On October 8, Hong Kong’s Securities and Futures Commission (SFC) and the UK’s Financial Conduct Authority (FCA) signed a memorandum of understanding (MoU) for a mutual recognition of funds (MRF) scheme, allowing for the cross-border distribution of approved retail funds.
The MRF with the UK is the fourth such scheme between Hong Kong and another country after similar bilateral arrangements were agreed with China, Switzerland, and France. It is the UK's first cross-border fund distribution agreement in the wake of its decision to exit the European Union, when the country's financial firms could lose the right to sell products across the bloc.
Setting up MRFs and bilateral fund-passporting arrangements is part of the SFC’s initiative to broaden Hong Kong’s position as a global asset management centre, giving local fund managers access to international investors while also encouraging foreign exposure to Asian markets.
As of June 30 the SFC had approved 50 Chinese funds and the China Securities Regulatory Commission (CSRC) had approved 15 Hong Kong funds for the HK-Mainland China MRF. A total of four SFC-authorised funds have been approved by the Swiss Financial Market Supervisory Authority so far, according to the SFC's latest quarterly report.
For the FCA, the new MRF scheme opens up new distribution channels given UK-authorised schemes are set to lose their legal status as Undertakings for Collective Investment in Transferable Securities (Ucits) once the UK leaves the EU.
We asked a consultant, lawyer, asset servicer, and fund industry association executive what they see as the main challenges for fund distributors in order to gain traction with investors in both jurisdictions, and whether investors in Hong Kong will benefit.
The following extracts have been edited for brevity and clarity.
Sally Wong, chief executive (Hong Kong)
Hong Kong Investment Funds Association (HKIFA)
The signing of the HK-UK MRF is an important first step but whether the scheme takes off hinges on a number of factors.
One important aspect is distribution as the landscapes in both markets are very different. In Hong Kong it is very much bank-dominated (accounting for 80%), whereas in UK about 80% is via independent financial advisors. The UK has banned inducements whereas Hong Kong is primarily commission-based. These represent different dynamics that managers have to navigate.
Another aspect is product offering. Both markets have an array of products that span the full spectrum (In the UK there are over 8,000 funds, while HK has about 2,000 authorised funds). Thus the issue is to identify and fill in the product gap. For managers that are already offering a Ucits range, the key question is how to select UK-domiciled funds or Hong Kong-domiciled funds that can complement the existing range.
At the HKIFA we are in dialogue with our counterparts in the UK to see whether we can prepare some background materials to give our members some colour for the respective markets.
Outside of this MRF, other pending issues include: the further relaxation of restrictions on the Mainland China-HK MRF; leveraging the Greater Bay Area to launch an enhanced version of MRF; and continuing to establish more MRFs with other jurisdictions, not just in Europe, but in Asia too.
Elliot Shadforth, Asia-Pacific wealth and asset manager sector leader (Hong Kong)
The recently announced MRF is set to benefit both UK and Hong Kong investors, bringing more investment solutions to both markets. Overall, the MRF will appeal most to retail investors rather than institutional investors; being an Asia-Pacific asset-management hub, Hong Kong already receives allocations from institutional investors around the world.
As sizeable international UK fund managers already have Ucits products for distribution in Hong Kong, we can expect the majority of the UK funds sold through the MRF will be from smaller-sized UK fund managers. However, Hong Kong as a distribution channel is extremely concentrated in banks and shelf space is limited. Around 80% of retail funds are sold through banks and 70% of all sales are made by just three banks. UK fund managers who plan to utilise the MRF channel will need to have a comprehensive market strategy to establish their brand and distribution networks in Hong Kong.
In addition, distributors in Hong Kong are remunerated by high trailer fees. A separate class of shares with higher management fees (compared with the UK class of shares) may be necessary to cover the high distribution costs in Hong Kong. With the right products, the right market strategies and the right distributors, UK funds sold through the MRF might be able to gain some market share in Hong Kong.
While current UK-covered funds must be part of a Ucits scheme, authorised either by FCA or as an Open Ended Investment Company, the big question is whether UK-domiciled funds can still be recognised under the MRF post-Brexit when UK funds are no longer part of the Ucits regime.
David Li, chief executive for Hong Kong (Hong Kong)
The signing of this MoU for sure brings more choice to investors and more distribution facilities to the funds domiciled in these two jurisdictions.
Many of our asset manager clients are still interested in launching Hong Kong unit trusts, and now, having more access to a major market like UK, it may lead to an increase in unit trust products.
Among clients who have launched them in Hong Kong, the unit trusts mainly focus on Asian market investment strategies. This will give UK investors more choice for more Asian-focused strategies. However, for institutional investors who have certain criteria on a fund’s jurisdiction and legal form, the Hong Kong unit trust opportunities may still be to come.
The MoU was signed just one day before the UK Treasury published its draft amendment on Ucits regulation. The amendment will give UK-domiciled funds a “UK Ucits” label [after Brexit]. It is worth noting that UK-covered funds under this MoU must be “UK Ucits” funds. So this MRF can possibly be interpreted [as suggesting] that the UK is open to other [forms of] funds passporting by entering into its first bilateral relationship ... Considering past experiences from other fund passporting schemes, it may take years to succeed. This may also cause a further setback for asset managers’ UK product plans.
For Hong Kong offshore product distribution, Ucits remain the most popular registered product and UK-registered Ucits funds rank third following Luxembourg- and Ireland-registered Ucits. With this easier approval for UK Ucits, we may see an increase of existing UK Ucits in the market in the coming one to two years.
Jeremy Lam, partner, head of financial services practice (Hong Kong)
The concept of mutual market access afforded by this bilateral initiative is a very positive development for both jurisdictions. Whilst European Ucits funds authorised by the SFC can be sold to retail investors in Hong Kong, there is no regulatory framework for allowing Hong Kong-domiciled funds to be sold to retail investors throughout Europe. This is no longer the case so far as the UK is concerned and opens up a potential new retail market for Hong Kong’s asset management industry.
For Hong Kong investors there are already quite a large number of Ucits funds, including UK Ucits funds, which have been authorised by the SFC for retail distribution in Hong Kong. It's difficult to say whether or not this is going to be beneficial to Hong Kong investors in terms of allowing them access to a whole new range of strategies that they don't currently have under the existing Ucits framework.
Similarly, UK investors already have access to a wide range of Asia-focused strategies (some of which are managed out of Hong Kong) under existing Ucits platforms being distributed in the UK. Successful market penetration in either jurisdiction is, however, likely to require a proven track record as well as a unique investment strategy.