In preparing our report on the rise of Hong Kong, we were reminded of the U2 song “Pride (In the Name of Love).” Not so much the song itself, but the 1984 video. The video features U2, before they became one of the world’s leading rock bands, riding a barge up Dublin’s River Liffey, which at the time was flanked by abandoned docklands. A visitor to Dublin today would find the same docklands filled with modern office buildings and apartments. The catalyst for this change was the founding of the International Financial Services Centre (IFSC) on the northern banks of the river. The IFSC was instrumental in Ireland’s transformation into a global cross-border fund domicile. Ireland’s ascent to a leading fund center was a combination of timing, regulatory change, and supportive policy.
Today, Hong Kong as a fund domicile, is at a similar inflection point as Ireland was thirty years ago. With China liberalizing capital markets, the support of Hong Kong’s policymakers, and the creation of a cross-border fund passport between Mainland China and Hong Kong — many in the industry predict that Hong Kong is poised to become the next global fund domicile.
We believe this is a fitting time to gauge the global asset management community's excitement about Hong Kong’s potential to become a leading fund domicile. We wanted to understand the group's expectations for Hong Kong's major challenges and key ingredients for success.
Our view is aided by analysis, experience, and our recent study of leading asset managers from around the globe. Although we cannot predict the future, we hope you find this whitepaper useful as you consider your strategy for Greater China, and that it provides insight into why we think Hong Kong as a fund domicile is on the cusp of its U2 moment, so to speak.
As a trusted provider to asset managers, Brown Brothers Harriman is focused on understanding the evolving landscape of the global cross-border fund industry. In 2015 we published our UCITS 2025 survey, which polled a group of leading asset managers to develop a picture of the present UCITS framework, as well as a projection for what it might look like in the future.
This year, we conducted a survey to understand the industry’s opinion on Hong Kong’s prospects to become a leading cross-border domicile and the resulting implications for UCITS in the region. Our results showed that the industry is bullish on Greater China and specifically Hong Kong. We also found that despite the optimism about Hong Kong, it is clear that many think UCITS still has a role to play in the region. Overall, the survey results confirm what many in the industry have noted anecdotally: Hong Kong is emerging as a leading cross-border domicile.
Greater China plays an important role in asset managers’ global strategies
- 68% of respondents rank Greater China as very or extremely important to their firm’s global strategy
Hong Kong will emerge as a leading cross-border fund domicile by 2025
- 80% of respondents believe there is a medium to high probability that Hong Kong will be a leading Asian cross-border fund domicile by 2025
Open Ended Fund Companies will be critical to the success of Hong Kong as a fund domicile
- 55% of respondents view the introduction of Open- Ended Fund Companies as very important to the success of Hong Kong as a fund domicile.
Hong Kong’s fund market is expected to double by 2025
- 50% of respondents expect Hong Kong’s local fund market will be approaching $1 trillion
Local Asian products will supplement UCITS products
- 63% of respondents anticipate that locally domiciled Asian products will supplement their UCITS products in the region.
AN OPPORTUNITY FOR GROWTH
Since the turn of the century, China has engaged in a deliberate program to open its capital markets for both inbound and outbound investments.
On the inbound side, the Qualified Foreign Institutional Investor (QFII) program allows qualified foreign participants to make investments in Mainland financial markets in US dollars. The RMB Qualified Foreign Institutional Investor (RQFII) program enables participants to establish RMB denominated funds in 16 approved regions globally to invest into Mainland markets.
On the outbound side, the Qualified Domestic Institutional Investor (QDII) program allows qualified Chinese financial institutions to invest in offshore markets. Additionally the Qualified Domestic Limited Partnership (QDLP) provides offshore managers the opportunity to fundraise from Mainland High Net Worth individuals for investment into offshore hedge funds. Along the way, China has gained the attention of global asset managers, both as an opportunity for investment but also for new investors.
On the bidirectional side, in July 2015 the Mutual Recognition of Funds (MRF) program was launched to give approved Hong Kong and Mainland China funds access to each other’s markets.
While China has been liberalizing its capital markets there has also been a deliberate policy to develop Hong Kong as a fund hub. Since 2010 the number of Hong Kong funds has more than tripled, from 200 to nearly 700 at the end of June 2016.1
Judging by our survey results, it is quite clear that China looms large over the cross-border fund industry. 68% of the respondents indicated that Greater China was either extremely or very important to their firm’s global strategy. Interestingly, 72% indicated that less than 20% of their assets under management (AUM) come from Greater China. For most, that percentage was less than 10% of their total AUM.
