China-Hong Kong Mutual Recognition
The Hong Kong Securities and Futures Commission (SFC) first announced its intention of working with the China Securities Regulatory Commission (CSRC) on establishing the Mutual Recognition scheme in November 2012, to allow eligible funds domiciled in Hong Kong to be distributed in mainland China and vice versa. The scheme was designed to strengthen local asset management capabilities in both mainland China and Hong Kong and to provide new opportunities for a wider distribution of funds.
Despite the fact that further agreement on the scope of funds, qualification criteria, application procedures, management of investment, disclosure, as well as investor protection was reached in January 2014, the initiative has taken a back seat. This is because it was largely overshadowed by the Shanghai-Hong Kong Stock Connect which went live in November 2014.
Fund managers now believe that the eagerly anticipated Mutual Recognition will be activated this year, as they were assured by the SFC’s Deputy CEO, that the launch of mutual recognition would follow that of Stock Connect. The SFC said in its 2015-2016 budget proposal that it is expecting “significant” practical and technical issues in the implementation phase of Mutual Recognition, which is “now at the final stage, subject to obtaining necessary approvals in the mainland”.
What is the relevance of China-Hong Kong Mutual Recognition and what are the potential opportunities for fund managers outside China and Hong Kong? Firstly, there is no doubt that China presents a material opportunity as it is a relatively untapped market. While China’s growth momentum has slowed, its absolute economic and wealth growth in mainland China remains strong and the underlying fundamental drivers of growth are sustainable. The longer-term trends show that China is significantly increasing its share of global financial flows.
Secondly, there were 2,009 SFC authorised funds as at December 2014 (SFC’s quarterly report), of which only 573 were domiciled in Hong Kong. The actual eligible funds on day 1 will be less than that figure, which gives room for new entrance to the market. Additionally, according to the former SFC deputy CEO and executive director of investment products, from about 600 funds domiciled in Hong Kong and China that qualify to participate in the upcoming mutual recognition scheme between the two markets, 100 are domiciled in Hong Kong versus 500 in mainland China (South China Morning Post Mar 2, 2015). These factors point to the potential opportunities for additional retail fund products.
So how can EU fund managers participate in this programme? The key requirement, at present, is to have Hong Kong domiciled funds. There are many European and US based leading international fund managers who launched a renminbi share class for locally domiciled funds last year. Some of the top players in the China space, also added more renminbi share class funds and diversified income products to its Hong Kong retail platform this year to meet the increasing investor demand. It is clear that many leading international fund managers are preparing for Mutual Recognition to go live.
Furthermore, we saw EU financial policy makers actively embracing this soon to be opened door to a new capital source. Discussions have been instigated with the CSRC about the potential extension of mutual recognition of mutual funds to “overseas markets”, i.e. go beyond China and Hong Kong. The CSRC also confirmed its plan subsequent to steadily promote mutual recognition of fund products between China and Hong Kong, as well as other overseas markets. This may represent a future opportunity for EU jurisdictions.
There are some comparisons between this new scheme and the Undertakings for Collective Investment in Transferable Securities (UCITS) where access to Hong Kong, one of the largest markets in Asia, is already established (approximately 85% of SFC-authorised funds in Hong Kong are UCITS domiciled in Ireland or Luxembourg), however, it is worth noting that UCITS funds do not have the same kind of accessibility to mainland China currently.
What is the outlook for UCITS in Asia? In our view, mutual recognition and the proposed Asian frameworks could have a significant impact on the role of UCITS in Asia. But we think that predictions of a decline are very wide of the mark. The ability to distribute UCITS around the world means that it will remain a platform of choice for firms in Asia and other regions helping their clients to invest globally. In the long term we expect UCITS to develop alongside – and perhaps in conjunction with - local and pan-Asian products. It follows that asset managers need to remain flexible over their use of UCITS in Asia.
Under the Mutual Recognition scheme, Hong Kong funds to be marketed on the mainland will have to receive registration from the CSRC and mainland funds will be subject to approval from Hong Kong’s SFC before sales could commence. It is therefore important for foreign managers to develop and maintain a good relationship with the local regulatory bodies.
Likewise, to implement an equivalent mutual recognition scheme with the EU, EU policymakers would need to allow mutual funds domiciled in China to be sold to European retail investors in order to gain the benefit of EU funds having access to Chinese investors. The open question is how EU policymakers will get comfortable with mainland China funds being marketed to EU retail investors?
In conclusion, with the introduction of Mutual Recognition to the market in 2015, we expect managers to take advantage of this newly opened channel for fund distribution and the expansion of Mutual Recognition to other jurisdictions will be an area for managers to watch.
Ronnie Griffin, Global Head of Trustee and Fiduciary Services, HSBC Securities Services
Patrick Wong, Head of China Sales and Business Development, HSBC Securities Services