Investor trust, not flows, will drive passport success: Khoury

Instilling investor confidence will dictate the success of Asia’s pending fund passport schemes, more than asset flows or number of participants, argues Paul Khoury of State Street.

“If regulators and participants stick to the rules and ensure a level playing field, and if they can identify and eliminate [fund] failures quickly, I think we will find ourselves in a very successful passporting environment,” said Khoury, the firm’s head of asset manager sector solutions for Asia Pacific.

He was speaking at AsianInvestor’s recent Art of Asset Management conference in Hong Kong during a Q&A session on fund passporting. The region has three proposed schemes pending: HK-China mutual recognition, Asean and Asian Region Fund Passport (ARFP).

Professionally Khoury speaks to asset management CEOs and CIOs to discuss the challenges they face and how they can navigate for growth. Fund passporting has made up a large part of his recent talks.

Khoury highlighted for the conference the key questions that managers were asking. Chief among them was how to grow distribution across Asia Pacific, given unanswered questions over how the three schemes will operate.

Finding out how to access flows was also foremost in managers’ minds, as well as understanding what the regulatory, compliance and governance issues might be.

“The questions they are grappling with are: when do they start to take positions in certain markets? When do they start to think about the types of product that will be successful? And when do they need to staff up and have people on the ground?”

Khoury suggested any scheme involving China would have the best chance of success from an asset flow perspective, given that China’s funds industry, including wealth management products, amounts to $600 billion. He concluded that HK-China mutual recognition would generate most flow.

At the same time he said the duopoly between Hong Kong and mainland China would not last forever, with Taiwan and Singapore potentially next in line to extend bilateral ties.

He argued that first-mover advantage in mutual recognition would be critical. “Whoever is able to deploy that passport quickly will be able to take the lion’s share of the market,” said Khoury.

It led to a question about how the three schemes could co-exist, and how long that might last. In an interactive poll of the audience, the most popular answer was more than five years, which given that ARFP is not due to be launched until 2016 would mean until 2021 at the earliest.

Khoury was more sceptical. “That is a positive message to suggest the three schemes can coexist for more than five years,” he said. “Perhaps a more realistic option is that there will be some consolidation from three schemes to two.”

He pointed to a potential merger between Asean and ARFP, which both have Singapore as a counterparty.

Khoury noted that Singapore’s current collective investment scheme is very much in line with the structure the Asean passporting region is seeking to provide, with a suggestion that Singapore could drive regulatory standardisation.

The chief challenge to the three schemes coexisting would be market fragmentation. “If they are going to coexist a number of structural changes need to occur,” he said.

“That is really where the negativity in the [passporting] debate seems to come through, people doubting whether the regulators – with markets at different stages of maturity – can come together to ensure the growth we have seen for the past 10 years in Asia Pacific remains.”

He forecast that the internet would play a significant role in facilitating fund passporting, meaning that managers needed to think about mechanisms for settlement and aggregation of information, as well as how they would provide clarity on currency, tax and valuation.

“Will regulators be able to instill confidence because they have been able to eliminate or quickly reduce schemes that failed quickly? I think by 2016 we will see funds flowing in a much more efficient way [than at the beginning].”

Khoury added that cost considerations would be key for managers given the need to establish locally domiciled businesses, as well as meet standards for compliance and regulation, monitoring, aggregation of data and work with trustees, custodians and administrators.

Interestingly, he noted at this early stage that managers seemed more concerned with ensuring they could keep their prices and products competitive. “It means that, at least from the outset, they are likely to absorb a lot of the costs themselves,” he said.

“As the products and markets around passporting start to mature, I think we will see the costs [re-routed] back to the investor. I think you will see a swinging pendulum [for costs] moving from investment manager to investor.”

Khoury acknowledged the most industry pessimism in Asia was reserved for the ARFP scheme, but he countered: “The types of structures and products and the underlying assets that Australia can provide in terms of mining, banking and telecom assets, can the region afford not to have those types of assets as well?”