Hong Kong: The Investment Fund Industry's Gateway to China
November 23, 2007
By Timothy Loh and Gavin Cumming
The QDII scheme enables PRC persons to invest in overseas financial products through QDII funds established by PRC banks and fund management companies. Limited in the types of investments which they can make, QDII funds may use SFC authorized funds to obtain global exposure. With applications to subscribe for 4 QDII investment funds reaching US billion in September and October, 2007 alone, global investment managers should not ignore the possibility of establishing an SFC authorized fund platform to access the growing PRC market.
TIMOTHY LOH | Financial Services & Law Review
Vol. 1 (2007) at p. 47
For investment managers around the world, the
race to capture market share in the People's Republic of China ("PRC") has begun. For anyone doubting the potential of
this emerging market for wealth management:
- in September and October, 2007, 4 investment funds
launched under the Qualified Domestic Institutional Investor ("QDII") scheme raised a
combined total of RMB 120 billion (approximately US$16 billion);
- all 4 issues were heavily oversubscribed, often
within the first day of the offer period; and
- aggregate actual subscription applications exceeded
RMB 280 billion (approximately US$37 billion), more than twice the QDII quota
allotted to these 4 funds.
QDII
The QDII scheme allocates foreign exchange
investment quotas to qualified domestic institutional investors. These investors may, in turn, accept
assets from PRC persons for investment and, subject to prescribed regulations,
invest those assets into overseas financial products.
Banks
The China Banking Regulatory Commission ("CBRC") was the first to
establish regulations for QDII, announcing on April 13, 2006 that qualified PRC
banks with QDII allocation would be permitted to invest in fixed income and
money market instruments. Since then, the CBRC has relaxed investment criteria, permitting in May, 2007
qualified PRC banks to invest assets of a
sponsored QDII fund in securities which are listed, and funds which are
authorized, in jurisdictions which have signed a Memorandum of Understanding ("MOU") with the CBRC.
The Hong Kong Securities and Futures Commission ("SFC") is currently the only
securities regulator with whom the CBRC has signed an MOU. As a result, SFC authorized funds now
serve as a crucial point of access for PRC banks with QDII quota wishing to
gain exposure to global equities markets.
Fund Management Companies
Not to be left out, on June 20, 2007, the China
Securities Regulatory Commission ("CSRC")
announced regulations allowing qualifying fund management companies with QDII
allocation to invest 100 per cent. of the net assets of a sponsored QDII fund
in securities which are listed, and funds which are authorized, in
jurisdictions whose regulators have signed an MOU with the CSRC.
As the SFC is one of the regulators with an MOU
with the CSRC, SFC authorized funds are eligible investments for QDII funds
established by qualifying PRC fund management companies.
GROWTH IN AUM
Following the announcements of the CBRC and the
CSRC earlier this year, retail interest in QDII products has been enormous. Against the backdrop of inflated
domestic stock markets and the need to diversify investments, investment funds
sponsored to take advantage of QDII allocations ("QDII funds") have been overwhelmed by
subscriptions. In September and
October this year alone, QDII funds have seen extraordinary investor demand.
China Southern Fund
A QDII fund sponsored by China Southern Fund
Management Co. received more than RMB 49 billion (approximately US$6.6 billion)
in subscriptions on the first day of its offer period. The fund's QDII initial quota was only
RMB 15 billion (approximately US$2 billion), although this was subsequently
increased to RMB 30 billion (approximately US$4 billion) due to the overwhelming
demand.
China AMC Fund
A QDII fund sponsored by China AMC received RMB 63
billion (approximately US$8.5 billion) in subscriptions, more than double QDII
quota which had been allocated to the fund.
Harvest Fund
A QDII fund sponsored by Harvest Fund Management Co.
received RMB 73.8 billion (approximately US$9.9 billion) in subscriptions,
against a QDII quota of RMB 30 billion (approximately US$4 billion).
China International Fund
A QDII fund sponsored by China International Fund
Management Co. received more than
RMB 100 billion (approximately US$13.32 billion) in subscriptions on the first
day of its offer period. The
fund's QDII quota was RMB 30 billion (approximately US$4 billion).
OPPORTUNITIES AHEAD
For investment managers outside of the PRC, the
QDII scheme presents opportunities both to advise on the management of the assets of a QDII
fund and to manage those assets by offering investment funds into which QDII
fund assets may be invested. In
the latter case, while the establishment of a distribution partnership presents its own issues, the establishment of an SFC authorized fund offers an
attractive point of entry into the PRC market.
