Tighter China rules not seen killing off “mini funds”

Fund managers in China that have too many small funds may have to wait six months to win approval for new products, but there are exceptions and some room for manoeuvre.
Tighter China rules not seen killing off “mini funds”

Fund managers in China deemed to have too many “mini funds”, including bond and money market funds, will have to wait six months to get new products approved, according to new rules that partly reflect the authorities' long-running efforts to wean the economy off debt.

But experts believe that a mixture of cultural reasons and nagging redemption concerns will mean that Chinese fund houses and the retail investors still left in these typically sub-Rmb50 million ($7.6 million) funds are less likely to agree to their mass closure than to let them switch into other underlying assets.

In a circular seen by AsianInvestor and sent to fund houses on November 24, the China Securities Regulatory Commission (CSRC) said overly small funds could be detrimental to the interests of investors and leave them bearing higher costs, especially where management fees are fixed. It also said that having too many mini funds reflected a firm's weak investment management capabilities. 

The CSRC said companies found to have "relatively more" mini funds would consequently have to wait longer to register new products. It didn't specify what it meant by "relatively more" but, crucially, excluded “initiating funds”—funds seeded with a firm's own capital—and equity funds from its definition of mini funds. 

According to Morningstar, there were 323 mini funds in China as of end-September, almost double the number a year earlier. They account for about 7% of the country's total 4,663 mutual funds but just 0.07% of the industry's total Rmb11.14 trillion in assets under management.
The CSRC usually adopts a 20-business-day expedited process for approving the launch of a retail fund, but the process will be expanded to six months for the most unusual cases, Melody Yang, partner at law firm Simmons & Simmons, told AsianInvestor. As the new rule stipulates a six-month review process, regulators are in effect urging fund managers with too many mini funds to either enhance the performance of these funds or wind them up, she said.
Ways out

If anything, the new rule will have a bigger impact on smaller fund managers than bigger ones, Zhang Weiwei, chief marketing officer at CCB Principal Asset Management, told AsianInvestor. That is because smaller companies have a higher chance of having too many mini funds.

But it won’t be serious enough to make them go out of business as they can still find ways to grow them or can agree with investors to change the underlying assets, Zhang said.

“Transforming the funds will probably cost fund managers the least, because they do not have to sell off [the assets] in the funds and then give back the money to investors,” Rachel Wang, director of Chinese fund manager research at Morningstar, told AsianInvestor.

“I think that in the Chinese culture, transforming the funds is more likely to happen than winding them managers in China always think winding up the fund is a bad thing, but it’s actually normal in other countries,” she said.

Liu Shichen, a product and distribution specialist at Shanghai-based consultancy Z-Ben Advisors, told AsianInvestor that some mini funds will doubtless be wound up because of the new rules. But he added that it was unlkely that "dozens" let alone "hundreds" of mini funds would close, 

The unlikelihood of many mini funds being wrapped up falls in part down to the retail investors using them. They could be loath to see mini funds closed because it is uncertain when exactly they would get their money back, Wang said. AsianInvestor contacted the CSRC by email to shed light on how long investors might have to wait to be refunded if a fund was wound up, but did not receive a response by press time. 

Z-Ben's Liu added that some fund managers could also choose to keep as many mini funds going as they can because they are pinning their hopes on China's fledgling funds of funds (FoFs) industry.

“A lot of fund managers have some index funds that focus on different sectors for strategic reasons, they tend not to liquidate these funds because they may become things, such as the underlying funds in FoFs in the future,” Liu said.

But Wang noted that although that is a possible consideration, the underlying funds should theoretically be those that perform well and the FoF industry in China may take a long time to realise its growth potential

Fewer entrusted investments

Liu said one key reason for the sharp recent growth in mini funds was the drop in bank's entrusted investments seen earlier this year. Chinese banks, which had Rmb29 trillion in wealth management products (WMPs) as of end 2016, outsourced a large chunk of their assets under management to external fund managers. 

But the banks have subsequently redeemed some of these entrusted investments, shrinking the size of many funds, he said. Since fund managers entrusted with bank money often invest it in bond funds and multi-asset funds, it is these funds that the regulator now has in its sights.

In an April report, Deutsche Bank estimated these investments at the end of last year at between Rmb5 trillion and Rmb6 trillion. But as Beijing wants to deleverage the economy, more stringent rules have been placed on WMPs, leading to banks withdrawing their entrusted investments earlier this year.

Huatai Securities has estimated that banks have redeemed as much as Rmb300 billion this year. 


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