For the past two years, one of the hottest topics in the cross-border fund space has been the long anticipated China-Hong Kong Mutual Recognition scheme. The scheme, which will introduce a fund passport for Hong Kong and mainland Chinese mutual funds, has captured the imagination of many in the industry. Almost immediately after its proposal, persistent rumors have swirled that UCITS funds will eventually be included in the scheme. As enticing as the chatter is, the idea of UCITS participating in the China-Hong Kong Mutual Recognition program faces fundamental issues that render the idea improbable.
It is easy to understand why the idea of UCITS joining the mutual recognition scheme would be welcomed by the industry, as the possibility of simply using an existing cross-border fund to access mainland China is a tantalizing prospect. However, from Beijing’s perspective, allowing UCITS into the scheme runs contrary to a core strategy of mutual recognition, which is to develop the asset management industry in mainland China, and to aide in the effort of establishing Hong Kong as a major financial services hub. Opening up the passport to UCITS would surely undermine this effort, as many asset managers would prefer to extend the distribution of their existing funds into China, instead of going through the expense of launching a local fund domiciled in mainland China or Hong Kong.
The rapid expansion of the Renminibi Qualified Foreign Institutional Investor (RQFII) is often cited as an indication that UCITS will eventually get access to the scheme. The RQFII program allows approved asset managers to establish renminbi-denominated funds, which invest into the mainland. The investment amounts are based on allocated quotas, which were originally, available exclusively to asset managers in Hong Kong; however within two years, the RQFII program was opened up to Singapore. Today, a total of nine countries have been granted RQFII quotas. Despite the expansion of the RQFII program, it is important to remember that the strategic goal of the RQFII program is very different from the goal of mutual recognition. RQFII is about liberalizing China’s capital markets and internationalizing the renminbi, while mutual recognition aims to develop the local financial services industry.
Beyond the challenges in China, the prospect of UCITS participating in the mutual recognition scheme also faces a major stumbling block closer to home. In order for UCITS funds to gain access to the passport, Chinese mutual funds would also have access to the European market. In effect, because the scheme is bidirectional, European policymakers would need to agree that a Chinese mutual fund is equivalent to a UCITS fund and could be freely sold to European retail investors. Given that it took nearly twenty years for Europe to fully embrace selling UCITS on a cross-border basis within the EU, it seems unlikely that EU policymakers would rush to embrace the distribution of Chinese mutual funds. This, coupled with the fact that EU policymakers do not even view US ’40 Act funds as equivalent to UCITS funds, makes the prospect of mutual recognition of Chinese mutual funds seem very dim.
There are still a lot of unknowns about the China-Hong Kong Mutual Recognition program and, indeed, the long-term outlook of the Greater China fund region. It is still unclear whether there is first-mover advantage for mutual recognition, or if it will be better for asset managers to hold out and enter in the second wave. It seems clear, however, that if and when asset managers want to distribute funds in mainland China, they will need to establish local products. As a result, a dual product strategy, using a combination of UCITS funds and locally domiciled products, will be required. To hold out hope for UCITS to join the party isn’t a strategy, it is simply wishful thinking.
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