The numbers are mouth-watering. During the first eight months of 2001, guaranteed fund products have been responsible for $236 million of $253 million net sales of mutual funds in Hong Kong. Fund managers in Taiwan want a piece of the action, but regulations stand in the way.

Now a taskforce of the Securities Investment Trust Companies Association (Sitca), an industry group in Taipei, is preparing proposals for Taiwan's Securities and Futures Commission (SFC) to clear away the legal obstacles.

Guaranteed funds offered in Hong Kong typically invest the bulk of investments (usually at least 85%) in zero-coupon bonds and the remainder in options on the underlying stock market. Depending on the terms, investors get back their principle and sometimes their fees at the end of the fund's maturity, plus whatever upside is available from the derivatives.

Tom Yang, vp at ABN Amro Asset Management, whose president, Frances Chang, is spearheading the Sitca initiative, says there is no zero-coupon market in Taiwan.

Another source notes Taiwan's fixed-income yield curve is not smooth, so a mutual fund company guaranteeing a lot of funds could get into trouble and be forced to go bankrupt if it were to honour its commitments.

The other safe alternative is bank deposits, but in Taiwan mutual funds are barred from allocating more than 50% in these, which is not enough for a guaranteed fund, says Yang. So guaranteed funds must invest outside of Taiwan.

But any product that moves offshore instantly runs against the central bank's concern about capital flight and the stability of the exchange rate. Currently the central bank insists even small investments must involve a cross-currency swap to ensure the same amount of New Taiwan dollars that leaves, returns.

Sitca is trying to win an exception for guaranteed funds, where no more than 10% of the actual investment need go to offshore derivatives. If the fund manager does very well on the deal, then this is a small issue. But if the trade's returns are mediocre, or a loss, the fund manager must still bear the high cost of swapping, says Yang.

The SFC has concerns about labelling a mutual fund as 'guaranteed' - it takes a tough line against fund companies' misuse of the term in advertisements - but is not against the notion per se. Banks are allowed to offer onshore guaranteed products, but these are not mutual funds. Rather they are structured notes that use the interest to invest in derivatives. SFC rules, which govern mutual fund companies, prohibit funds from doing the same, and also prohibit purchasing derivatives without an underlying purposes such as trading goods; legally the guaranteed fund's use of options is seen as mere speculation.

The SFC will have to add and amend a lot of its regulations to allow guaranteed funds, and the central bank will have to be accommodating. Market participants believe, however, that the SFC is willing to do the work if Sitca comes up with a good proposal. "If a new product satisfies a market need without hurting stability, and if it is in line with international standards, then the SFC will support it," says one source.

Yang is optimistic the central bank will cooperate, because the currency is not under severe pressure right now. He believes Sitca's proposal will be finalized by early next year, and that the authorities will need another six months or so to approve it.