Last summer, after years of speculation, the China Securities Regulatory Commission (CSRC) and Hong Kong’s Securities and Futures Commission (SFC) launched the long-awaited Mutual Recognition of Funds (MRF) program. The program is a cross-border fund passport that allows funds domiciled in Hong Kong and Mainland China to be sold in either market. Though the MRF went live in July 2015, the industry spent most of the year preparing to access the new fund passport. Therefore, 2016 can really be viewed as the first year of the MRF age.
Key Elements of the MRF
The CSRC and SFC jointly control the eligibility and selection of specific funds approved for MRF. The initial quota for the MRF program is RMB 600 billion ($96.8 billion) and will be based on total utilization across the MRF market. Managers do not need to apply for a quota, which creates an incentive to be an early mover, since more of the quota is conceptually available. Another key aspect of the MRF is that there are restrictions on how much money can be raised from investors from the host country (i.e. where the fund is not domiciled). Funds from host country investors may not exceed 50% of the fund’s total assets. This means that in a Hong Kong MRF sold into Mainland China, assets from Chinese investors cannot be more than half of the value of the fund. This limitation favors funds with greater size because they will have greater capacity to absorb new investors.
There are also general requirements on the types of funds eligible for the MRF. Only general equity funds, bond funds, mixed funds, unlisted index funds, and physical index-tracking exchange-traded funds qualify for the MRF. In addition, a fund must be established and authorized for more than one year, and it must have a minimum of RMB 200 million, or its equivalent in a different currency, on the date of application.
Challenges and Opportunities for Asset Managers
The MRF offers global asset managers the opportunity to access Mainland China without having to establish a Chinese domiciled fund. For Hong Kong, it is an important step towards establishing itself as a global cross-border fund domicile. The opportunities and challenges presented by the mutual recognition scheme can be broadly categorized by the direction of fund flows: northbound (Hong Kong to China) and southbound (China to Hong Kong).
Northbound opportunities include the ability for global asset managers to utilize their expertise to gain access to the Chinese market. Speed of access to the market is also an advantage; according to Sally Won Chi-ming, chief executive of the Hong Kong Investment Fund Association, funds registered in Hong Kong should have an approval time of less than six months for mutual recognition.
However, northbound challenges do exist. In particular, firms entering the mainland may need to partner with a Chinese fund manager or custodian with strong onshore knowledge in order to market their products to mainland investors. Similarly, entrants need to consider distribution platforms and arrangements with large banks or wealth managers in the mainland. There are unanswered questions around matters such as operational workflows, cross-border money transfer, quota usage, and application procedures. Finally, it is important to remember that marketing, advertising, training, and education costs are often higher in China than they are in Hong Kong.
Southbound opportunities include a greater variety of ETF products than what Hong Kong can currently offer and strong demand for Chinese equity funds in Hong Kong. Additionally, onshore managers have some advantage due to their more intimate knowledge of the Chinese market.
On the other hand, southbound challenges include competition with global asset managers who have longer track records, potential operational flow issues, and concerns regarding the efficiency of transaction settlement.
The MRF scheme launch was met with substantial fanfare. It was seen as the dawn of a new beginning for asset management in the region. While the project has been slow to get off the ground, momentum is growing as an increasing number of managers begin to investigate the MRF. Seventeen funds domiciled in Hong Kong have applied for public offerings in China, while thirty funds domiciled in Mainland China have submitted applications for Hong Kong distribution. As of 6 January 2016, three Hong Kong funds and twenty-three Chinese funds have received regulatory approval under the MRF scheme. Now that the funds are finally making their way to market, the question remains whether investors are ready as well.
Importantly, the MRF may expand to include other jurisdictions. The SFC is already in discussions with Taiwan’s Financial Supervisory Commission about the introduction of an MRF. In November 2015, they reached an agreement on the sale of funds directly between Taiwan and Hong Kong. The MRF may very well evolve to become a Greater China fund passport, with Hong Kong emerging at the center as an important cross-border fund domicile.
Asia Region Funds Passport
Later this year, the Asia-Pacific Economic Cooperation will launch the Asia Region Funds Passport (ARFP) to facilitate cross-border distribution of managed fund products across Asia. ARFP will become the third Asian cross-border scheme to go live in the last three years.
In September 2015, finance ministers from Japan, Australia, South Korea, the Philippines, Thailand, and New Zealand signed a Statement of Understanding, which indicates their commitment to joining the AFRP when it goes live this year. There were two surprises with the signing. The first was that Japan, which is historically a very domestic market, agreed to join the ARFP. The other was that Singapore, citing concerns over tax issues, declined to sign the Statement of Understanding. Singapore’s action was unexpected because it has been a vocal champion for the ARFP. However, most industry observers believe that Singapore will eventually sign on.
Supporters of the framework believe the ARFP has the potential to reach $600 billion under management within fifteen years. As we have seen with other cross-border fund projects, it is a marathon, not a sprint, and it will take time for the full potential of the ARFP to be realized.
This article was originally published in the 2016 Regulatory Field Guide. The guide features insights from a number of our experts on key regulatory developments that will have the greatest impact for asset managers in the year ahead – and beyond. Visit bbh.com/regulatoryfieldguide to explore the guide.