Continental Drift - Asian Strategies for Western Asset Managers: FAQ
18 October 2012
This article, structured as responses from our Asian Regulatory and Funds team to a series of frequently asked questions, looks at Asian financial markets from the point of view of Western asset managers, covering key developments, challenges of launching and the success of UCITS. The series will conclude by highlighting West-East common ground and the scope for cooperation.
Can you give us an overview of the Asian Asset Management Market?
Asia is an attractive market for the distribution of funds. The region’s economies have generally bounced back following the global financial crisis, and the rapid rise of the middle class across the region has not only resulted in more disposable income, but also increased demand and sophistication towards investments. Asia is home to 60% of the world’s population, yet Asian investors’ investments account for only 13% of the investment fund industry’s global assets under management. The figures suggest that the Asia asset management industry has immense potential to become the largest asset management region in the world.
How important is Asian distribution for Western Funds
Based on the promise of growth in the region, many Western fund managers are hoping to get a piece of the asset management market action as soon as possible. China will be the key driver of this growth, and the gradual internationalisation of the RMB, along with the belief that the RMB will appreciate over time means that Western asset managers ignore Asia at their own peril.
However, Western asset managers should be wary of being over-ambitious with Asian distribution. It is tempting to see Asia as an antidote to declining profitability in Western markets, but Western managers looking to make quick returns are likely to be disappointed. In developed markets, asset managers often focus on profitability, but this approach is unsuitable in Asia, given the slow easing of capital controls and the time needed for savers to develop into investors. Therefore, patience is key. A focus on asset growth, branding and strong distribution channels is likely to be rewarded in the longer term.
What are the key challenges of launching and selling in Asia?
Frequently, Western managers approach the Asian region with a whole-of-Asia expansion strategy. More and more are realising that this is fraught with difficulties. The Asian market is fragmented, with no single rule-making body and acute differences in growth rates, culture, tax, regulation and product preferences. Asset managers hoping to distribute in Asia should therefore adopt a tailored approach to each market.
Entrants must invest in branding, as big names in Europe are not necessarily known in Asia. At the same time, fund managers should develop an understanding of local product preferences. For example, while balanced funds and equity funds are favoured by Chinese investors, who prefer stock market investments, India’s bond funds account for most of its market, since corporate and individual investors there tend to take a more risk-averse approach.
Importantly, a key obstacle for Western asset managers looking to launch in Asia is distribution. Distribution channels are often dominated by large consumer banks (as in the case of China), and few investors seek independent financial advice. For a Western fund to enter a local market, getting products onto distributors' recommended lists is vital. Fund managers can explore the possibility of setting up distribution partnerships or joint ventures with local firms to facilitate market access.
There is also increasing competition between Western asset managers and those in local markets. Asian managers have the advantage of cultural understanding and local relationships. Yet, once they expand beyond their home markets, they face the same regulatory, operational and cultural challenges as their international counterparts, on top of problems arising from the lack of infrastructure and products for distribution. Nonetheless, comparisons between international and domestic asset managers may be too simplistic as many international funds hire locally in Asia, therefore acquiring the know-how required to market suitably.
Can you describe the regulatory environment across Asia?
Regulation varies from country to country. Unlike in Europe, there is no region-wide passport. We must distinguish between cross-border centres, such as Hong Kong and Singapore, that have established themselves as offshore-oriented markets, and emerging markets that have yet to develop institutional structures that allow the distribution of overseas funds. For example, in emerging markets such as Malaysia and Thailand, offshore funds can only be sold through wrapped products; South Korea allows distribution only through local feeder funds; inward-focused markets such as China and India prohibit full distribution of offshore funds.
We have seen regional initiatives designed to enhance cooperation among Asian countries in relation to the distribution of Asian funds, including moves towards an Association of Southeast Asian Nations (ASEAN) Funds Passport and an Asia-Pacific Economic Cooperation (APEC) Asia Region Funds Passport. These initiatives aim to standardise the regulatory framework, allow cross-border distribution of investment products across Asia and foster greater economic cooperation and growth in the region.
It is early days yet: only Thailand and Singapore have taken tentative steps towards mutual recognition of ASEAN funds so far, and these economies cannot benefit from the scheme until other ASEAN members are prepared to embrace the initiative. The first phase is likely to include a core group of economies with broadly similar regulations, such as Singapore, Hong Kong and Australia.
