By Larry Cao
What purposes do these programs serve?
One of the advantages investors and investment managers in the US enjoy is that the 50 states are indeed very “united”. Although there are state regulations, the cost of the operating a national firm or to offer products across states in the US is substantially lower than that in Asia. The sheer size of the US market has been a huge bonus for the investment management industry there, each fund product having the potential of reaching a much wider audience. An average fund in the US usually manages hundreds of millions US dollars, while many funds in Asia only have tens of millions of dollars in assets under management.
The cost of running a fund such as back office/ settlement operations, portfolio management team compensation, etc. tend to be fairly fixed. As asset managers in the UScan expect to leverage the fixed cost over a larger base, it’s far easier for them to launch an additional product. This is part of the reason why fund offerings in the US have much more variety than those elsewhere.
UCITS is the European answer to their more segmented markets. The structure allows the same product to be sold across EU. The various fund passporting schemes in Asia are striving to be the Asian version of UCITS, allowing one product created in a member country to be sold in another member country.
In addition to benefiting investors and investment managers, a unified structure also lowers regulatory cost, so regulators are very much supporters of such schemes as well. Regulators participating in a fund passport scheme get to synchronize their regulatory framework to some extent, which serves as an opportunity to evaluate their own rules vs those of their more advanced or less sophisticated neighbor countries.
The extra incentive for Asian regulators is to foster growth of the local fund management industry. Given the constraints we have described, successful Asia-originated investment managers are far between. If these schemes are to succeed in achieving their objectives, investment managers from Asia would have a better chance to survive and prosper. So the question is, will they succeed?
Will they succeed in achieving these objectives?
After the launch of ASEAN CIS last year, I attended an industry conference here in Hong Kong. Participants from both buy side and sell side overwhelmingly focused their attention on the mutual recognition program between China and Hong Kong as a big driver for business. The other two schemes got a lukewarm reception at best.
It’s not hard to understand why there is a general lack of interest in the ASEAN CIS. The Philippines and Thailand both have retail driven markets with limited size. As a result, many managers do not have plans to expand into these markets and ASEAN CIS may not offer enough incentive for them to change their mind. The scheme will mostly benefits asset managers operating in Singapore with existing business in the Philippines and Thailand, or those are already planning to expand in these two countries.
Although AFRP will operate in some of the biggest markets in the Asia Pacific region, challenges remain. Unlike the environment UCITS operate in Europe, the eight countries in the program do not enjoy a unified currency. The tax system is also different, resulting in different treatment of dividends etc. These issues create back-office nightmares and to some extent negates the benefits of the program.
The only promising fund passport scheme for participants at the conference I mentioned was the Mutual Recognition of funds between mainland China and Hong Kong, and for good reasons.China has stock markets boasting total market capitalization, second only to that of the US, and a growing demand for mutual funds as well. The market has effectively been closed to the rest of the world to a large extent due to foreign exchange restrictions.
The Mutual Recognition program started with a US$ 300bn quota authorized. This is the first time international investors can invest in China’s stock market via local fund shops. Previously only institutional investors with earmarked quotas had that privilege. It’s also the first time Chinese investors have gained access to funds operating outside of China. And they can invest in these funds now using their RMB funds. I cannot think of another case where investors all of sudden can benefit so much from diversification.
Investment managers are excited because the market size covered under this agreement will make it possible for many unprofitable funds to become profitable and profitable ones to be even more so. The CSRC and SFC have always enjoyed good working relationships. Negotiating this agreement gave them fresh opportunities to evaluate their own and the other party’s framework, as well as implementation details. There is clearly an opportunity for both sides to benefit from this exercise.
What can we expect in the coming years?
Although significant challenges remain for any of the fund passporting programs to show as much promise as UCITS, I am generally optimistic about the programs’ future. The Mutual Recognition program should continue to attract fund flows from both sides. AFRP and ASEAN CIS will grow their membership and clout. The benefits to investors, investment managers, and regulators will all increase. What we need to watch is how soon this will take place and identify ways to help grow faster along the way. BM