Hong Kong extending reach as funds domicile

Hong Kong is expanding its influence as a funds hub, noted market observers, with one example the recent approval of an HK-domiciled product for sale to pension schemes in Chile.

The ChinaAMC CSI 300 Index exchange-traded fund was reportedly approved by the Chilean regulator in September, only the second HK-domiciled vehicle to get the green light there, after the Shares FTSE A50 China Index ETF in 2012.

“This shows the scope of Hong Kong’s ambition to become not just a regional domicile, but a global one,” said Sean Tuffy, head of regulatory intelligence at US-based custodian Brown Brothers Harriman.

This trend looks likely to gain momentum. For one thing, when the Hong Kong-China mutual recognition scheme is implemented – as is expected by the end of March – there will likely be a ratio governing flows, noted Tuffy. “Simply put, for every dollar raised in China mainland, you would have to have a dollar raised from somewhere else.”

He also pointed to the tighter constraints that US funds face on distribution, as compared to Hong Kong vehicles. US funds are sold to Chilean pensions but are not tax-efficient for investors, said Tuffy, adding that many firms will typically try to sell their EU Ucits funds instead.

US funds must distribute at least 90% of their income and capital gains. For many foreign investors, this distribution is taxed as income rather than capital gains. Other regimes, such as Hong Kong, don’t require such ongoing distribution, Tuffy noted. Instead, the income/capital gains is allowed to "roll-up" and is only realised when the investor redeems. Moreover, foreign investors in US funds are taxed on their investments.

Tuffy said such restrictions represent a missed opportunity for the US mutual fund industry, whose assets hits $15 trillion in the first quarter of 2014, according to investment industry body ICI Global.

“With large US asset managers present in many Asian countries, you could argue that it doesn’t matter,” he said. “But it deprives Asian investors of the full asset management capabilities of the US.” Many mid-sized US players don’t have the resources to branch out abroad, added Tuffy.

Though legislation has been drafted in the US to create a special fund entity to circumvent such hurdles, he said there is a lack of political will to pass it.

The Asia Region Funds Passport is a good opportunity for the US, as a member of Apec, to sell funds into Asia, he noted, although the US is very unlikely to join the ARFP in the near future.

The governments of Australia, Korea, New Zealand and Singapore agreed to establish a pilot for ARFP at the Apec finance ministers meeting in September 2013. Subsequently the Philippines and Thailand joined the consultation.

Looking to the year ahead, Tuffy echoed recent comments by RBC Investor & Treasury Services chief executive Harry Samuel, who warned that asset managers would be subject to rising regulatory scrutiny. The US’s Financial Stability Board is due to release this week its second consultation paper on this issue this year.

“I think [regulatory scrutiny is] going to be one of the big themes in 2015,” Tuffy said, adding that US regulators were using a “banking mindset for markets activity”.

Because of the size and growth of the asset management industry, some regulators argue that large fund houses can pose systemic risk, he added, hence their reporting burden is likely to rise.

In its 2014 annual report, The US Treasury’s Office of Financial Research included a section on where it saw gaps in the data that was provided by asset managers.

Moreover, since capital-adequacy rules such as Basel III have meant banks have had to reduce their bond inventories, investors can no longer rely on bank liquidity to support them to meet redemptions – a concern for both regulators and managers.

“That’s an unintended consequence of the regulator’s own making,” Tuffy said. “We’ve moved to a place where you don’t really have intermediaries in the bond market the way you used to.”

He said a lot of asset managers he had talked to had expressed concern over this issue, but so far no-one had yet thought of an answer.