Cross-border funds distribution

Cross-border investment schemes between Hong Kong and China haven’t lived up to potential but a new wealth channel seems promising

Hong Kong’s fund management industry has long pursued the goal of distributing fund products to China. But that goal remains largely unachieved in spite of the fact there are now two cross-border schemes in operation.

The first major initiative was the Mutual Recognition of Funds (MRF) scheme, inked by the China Securities Regulatory Commission and the Hong Kong Securities and Futures Commission in 2015. Thus far, it’s only yielded subdued results for participating firms on both sides of the border, prompting the Hong Kong Investment Funds Association (HKIFA) to survey its members early this year with a view to putting forward recommendations to the authorities to revitalise the scheme. The findings, based on responses from 31 member firms, were released in May.

HKIFA Chief Executive Officer Sally Wong tells Asia Asset Management that it’s an opportune time to revisit the MRF in order to revitalise it. “We wish to unleash the full potential so as to enable more managers to partake in it and to offer more products so as to better serve the diversification needs of Mainland investors,” she says. “To move the dial, we should work on the last mile, enhance the rules, and remove the prescriptive requirements.”

Hong Kong and China regulators began discussions for the MRF ten years ago, wherein retail funds approved by the home regulator that meet certain eligibility requirements may apply to the securities regulator of the other market for a public offer to their investors. 

It wasn’t exactly a ground-breaking idea. Hong Kong had already formed a mutual recognition of funds agreement with Australia in 2008. However, that arrangement did not result in much take-up on either side because of issues with tax treatments and other operational complications between the two jurisdictions.

Australia initiated a more ambitious regional framework, the Asia Region Funds Passport, in 2010 under the sponsorship of the Asia Pacific Economic Cooperation. Several countries joined the discussions but China and Hong Kong did not participate.

The MRF with China very quickly caught the imagination of Hong Kong’s fund management industry and was hailed as a potential game-changer. It would open up China’s retail market for access by international investment funds domiciled in Hong Kong without establishing a local presence. It would also bring China funds to Hong Kong, giving international investors first-hand and direct access to Mainland securities investment funds, and thereby access to the investment capability of Chinese investment managers in a broader range of strategies and sectors.

After three years of discussions, final details of the scheme were announced in 2015. The first batch of seven funds – three northbound, or Hong Kong into China, and four southbound from China into Hong Kong – were given approval to start distribution at the end of that year.

Six years on, as of end-2021, 36 Hong Kong funds were selling into China under the scheme, with cumulative net inflow since inception of 14.2 billion RMB (US$2.13 billion), according to data from China’s State Administration of Foreign Exchange. Meanwhile, there were 47 China funds selling into Hong Kong, with over 1 billion RMB of net inflows since inception. It’s a far cry from the industry’s initial expectations.

Hong Kong has also since entered into similar arrangements with France, Luxembourg, Switzerland, Netherlands and the UK. 

Recommendations

The HKIFA survey makes three key recommendations to revitalise the MRF scheme’s growth, all based on hurdles that have long aggrieved the industry.

Top of the list is scrapping the so-called 50/50 sales rule, which requires that the value of MRF funds sold to investors in the Mainland must not be more than 50% of the total net asset value. This means even if a fund is very popular with Mainland investors, sales must be stopped when it reaches the 50% limit. 

The total NAV of Hong Kong-domiciled funds as of end-2021 was $178.6 billion, according to figures from the city’s securities regulator. This works out to just over $200 million each on average for the 866 funds; most of them would have limited capacity for potential inflows. Moreover, the requirement is onerous to monitor for compliance.

Another key recommendation is removing the requirement for personnel covering the investment management functions of the fund to be based in Hong Kong. 

As of March 2022, there were 2,247 authorised unit trusts and retail funds in Hong Kong and the total NAV was $1.93 trillion. Hong Kong domiciled funds represented less than 10% market share by value; UCITS funds account for the lion’s share.

