The risks and costs involved in setting up a wholly foreign-owned enterprise (WFOE) in China have been highlighted by analysts, weeks after the removal of legal uncertainties.

The operational challenges and costs of establishing a financial servicing platform include interactions with other platforms, choices over business lines, and personnel hiring. 

Global managers who plan to enter China have also been urged to reflect on their timing, with most of their peers having chosen the wrong moment to make the plunge.

Overseas managers have been able to access the China market via an absolute-controlled firm, outside the routes of representative offices and joint-venture establishments, for the first time in the history of the mainland fund industry.

Several global fund managers have set up their 100%-owned WFOE over the past few years. But it was only in July this year that legal uncertainty was removed through the introduction of a new rule.

That month the Chinese government said it would allow foreign firms’ mainland WFOEs to operate in the same way as domestic private fund managers, meaning they could trade domestic securities, manufacture their own products, and provide servicing to institutions and wealth investors.

Foreigners’ first challenge will be over WFOEs’ interaction with other existing China platforms. “Part of [firms’ China-related] operational functions can be put into the WFOE, to centralise their China business,” said Ivan Shi, senior research manager at Shanghai-based consultancy Z-Ben Advisors.

“Do not think the business scope of such private fund management platforms is narrow,” said Shi. “China could have further liberalisations in the coming years, and such platforms might be allowed to have different functions. For example, foreign managers are required to partner a local distribution agent under the mutual recognition scheme right now, but they may be allowed to execute onshore marketing via such onshore platforms in the future.”

The liberalisation in July provided foreigners with regulatory certainty, with WFOEs allowing them to woo wealthy clients and institutions. However, foreigners have been urged to ensure they have a clear vision of what business lines to engage via such platforms.

“The China market is still a small part of many foreign managers’ business, and there are many hurdles for them to enter this volatile market, thus they will need long-term plans if they really want to tap it,” Shi said.

When entering the market, timing is critical, with Z-Ben observing that many foreign managers had moved into China when equity markets were peaking. “Many foreigners’ China strategy correlates to equity market sentiment, and they either pulled back or adopted a wait-and-see strategy when China A-shares were in the trough over the past few years,” Shi said.           

The recent market correction could be an opportunity for foreigners to rethink their plans, while successful firms needed to have a long-term strategic approach, Shi added.  

Significant costs were unavoidable if foreigners handled the execution wrongly. This was the case both in terms of the actual legal structure of the entity as well as operational details, particularly personnel, Z-Ben noted in a report.

“Key-man risk is becoming prevalent within the mainland market and with one of the highest rates of turnover in the world, structuring recruitment and retention schemes will be among the critical elements in determining whether or not a market entry strategy is successful,” Z-Ben noted.