Regulators in Hong Kong and mainland China have established a working group to discuss the development of a mutual recognition platform for the cross-border sale of collective investment funds. Catherine Simmons, State Street’s Head of Regulatory, Industry and Government Affairs in Asia Pacific, discusses the opportunities and challenges.
How significant is the proposal?
The mutual recognition regime would not cover all funds. Only funds that meet certain conditions, most of which have not been announced, would qualify. One condition appears to be that funds need to be domiciled in Hong Kong or mainland China. If agreed, the mutual recognition regime could fundamentally change the funds landscape in Hong Kong, the region and beyond. The regime may help to unlock substantial savings in the mainland China market and facilitate further foreign investment in China. Hong Kong would likely become a major regional funds center and possibly a global fund center. Foreign investors, particularly large institutional investors, might also be more comfortable investing in a China fund that is recognised by the HKSFC than going directly to the mainland which could result in increased global flows into Hong Kong.
What is the impact on UCITS?
It appears UCITS funds will not be part of the initiative — for the time being at least. A fund must be domiciled in Hong Kong or mainland China and must also be authorised by the SFC or China and operate in Hong Kong, which many take to mean managed in the city. And only certain funds will qualify. Since UCITS funds are normally domiciled in Luxembourg or Ireland, the local domicile conditions would appear to exclude them. In addition, while the HKSFC authorises some UCITS funds, the CSRC does not - posing an additional barrier for the inclusion of UCITS. There will still be a role for UCITS funds in Hong Kong and the broader region as the new funds will target a different sort of investor and probably offer a different sort of product. Achieving recognition for UCITS in China may be delayed as Chinese investors will have a broader range of investment options via the mutual recognition regime. Investment may also be directed away from some other UCITS funds in Asia.
The impact on Asian fund passporting proposals?
The Hong Kong-China mutual recognition regime could be a valuable way for Hong Kong to differentiate itself from others and attract fund management companies. The two ideas are not mutually exclusive. But Hong Kong’s focus on this initiative may delay its focus on a broader Asian initiative. The Hong Kong-China initiative might also set a precedent for others, so there could eventually be an ASEAN-China or Australia-China mutual recognition regime – reducing the perceived need for an Asian scheme. The extension of this scheme to others is a possibility. Offshore RMB initiatives began in Hong Kong and then broadened to others like Singapore, London and Taiwan. Major trading partners such as Australia and Brazil are next. What this scheme means for funds passporting all depends on what policymakers want to achieve.
What are the challenges?
Some of the important issues that need to be addressed are how the funds will be sold, the dispute resolution regime, different levels of investor sophistication, tax and capital controls in China. The funds, will probably be sold locally, given capital controls in China and the responsibility of local regulators for investor protection. While some Chinese investors currently travel to Hong Kong to buy investment products, many more would buy Hong Kong funds if they were offered locally in China. Selling on-shore in China is what makes this scheme potentially very attractive. For dispute resolution, the initiative might borrow from UCITs, where a local agent is responsible for helping to resolve disputes. Tax issues, such as capital gains and profits tax, will also need to be addressed.
What will happen to QFII and QDII?
Even with the mutual recognition of funds, there will be a role for QFII and RQFII, because they serve different purposes. QFII allows foreign companies to access the Chinese market to invest in A-shares and index futures, with a slant toward larger, institutional players. RQFII allows offshore RMB collected in Hong Kong to be sent back in to China and directly invested in the mainland equity and interbank bond market or into A-share ETFs listed in Hong Kong. The mutual recognition regime may divert some funds away from QDII by allowing mainland investors to use another mechanism to invest in overseas markets. But perhaps the mutual recognition regime will focus on one type of investor while the QDII regime focuses on another. More details on the mutual recognition regime are needed.