02 Jul 2013
China’s gradual opening of its market to the freer flow of capital will provide a massive boon to fund managers globally.
When the mainland Chinese and Hong Kong regulators formally recognise each other, on a date yet to be determined, they will give international asset managers unprecedented access to the world’s most exciting growth market. If China’s burgeoning middle classes shift even a modest amount of their wealth into Hong Kong-based funds, they will create a huge growth opportunity.
In November 2012, the China Securities Regulatory Commission (CSRC) and Hong Kong’s Securities & Futures Commission (SFC) formed a working group to plan the terms of mutual recognition, aiming to permit mainland Chinese firms to sell their funds into Hong Kong, and Hong Kong-based firms to sell theirs back into China.
This agreement has obvious potential benefits for international asset managers with operations in Hong Kong. Chinese individuals have US$6.5 trillion in bank deposits, according to the Peoples Bank of China (PBoC), with this amount growing rapidly. If PBoC depositors decided to move just 25% of their savings into Hong Kong-based funds, this would equate to US$1.6 trillion in assets under management. In the longer-term, the savings pool is likely to expand rapidly, with China’s middle class forecast to make up 40% of its population by 2050.¹
While the exact timing of mutual recognition is still unknown, the pace of Chinese reforms has recently surprised even the most bullish China observers. As we understand matters, the two parties are working hard to resolve a number of complex issues, including product distribution, investor protection, eligibility criteria and capital requirements.
For international asset managers, the recent discussions represent an opportunity to access one of the most promising markets for growth in assets worldwide. This initiative is the latest, and by far the most significant, move by the Chinese government to open up its investment fund market, as it pushes to liberalise its capital account and internationalise the currency.
In the past, the CSRC has introduced several schemes to increase the flow of investment in and out of China, but they’ve been more limited in scope and haven’t given international asset managers the opportunity to market their funds to Chinese investors. Both the Qualified Foreign Institutional Investors (QFII) and RMB Qualified Foreign Institutional Investors (RQFII) schemes have provided foreign investors with the means of investing directly into the mainland. However, quotas have limited their size.
Understandably, the regulators’ move towards mutual recognition has sparked considerable excitement, as it would go a long way towards opening up the Chinese retail fund market. But the regulators are likely to extend recognition only to domestic Hong Kong funds, as opposed to all locally authorised funds.
In order to create an environment that’s more attractive to international asset managers, Hong Kong’s government is taking a number of steps. In its February Budget, the government announced plans to establish open-ended investment companies (OEICs) alongside the unit trust structures already there. The government has also announced measures to provide tax exemptions for private investments in offshore funds.
For international asset managers seeking to take advantage of the anticipated regulators’ agreement, there are a number of important practical issues. Brand and distribution will remain essential. As a result, Sino-foreign joint ventures are likely to remain important even as the China market opens up.
Joint ventures are important in a market where local banks dominate distribution and overseas brands have penetrated the local market with limited success. A joint venture also lays the foundation for offering differentiated and higher-value services, such as wealth management.
What’s more, establishing an authorised fund in Hong Kong can be a complex process, which requires a good understanding of local regulations, accounting and disclosure requirements and tax efficiency. These factors have implications for matters ranging from fund structures to IT systems.
We’re optimistic that Hong Kong and China’s regulators will soon reach an agreement that will give international asset managers a direct route into the fast-growing China market.
Once the regulators announce they’ve reached an agreement, then the benefits of mutual regulatory recognition could flow quickly to international asset managers with Hong Kong-based funds. China is moving quickly and now is the time to prepare.
¹Study by Shanghai’s Academy for Social Sciences.