Building Blocks

Draft legislation in China will allow for foreign fund management companies to enter joint ventures with domestic securities companies or their asset management subsidiaries for up to 49% of ownership after three years. The goal is to establish an open-ended mutual funds industry, but turning the draft legislation to law hinges upon China’s accession to the World Trade Organization. Currently, China has a booming $6-7 billion closed-end mutual funds market that remains closed to foreigners.

Last week, Dresdner RCM Global Investors signed a technical services agreement in Shanghai with Guotai Junan Securities. Bruce Kho, managing director-Asia at Dresdner RCM (pictured right), and Mark Konyn, director and head of marketing for Asia (pictured left), met with FinanceAsia to discuss the building of a fund management industry in the People’s Republic of China.

Q: How long have you been dealing with Guotai?

Mark Konyn: Dresdner RCM’s first contact with them was in 1996 through initial discussions via Frankfurt. We in Hong Kong made our own trips to Shanghai, and formalized the relationship with a technical cooperation agreement in 1997. Things have moved on and it made sense to frame this agreement in context with what’s expected from the new legislation. We’ve dusted it down, refined it and made it consistent with what we expect. We do believe this will result in a joint venture, once the regulations are available. We needed to replace what we had in place before and make it quite clear that we’re in the running and that we plan to be significant players.

Q: What had to change in the original agreement?

Konyn: First, we had to recognize the current view, which is that at the outset when joint ventures are allowed, a foreign player can have up to a third of the ownership. If you don’t have a services agreement in place when you roll forward into a joint venture, if you haven’t already confirmed some of these details, there’s a risk. There’s a lot to confirm up front. We talked about knowledge transfer, risk management and a sound foundation of fund administration, which is critical for the success of any joint venture. We’ve all got our eyes on the market of open-ended funds.

Bruce Kho: The Chinese side is very keen on ideas such as risk management, the information technology side, the funds operation side. These are the less glamourous parts of the business.

Q: Specialized areas such as trust administration don’t appear to be clearly defined in China. What form will these processes take under joint ventures?

Kho: It’s the next thing we have to discuss. We’re somewhat hampered by the fact that the rules aren’t out officially by [China Securities Regulatory Commission].

Konyn: Closed-end funds are a different animal than open-ended funds. With closed-end funds, the fund management company doesn’t have to deal with regular inflows and outflows, and you don’t have to administer the shareholder registration - everything is run just like another share on the exchange, it’s very simple. So far in China, no foreigners have been involved. It’s only for A-share investors.

When you move into the open-ended funds environment it becomes more detailed and complex. When you take the money from shareholders, you promise them they can get their money back. How does that mechanism work; how do they make their representation to get their money back? All those details are actually much more complicated. As Bruce has said, that’s the next area we have to look at. We have a lot of knowledge within our organization and that’s what we’re going to bring to bear on this relationship through the technical services agreement, and following on from that through the joint venture. To me, the joint venture really becomes an ongoing business once we start getting involved in that. Of course there are other pools of institutional money that will be available, but the real guts of it is the open-ended fund opportunity, because it’s going to be big.

Kho: The CSRC is very keen to learn from experience from other parts of the world. They’ve looked at various models around the world, not just Hong Kong, to come up with the right structure for their market.

Konyn: The authorities want to make sure the administration functions well. And it has to function well from day one. It’s not the sort of thing you can improve upon, it has to reach a minimum standard at the outset. At our signing ceremony there was a representative from the Shanghai branch of CSRC. He got up and made a formal speech, congratulating both parties on the signing, and really affirming it’s important there’s this input from international companies.

Kho: He even said this is the first agreement between a foreigner and a local securities company. All the other technical services agreements have been signed between foreign fund managers and domestic asset-management subsidiaries.

Q: What’s the benefit for dealing directly with the securities company parent?

Konyn: For us, clearly the benefit is brand distribution capability. The fact that our arrangement is directly with the securities company gives us a lot of confidence. We’ve got the buy-in from the very top of the organization. When it comes time to offer products, that signal has to come from the very top of the company.

Kho: They have 118 branches – that’s very important.

Q: Will the JV cater to institutional or retail customers?

Kho: I would say it’s both.

