Financial centres of Asia growing in power
Hong Kong’s financial success has been closely tied to the economic fortunes and regulatory whims of China for decades, but now that relationship is about to come into sharper focus for the investment funds industry, rewarding Hong Kong’s asset managers with a mammoth new market opportunity.
Hong Kong’s government, led by the Securities and Futures Commission (SFC), is aiming for a mutual recognition deal with mainland China’s regulators. This would mean that qualified SFC-authorised funds domiciled in and operating from Hong Kong and qualified Mainland funds could obtain authorisation and be sold directly in the other’s market.
It’s an opportunity of enormous proportions for Hong Kong’s $1.1trn fund management industry, and one that could give it a significant edge over other fund markets such as Singapore and Australia competing to become a regional fund centre.
PwC says a Hong Kong-domiciled fund generates 4.6 support jobs for every analyst or portfolio management position it creates, assuming the fund services would also be based in Hong Kong. If all of Hong Kong’s authorised funds were to be domiciled in the SAR, it would generate US$3.5 billion in support service provider fees, contributing 1.5% growth to the economy.
At the end of 2012 only 306, or 1.7%, of the 1,842 SFC-authorised funds were domiciled in Hong Kong. Most funds are domiciled in Europe or the Cayman Islands, and are sold in Hong Kong under the UCITS passport.
Until a mutual recognition deal with China appeared on the radar, the only reason a fund manager would choose to domicile a fund in Hong Kong rather than in more popular and scaleable UCITs jurisdictions was to tap into Hong Kong’s Mandatory Provident Fund.
Fund service providers say that using the UCITs platform in Hong Kong can mean additional regulatory work, as the fund must pass muster in both Europe and Hong Kong. UCITs provides international portability and scale, but it does erode autonomy for foreign funds. This has led to a slow trickle of funds choosing to domicile in Hong Kong, but a mutual recognition deal is expected to open the floodgates.
“Mutual recognition between China and Hong Kong would further polarize the Asian landscape through access to Mainland China,” says Mark McCombe, BlackRock’s chairman in Asia Pacific. “However, further changes are needed to make Hong Kong a stronger candidate to become Asia’s preeminent international fund centre, though the contemplated steps proposed in this year’s Hong Kong Budget are definitely a step in the right direction to achieve Hong Kong domiciled vehicles.”
Getting ready for change
Industry players are starting to get into position for change. Northern Trust in April announced it is expanding its fund administration and custody capabilities to support locally domiciled Hong Kong funds, including exchange-traded funds, as well as other regional investment funds. Northern Trust will provide global sub-custody and fund administration services, including fund accounting and shareholder services.
“We recognise the significant demand from investors, asset managers and regulators for local products in the Hong Kong and greater China markets,” says Camie West, head of global fund services in Asia. “This service offering provides our asset manager clients with improved access to these markets through locally domiciled vehicles, coupled with Northern Trust’s fund administration expertise and proven global infrastructure.”
Australia, Singapore and Hong Kong are all natural regional centers for Asia ex-Japan, given the continued currency restrictions that apply in Shanghai and the rest of China.
“Australia has had that opportunity for many years and hasn’t grasped it,” says Alan Naughton, global product head for investors and intermediaries and transaction banking at Standard Chartered. “The fund industry in Australia is extremely deep and sophisticated, very highly developed off the back of the superannuation industry. But it has not historically exported its funds.”
Singapore doesn’t offer much that Hong Kong doesn’t also have, and it is on weaker footing when it comes to accessing China. That puts Hong Kong in a unique position, says Margaret Harwood-Jones, also with Standard Chartered.
“It will put them [Hong Kong] in a different position in global competition,” Harwood-Jones says. “There is mutualisation and collaboration between smaller areas, and Greater China is certainly the one that is being talked about the most. But I’m not sure even with that success that it would displace the need for the world-wide brand of UCITS, because that’s the only thing that the worldwide fund industry has. More and more people are saying there is a place for both, a long term co-existence.”
Naughton points to agreements among the world’s leading Islamic finance centres as an example where regional mutual recognition can be beneficial to the countries involved without having a significant broader global impact.
The Gulf Cooperation Council launched a common market in 2008, removing all barriers to cross country investment and services trade. In addition, in 2007 the Dubai Financial Services Authority (DFSA) entered into a mutual recognition agreement to facilitate cross border distribution of Islamic investment products with the Securities Commission of Malaysia (SC).
“I don’t know that the market there is particularly deep as a result. It is a modest sized mutual fund industry, largely cantered around Bahrain,” Naughton says.
Marie-Anne Kong, asset management leader for PwC in Hong Kong, says Hong Kong needs to examine its tax laws to make sure they are competitive with other fund centres. “More focus is needed on the products and structures part of the industry. We feel this is the area that is Hong Kong’s weak link.”
In announcing its 2013-14 budget the Hong Kong government said it plans to amend and extend the current offshore fund exemption to private equity funds, so that they qualify for the same tax exemption as other offshore funds. The government said it will also review the legal, tax, and regulatory framework to allow open-ended investment companies to be domiciled in Hong Kong. Currently investment funds domiciled in Hong Kong must be structured as unit trusts.
So far, Hong Kong has done most of the talking. Beijing has been largely quiet on the matter, not offering insights on where Mainland regulators and the industry are in the process.
Another big question is how regulators will judge eligibility, with the industry speculating it could be based on how long the fund has already been domiciled and sold in Hong Kong, how long the manager’s track record is, or even what the fund strategy is. These questions, along with many others, are waiting to be answered.