scheme is expected to launch in the first half of 2018, although an exact date has yet to be announced. In essence it allows a compliant fund based in one of the participating countries—Australia, New Zealand, Thailand, Korea and Japan—to conduct cross border marketing to in the others.
In theory the funds passporting scheme could help create Ucits-like cross-border funds. That would expand the potential customer base for fund managers, while the increased competition will hopefully improve product quality and reduce fees for retail investors.
Japan’s commitment to the ARFP is a big milestone for the initiative due to the country’s large fund distribution business.
“They do bring a fair amount of market weight into the ARFP initiative,” Phillip Yeo, international head of product development and management at Japanese investment manager Nikko Asset Management, told AsianInvestor.
The total assets under management (AUM) in open-ended funds among the ARFP countries was $1.6 trillion as of January 25, according to data from investment researcher Morningstar. Japan accounts for 37% of that, or $613 billion—the highest among the participants.
The spread of a ARFP-registered funds could have profound implications on Asia’s fund industry.
Currently, different jurisdictions employ their own regulations and registration processes around domiciled funds. This requires fund managers to comply with regulatory requirements on a country by country basis, which is both costly and time consuming.
But funds that are ARFP-approved would be able to be sold across all participating economies, with investors receiving the same standards of fund management and protection as in their home market.
The ability for fund houses to access the combined AUM of the ARFP countries is a particular draw, experts said. And as the country with the largest fund industry, Japan is top of the list for funds based in other countries.
“Under the ARFP regime, countries will be able to cross borders and passport and sell directly in Japan and access the whole Japanese mutual fund market,” Nikko AM’s Yeo said. “That’s the attractiveness for the other countries to participate in the ARFP.”
Attracted to BRI
For Japanese investors, this offers an opportunity to more easily access funds representing often fast-growing companies with good corporate earnings. China’s Belt and Road Initiative (BRI) is particularly generating interest among Japanese investors, according to Nikko AM’s Yeo.
Announced in 2013, the BRI is China’s ambitious push to develop multiple land and sea economic corridors across Central and Southeast Asia, as well as the Middle East, Africa, and Europe.
As of September 2017, there were over 2000 BRI-related projects requiring about $1.3 trillion in spending, according to a report by Australian metals and mining conglomerate BHP. This includes drilling projects, marine ports, high-speed rail lines, utilities, and telecommunications infrastructure across 68 countries or regions.
Japanese investors are interested to buy growth in Asia, Yeo said, and the BRI is a particularly prominent investment theme.
“China’s trying to build connectivity into Europe, and they will need to build infrastructure. Asian companies could be suppliers of the infrastructure,” he added.
WisdomTree’s Koll agrees: “There’s huge demand from the Japanese pension and the Japanese insurance community [for BRI-related opportunities]”.
Currently, Japanese investors can access BRI by investing into Japan-domiciled funds, Yeo said, such as Nikko AM's New Silk Road Economies Equity Fund. When the ARFP eventually launches, investors in Japan will have more options to invest in BRI funds domiciled outside of Japan, he added.
More notably for Japanese investors, the passporting scheme is also expected to result in greater transparency and better governance of ARFP-approved funds. “Once you’re a member of the club, there’s no place to hide so everybody’s on their best behaviour,” he said. “For Japanese investors, that’s very important.”
For example, the FSA plans to implement new fiduciary rules later this year to improve transparency within the local fund industry, including clarity on commission rates and what the customer is paying for, as well as a requirement to disclose conflicts of interest with clients.
The interest of Japan’s investors in Asia means that much of the ARFP flow may be out of Japan, rather than in. “The deal flow is not exactly just one way, but for all intents and purposes, it’s long term Japanese investment committing to generally higher yielding assets in the rest of Asia,” Koll added.
But Japan’s market does hold some appeal to Asian investors too. Japanese real estate investment trusts (J-Reits) appeal to Asian investors seeking a decent stable return, Yeo said.
“At the start of last year, Japan Reits were delivering 2% yield dividend. Today, J-Reits’ [yield] is about 4%,” he explained.
The average dividend yield of J-Reits was 3.97% as of January 26, according to data provider Japan-Reit.
Regional investors are also interested in exposure to Japanese infrastructure developments. However the opportunities may be relatively scarce, Jesper Koll, Tokyo-based chief executive of US fund firm WisdomTree, told AsianInvestor.
“While interest is high, the actual deal flow is very low, which is natural given the fact that Japan is an advanced and very developed economy,” he explained. “In terms of real pure infrastructure plays, there are very few opportunities.”
While ARFP is aiming to launch in the coming months, there are stil obstacles to overcome.
One of the big challenges in getting the scheme up and running will be for all participants to agree on mutually recognised regulations, guidances, and codes, Han Ming Ho, Singapore-based partner at US law firm Sidley Austin, told AsianInvestor.
This includes agreements on tax equalization and tax neutrality from the investors’ viewpoint, different cross-border disclosure requirements, and gaps in operational infrastructure such as how to deal with capital controls across jurisdictions, Nikko AM's Yeo said.
“Trying to get these lawmakers to agree when the legal framework of marketing a fund is different in different jurisdictions can be a challenge,” he noted.
One example of this is the Asean Collective Investment Scheme (CIS), a passporting programme between Singapore, Malaysia, and Thailand. The scheme has its share of issues since its launch in 2014, an August 2017 report by UK bank Standard Chartered Bank said.
This includes currency restrictions that hamper the ability of investors to see their returns in their currency of choice, and excessive auditing regulations that require fund managers to file fund documentation in each CIS country. Just six mutual funds had been launched under the CIS scheme as of August last year, according to a October 2017 report by US bank BNY Mellon.
The ARFP announced a pilot programme on January 5 to test regulatory processes and taxation treatments, as well as identify any remaining barriers or areas of concern in the ARFP scheme. Fund operators and distributors, as well as legal and tax-related advisory service providers, are expected to take part when the programme launches in early 2018.