SFC Funds Eligible as QDII Investments
As noted above, SFC authorized funds currently
serve as a crucial point of access for PRC banks with QDII quotas to obtain global
exposure to equities. Furthermore, SFC
authorized funds are eligible investments for fund management companies with
QDII quotas. Consequently, an SFC
authorized fund offers maximum flexibility in pursuing distribution channels in
the PRC.
SFC Funds Key to Untapped Bank QDII Quotas
To date, 21 PRC banks have received QDII
allocations, with a combined QDII quota of US$16.1 billion. A large proportion of this quota
remains unused.
SFC Funds Key To Distribution
PRC banks offer the widest retail distribution
network in the PRC with approximately 80 per cent. of all fund sales taking
place through bank branches.
Hong Kong Contingency
At the same time, Hong Kong investment funds
account for approximately 2.7 per cent. of the global investment market,
roughly comparable to Canada which trails at approximately 2.5 per cent. In the
first half of 2007, the Hong Kong investment funds industry registered gross
sales of US$20 billion and net sales of US$4 billion. As a result, SFC authorization brings with it not only
access to the PRC market but also a major and growing global funds market in
the form of Hong Kong.
SFC AUTHORIZATION
The SFC is receptive to a range of different fund
structures. There is no
requirement for the fund to be domiciled in Hong Kong. Indeed, as at the end of March 2007,
approximately 51 per cent. of SFC authorized funds were domiciled in Luxembourg,
19 per cent. in the Cayman Islands, 17 per cent. in Ireland and 5 per cent. in
Hong Kong.
To be authorized in Hong Kong, investment funds
should comply with the Code on Unit Trusts and Mutual Funds ("Mutual Fund Code") or, in
the case of specialized funds such as real estate investment trusts, other
applicable codes. Broadly,
to obtain authorization, overseas investment funds must satisfy the SFC on 2
matters:
- the suitability of their structural and operational
requirements and investment restrictions; and
- the suitability of their investment manager.
CORE STRUCTURE
In assessing the suitability of an investment
fund's structural and operational requirements and investment restrictions, the
SFC differentiates between investment funds domiciled in recognized
jurisdictions ("Recognized
Jurisdiction Schemes") and other investment funds.
Recognized Jurisdiction Schemes
Recognized Jurisdiction Schemes are investment
funds regulated in recognized jurisdictions, namely France, Germany, Guernsey,
Ireland, the Isle of Man, Jersey, Luxembourg, the United Kingdom and the United
States.
Recognized Jurisdiction Schemes are fast tracked
and are reviewed by the SFC on the basis that the investment fund's structural
and operational requirements and core investment restrictions already comply in
substance with the Mutual Fund Code.
However, the SFC expects recognized jurisdiction funds to comply in all
material aspects with the Mutual Fund Code and reserves the right to require
such compliance as a condition of authorization.
UCITS Investment Funds
UCITS investment funds regulated in Luxembourg,
Ireland or the United Kingdom form a special category of Recognized
Jurisdiction Schemes which may benefit from fast track authorization. However,
UCITS investment funds which use financial derivatives instruments for
investment purposes are subject to a higher degree of scrutiny.
Other Schemes
If an investment fund is not a Recognized
Jurisdiction Scheme, authorization generally requires full compliance with the
provisions of the Mutual Fund Code unless the SFC grants a waiver. For investment funds which have already
been commercialized, compliance with the Mutual Fund Code may present hurdles,
particularly where the existing constitutive documents do not comply substantially
with the Mutual Fund Code.
INVESTMENT MANAGER
The SFC generally requires that the investment
manager be based in a jurisdiction ("AIR
Jurisdiction") with an acceptable inspection regime (currently
Australia, France, Germany, Ireland, Hong Kong, Luxembourg, the United Kingdom
and the United States). However,
exemptions from this requirement may be granted on a case by case basis.
A sub-manager to whom the investment manager
delegates investment discretion, need not be based in an AIR Jurisdiction
provided that the sub-manager meets certain requirements, including that it be
within the same corporate group as the investment manager, that it have
internal controls commensurate with those expected under the Mutual Fund Code,
and that it be regulated in its jurisdiction of operation.
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