Now that sentiment has pulled back from the abyss the world appeared to be facing at the height of the financial crisis, fund management companies are entering a period of reviewing their business plans, in the light of a very different global environment. One key issue for any fund manager that has aspirations to be a global player, is the potential to enter the domestic fund management market in China. Joseph Mariathasan reports.
The news that Citic Securities, China’s largest listed securities brokerage was searching for investors to offload part of its 100% stake in China Asset Management Company, certainly highlighted the opportunities. However, to be able to develop a China entry strategy, as Edward Wang, a Director of China specialist Vermilion Partners points out, it is important to understand that financial services in China is a “Policy Sector”. The China Securities and Regulatory Commission (CSRC) is a very significant stakeholder in both domestic and foreign fund managers in China, having influence over many aspects of the business and direct control over the approval of new firms and funds and changes in shareholder structures. Indeed, it is purely because the CSRC is enforcing its regulation that no single shareholder should own more than 49% of a fund management company that Citic is being forced to sell part of its equity. Citic is reputed to be looking for a foreign partner as Chinese companies are allowed to hold up to 75% if foreign investors hold the remaining 25%.
During the last 5 years, the CSRC has adopted a policy of reform and development. The Chinese equity markets and industry players have responded and strengthened considerably. As the public followed the lead set by government and its policies, the AUM of the fund management industry grew rapidly, increasing by over 400% from June 2005 to June 2007. Over the same period the average funds under management grew from an uneconomic RMB8bn per firm to a healthier RMB33bn, reflecting the steep industry growth in AUM and relatively few new market entrants. Although there were many prospective market entrants, the CSRC put a virtual freeze on the establishment of new companies during the period. As a result, Wang explains, many prospective foreign entrants had no alternative but to consider investing in existing players: “Their attention focused on the top of the second tier as the top tier is widely held to be off-limits as a “Chinese solution” will typically be found. There was also significant encouragement to look at cleaning up the bottom tier.” But the global financial crisis started impacting China’s equity markets, which were already perceived to be in a bubble, in October 2007. Industry AUM which stood at a respectable RMB3.27trillion at the start of 2008 finished the year at around RMB1.65tr despite fairly limited retail redemptions. China’s equity price rebound in 2009 was met with a rise in retail redemptions as investors found themselves in a position to sell out and recoup previously unrealised losses. In the second quarter of 2009, AUM grew by less than 15% to reach RMB2.3 trillion despite the local index rising by an impressive 26.3%.
The regulators’ appetite for approving new fund management companies varies according to a range of factors says Wang, including: economic outlook; buoyancy of the securities markets; condition of existing fund management companies; and pressure from overseas governments lobbying on behalf of their own fund management companies. Previous downturns have proved to be successful entry points for overseas fund managers. However, Wang sees that the fall of once highly regarded Western financial institutions such as Lehman Brothers, Merrill Lynch and AIG means that the regulators are being extremely cautious in letting in any more foreign players, particularly now that the number of JVs exceeds the number of domestic firms. There are currently several new fund management companies awaiting approval to commence operations, with a gap of a year since the last approval was given. But with RMB10bn seen as the minimum amount of assets under management required to break even, the CSRC is concerned about introducing too much competition. Indeed, Wang sees that it is unlikely that more than 5 new fund management ventures will be approved this year.
Overall, Vermilion expects that the regulatory position will continue to ease over the medium term, though this will be gradual. In the near term it recommends that a prospective entrant should focus on either: Investing in an existing company; or seeking a partner with strong connections at Central Government level so that they could assist in facilitating the approval process. As Wang argues, due to the downside of dealing with legacy issues if an investment is made into an existing company, foreign fund managers may find it preferable to focus instead on establishing a new company. In terms of establishing a new JV, currently it is difficult, though not as difficult as it has been to gain approval. However, foreign fund managers will need a partner which can influence both the CSRC and the State Council. Accordingly, one can either: Partner with a powerful financial services business; or partner with a powerful non-financial services business which controls or has significant influence over a financial services firm that can be used to meet the technical requirement of having a domestic financial services firm as a shareholder in a JV.
The advantage of partnering with a powerful financial services business is that it is more likely to gain approval quickly and have the necessary infrastructure to assist in developing the business. The disadvantage is that they will be less willing to give up control and will be more likely to interfere in the management of the business. The converse may be true of a powerful non-financial services business. But ultimately, as Wang points out, the CSRC has to go to the State Council for the final approval and then considerations will be based on political and diplomatic considerations as much as economic. US companies with the implicit backing of the US Government may be able to wield more influence than European, although conversely, if relations take a downturn, they find themselves disadvantaged.