Mutual fund recognition no silver bullet for Hong Kong

While initiatives like Mutual Recognition of Funds will help help Hong Kong become an international fund hub, the industry should not expect rapid results.

By Charles Gubert

Hong Kong’s efforts to become an international fund hub are progressing, but market participants must recognise that initiatives like Mutual Recognition of Funds (MRF) will not see instant results, and it may take time before flows are at significant levels.

MRF came to life in July 2015 and it allows fund managers in China and Hong Kong to sell their products into each other’s respective market. So far, large flows have not been forthcoming yet although the Hong Kong Securities and Futures Commission (SFC) is bullish MRF will succeed. The slow start is also a result of the delayed regulatory authorisations, which came about as China responded to market volatility. 

“MRF is a long-term project and markets have been difficult for China since the Asian market crash in 2015. However, capital outflows have normalised while the Renminbi has been stabilised. This should help bring about increased growth in terms of investors heading to the mainland,” said Christina Choi, executive director of investment products at the SFC, speaking at Fund Forum Asia in Hong Kong.

A paper by Standard Chartered – China’s Broadening Landscape – found funds in Hong Kong being sold to China accounted for $1.1 billion, of which two products by J.P. Morgan accounted for 90% of this sum total. “Inbound MRF – mainland funds sold in Hong Kong – has been nothing to write home about. In 2016, 25 funds were launched and a total of $14 million was raised by the end of the year,” read the Standard Chartered paper.

The MRF initiative is part of Hong Kong’s wider efforts to become a critical fund hub. In fact, a survey by Brown Brothers Harriman (BBH) in 2016 found 63% of respondents identified MRF as either critical or very important to Hong Kong’s ambition to become a global fund hub. At present, Hong Kong has a monopoly over MRF’s links with China, but the BBH study said just 20% expected this exclusivity to remain in place by 2025 with 33% stating it would lose this privileged access.

The same BBH study said 86% felt MRF would open up to other domiciles within five years. Educated guesswork would suggest that local markets such as Taiwan or Singapore will be next in line for MRF access but some hint more left-field candidates like the UK or Luxembourg could be beneficiaries. However, the UK has probably fallen out of favour due to Brexit uncertainty, while market experts doubt Luxembourg UCITS will be tolerated in China.

Hong Kong, however, announced its own MRF with Switzerland following successful negotiations between the SFC and FINMA. Choi highlighted local managers wanted the opportunity to access other markets including those in Europe. “We are in discussions with other European regulators to promote Hong Kong funds,” she said. 

The Hong Kong-Switzerland MRF is less restrictive than its mainland equivalent insofar as a wider range of fund structures and strategies can take advantage of the scheme, namely users of derivatives; money market funds; feeder funds and funds of funds. The rules oblige managers to appoint a local agent in the host jurisdiction, although experts in both countries have welcomed the scheme, pointing out it will bring significant capital raising benefits.

“The Hong Kong-Switzerland MRF will provide an excellent opportunity for local managers to raise money from the huge Swiss private banking market and high net worth investor (HNWI) community. It is a great opportunity for APAC managers with solid strategies and the right expertise, and MRF will streamline the vetting process for authorisation in both countries. The scheme extends market access to non-UCITS, which will increase investor choice in Hong Kong,” said Remi Toucheboeuf, head of asset and fund services product for Asia at BNP Paribas Securities Services.

Hong Kong – often viewed as an entry point for foreign investors to the mainland – has seen significant interest amid Chinese market reforms, including Stock Connect between the exchanges of Hong Kong and Shanghai and Shenzhen. A number of other liberalising measures in China will be felt firmly in Hong Kong, including the proposed ETF (exchange traded fund) Connect, the opening up of China’s interbank bond market (CIBM) and extension of quotas under the Renminbi Qualified Institutional Investor (RQFII) scheme.

“We are conscious that while Hong Kong has been distributing a lot of overseas fund, there has been growth in Hong Kong domiciled funds due to various openings like Renminbi internationalisation; RQFII; Stock Connect and CIBM. Hong Kong is in a good position to help investors tap opportunities,” said Choi.

Flows into China could see a spike if the MSCI finally includes the country’s A Shares on its benchmarks. China has been spurned three times now by MSCI for inclusion, mainly as a result of concerns about its capital controls.

It was reported that BlackRock was supporting A Share inclusion on the MSCI. Other providers including Bloomberg and FTSE Russell have incorporated China onto their indices but some attendees at Fund Forum Asia, however, are sceptical an MSCI upgrade will happen given the recent history and tightening of capital controls.