A Greater Gateway, Issue 2. Hong Kong's mutual fund industry looks set for sustained growth due to opportunities in mainland China and as Hong Kong-domiciled funds get broader global distribution.
As mainland China moves to relax controls over flows of capital across its borders, Hong Kong’s prime position as a fund management center presents new opportunities for asset managers across the world. The city’s mutual fund industry looks set for sustained growth due to opportunities in mainland China and as Hong Kong-domiciled funds get broader global distribution.
Hong Kong’s future prospects as a fund management center have always been tied to the promise of accessing the massive mainland China market. Mutual fund assets under management within China surged 84.6% year-on-year in 2015 to RMB8.1 tn (from US$1.18 tn in 2014)1, while the fund penetration rate still remains very low: mutual fund AUM was just 10% of GDP in 2015, compared to 91% in the US.2 Moreover, Chinese investors are keen to diversify their investments, as the surge in interest in money market funds and wealth management products in recent years has demonstrated.3
Consequently there was considerable excitement over the launch in July 2015 of the Hong Kong-China Mutual Recognition of Funds (MRF) scheme, which allows Hong Kong-domiciled funds to be distributed in the mainland, and vice-versa.
The MRF scheme has not grown as quickly as initially expected, not least because of the slow approval by mainland regulators of funds for distribution and an imbalance in flows. Just six Hong Kong products have been approved, attracting RMB8.5bn (US$1.2bn) of net inflows from mainland investors in the first 10 months after they went on sale in January 2016, while 50 Chinese funds attracted just RMB96mn (US$13.6mn) in Hong Kong for the same period.4
Events in China since the summer of 2015, including volatility in the A-shares market and an economic slowdown, as well as mainland authorities’ concerns over potential capital outflows due to a weakening currency, explain the modest start to the scheme. But these shortterm concerns should not mask the considerable opportunities that China market presents to Hong Kong fund managers, particularly because the city retains “firstmover” advantage as the main gateway to distribute products in China.
“There’s a tremendous upside for potential growth of the retail fund management business in China,” says Alan Fong, APAC Product Segment Manager at BNY Mellon. “Despite its current issues, China recognizes the need for its investors to diversify in the long run. And being able to control flows through the channel out of Hong Kong remains one of the most measured and attractive ways for China to allow for diversification without opening the floodgates.”
While China understandably remains the focus, Hong Kong is also bidding to expand the distribution of locally domiciled funds into other markets. In early December 2016 the city’s Securities and Futures Commission (SFC) announced it had signed a Memorandum of Understanding with Swiss authorities for another mutual recognition agreement, which will allow eligible Swiss and Hong Kong public funds to be distributed in each other’s markets.5
The promise here is perhaps not in the Swiss market directly. Certainly, the prospect of managing the assets of Swiss private bank clients should not be discounted. There are secondorder benefits too, since growth in Hong Kong’s overall fund market gives asset managers more opportunity to expand their business in China (as the MRF scheme with the mainland stipulates that only 50% of the value of a fund’s assets can be sold to mainland investors).
Perhaps more significantly, the Swiss deal is a sign of Hong Kong’s growing potential as a fund domicile. Unlike the one-way approval of UCITS funds in the city, it is based on mutual recognition. Since China is unlikely to grant unilateral access to UCITS funds, Hong Kong can reinforce its position through such agreements as a global fund domicile and gateway to Chinese investors.
“Although it’s not as lucrative as Hong Kong-China mutual recognition, it is important as it’s the first such deal outside Asia” says Hozaifa Arsiwala, Managing Director, Head of APAC Product and Global Head of Client Analysis & Solutioning, Asset Servicing at BNY Mellon. “It bodes well for the arrangement of similar deals with other jurisdictions, such as the UK post-Brexit.”
The deal also underscores how Hong Kong’s regulators have been taking a broad approach in promoting the city’s domicile status, including measures such as streamlining the funds authorization process in 20156 and preparing to implement a new law that allows the establishment of open-ended fund companies, in addition to unit trusts.7 Such initiatives, combined with the appeal of the MRF, are bearing fruit: the number of locally domiciled mutual funds and unit trusts in Hong Kong grew 10.4% from March 2015 to March 2016.8
Despite some short-term issues related to volatility in mainland China, Hong Kong’s position as a gateway to the wealth of the world’s second-largest economy gives its fund management industry massive long-term potential. Its continued development requires a holistic approach from the authorities – including toward issues like tax rules and developing a world-class talent pool – but the signs are good that it is headed in the right direction.
From an industry perspective, global fund managers should recognize the need for long-term planning. Getting fund approvals via the MRF may be one thing, but honing an appropriate distribution strategy on the mainland is another.
An additional consideration is the technological challenge of dealing with multiple parties in manufacturing, servicing and distributing cross-border fund products, the complexity of which may be compounded by differing information formats and standards. The use of Application Programming Interfaces (APIs) and integrated technology platforms will be increasingly vital to address such challenges and maximize insights from the available data. Addressing these challenges now, even amid some uncertainty about China’s short-term outlook, will put global fund managers in Hong Kong in prime position to seize the opportunities the city’s maturing mutual fund sector undoubtedly presents.
1 Source: Cerulli Associates, Global Markets 2016
2 Source: Ernst & Young, “Mutual Funds: Ready for the next leap”, 2015
3 AUM in Chinese banks’ wealth management products reached RMB23.5 tn in 2015. Source: Cerulli Associates, Global Markets 2016
4 Source: AsianInvestor, “SFC’s Choi responds to concern on MRF delays”, 14 December 2016.
5 Source: Securities and Futures Commission press release
6 Source: Speech by Securities and Futures Commission Chairman Ashley Alder, 8 November 2016
7 Source: Hong Kong Legislative Council, Securities and Futures (Amendment) Bill 2016, January 2016
8 Source: Securities and Futures Commission, Fund Management Activities Survey 2015, released July 2016
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