For the moment, jurisdiction-by-jurisdiction approaches are needed, taking advantage of any bilateral arrangements that may be in place, for example mutual regulation of certain retail funds between Hong Kong and Malaysia.
UCITS, especially Luxembourg UCITS, have been very successful across Asia. Why?
Undertakings for Collective Investment in Transferable Securities Directives (UCITS) funds have been very successful across Asia, far outselling US funds in the region. This is because UCITS is seen as a gold standard of regulation and investor protection, while providing cross-border synergies and economies of scale. Once authorised by an EU member state, UCITS can be marketed freely throughout the EU and, in the past decade or so, UCITS have been sold around the world, making it a global brand. Around 75% of UCITS distributed internationally are based in Luxembourg, benefitting from the country's strong economy, extensive double-tax treaty network and reputation as a stable democracy.
However, while UCITS make up the majority of fund sales in regional hubs such as Hong Kong SAR, Singapore and Taiwan, other markets in Asia have not been as receptive. This is partly due to the differences in the regulatory environment across markets as well as the challenges to launching as explained above.
The outlook for UCITS therefore remains positive. It is important to note that Chinese banks and fund managers are able to invest directly in foreign investment funds (such as UCITS) through the Qualified Domestic Institutional Investor (QDII) scheme. South Korea and Malaysia are emerging as rapidly maturing markets, and Japan has also exhibited an increasing appetite for UCITS.
How effective is the 'fast track' for UCITS funds?
Hong Kong operates an essentially "fast track" system for UCITS approval in response to the high demand for these products and regulators being comfortable with its proven track record. The effectiveness is evident in the number of UCITS funds approved in the city – by December 2011, over 5,000 UCITS funds were registered in Asia, with over 1,200 registered in Hong Kong.
It is important to note that, on top of UCITS approval from the home regulator, local requirements also apply. For example, in order to comply with Hong Kong rules, funds must comply with the Code on Unit Trusts and Mutual Funds (UT Code) published by the Securities and Futures Commission (SFC) which details structural and documentation requirements, ongoing reporting and disclosure requirements and the requirement to appoint a local representative agent. The "fast track" is essentially a head start for UCITS funds, taking for granted that the structural and documentation requirements have been broadly followed, although it is not the end of the story. Asset managers still need to adapt UCITS funds to local requirements. This means the process is probably better described as "faster track" than "fast track".
What other fund vehicles and strategies may become popular, if nurtured in Asia?
The Alternative Investment Fund Managers Directive (AIFMD) will be implemented in steps starting from July 2013, providing investment managers of eligible hedge funds, private equity and other types of non-UCITS funds with an EU passport much in the same way as the UCITS scheme. Many speculate as to whether the success of UCITS in Asia can be replicated in the alternative space by AIFMD. Although AIFMD may take longer to gain traction in Asia, in our view it will offer opportunities and will become a must for Asian fund managers with European investors. In addition, AIFMD would inevitably set a standard against which alternative funds across the world would be measured.
Western alternative fund managers have a long history of using Luxembourg specialised investment funds (SIF) because they provide sophisticated investors with a flexible investment vehicle which can invest in any type of assets. This type of structure has recently generated interest from Asian alternative fund managers and private banks, since SIFs offer investors a balance between the need for regulation (and thus protection) and flexibility.
In terms of strategy, Western asset managers are warming to bond funds denominated in RMB, also known as 'dim sum bonds'. These bond funds provide Western investors with the opportunity to explore the Chinese market via Hong Kong's open economy.
Any concluding words?
Clearly, there is no one-size-fits-all Asian strategy. While there is talk that initiatives such as the Asia Region Funds Passport and the ASEAN Funds Passport could directly compete with UCITS, this remains an aspiration, and fund managers tend to be realistic about the likelihood of these materialising in the foreseeable future. Instead of waiting for a pan-regional regime to provide a favourable distribution environment, fund managers have acknowledged the need to act promptly in order to achieve the critical mass that Luxembourg and Ireland acquired with UCITS. We expect to see continued use of the UCITS brand, coupled with a greater network of bilateral and multilateral distribution agreements.
Since establishing a presence in Asia more than 20 years ago, Allen & Overy has lawyers based throughout the region, enabling us to keep our clients up to speed with local legislative and regulatory developments as and when they occur around the region. This now includes our on-the-ground Luxembourg desk in Hong Kong, and our ability to cover a broad footprint of Asian markets, including our recent opening of offices in Vietnam, an increasingly exciting funds market in the region.