HK-China recognition: a Christmas present for HK?

The formal signing of the HK-China mutual recognition scheme will likely be a Christmas present for Hong Kong, forecasts Stewart Aldcroft, senior adviser and managing director at Citi.

“I said back in January [when the scheme was first announced] I thought it would be a Christmas present for Hong Kong. I still think [this is the case], but if not, it will be closer to the Chinese New Year,” he suggests.

Aldcroft’s call a year ago may prove to be prescient. Last week, Alexa Lam, deputy CEO of the Securities and Futures Commission (SFC), told a forum that the regulators involved are in the “final stretch of the journey”.

The next step will be ceremonial, with a formal signing between the SFC and the China Securities  Regulatory Commission (CSRC).

After that, Citi believes it won’t take long before funds are transferred cross-border. Catherine Simmons, managing director and head of government affairs for Asia Pacific at Citi, points to the rapid rollout of the renminbi qualified foreign institutional investor (RQFII) scheme, which only took two-to-three months to get off the ground.

“I’d like to believe [money will begin flowing] by June,” Aldcroft says.

Yet questions remain over how many funds will be able to participate in the HK-China mutual recognition scheme once it is launched.

In order to qualify, funds must be Hong Kong-domiciled and registered with the SFC and approved by the China Securities and Regulatory Commission (CSRC).

At least to begin with, mandatory Provident Fund (MPF), Ucits, Cayman or other funds will not be allowed to participate, nor will complicated strategies using derivatives for example. And funds with trustees that incorporate derivatives will not be considered either.

There is also a minimum AUM requirement – in China, funds must have at least Rmb200 million ($33 million) and 200 investors – which will weed out a fair number of funds, Aldcroft notes. “There really aren’t that many [that meet the criteria in Hong Kong],” Aldcroft says. “Maybe 120 or 150.”

But he maintains this won’t be the case for long. There has been an uptick in fund houses with Cayman- or Bermuda-domiciled funds seeking to re-domicile product to Hong Kong in 2013, and Aldcroft expects the trend to continue next year.

“Many global firms are seeking to prepare themselves by domiciling funds in Hong Kong, as the Hong Kong SFC has said this will be a requirement,” Citi noted in a report. “There is speculation that local management of funds will also be required and so firms are considering how they might meet this requirement.

“As the other requirements are not yet known, some firms are taking a guess in terms of assets and asset manager requirements, based on other China entry programmes such as QFII and QDII.”

It’s an about-turn from 20 years ago, when fund houses in Hong Kong increasingly sought to register and domicile their funds in the Cayman Islands, Virgin Islands and Bermuda, because of uncertainty over what would happen to Hong Kong post-handover, he notes.

“Today we have the opposite situation. People want to be here in order to be part of China,” Aldcroft observed. “The types of funds considered will be simple. Single country equities, regional equities or global equities. They won’t be using derivatives. Complicated product simply won’t work.”

There may also be some sector funds in the cross-border scheme, with Aldcroft pointing to consumer stocks as a likely choice for fund houses, particularly those looking to sell to Chinese retail investors. “Go to the IFC [mall] or Pacific Place [in Hong Kong]. Chinese shoppers are pouring into brand names."

Distribution will be an issue once the scheme gets up and running. At present distribution in the mainland is dominated by the big four banks – Agricultural Bank of China, Bank of China, China Construction Bank and Industrial and Commercial Bank of China, which account for 70% of fund sales in the country.

Access to these banks is difficult for foreign fund managers and smaller firms, and it’s still unclear if other fund distributors will be allowed to participate.

As such, this may open opportunities for online distribution, which should offer foreign firms more chances to access mainland investors.

“Online distribution has been positively encouraged by the CSRC,” Aldcroft notes. “[It’s a] fantastic opportunity for Hong Kong managers wanting to access the China market.”

The proposed development of two other cross-border schemes this year –the Asean scheme and the Asia Region Funds Passport – have along with HK-China recognition brought Ucits’ future in the region into question. Asian CEOs suggestd recently that Ucits’ days were numbered, arguing that investors in the region will prefer locally domiciled product.

But Citi disagrees. “Ucits will not have access to these schemes but that doesn’t mean it’s the end of Ucits. They’ll still be used in the region,” Simmons says. “They have access [to retail investors] in Hong Kong, Taiwan and Singapore, but would still love to access China, India and Indonesia.”

Retail investors in Asia will invest in Ucits for global exposure, Simmons argues. “Ucits are not dead. They will still live. They will just serve a different function.”