Mutual recognition seen as milestone, but queries raised

Senior figures from Hong Kong’s funds industry have expressed excitement and surprise at the landmark announcement of mutual recognition, which if successful is expected to result in the scheme’s expansion to other jurisdictions.

Certainly they have welcomed an initial macro quota system that will see Rmb300 billion ($48 billion) applied to mutual recognition on each side overall, rather than limits being imposed on single funds or fund companies.

Many see mutual recognition as a milestone to transform Hong Kong’s domestic funds landscape, which has hitherto been heavily reliant on offshore Ucits products (see the accompanying article on the SFC’s latest press conference).

But some flagged the prospect of a regulatory bottleneck as fund houses clamour to apply on the official launch day of July 1, while others disagreed over who was best placed to benefit and whether compromises were being made to protect Stock Connect.

“It has come more quickly than we thought, it’s a bit of a surprise there is no lead time,” said Mark Shipman, a partner at law firm Clifford Chance in Hong Kong, referring to last Friday’s announcement.

The Securities and Futures Commission (SFC) and the China Securities Regulatory Commission (CSRC) released a joint statement in mid-afternoon last Friday (May 22) to announce the long-awaited scheme would be launched on July 1, as reported.

The regulators said they would hold briefings to explain application procedures and noted the July 1 implementation date should allow firms sufficient time to prepare to understand market differences and “prudently assess the risks”.

Shipman described mutual recognition as Asia’s first realistic cross-border funds scheme. “People will use this, it will be practical,” he said. “My fear is that everyone will apply on July 1.”

He described it as a stepping stone to breaking down boundaries between China and international markets, arguing the scheme would be more beneficial to global houses due to demand and weight of numbers with China’s middle class.

Sally Wong, chief executive of the Hong Kong Investment Funds Association, described the scheme as a building block and cornerstone for something bigger.

She noted a number of fund houses had been setting up Hong Kong-domiciled products in preparation and said this would expand, changing the landscape.

“[Mutual recognition] will attract more international players to set up here, supporting Hong Kong’s asset management system,” she stated.

She argued there was latent demand for international exposure from the mainland side, and stressed that if everything ran smoothly with product launches and the scheme proved successful, it would likely be expanded.

“Based on success more jurisdictions will join in,” Wong stated. “With demographics and growth of the middle class, the next century is for Asia to develop its asset management industry. Hong Kong and China can take a leading position in what will be a gamechanger for the region.”

Lieven DeBruyne, chief executive at Schroder Investment Management in Hong Kong, said the firm planned to apply to launch on July 1. “We want to be one of the initial fund houses that will have qualified product in China,” he said.

While questioning whether multiple distribution agreements would be allowed, he also described the scheme as a gamechanger, depending on the uptake of funds and the development of China’s savings market.

He agreed bilateral expansion of the scheme was most likely, although he warned against any expectations of a regional passport at this stage.

“If mutual recognition is a success other markets could be included and the obvious one would be Taiwan,” he said. “But a regional fund passport would mean a unified fund structure. Now what we have is a regulatory agreement. There are different fund structures in its set-up.”

Fund houses on both sides of the border will await briefing notes and guidelines on the application process from the regulators, which will take place over the next few weeks.

Certainly there are outstanding questions to be resolved, including clarity on how mainland investors will be registered, noted Stewart Aldcroft, managing director at Citi Securities and Fund Services.

“I believe China Securities Clearing is offering to do this, but others may also,” he said. “The key issue is to find out what funds mainland investors are interested in.”

He also questioned what the registration and transfer agency terms would be, as well as the implications for cross-border fund marketing.

“Hong Kong investors have had access to a variety of China funds for some time. What will be new are smaller companies operating in specialist areas, so we could see a shake-up in the short term.”

But he stressed that mainland firms were in the box seat as they had prime access to the domestic market. “If they set up in Hong Kong to develop global products they already have branding on the mainland, which foreign companies would find it hard to compete with. Global firms have work to do to establish branding in China.”

One banking source who preferred to remain anonymous noted that rules stipulating funds sold to Hong Kong investors should not be predominantly investing in Hong Kong seemed to be a quid pro quo to protect Stock Connect.

“I’m wondering what compromises are being made to support mutual recognition while protecting Stock Connect,” he said. “It remains unclear how this plays out for Shenzhen Connect, where you might naturally expect ETF products to be created.”