Taiwan fund managers to see little benefit from MoU

The long wait is over. After months of delays, an official memorandum of understanding (MoU) was at last signed this week by the China Securities Regulatory Commission and Taiwan's Financial Securities Commission.

The announcement was made with little fanfare in Beijing. The CSRC acknowledged the MoU with a two-paragraph notice on Tuesday, and the Chinese market expressed noted disinterest. Yet, across the strait, the announcement drove the Taiex to its latest high. Financial stocks in particular are through the roof in Taipei. At the market close at the end of last week, average price-earnings ratios for the Taiex climbed to a startling 134x.

By midday yesterday, the overall index was already touching 7773.19 points, close to double the 4089.93 level it fell to on November 20 last year.

Something is amiss, judging from the stark contrast between responses to the news from two sides of the straits. The excitement is truly palpable in Taipei where the normalisation of trade relations between China and Taiwan has been a long-term goal. For now, the banking and insurance industries are expected to be the main beneficiaries.

Little mention has been made by the FSC to date on exactly how the fund industry will benefit. That is understandable, because the unspoken truth is that the fund sector in Taipei will benefit little from the MoU -- for the foreseeable future at least. Unless we're talking about benefits derived from an unquantifiable boost in sentiment and thus improved stock valuations.

Remember, just earlier this year, the Taiwanese fund industry shed some 10% of total investment management staff. For years, industry leaders have talked of the need for the fund industry of 39 various houses to consolidate -- 17 of these are operating with an AUM of under $1 billion and little economies of scale to speak of, while offering strategies largely identical to those of the larger shops. To counter their limited growth opportunities, local fund houses have long talked of expanding beyond Taiwan to seek growth elsewhere.

And where better -- at least on paper -- than to play the markets where they can understand the language and culture: China?

The industry wants to invest in Chinese A-shares and to earn fees from Chinese asset managers by advising qualified domestic institutional investor (QDII) clients on buying Taiwanese assets. But neither of these scenarios will materialise any time soon.

The latest draft of qualified foreign institutional investor (QFII) regulations from the State Administration of Foreign Exchange (Safe) has stated that it will no longer tolerate approved QFII players renting out their forex quotas to others. To invest in A-shares, Taiwanese managers will need to queue up and wait for their own quotas.

The basic qualification needed to apply for a quota is an average AUM of $5 billion over the past three years. None in Taiwan hits that mark. Taiwanese firms, like other foreign managers, will need to convince Safe they are long-term and stable investors -- the criteria were set with the intention of limiting sudden fluxes of foreign hot money (after observing the painful lessons learned by Thailand during the Asian financial crisis).

The biggest Taiwanese manager, Polaris, had an AUM of NT$134.69 billion ($4.19 billion) as of September 30, almost $1 billion short of Safe's mark. Most of these assets are carried in Polaris's famous suite of exchange-traded funds, which have been flooded with foreign money punting on the Taiwan market's resurgence due to improved relations with China since March. (The Taiex has surged by some 70% in 2009.)

The fourth and fifth largest firms are Capital and Yuanta Funds with AUM of NT$124.30 billion ($3.87 billion) and NT$114.60 billion ($3.57 billion), respectively, at the end of the third quarter. The vast majority of local houses not operating in the top-tier have an even greater asset shortfall.

Apart from Fidelity, every foreign house operating in Taiwan has a China JV and QFII quotas and runs A-share strategies or products. For fund houses such as JP Morgan Asset Management and PCA Funds (Prudential's Taiwanese subsidiary), second and third in the market respectively, importing existing strategies into the Taiwan market is just another product to add to the local shelf. Getting the China touch is not such a big deal for them as it is for indigenous Taiwanese players starved of growth in the saturated local asset management market.

Barring a sudden political U-turn by the higher authorities to waive Safe's conditions for ensuring the stability of FX inflows and outflows, it is hard to see how Taiwanese fund managers will bypass these requirements.

Meanwhile, there is talk of Taiwanese fund houses playing adviser to mainland managers' QDII units. But again, there are strict rules that Taiwanese players will have to meet.

To fulfil such a role, a Taiwanese firm will need to have at least $10 billion worth of assets, run directly within its business entity, together with an impeccable track record and counterparty exposures approved by both Safe and the CSRC. Taiwanese managers used to spreading out businesses and assets over chains of financial holdings and special-purpose vehicles can very much forget that approach -- direct entities only need apply.

Furthermore, the CSRC and Safe are notably cautious on revealing the direction of QDII developments after the spectacular flop of the first generation of QDII funds. (See recent issues of AsianInvestor magazine on the CSRC's struggle even with approving active global funds or QDII ETFs.)

The CSRC is running a long backlog of regulatory approvals for JV deals signed from 2006, such as those between BNY Mellon and Western Securities, or Singapore's UOB and Ping An. With the biggest financial holding companies having struggled to recapitalise after the crisis, the prospect of Taiwanese firms entering the onshore China market via acquisitions of existing Chinese asset management firms, or via greenfield JV setups, is something that will happen much further down the line.

Over time, Chinese managers will invest in Taiwan. But perhaps this will not result in the flood of liquidity the Taiwanese fund industry is hoping for, and as took place in Hong Kong in the summer of 2007.

Taiwan's managers like citing Hong Kong as an example -- but Taiwan is not Hong Kong. For now, talk of cross-strait normalisation is all very well, but industry players will need to differentiate the stuff of realpolitik from real business.

(See AsianInvestor's December issue for industry leaders' take on the MoU and where Taiwan will go from here.)