By: Chris Schmutz
Over the past year, China has experienced a number of changes that open new opportunities for Chinese investors. These are important opportunities to be aware of since they’re driving how Chinese investors are using their assets, so I thought a recap of the latest developments would be helpful.
Last year China announced liberalizing measures that expose large foreign international investors (central banks, sovereign wealth funds [SWFs], financial organizations) to its $5.4 trillion interbank bond market (CIBM). This allows these investors to trade domestic bonds and forward contracts, bond repurchase agreements, and interest rate swaps without having to obtain pre-approval from the People’s Bank of China (PBOC) or complete time-consuming registration forms. The measures have now been extended to other financial institutions including asset managers, commercial banks, and securities firms, but not to hedge funds. This facilitates enhanced international investor interest in China at a crucial juncture.
Mutual Recognition of Funds (MRF) also launched in 2015. It allows for Hong Kong managers to sell their vehicles to mainland retail investors and for Chinese asset managers to sell into Hong Kong. Before MRF, if they wanted to distribute into China, foreign asset managers were required to enter into an equity partnership with a mainland financial institution. While this was risky and expensive, most foreign managers would still use mainland distributors because the domestic retail market was hesitant to invest in stand-alone foreign managers. While market volatility slowed regulatory approvals in Hong Kong and China, the first MRF approvals were granted in December 2015. It is too early to tell if MRF will be extended to other fund jurisdictions. Some expect that there may be regional trials (e.g. in Singapore and Taiwan) before it’s extended to established UCITS and Alternative Investment Fund Manager (AIFM) domiciles (e.g. Ireland and Luxembourg).
Stock Connect is also gaining traction. Stock Connect allows investors to trade Chinese A Shares and mainland investors to gain exposure to Hong Kong-listed securities. It enables foreign asset managers to transact in mainland securities. Stock Connect may also be extended further afield. It is likely that Shenzhen’s stock exchange will be on-boarded onto Stock Connect at some point this year, and the UK has been shortlisted as a possible candidate as well.
Despite being a tough market for hedge funds to break into, a handful of foreign hedge funds have used the Qualified Domestic Limited Partnership Program (QDLP) to win mandates from high-net-worth-individuals (HNWI) in Shanghai. These managers can raise only a limited amount of capital and these quotas have not been extended as the government seeks to reduce capital outflows following the market turbulence. Nonetheless, these early adopters feel they will reap the first mover advantage benefits as HNWIs become more accustomed to hedge funds.
As HNWIs adapt, funds will need to look into options to support the processing and administration of a broadening range of asset classes and geographies in multiple currencies and in accordance with varying local and global accounting standards. Managers will also need a way to organize and share valuable research so that they have more time to evaluate, deliberate and execute on new investment ideas. As the market continues to change, it’s important that managers keep up with the change and adapt their business and approach accordingly.