China's new pension rules set to rekindle MRF interest

China has decided that voluntary pension products sold in the mass market will use the funds of funds (FOFs) format, and can include approved Hong Kong-domiciled funds as underlying vehicles.

The development looks set to reignite the thus-far muted interest of Hong Kong fund managers in selling funds through the mutual recognition of funds (MRF) scheme.

The trial rules on the pension securities investment fund, which were announced by the China Securities Regulatory Commission (CSRC) on March 2, confirm the FOFs structure and eligibility of MRF funds to help develop the mainland's pension market, even as the rules on the underlying funds were relaxed compared with the consultation paper.

"This is a positive for asset managers with Hong Kong-domiciled funds to revisit MRF," Sally Wong, chief executive of Hong Kong Investment Fund Association (HKIFA), told AsianInvestor.

Market participants in Hong Kong were highly enthusiastic about the MRF scheme when it was first launched in 2015 because of the potential presented by selling offshore funds to Chinese investors. But the enthusiasm waned after the fund houses discovered that the regulatory process for fund approval was long and uncertain, she added.

Fourteen Hong Kong-domiciled funds are have applied to become MRF funds. Some submitted their applications in 2015 but have yet to be approved, according to the CSRC.

MACRO DRIVE

While MRF funds can help mainland investors gain offshore market exposure, the regulator has been slow to approve such funds as a depreciation of the renminbi led to a surge in capital outflow, Rex Lo, managing director of business development at BEA Union Investment, told AsianInvestor. BEA's only two MRF funds were approved in the past four months, nearly two and a half years after the fund house applied.

The Hong Kong Securities Futures Commission (SFC) authorised 50 mainland funds (southbound funds) as of December 2017, while the CSRC had approved 10 Hong Kong funds (northbound funds), according to SFC’s latest quarterly report. (The 10 northbound funds do not include BEA Union Investment’ MRF fund approved in March)

Chinese investments into northbound MRFs led to a capital outflow of Rmb12.3 billion ($1.94 billion) between January 2016 and January 2018, statistics from the State Administration of Foreign Exchange (SAFE) shows. 

However, the desire of the Chinese government to promote more extensive and sophisticated retirement savings system could revitalise the appeal of northbound MRFs and could accelerate their approval, hope fund house executives.

The CSRC’s new rules recognise the benefits of using MRF funds to help Chinese pensioners diversify their investments, and given improvements on the macroeconomic front and a stronger renminbi, the regulator could approve more northbound MRFs this year. 

Capital outflows from China have stabilised since the fourth quarter last year because the yuan has strengthened, Xia Le, Hong Kong-based chief economist for Asia at Banco Bilbao Vizcaya Argentaria, told AsianInvestor. 

Authorities have also implemented stricter control to prevent capital outflow through unregulated channels. For instance, mainlanders are now subject to an upper limit when they use their bank cards to buy insurance policies in Hong Kong, he said.

“When illegal [capital outflow activities] are curbed, legal channels can be relaxed … There can be a breakthrough in MRF [northbound approvals] this year,” Le said.

UNDERLYING FUNDS

AsianInvestor reported in November last year that China's consultation paper on rules related to voluntary pension products look set to heavily promote FOFs as a key structure, which enables small investors to gain exposure to a broader array of assets via different funds with fewer risks.

There are currently nine FOFs in China, six of which were granted CSRC approval in September last year. Lately, Zhongrong, CIFM—a joint venture between JP Morgan and Shanghai International Trust—and First Seafront successfully registered their FOFs on March 6.

While draft rules in the consultation paper are largely the same as the newly released ones, the regulator is less stringent about the underlying funds in the latest version of the paper.

THIRD PILLAR

In China's pension system, the first pillar of retirement (social security) is run by the government, the second pillar is mainly made up of corporates’ annuities schemes, while the third pillar is built from personal savings and voluntary individual contributions to pension plans.

However, China over-relies on the first pillar while the third pillar has yet to be created. As of end 2017, the first pillar had assets of Rmb4.6 trillion, and the second pillar had accumulated nearly Rmb1.3 trillion, according to the Ministry of Human Resources and Social Security (MHRSS).

In early February, the MHRSS and the Ministry of Finance in China, together with the National Development and Reform Commission, the tax authority, the central bank and the three financial regulators, announced that they had established a work leading group to start building the third pillar, without further elaboration.

There are only 10 MRF-approved funds currently sold in the mainland, which is not not enough to satisfy the huge pension market in China. If the regulator can relax the rules on northbound MRF fund approval, it can help develop the pension FOFs market, Lo of BEA said.