Tighter Chinese rules governing institutional investment in mutual funds – issued on Friday, earlier than many expected – look set to put a further dampener on the domestic mutual fund market. But they are also tipped to drive improvements in the industry in the longer term.

The guidelines aim to curb the practice whereby an asset manager sets up a mutual fund for an individual institution or a small number of institutions, rather than providing traditional segregated accounts.

The goal of the China Securities Regulatory Commission (CSRC) is to ensure a level playing field and protection for retail investors (see box below for a summary of the requirements).

Rapid growth

Volumes of these so-called ‘tailor-made’ mutual funds grew fast last year, driven largely by banks outsourcing investments to external managers, said a Shanghai-based institutional salesman at a fund house. Other asset owners, such as insurers and pension funds, prefer to use traditional SA mandates, he added.

Of the 1,151 mutual funds launched in 2016, 587 were tailor-made for institutions, accounting for Rmb493.1 billion ($71 billion, or 46%) of all Chinese mutual fund-raising volume last year, according to a January 13 news report from local publication 21st Century Business Herald, citing an unnamed Chinese fund house. The tailor-made funds had swelled to Rmb903.8 billion by the end of 2016.

However, the market suffered a setback late last year that sparked the move by the CSRC to start consulting on the new guidelines in February, said the institutional salesman.

SUMMARY OF THE NEW REQUIREMENTS

The Chinese securities regulator's new guidelines on institutional investment in mutual funds set out the following requirements:

New funds
If an asset manager wants to launch a fund and allow a single investor to account for more than 50% of the fund’s AUM, it must:

  • put at least Rmb10 million of its own capital into the fund and keep it there for at least three years;
  • operate it as a closed fund or only open it for subscriptions and redemptions once every three months;
  • not allow individual investors into the fund;
  • list all the relevant information in the fund’s prospectus and contract.

Existing funds
If an asset manager has an existing fund, of which one institutional investor accounts for more than 50%:

  • it cannot accept more subscriptions from that investor; and
  • it must ensure that in future one investor will account for no more than 50% of the fund.

If the asset manager wants to allow a institution to account for more than 50% of a fund, it must comply with the requirements for new funds (see above) and the general disclosure requirement, as below.

General disclosure requirement
In the future, if a single investor accounts for more than 20% of a fund’s AUM, managers must disclose the investor type, its weighting in the fund and any change in its weighting within a reporting period. 

A liquidity crunch in the last quarter of 2016 saw China’s 10-year Treasury yield surge from a one-year low of 2.66% on October 21 to 3.387% on December 20.

This sparked huge redemptions from mainland money-market funds (MMFs), including tailor-made products. The biggest exchange-traded MMF in China, Fortune SG Tianyi MMF, saw Rmb5.6 billion of outflows redemptions in a single day on December 20.

Yet asset managers were not to be discouraged, rushing to set up new tailor-made funds before the expected restrictions came in, said the salesman. ICBC Credit Suisse launched a Rmb90 billion bond fund at the end of February, he noted, which is believed to be an institutional tailor-made fund.

The salesman suggested that this move led the regulator to rush out the guidelines' release, when many had expected them to be introduced in April or May.

Tax attraction

The attraction of investing via mutual funds rather than traditional segregated accounts (SAs) is down to tax benefits. Income tax on SA investments is 25%, whereas income distributed by mutual funds in the form of dividends is only subject to 6% in value-added tax, added the salesman.

However, the regulator is concerned that such activity may give banks too much of an influence over a fund’s investment decisions. Hence the new guidelines seek to restrict an asset manager’s ability to provide tailor-made products.

The high concentration of one fund with one institution breaches the investment independence of asset managers, and is likely to cause a product liquidity crisis and result in unequal treatment of investors, said the CSRC in the guidelines.

As a result of all this, fund managers will need to truly improve their active capabilities to attract institutional clients, noted the unnamed salesman, rather than simply offering a "channel" for them, such as tailor-made products.