Hong Kong Seminar Suggests RQFII and Shanghai Stock Connect Are Complimentary While UCITS Remain More Attractive Than Asian Passports
Irish Government Committed to Chinese Fund Opportunity
This month we held another well attended event with over 150 people attending a seminar at Deloitte’s offices in Hong Kong.
His Excellency Paul Kavanagh, Ambassador of Ireland to China outlined how Ireland has emerged from economic turmoil to once again become the fastest growing economy in Europe. GDP expanded by 1.5% in Q2 2014 following an upwardly revised 2.8% expansion in Q1. The level of GDP is up 7.7 year to date. The pick-up in GDP growth reflects a rebound in hard-hit, domestic-facing sectors such as construction and retail and a better performance from the export sector after a poor 2013. The Ambassador explained how it is now possible that Irish GDP could expand by around 5% in 2014. He also emphasised the Irish government’s commitment to the development of the fund industry and Ireland’s partnership with Hong Kong and China as the preferred fund services platform partner.
This commitment is demonstrated by the establishment of a permanent Consulate in Hong Kong, with Consul General Peter Ryan also emphasising the importance of the fund industry to the development of Ireland and Hong Kong. IFIA CEO Pat Lardner presided over 4 panels on the topics of RQFII, Shanghai Stock Connect, Asian Passports and Distribution Strategies.
He also welcomed the Central Bank of Ireland’s new regulatory framework for funds to do loan origination. It is the first dedicated regulatory regime in the European Union for such "non bank" loan funds and comes under the umbrella of the EU's Alternative Investment Fund Managers Directive (AIFMD). During our panel discussions, State Street and Dillon Eustace said they are already seeing significant demand in this new product.
Christian MacManus, Partner at Deloitte noted the market leadership of Ireland in RQFII UCITS with CSOP, Harvest and E-Fund all having products in Ireland, with more products in development not only in equities, but also in bonds. Ko Tseng, Managing Director For E Fund in Hong Kong emphasised the usefulness of UCITS not only for raising money in Europe, but also back in Asia. The reason E Fund set up an RQFII UCITS was because the level of foreign participation in the A Share market at 2-3% of volumes is low compared to markets such as Taiwan and Korea where it is 20-30%.
The pent up demand for international investors to gain access to the A share market is clear. Patrick Wong, head of China Sales and Business Development for HSBC Securities said that this applies not only to equities, but also fixed interest, where the development of RQFII UCITS products is well advanced. Submissions for such products are already in process with the Central Bank of Ireland and we should expect product announcements soon, meaning Ireland would be the first domicile with commercial product launched in the Chinese interbank market, just as it was with ETFs. This interbank market represents a significant opportunity for international investors. Adding together the various centres, it is a $4.6trn market, making it the third largest in the world. Yields are attractive on a global basis, with government related bond yields of 3-5% available and corporate bond rates in the mid-teens.
Shanghai Stock Connect Seeing Huge Interest
The Shanghai Stock Connect programme has also generated huge interest in equities. Tae Yoo, Head of Client Business Development at the Hong Kong Stock Exchanged updated the audience on several aspects of the preparation process.
Stock Connect will allow investors with or without RQFII licences to buy in aggregate RMB13bn of Shanghai stocks per day. Mr Yoo explained that the RMB13bn level has to do with the daily funding capabilities of Hong Kong in RMB. Stock connect will allow hedge funds for example to access A shares without having to use banks’ QFII quotas. The bourse connect rules require an asset manager to transfer shares held in the custodian bank account to the broker the day before they execute a sell order. This T-1 rule was the subject of much debate during the seminar with Lisa O'Connor from Standard Chartered saying some clients are concerned about the impact on best execution. Mr Yoo said there will soon be announcements on tax, rights issues and short sales which he believes should all be pleasant surprises for investors. There will be a tax announcement close to the date of the launch of Stock Connect so that market participants know the exact tax requirements.
Naked shorts are not allowed, but covered shorts and SBL are close to being finalised with the CSRC and Shanghai Stock Exchange. These rules should be closer to the current rules of the SFC then the CSRC.
Philippa Allen, CEO of Compliance Asia and other panelists agreed that Stock Connect was not designed to compete with RQFII and in fact they could help stimulate demand. For example an ETF provider can now launch a CSI 300 index tracker product outside HK. They can allocate Shanghai trades to Stock Connect and use their RQFII quota for Shenzhen allowing them to create the fund. Paul Moloney from Dillon Eustace is seeing clients make such adjustments to their products. Lisa O'Connor from Standard Chartered said the intraday liquidity programme is a big step forward for Stock Connect. While RQFII and QFII are seeing great interest and the government is extending the location of quotas to places such as Korea and the volume too, many institutions still struggle to gain access to the market via these programmes. Patrick Wong believes these initiatives can pave the way for MSCI and FTSE to include China A shares in their main global indices.
Across all our panels, our experts were unanimous in the view that RQFII and Stock Connect are complimentary rather than competitors. Overall, a greater selection of products should stimulate overall awareness of China A share investment opportunities amongst international investors, driving more demand for all product types. While in Hong Kong the RQFII quota has already been used up, the pace of usage in places such as London has been slow, suggesting awareness and demand outside managers developing product in Asia is still nascent. Stock Connect has its own restrictions on daily quota and is not allowed for bonds or passive funds or ETFs, our panellists believe it is more useful for smaller funds and retail our panelists believe.
Asian Passports Little Risk to UCITS For Now
While Stock Connect should be a success, our panels were more skeptical on the market potential for Asian passports and their risk to the market leadership of UCITS products.
Brad Okita, Managing Director of Greater China for Neuberger Berman explained these passports aren’t that exciting for global managers, but could be more interesting for local managers and insurance companies. Setting up new fund families is costly and timely and funds already with established UCITS platforms such as Neuberger Berman in Ireland don’t see the benefit of also setting up new Asian passport families. Damian Barry, Senior Vice President of State Street, thinks the development of Asian passports is at least in its early stage. He believes the schemes so far are really only about mutual recognition and not real passports. If all these schemes could come together around the region, this could be good for investors, but it’s not happening. The ASEAN scheme which has been recently launched may help the Singapore fund management community, but UCITS are already widely sold in Singapore, Malyasia and Thailand, so its not clear why many funds would feel the need to use it. The current ASEAN passport is basic as it is only for retail and there are distribution complications. In smaller countries, where UCITS aren’t sold today, there could be some market share loss. However State Street client interest at present is low in ASEAN due to cost and scale considerations. UCITS are likely to remain the dominant retail product in Asia for the next decade Damian believes.
Stewart Aldcroft, Senior Advisor for Asian Fund Management at Citi, believes the APEC passport could be interesting, as it’s hard to sell a UCITS into Australia due to tax issues for example, but it’s too early in the process to know if this will be an interesting product. In the meantime firms continue to set up UCITS funds both in Korea and Thailand, with K Fund setting up a UCITS fund family recently despite these new passports.
The attractiveness of the HK China mutual recognition scheme is also unclear and is taking longer than expected. There are clear benefits for Hong Kong fund managers, but distribution is the issue when the programme finally gets underway, as this is dominated by the four big banks. Our panelists did not think online sales by the likes of Tencent could create a new distribution platform as fund selling in China is still a sales intensive and person to person process outside of money market funds. The required investment in staff means only the largest fund managers will be able to afford market participation.
Conor O'Mara, IFIA Representative, Hong Kong