Hong Kong-domiciled fund managers looking to market into mainland China following the long-awaited introduction of Mutual Recognition (MR) have been advised to enter into distribution agreements with Chinese financial institutions.
MR obviates the need to enter into an equity partnership with a Chinese securities, brokerage or fund management firm, something which has been much welcomed by the Hong Kong asset management industry, who routinely complained it was expensive and added to their due diligence workloads. The rules also allow Chinese asset managers to sell into Hong Kong.
“MR means Hong Kong fund managers do not need to enter into a Joint Venture (JV) with a local market participant if they are looking to solicit mainland Chinese retail capital. But these foreign fund managers need to be cognizant that most Chinese retail investors may not have the same level of expertise and education as institutional investors when it comes to investment. As such, fund managers should work with Chinese banks and platforms to distribute their vehicles as distribution on a standalone basis is likely to be very challenging,” said Cindy Chen, country head for Securities Services at Citi in Hong Kong.
Another growing mechanism to attain distribution is through China’s Internet groups such as Alibaba, Baidu and Tencent. Some Internet groups in China are venturing into online distribution. “The online distribution space is an emerging channel but it is not responsible for the majority of the flows. The majority of fund managers are looking to partner with local banks to distribute,” commented Chen.
China has a sizeable and growing middle class, with many investors hoping to diversify their investments beyond Chinese shares and fund managers. Like previous initiatives such as the Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investor (RQFII) schemes, MR does have quotas with $48.33 billion being set on the amount of funds that can be sold both north and southbound. The majority of funds utilizing MR will be fairly vanilla equity and bond strategies, as well as exchange traded funds (ETFs). However, in time this could be extended to more esoteric products.
Nonetheless, approval for the first batch of fund managers has yet to materialize. In July 2015, the China Securities Regulatory Commission (CSRC) said 100 Hong Kong domiciled funds and 850 Chinese funds qualified. The recent market volatility, however, has led to delays in approvals from the country’s regulator.
MR is just one of a series of regulatory reforms that China has introduced over the last few years as it gradually opens up its capital markets to foreign investors. Hong Kong-Shanghai Stock Connect, a scheme designed to allow investors with Hong Kong brokerage accounts to trade China A Shares and Chinese investors to trade in certain Hong Kong securities, has taken off despite a slow start.
Reforms to rules around the pre-funding of trades and recognition of beneficial ownership have provided reassurance to foreign investors weary of counterparty risks in China. “This had been a particular challenge for UCITS funds domiciled in Luxembourg and Ireland but it has been resolved,” said Chen. It is highly likely Stock Connect will be extended to Shenzhen while a report has been commissioned to assess the viability of a UK-Shanghai Stock Connect.
Other liberalizing measures include relaxed access to China’s $5.7 trillion interbank bond market. The rules mean large institutional, foreign investors – such as Central Banks and Sovereign Wealth Funds do not need a quota to trade bonds, interest rate swaps or enter into repurchase agreements on the mainland. Chen acknowledged this could ease some of the recent market volatility in China, adding fund managers could be allowed access to the interbank bond market in due course.