Many managers are looking to Greater China as a growth market for the future, even though it is only a relatively small portion of their businesses today. This is hardly surprising, when compared to the size of the Mainland China’s fund market, which as of 2015 stood at $1.3 trillion. Beyond the size of the marketplace, Mainland China’s three-year compound annual growth rate of 81% hints at the potential for growth.3
Additionally, according to the World Bank, the average Chinese household saves about 30% of its disposable income, primarily in cash, which makes the potential for funds even greater. With the continued liberalization of the market, by our estimates this number is set to grow to at least $4 trillion by 2025, which makes it clear that it is a market that asset managers cannot afford to ignore.4
HONG KONG: AN INTERNATIONAL FUND CENTER
80% of the respondents think there is a medium to high chance that Hong Kong will be the leading Asian cross-border fund domicile in 2025. Equally as interesting is that only 2% thought there was no chance of this happening.
When we expanded the question to evaluate which country will be the leading Asian cross-border fund domicile by 2025, Hong Kong was still the leading candidate with 53% of the votes, followed by Mainland China with 27%. Hong Kong received nearly three times as many votes as Singapore, which is often touted as Hong Kong’s potential rival for the leading Asian cross-border fund center.
Given the expectations for Hong Kong, we wanted to know what events or conditions respondents thought would solidify Hong Kong’s position as a leading fund center, as well as what they anticipate will be the biggest hurdles. In terms of what would solidify its position, the respondents were split. The two biggest suggestions were continued exclusive access to Mainland China and expansion of links with other Asian domiciles. While these ideas may seem at odds, they are actually complementary. Maintaining sole access to Mainland Chinese investors through the MRF scheme would obviously be an advantage for Hong Kong. So, it is not surprising that asset managers think maintaining exclusivity is important.
However, there is a core limitation of the MRF scheme that restricts investors from the host jurisdiction (i.e. where the fund is not domiciled) to no more than 50% of the fund’s total assets. This means that investments from Mainland Chinese investors cannot be more than half of the value of a Hong Kong MRF fund. This limitation favors larger funds because they will have more capacity to absorb new investors. So, it stands to reason that groups would like to see the expansion of the Hong Kong fund passport to other Asian domiciles. If Hong Kong funds can be more widely distributed, more assets can be raised. This would in turn allow managers to raise more assets from Mainland investors.
EXPECTED GROWTH OF LOCALLY DOMICILED PRODUCTS FROM 2016 TO 2025
Based on where the respondents have product today compared with where they expect to have local product in 2025, there is a clear preference for Greater China. While the Mainland China numbers predict eye catching growth, this can be partly attributed to a small baseline; it nonetheless shows how important the respondents think the jurisdiction will be in the future. Interestingly, Australia also seems poised for growth. It is possible that this is related to Australia’s participation in the forthcoming Asian Region Fund Passport program.
Respondents did not identify a single potential obstacle to Hong Kong becoming a leading fund center. Instead, regulation, registration issues, and distribution channels are seen as equally likely to be potentially significant issues.
Distribution channels were identified as a significant obstacle for Hong Kong, which is consistent with respondents acknowledging that Hong Kong will need to expand its links with other Asian domiciles in order to solidify its position as a leading fund center. While access to Mainland China is important for Hong Kong, to become a true cross-border hub it needs to have broader distribution in other jurisdictions. Distribution can also be challenging for asset managers because banks are the primary distribution channel in Greater China instead of the advisory model most manages are used to.
Regulation and speed of registration are constant concerns of the industry, not only in Hong Kong but in other cross-border jurisdictions as well. As Hong Kong policymakers seek to support the development of the domicile, it will be important to strike the right balance between robust regulation and business friendliness.
The Hong Kong Securities and Futures Commission’s (SFC) Open-Ended Fund Company (OFC) initiative is an example of proactive regulatory policy that will continue to bolster the domicile’s attractiveness for cross-border funds. Historically, Hong Kong open-ended mutual funds could only be established as unit trusts. But starting in 2017, asset managers will be able to launch corporate fund vehicles as well. The OFC is an important development because, over the last two decades, corporate fund vehicles have become increasingly popular for cross-border funds. In fact, when asked, 55% of the respondents indicated that introducing the OFC is very important to Hong Kong’s success as a fund domicile. The good news for the industry is that this is already a priority for the SFC.
To quantify the potential for Hong Kong, we asked respondents to predict the size of the local Hong Kong fund market by 2025. At the end of 2015, the market stood at $146.6 billion. 50% of the respondents think the market size will at least double by 2025, putting it between $500-$999 billion. We believe the pace of liberalization will continue to accelerate in China. Additionally, in the medium term, we expect Hong Kong and Taiwan will finalize negotiations over reciprocal access to each other’s fund markets. This will give Hong Kong funds a critical route to increase asset size, in particular to grow its footprint in Mainland China through the MRF program. Given these tailwinds, we agree with the 20% of the respondents who think that the local fund market will be approaching $1 trillion by 2025.
