No one expects doing business in China to be easy but the Hong Kong fund industry's frustrations over how haltingly mutual recognition is working out, as highlighted last week in AsianInvestor, also extends to fund firms with wholly foreign-owned entities (WFOE) in China.
For asset managers, the WFOE setup in Shanghai's free-trade zone has become the preferred option for market entry into China over the last two years.
On the surface, the programme appears to be going well. A new report by Shanghai-based China-entry consultant Z-Ben Advisors, reflects what it sees as the rapid evolution of the China WFOE.
“Last year’s numbers should dispel any notion that global managers cannot grow onshore,” it said.
Total assets under management by WFOEs have been rising steadily, Z-Ben said, with fund flows data now resembling those for the domestic private fund industry.
The numbers are still modest, however.
“Less than 2% of the 8,600-odd private funds wield more than Rmb2 billion [$291 million] in AUM,” Z-Ben said. “Winton is leading the way for global managers, though it has been running its strategy with domestic partner Hwabao for six years. The other hedge funds – Man and Bridgewater – are also seizing on opportunities for rapid growth.”
But Z-Ben also acknowledged the problems being experienced: “Individual gripes about viability and competitive advantages of foreign brands may hold some truth,” the report said.
Having received approval for an investment management WFOE, the next step for a foreign fund firm is to gain a private fund management (PFM) licence. With it, they can then launch a private fund investing in listed securities onshore. Currently, this means a fund can offer exposure to either China A shares or local bonds.
Such a fund can only be distributed to high-net-worth investors or institutions and investors must have assets of at least Rmb3 million, with a minimum subscription to the fund of Rmb1 million.
Rex Lo, managing director of business development at BEA Union Investment Management in Hong Kong, said his firm is in the process of acquiring its PFM.
"But I’m afraid we are facing some challenges because right now we are only allowed to invest in these local securities,” he told AsianInvestor. So the first obstacle is one of unfamiliarity. Even sophisticated investors in China will not have heard of some of the companies selling under the PFM programme.
NO TRACK RECORD
Furthermore, the funds being launched by BEA Union and others do not have a track record. “So as we talk to the clients, the first thing they ask is do we have experience of onshore securities products. This is the challenge for all WFOE managers,” Lo said.
The viability issue, acknowledged by Z-Ben, is certainly contentious.
As Citi's senior fund industry adviser Stewart Aldcroft told AsianInvestor: “Once you get your PFM licence you can utilise your quota, which typically comes in $50 million or $100 million lots. But that doesn’t pay the rent; if you’re a global fund manager you want to be able to showcase your global skills, but if you can only sell $50 million worth of it and you can’t get it out to the street (via retail bank distribution), you have to sell it privately, and it becomes even more of a problem.”
The idea that getting $50 million of quota is not enough to sustain a foreign manager's business in China, was echoed by Lo.
“I agree it is not viable if you only have a $50 million quota but this is the way the game works. They [the State Administration of Foreign Exchange] wouldn’t give quotas aggressively. You have to set up in anticipation of getting more. It’s a footprint you have to create on the basis that it’s a big enough market.”
That and the fact many don't have a track record managing mainland Chinese securities begs the question of how foreign funds can compete and why the WFOE is a popular option. The reason has much to do with a lack of choice.
Lo noted that foreign managers used to be able to apply for the Qualfied Domestic Limited Partnership (QDLP) licence, which meant they could raise assets onshore and invest offshore, a situation offering competitive advantages for all foreign managers.
But that programme is in suspension too. Lo said,
“As far as I know, no new quota was been given to any QDLPs over the past six months,” he said. "The QDLPs who launched private funds over the past few months actually had obtained their quotas in early 2018 or even before."
AsianInvestor requested an update from the China Securities Regulatory Commission (CSRC), but the Chinese regulator gave no indication if or when the quota taps will be turned on again. If anything, statements made by senior Chinese Communist Party officials last year on the liberalisation of financial services have since been walked back in the midst of China's trade dispute with the US.
Lo said, that from the regulator's and government's point of view, "they want to enhance the Chinese fund industry and make better-quality managers and quality investment products available to the local investors. Over the past few years, there were a lot of poor-quality private managers set up in China."
The policy can change quickly, as it has in the past.
However, Gerard DeBenedetto, a former executive director of Guotai Asset Management in Shanghai who subsequently helped setup Anzhong Asset Management for Italian firm Azimut, thinks foreign managers need to change their psychology and be less reactive.
Historically, securing licences have been seen as the key to getting on in China. “If the CSRC was granting licences, it was a must for the local guys to try and get that new licence,” DeBenedetto said.
“This type of psychology still exists – [but] it's just the foreigners trying to play catch up; get a WFOE license, then a quota,” he told AsianInvestor. “This is a very reactive type of strategy.”
For DeBenedetto, who now works in the wealth management business in the US, “a $50 million quota for a WFOE is a sure way to lose a few million bucks a year.”
“But a lot of firms are willing to grind it out for the long haul and adjust strategy on the fly – which is fine for JP Morgan or UBS, who have been there a long time and have a number of potential revenue streams, but if your only business in China is a WFOE you need to be a bit smarter.”
There are ways of doing this, he said, including running an WFOE through existing Qualified Foreign Institutional Investor or Renminbi Qualified Foreign Institutional Investor schemes.
“The QFII strategy or RQFII strategy should be run on the ground by the WFOE team,” he said. “The strategy should be something that your firm is known for and replicated for the local market. This gets you a track record, for what it's worth, and provides some revenue to support the operation.”