Why firms should not expect mutual recognition lift-off

There are reasons to believe mutual recognition of funds between Hong Kong and mainland China will take longer to gain traction on both sides of the border than many expect, a leading lawyer in the region has warned.

Effie Vasilopoulos, a partner at law firm Sidley Austin – which recently scooped Law Firm of the Year at AsianInvestor’s industry awards ceremony – noted that Hong Kong’s securities regulator appeared to be far more advanced in its preparations for the cross-border scheme than its mainland counterpart.

Three areas she highlighted as in need of urgent clarification from the China Securities Regulatory Commission (CSRC) surrounded the approval process for eligible funds; clearing and transfer arrangements; and marketing rules in China. “All of these are fundamental to the operation of the scheme,” she noted.

While she acknowledged Hong Kong’s Securities and Futures Commission (SFC) had already outlined a number of specific requirements, she observed that mainland funds sold in Hong Kong would require a wrapper and that the SFC had included a loaded catch-all in its preconditions, to include “any areas that may have a significant impact on investors in Hong Kong”.

“That is a huge gate through which the SFC can mandate additional requirements on a case-by-case basis. Documentation is completely different in the mainland and there will be new disclosure standards for mainland funds offered here [in Hong Kong],” Vasilopoulos said, raising questions around the provisions for investor compensation in the event of fund fraud.

These factors led her to suspect mutual recognition would take longer to get off the ground than some anticipate. “Nothing ever happens quickly in a China context,” said Vasilopoulos.

While she praised the long lead-in time of mutual recognition, first unveiled by former SFC deputy CEO Alexa Lam in January 2013, she voiced surprise that the July 1 implementation was so close to its announcement date (May 22). “There are a lot of moving parts that need to be fleshed out,” she said.

At the end of last year there were about 100 Hong Kong-domiciled funds potentially eligible for inclusion in mutual recognition, compared with around 850 funds on the mainland.

Vasilopoulos said she expected many managers to adopt a wait-and-see approach. “This is not a get-rich-quick scheme. It will be interesting to see how many [of the 100 eligible] proceed on July 1.”

The area she identified as likely to cause the biggest headache for global managers was distribution, given the mainland market was dominated by big domestic banks. “Managers that we might think of internationally as well known will find it takes time to achieve scale in China,” she said.

Vasilopoulos noted that authorities in China would need to update the Securities Investment Funds Law around marketing and encourage more distribution channels to help the scheme prosper.

At present there are 32 independent fund sales institutions – the equivalent of IFAs – registered with the Asset Management Association of China, many of them third-party distributors with an online platform such as Shanghai-based Tian Tian Fund, Howbuy, Noah Upright and Shenzhen-based Tenyuan.

Due to the runaway fundraising success of money-market funds in China, onshore retail investors have become more comfortable with the concept of funds sold online. Additionally, Chinese securities firms have tended to focus more on distributing trust products than mutual funds.

“This is a good inflection point for authorities to reconsider what the new normal should look like in terms of distribution, a new chapter for first-time foreign participation in the market,” said Vasilopoulos.

Referencing the different treatment that products from various organisations receive on the mainland, overseen by different regulators, she added: “What we need in China are national laws that cover the industry in uniform fashion.”

Late last week the CSRC hosted a mutual recognition workshop in Shenzhen featuring 400 industry participants from both sides of the border to provide more information on the scheme.

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