WHAT ABOUT UCITS?
Currently, UCITS are the dominant cross-border funds in Greater China. Any discussion of the potential rise of Hong Kong as a fund domicile must consider the implications for UCITS in the region. Despite a clear opinion that Hong Kong will become a leading cross-border fund domicile, the respondents remain bullish on the long-term prospect for UCITS.
58% of respondents believe that the popularity of UCITS in the region will increase by 2025. While this initially may seem puzzling; when taken together with the fact that 63% of the respondents think locally domiciled products will supplement their UCITS products in Asia, it makes sense. In Asia, UCITS is largely an institutional product. So, it is likely that groups are considering using local products for retail distribution strategies. This means that the choice between UCITS and local product is not binary, rather they are complementary strategies.
MUTUAL RECOGNITION OF FUNDS
Perhaps the largest development in Greater China’s fund market in the last few years was the launch of the MRF program in 2015. The MRF program is a cross-border fund passport that allows funds domiciled in Hong Kong and Mainland China to be sold in either market. The MRF was flagged by 63% of the respondents as either critical or very important to Hong Kong’s ambition to becoming a global fund hub. This is not surprising given it is Hong Kong’s position as a gateway to China that has excited many in the industry.
Currently, Hong Kong has exclusive access to the MRF program. However, only 20% of the respondents thought that Hong Kong would maintain its exclusivity in 2025, with 33% saying that Hong Kong would lose exclusive access. Interestingly, almost half of the respondents were unsure. This ambivalence may be explained by the fact that, on one hand, Hong Kong has been given exclusive access to China only for that access to be expanded over time; and on the other hand, there is a stated policy goal to grow Hong Kong as a fund domicile. Of those who didn’t think Hong Kong would maintain exclusive access to the MRF or were unsure, a staggering 86% thought MRF would open up to other domiciles within five years, with almost 50% predicting it would be within three to five years.
When asked what domiciles were likely to get access to the MRF, this cohort was split. The top three selections were Singapore, the European Union (EU) and the United Kingdom (UK). Of these, the two western jurisdictions are interesting choices. We have long argued it is unlikely that the EU will get access to the MRF. The biggest reason for this is that the MRF is inherently a bilateral agreement. This means, in order for EU funds to access Mainland China, the EU would need to allow Mainland Chinese funds to be sold into the EU. Given how the EU has dragged its feet in extending the AIFMD passport to non-EU countries, this seems unlikely.
The UK is a more interesting case. In light of the decision by the UK to withdraw from the EU, it is more plausible that the UK and Mainland China could establish mutual recognition. Both countries have indicated they would like to have closer ties, demonstrated most recently with the proposed London-Shanghai Stock Connect. Once the UK exits the EU, it will be free to negotiate mutual recognition with China. However, it is unlikely for these discussions to start before the formal UK exit, which will not happen until 2019 at the earliest.
Overall, there is clear enthusiasm for Hong Kong to develop into a leading fund domicile. For groups who do not have a strategy for Greater China, now is the time to consider one. However, despite the enthusiasm, a measure of caution should be taken. Entering Greater China requires patience and managers entering the region should not expect overnight success. For example, choosing a fund domicile is only one part of the equation.
As with all cross-border funds, a clearly articulated distribution strategy is a necessity. Not even the largest asset managers can take the “if we launch it, investors will come” approach. Moving into the region also requires long-term commitment. In particular, there are local substance requirements to consider. Policymakers are looking to develop Hong Kong into a fund center, so managers will need more than a brass plaque to set up a fund. This is particularly true for managers who wish to avail of the MRF passport. In order to access the MRF from Hong Kong, fund managers must have a physical presence in Hong Kong and will need to be registered and hold the appropriate local license. Additionally, before a fund can apply for an MRF passport it must have a track record of at least one year and a minimum size of RMB 200 million (~$29 million).
Given these requirements, asset managers must plan ahead if they want to take advantage of the domicile’s growth opportunity. Based on the market’s potential and the responses to our survey, now may be that time.
METHODOLOGY AND PARTICIPANT PROFILE
The report’s findings are drawn from survey responses of 52 global asset managers in October 2016. Additional details on the profile of participants can be found below.
1 Hong Kong Securities & Futures Commission, 30 June 2016
2 For the purposes of the survey, Greater China was defined as Mainland China, Hong Kong, Taiwan, and Macau
3 BBH analysis based on Cerulli, Z-Ben data, December 2016
4 BBH analysis based on Cerulli, Z-Ben data, December 2016
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