Alternative funds may not have a place at the table when the Hong Kong-China mutual recognition scheme is formalised, although separate provisions may later be put in place for private equity, predicts Roy Stockell, Asia-Pacific asset management leader at Ernst & Young.  

The mutual recognition agreement is a cross-border fund sales scheme that will target retail investors and allow Hong Kong-domiciled funds to be sold on the mainland, and vice versa for China-authorised funds. It is thought to be in the late stages of finalisation by Chinese and Hong Kong regulators.

“Alternative funds are not ideally suited for a retail investor,” says Stockell, “and the mutual recognition scheme is designed, at its core, to give [cross-border] access to the retail investor."

While it is still uncertain whether hedge and other alternative funds will be allowed to participate in the scheme, funds that use derivatives or leverage are expected to be left out, at least in the initial stages of operation.  

This would categorically exclude hedge and PE funds, but Stockell says he has not heard of any specific exclusion for alternative funds. Such a product will simply need to have an open-ended investment company structure that is both regulated and operating onshore in its local jurisdiction, he notes.

Stockell’s advice to hedge funds is to wait until the rules are finalised and then look at whether their strategy fits within the rules.

The scenario could be somewhat different for PE funds, particularly those operating in Shanghai, where the qualified foreign limited partnership (QFLP) pilot scheme has been running since 2011. It enables a limited number of foreign PE firms to make equity investments in China and has subsequently led to the establishment of QFLP funds by global, regional and domestic entities.

“I suspect what the regulators will do is have a special category for private equity,” says Stockell, "because of the amount of investment it gives directly into, for instance, the IPO market.”

Hedge funds might be better suited to other cross-border schemes – notably the proposed free trade zones in Shanghai and Shenzhen. In September, six foreign hedge fund firms received quotas under Shanghai’s qualified domestic limited partner scheme, allowing them to raise money from mainland investors.

The Hong Kong-China mutual recognition scheme has yet to be rolled out – although initial speculation had suggested the launch would happen by the end of 2013. When that did not occur, forecasts shifted to the lunar new year holiday, which ended last week. “I’ve given up predicting it,” says Stockell.

In the 13 months since it was first announced, the proposal has certainly generated a great deal of interest, speculation and criticism.

Both E&Y and Citi argue the longer-term benefits of the scheme need to be kept in mind, with China using it as a means to gain access to global investors via Hong Kong, and Hong Kong serving as a hub for international access to the mainland’s fund sector.

“China could potentially, through Hong Kong, become the secondary major financial hub in the world – if the not the primary hub, if we go out another 20 years,” says Stockell. “And that seems to be where the Chinese government wants to take this.”