Asia Region Funds Passport: a long way to go

More than a decade on, Asia fund passport scheme remains an aspiration

Fund distribution in Asia Pacific has always been highly fragmented. When the idea of a regional fund passport was first mooted over ten years ago, the possibility of creating a product in one jurisdiction and exporting it to multiple countries through passporting arrangements without setting up a local shop quickly caught the imagination of fund managers and regulators.

Three different cross-border fund passporting schemes have since gone live in the region. But for most players, the opportunities behind those concepts remain an aspiration.

The Mutual Recognition of Funds scheme for cross-border distribution of funds between China and Hong Kong was launched in May 2015, and has seen slow but steady increase in activities and volumes. However, it is restricted to fund distribution between the two jurisdictions.

The ASEAN Collective Investment Scheme framework was signed in August 2014 by Singapore, Malaysia and Thailand to allow fund managers within those Southeast Asian countries to distribute fund products to retail investors across borders via a streamlined process.

Six funds from Singapore, nine from Malaysia and one from Thailand have been approved under the scheme, although the amounts of cross-border assets being raised so far are unimpressive. In February 2019, the three countries introduced further measures to streamline the scheme. The Philippines is currently in discussions to become a new signatory.

The Asia Region Funds Passport (ARFP) was the first of the three regional schemes, and the most ambitious. The concept was first recommended by the Johnson’s Report at the Australian Financial Services Council Forum in January 2010, with the aim of boosting the country’s financial industry. 

“An agreement to establish an Asian region funds passport opens up the possibility of Asia’s savings being managed from Australia and for Australians to more easily tap into the extraordinary economic growth and development in the region,” John Brogden, the FSC chief executive at that time, said in presenting the initiative.

While Australia had self-interest in championing the initiative, the potential opportunities of distributing funds across Asia Pacific through the scheme also caught the attention of other Asian markets.

 Cue from UCITS

Economies in Asia have recovered strongly from the 1997/98 Asian financial crisis and have been enjoying continuous growth, leading to rising public and private wealth. Investment fund penetration rates, while still relatively low compared with Western countries, have been growing consistently. However, a large share of these investments are captured by Undertakings for the Collective Investment in Transferable Securities or UCITS funds, especially in Hong Kong, Singapore and Taiwan, and to some extent in Japan and South Korea.

The UCITS framework for the management and sale of mutual funds was adopted in December 1985 in Europe, and the first UCITS directive was implemented in 1988. In essence, the framework enables funds to operate freely throughout the European Union on the basis of a single authorisation from one member state.

The UCITS regime has been continually refined over 35 years and has evolved to become a gold standard in the fund industry, accounting for around 75% of all collective investments by small investors in Europe. UCITS products are distributed in over 70 countries, including those in the Asia Pacific.

UCITS funds are domiciled in the EU, especially in Luxembourg and Ireland. This means that the associated fund services are also located in the EU. So Asia misses out on the economic activity and additional government revenue that flow as a consequence of such service provision.

Asian regulators are also increasingly concerned that the UCITS framework is being driven by the European agenda rather than what is necessary to drive growth in Asia. Several UCITS directives have been introduced over the past decade, and Asian regulators have found it increasingly difficult to ensure local interests are best looked after.

Apart from promoting the local asset management industry, the desire to create a competitive product by the region and for the region to rival UCITS was a catalyst for Asian governing bodies to introduce their own regional initiatives.

ARFP workshops involving policymakers, regulators, industry and technical experts from different countries were organised through the Asia Pacific Economic Cooperation platform. This led to the signing of a statement of intent by Australia, South Korea, New Zealand and Singapore in September 2013.

However, negotiations on the ARFP were highly technical and often very complicated in balancing the financial interests and market practices among participating countries.

Lack of commitment to address unequal tax treatments prompted Singapore to decline signing the statement of understanding in 2015. Singapore’s lower tax rate relative to other participating countries would put its managers at a disadvantage when bringing funds to a higher tax regime, while funds from the other countries could come in to take advantage of its lower tax regime.

But Japan’s signing of the statement of understanding was the turning point and strongly boosted the size of potential market coverage and the credibility of the ARFP. In April 2016, Australia, Japan, South Korea and New Zealand signed a memorandum of cooperation setting out the rules and cooperation mechanisms. Thailand also became a signatory later.

Amendments of legislation, market preparations and pilot tests by the five signatories took another three years, and the ARFP officially went live on February 1, 2019.

First applicant still waiting

However, the initial excitement over the scheme seems to have waned. Even in Australia, there has been little fanfare about exporting funds to Asia. Thus far no Australian manager has filed an application for ARFP.

In spite of Australia’s booming and increasingly sophisticated fund industry riding on its superannuation growth, the number of successful entries by Australian managers into Asian markets have been few and far between. They have made very little investment on developing brand and building distribution partnerships in Asian markets. Few of their investment strategies appeal to Asian investors.

Nonetheless, the ARFP scheme saw its first application for registration very soon after the official launch.

Wellington-based Smartshares Limited applied to the New Zealand Financial Markets Authority (FMA) to offer its SuperLife NZ Dividend Fund in Japan through the scheme. Smartshares believes that the fund, with its offer of higher dividends, will be a draw for yield-seeking Japanese investors. The fund also has a ‘green’ appeal given its weighting on clean energy stocks in the New Zealand stock market index.

But the fund’s application has been under review by the FMA since February 2019. There is still no clear date when it will obtain both home and host jurisdiction authorisation.

According to Smartshares Chief Executive Officer Hugh Stevens, the process has taken longer than expected because of the many decisions that the regulator has to make, including the nature of home country disclosures. Currently, rules of host jurisdictions differ significantly with regard to disclosure requirements.

“The regulator and Smartshares have been working to strike the right balance between simple explanations of policies and risks, understandable by retail investors, while also ensuring compliance with the more technical language used in New Zealand regulations and the passport rules,” he says in an email reply to questions from Asia Asset Management.

According to Stevens, they are now very close to completion with one of the last tasks – appointment of an independent party to conduct an ‘annual implementation review’.

The ARFP approval process is complicated compared to the market practice of launching a fund in a foreign jurisdiction as a sub-fund under a master-feeder structure, such as the ‘toshin funds’ in Japan. Although this would incur more cost, the process is simpler and has been working well. The structure also allows foreign players to leverage on the local partner’s brand name and distribution network.

Apart from lack of tax neutrality treatment between local and foreign funds, currency restrictions mean foreign funds must be offered in a local currency share class in those jurisdictions. This could hamper return and competitiveness.

That begs the question that many sceptics have in mind about the ARFP: why bother? But Stevens remains optimistic. “All good things take time!”, he says.

It has taken UCITS more than 30 years to establish itself as a global brand. The ARFP will have a long way to go to become a true fund passport in Asia Pacific.

*This article was published in Asia Asset Management’s April 2021 magazine titled “A long way to go”.