As the China mutual fund industry continues along its reform agenda of internationalization, regulatory developments are driving new opportunities. Historically, access for foreign asset managers has been highly restrictive, but plans made in 2019 and new options available in 2020 are presenting opportunities for foreign asset managers to evaluate. The ability for asset managers to increase their access to this market could be a once in a lifetime opportunity for the industry – there is no other place in the world where trillions of dollars of new capital are up for grabs for asset managers.
Foreign majority ownership
One of the most noteworthy developments in recent years has been the China Securities Regulatory Commission (CSRC) paving the way for foreign asset managers to take a majority ownership position in their joint venture fund management companies (FMC). As part of the proposal, foreign ownership caps will be fully removed by 2021, which would allow foreign asset managers to take 100% ownership of the domestic FMC. In July 2019, the CSRC announced a series of policies to further open the financial sector. This included accelerating the timeline for removing FMC foreign ownership limits by one year to 2020. The CSRC subsequently clarified that effective April 1, 2020 FMC foreign ownership limits will be removed altogether.
Setting up business in China
One of the more popular options for foreign asset managers setting up businesses in China has been the Wholly Foreign Owned Enterprise (WFOE) route. As of October 2019, there were more than fifty investment WFOEs with two viable paths for structuring onshore products:
- Applying for a private fund management (PFM) license to set-up domestic private funds
- Applying for quota for the Qualified Domestic Limited Partnership (QDLP) scheme and launching domestic funds
WFOEs provide foreign asset managers the ability to set-up a domestic funds business, engage with regulators, establish servicing relationships, as well as understand the onshore distribution dynamics. For most asset managers, WFOEs have been a stepping stone in their strategy with the end goal of establishing a retail funds business through an FMC. This path became clearer in August 2019 when the Asset Management Association of China (AMAC) announced they will welcome PFM WFOEs to enter the China public fund industry. At this point, no further guidelines related to the conversion of a WFOE to an FMC have been announced, but it seems there is an option to simultaneously operate a PFM and FMC. There is some precedent where domestic PFMs have transitioned to FMCs, but it is not clear if the same requirements would be applicable to foreign asset managers going through this process.
Aligned with the removal of FMC foreign ownership limits, the expectation is for a group of existing PFM managers to apply for their FMC license in the first half of 2020. Pivoting from a PFM business that limits the managers to distribute products to qualified Chinese investors to an FMC business that provides access to the full retail market will come with new operational and distribution challenges.
As foreign players develop their public fund strategy, Chinese regulators are further evaluating areas where their market is different than international standards. An area of recent focus is the outsourcing of core operational tasks including the fund’s valuation, transfer agency, and financial reporting. Globally, it is common for these operational tasks to be outsourced to third-party providers, while in China, the FMC is responsible for these roles. As a result, FMCs have built out operational teams within their firms to perform NAV calculations and other operational responsibilities.
Outsourcing is beginning to make more progress in China. Aligned with foreign managers applying for FMCs, the regulator is evaluating a public fund outsourcing pilot for onshore banks and securities firms. This pilot would allow the outsourcing of certain operational tasks to third party firms. The rules for this pilot have yet to be announced, however, it is understood that both the outsourcing provider and the FMC would need to undergo on-site inspections to ensure the appropriate control environment is in place including, but not limited to, systems, experienced personnel, and oversight best practices. The announcement is expected to coincide with the first foreign managers receiving their FMC license subsequent to the removal of the foreign ownership limit in April 2020. Once the licenses are issued, the clock begins and managers will have six months to launch a product.
Currently in China, outsourcing is much more prevalent in the private funds space and those tasks are mostly performed by securities firms. For public funds, there is one example of an approved outsource arrangement, which was completed in 2017.
As we head into the next phase of the China market development, foreign asset managers will have a role to play. As highlighted by operational outsourcing, the domestic market operates in a manner that doesn’t follow other global markets. Flexibility and patience will be critical as foreign asset managers continue to develop their China strategy and expand their onshore footprint to capitalize on the expanding pool of capital that resides outside the asset management industry.
It is clear the sophistication of the market and investors continues to increase as the capital markets continue to open to foreign participation. The reform agenda will progress with a focus on shifting assets into the traditional channels away from the legacy bank wealth management products. Policies that are specific to inbound investment is also being updated to ease foreign access to the onshore equity and bond markets.
As we all know, change in China can happen rapidly and optionality is important for any onshore strategy.