CSRC plans funds industry shake-up with rule changes

A proposed easing of rules governing segregated accounts in China is expected to encourage a host of fund management companies (FMCs) to enter the arena and spur greater competition with hedge funds.

Segregated accounts are designed for high-net-worth individuals, who are required to commit at least Rmb1 million when subscribing. That compares with a minimum subscription of Rmb1,000 for mutual funds, which typically target retail investors.

Since January 1, 2008, FMCs in China have been allowed to raise funds from such clients whose assets are placed into a separate account, with a fund manager then investing the assets in the stock market. As a business it is akin to a hedge fund unit within an FMC.

At present, FMCs with segregated account assets are required to have more than two years’ experience in managing equity funds. Each company needs to have net assets of at least Rmb200 million and assets under management (AUM) of Rmb20 billion.

But the CSRC published new draft proposals recently – Pilot Measures for Fund Management Companies on the Management of Segregated Account Assets – that intend to change all that.

It is seeking to abolish the threshold requirements on FMCs and lower the AUM minimum requirements, as well as reduce the minimum initial asset level for each segregated account from Rmb50 million to Rmb30 million to attract more clients. Further, it is looking to raise the cap on the percentage that an individual stock can represent in a portfolio to 20%, from 10%.

This should enable fund managers to overweight a favoured stock to increase portfolio yield. Commodity futures, which are still seen as a high-risk investment, will also be added to the list of investible assets in a move designed to deepen the options available for clients.

The proposals also increase the frequency with which clients can subscribe to and exit from a segregated account fund from once a year to once a quarter, giving investors greater flexibility.

The regulator is due to collect feedback on its plans from FMCs and consider changes before implementing the measures. Jiaqing Yue, research head of fund investment consulting firm Howbuy, estimates that the process will take no longer than three months.

“The capability to manage segregated accounts doesn’t have much to do with FMCs’ net assets and AUM,” says Yue. “As long as the FMC has a capable fund manager, good corporate governance and prudent risk control, it should be allowed to manage assets of high-end clients.”

Effectively the CSRC is seeking to encourage more FMCs to tap into the asset management industry for high-end clients to spur competition with hedge funds, which have grown at a much faster pace.

This year has seen more than 400 hedge fund products issued in China, whereas little more than 100 products have been launched by FMCs. The market share of FMCs in the A-share market, in terms of market capitalisation, has shrunk from 28% in 2007 to less than 15% today.

Hong Liu, executive director in the entrusted investment department of Da Cheng FMC, notes that these new rules will make it easier for FMCs to launch segregated account products.

By the end of the third quarter there were 27 FMCs with less than Rmb20 billion in AUM as well as two new companies (BNY Mellon Western FMC and Zheshang FMC), all of which could apply to launch segregated account products under the new rules. From the start of 2008 to October 15 this year, the CSRC has approved just 35 FMCs to manage segregated accounts. 

The bulk of revenue and profit for FMCs still comes from mutual fund products rather than from segregated accounts.

“But the huge potential of the high-end asset management market is just waiting to be tapped,” says Yue, who believes some smaller FMCs could reap handsome profits and establish good reputations if their segregated account services perform well.

The proposals also offer the promise of greater flexibility in terms of fee-charging. The management fee of an FMC is usually 0.5% of AUM. The performance fee is up to 20% of net profits, provided the return is higher than a certain threshold (typically ranging from 5-10%).

“It is too early to predict how FMCs will change their fee structure”, notes Yue, pointing out that FMCs are still focused on building their client bases before they can consider launching different products with different fee structures.

He also raises the point that improvements to segregated funds could be a way to retain top staff, at a time when FMCs are increasingly seeing talent defect to hedge funds.

Another factor behind the regulator's move is that fund managers still face a large number of restrictions when managing mutual funds. “After switching from mutual funds to segregated accounts, [fund managers] can adopt a more flexible approach in making investment decisions,” says Howbuy analyst Linghua Zeng.

While Zeng does not anticipate mutual fund clients moving to the segregated accounts side, he does believe that the new wave of segregated account services will compete with hedge funds.

“At the end of the day, it’s the performance that counts,” says Zeng, who expects competition to increase in a gradual manner. “Investors will see how the new [segregated account] products render results.”

However, he notes that while the proposals grant fund managers more flexibility in allocating assets, they will also bring more pressure as they will no longer be able to blame restrictions for non-performance.