Konyn: It depends on how the savings industry and capital markets develop on the Mainland. The overriding objective from the authorities’ point of view is how to channel domestic savings to the capital market in the most efficient way. It may be in the near term that it requires other institutions to help gather those assets before moving them into open-ended fund structures. Or maybe securities companies such as Guotai are effective at tapping into that personal wealth and bringing personal savings into the funds directly themselves. At this stage, we’re keeping an open mind and our partners are keeping an open mind of how that industry develops. In the longer term, everyone’s got the vision that it develops into a full-blown mutual fund environment. But there’s no guarantee. Look at Japan – it’s been very difficult to build that business there.

Kho: I don’t think we can answer every issue you raise. We just have to look at the response to closed-end funds – it’s been very good.

Konyn: It’s all a domestic business. Last year they were all trading on 100% premiums because they were viewed as future Epos. The premiums have come down this year but it shows there’s a lot of savings money chasing too few investment opportunities. That’s why development of an open-ended funds industry is critical to the development of the capital markets.

Q: How well are present rules and regulations monitored and enforced?

Kho: The people that we’ve met at CSRC are really very up front, real professionals. I do believe when they consider these kind of reforms they consider models all around the world. I am very confident about the way the regulators are moving. They’ve come a long way.

Q: What’s happening now concerning the regulators of most interest?

Konyn: The actual framework for the open-ended funds themselves. There’s been some draft work. Registration and policing of the fund industry - we’ll be very keen to see who the players are when the final versions are available. But even more, we want to see the final drafts on funds side because that will really dictate what you can offer the market. It will govern how you operate.

Q: The situation seems to be in flux. How do you establish yourself in such a market?

Kho: I would say that your point about things being in a state of flux is not the case. The regulators know what they want and have done a lot of research. The drafts are all there, waiting for WTO. Most people expect WTO will be finalized this year. Irrespective of whether they can finalize WTO or not, I do believe from reading between the lines and talking to the authorities, there is no turning back as far as these changes are concerned. They will come out with these reforms, as well as eventually pension reforms too. They are working on that at the same time.

Q: Do you have any sense of whether pension money will find its way to the mutual fund industry?

Konyn: At this stage we don’t know where or how the funds are going to flow. Clearly, what you need to do to position yourself is be present in all segments of the industry to benefit from those reforms when they’re enacted.

Kho: I think China will want to look at the success of open-ended funds first. There has to be a proven vehicle before you put funds in it. What will happen first is they will invite foreign fund managers to help manage some of their pensions. That will come earlier than the 401(k) type of products.

Q: What are the key institutions that have pension money in China – where will you pitch for mandates?

Konyn: It’s private sector pension funds. There are pools of money within various authorities but basically pension liabilities are funded out of current budgetary spending. That’s a big issue, how to fund the liabilities, particularly when you start to privatize the state-owned industries or rationalize the SOEs. They’re very much dependent upon the government for their welfare benefits. If they move toward the private sector they have to give up those benefits. The challenge isn’t so much how to manage the pension assets but how to accumulate the assets. If you look at what else has been done in this region, Taiwan is a good example. For many years, going back five years, the civil service, for example, has been accumulating funding for pension liabilities to the tune of $1 billion a year.

Kho: It shows that these kinds of problems in China aren’t unique. They happen everywhere. You need to take your hat off to China – they’re looking to this in a longer-term way than other countries in Asia. China is now a very interesting country. It’s moving very fast with all sorts of reforms.

Q: How will you make a profitable business in China? 

Kho: Mutual funds. For the first few years we can have up to 49% of a joint venture, so in terms of distribution and so on we have to rely a lot on our local partner. That’s why it’s important to pick the right partner. We like Guotai Securities. They have a good name, good distribution power. We’ve worked closely with them for a number of years now. We’re confident we can get that right.

Q: Is there any model for management fees?

Kho: I heard for closed-end mutual fund companies it’s in the region of 1%-1.5%, with a sales charge of 2%.

Q: With that as a rule of thumb, how long is it before you can make a profit?

Kho: To be very frank, we haven’t got to that stage. We just believe with the right partner, with good distribution, with this new market, if we look at what has happened with the closed-end funds volume we can have a very good business. Those who start earlier should be in a good position to get the business.

Q: It’s clear how much of a joint venture you can own, and what the partners want to get out of it. But in terms of making decisions, who’s in charge?

Kho: We have yet to finalize these kind of details. The first thing we finalized was the technical cooperation agreement [in 1997], which was the most important thing. We need the partner to be very happy. We have talked with them for many years now; we have a good relationship. Which means the next step is easier to handle.