It’s expensive to build and maintain a platform specifically for Hong Kong domiciled funds. It’s also difficult to achieve scale because they are not well-recognised outside Hong Kong. And it’s hard to have product differentiation against the wide range of UCITS offerings. Allowing MRF funds to delegate investment functions to teams outside Hong Kong can harness global expertise and build economy of scale. 

Along similar lines, the survey recommends that MRF funds be allowed to use a master-feeder structure so that they can provide a range of investor choices at the feeder level and pull up capital at the master vehicle for investments. This will allow them to scale up more easily as well as save on operation and trading costs. 

Survey respondents would also like to see the approval process streamlined and the timeline shortened. This typically takes eight to nine months at present; sometimes it can even be more than a year.

Nearly 40% of respondents believe that these recommendations, if adopted, will be able to attract an additional $500 million of inflows to their MRF offerings. Some are more optimistic, predicting $1 billion-$5 billion of additional inflows.

Some respondents also suggest expanding the suite of MRF products to allow broader investment strategies, such as multi-assets funds, thematic funds, unlisted exchange-traded funds, fund of funds, and alternatives. Under current rules, more interesting strategies will almost invariably be deemed as complex and thus not eligible for the scheme. 

A new wealth channel

While the growth of MRF funds is constrained by hurdles, the Greater Bay Area (GBA) Wealth Management Connect (WMC) scheme launched in September 2021 presents unique business opportunities. Although it’s early days yet, over 30% of survey respondents were optimistic that the scheme would provide their biggest business opportunities in the medium and longer term.

The GBA solidifies links between Guangdong, Hong Kong and Macau into an integrated economic business hub in southern China, with a combined population of over 86 million. As of end-2020, the area had a gross domestic product of nearly $1.7 trillion, which would rank it as the world’s 12th largest economy. Development of the GBA is a priority in China’s national masterplan and Beijing aims to turn the area into a vibrant economic and technological growth engine of the nation by 2035.

The WMC allows eligible residents in the area to invest in wealth management products distributed by banks in each other’s markets through a closed-loop funds flow channel established between their respective banking systems. Individual retail investors can open and operate cross-border investment accounts directly and choose their preferred products.

The initial rules of the scheme are conservative. The product scope covers relatively simple wealth management products with low to medium risk. Cross-border renminbi fund flows are subject to a quota of 1 million RMB for each individual investor, while northbound and southbound flows are subject to an aggregate quota of 150 billion RMB shared by Hong Kong and Macau.

Despite these constraints, the WMC has had a promising start. Christopher Hui, Hong Kong’s secretary for financial services and the treasury, told the city’s Legislative Council in April that as of end-February, 24 Hong Kong-based banks had begun offering WMC services together with their Mainland partner banks. Over 24,000 individual investors participated in the scheme and cross-border fund remittances totalled over 670 million RMB. 

The value of offshore investment products held by Mainland investors under the WMC stood at around 118 million RMB, including 16 million RMB in funds and 102 million RMB in deposits. Mainland investment products held by Hong Kong and Macau investors were valued at around 204 million RMB, including 172 million RMB in wealth management products and 32 million RMB in funds.

The WMC is a lot simpler for fund managers to participate. Although the current quotas and product eligibility restrictions would limit long-term growth, regulators have promised to review them if the scheme proves popular and operates smoothly.

China is the big prize for fund managers based in Hong Kong, given the city’s role as the gateway to the Mainland. Cross-border fund distribution schemes such as MRF and WMC and the recently announced ETF Connect are useful options in their overall business strategy. 

But if fund managers really want to take full advantage of the fast-evolving Chinese market, they need to be present onshore and have people on the ground to feel the pulse of investors and manufacture the right products. An integrated onshore and offshore strategy is required to seize the prize.

*This article was published in Asia Asset Management’s July 2022 magazine titled “A mixed picture”.