Mutual Recognition Scheme Could Make Hong Kong an Asset Management Hub

The Hong Kong Securities and Futures Commission (SFC) and China Securities Regulatory Commission (CSRC) are planning a mutual recognition scheme that would allow Hong Kong domiciled funds to be distributed into mainland China and vice versa, which could have huge consequences on the mutual fund landscape of the region.

According to a white paper from Brown Brothers Harriman, the mutual recognition scheme would lead to a low estimate of $146 billion invested in Hong Kong domiciled funds to a high estimate of $598 billion by 2018. Currently, UCITS funds are sold into Hong Kong, but under this new scheme, Hong Kong would be able to take more control of its fund industry and shift the balance of financial power.

“It would position Hong Kong to move from being focused on distribution to an asset management hub that has more substance and is focused on managing funds, creating unique products and everything that comes with that (administration and servicing of the funds),” says Bill Rosensweig, partner and head of Brown Brothers Harriman Hong Kong.

The scheme has such large potential in part because China’s current investment landscape lacks diversity and has a relatively small internal mutual fund industry.

“Right now there is tremendous wealth in China sitting in the form of bank deposits,” says Rosensweig. “If it stays that way forever, then there will be limited growth in the Chinese domestic fund industry or in the appetite for Hong Kong funds sold into China. But if you start making assumptions about Chinese investors investing more broadly for things like retirement, saving for their kids’ education, you name it—they will realize the need for geographical diversification outside of their home market.”

Currently, Chinese retail investors have $6.2 trillion sitting in cash deposits and $428 billion in Chinese domestic funds. BBH estimates that with the new platform, there will be a 1-2% shift away from cash deposits and a 4-20% shift away from existing mutual funds.

“If you look at different assumptions about mutual fund penetration rates in China, which are comparatively low now, you see that relatively small changes in the percentage of mutual fund penetration can lead to a lot of investable assets quite quickly,” says Rosensweig.

BBH also estimates that their will be a 20-70% shift away from UCITS funds into the mutual recognition platform as fund managers will find it easier and cheaper to set up a fund domiciled in Hong Kong to reach Chinese investors. Setting up a fund locally should also be more palatable for regulators rather than allowing foreign funds to be sold within.

“This Hong Kong platform will allow the best, most sophisticated global asset managers to have a product set that can be sold directly into China,” says Rosensweig. “So if you’re a regulator looking after the best interest of investors, this platform provides investors access to global investment expertise but in a structure that is controllable from a regulatory perspective.”

The mutual recognition scheme still requires regulatory approval, but there is a sense that this will be accomplished due to the shared connection of Hong Kong and China. While there are separate laws, “at the end of the day, it’s part of China, and so there’s a strong sense that cooperation will be successful because there aren’t the same political barriers to cross-border distribution that you might see in other Asian markets,” says Rosensweig.

“It’s quite a unique situation—Asia is quite fragmented,” he adds. “Each country has its own approach to its financial markets, and there is nothing like the common framework of UCITS that the EU has allowed for in Europe. Everyone in Asia likes the idea of cross-border products but wants their market to be the chosen domicile. Every market wants to become the Luxembourg of Asia, but what’s unique about Hong Kong is that it’s a gateway to China.”