Asia Fund Passports – Opportunities and Implications

Official discussions of a fund passport started over 7 years ago, with concrete memorandums of understanding signed in 2013. While early discussions often included the idea of certain markets becoming “regional hubs” recently this has given way to the more constructive language of trade. Fund passporting schemes are about freeing up the trade of financial services within the region. Considering the potential economic benefits that can come with this are meaningful, especially in the form of improved employment opportunities for fund management teams in the region, along with back office operations from administration, custodian functions to legal, compliance and accounting support. As with any trade negotiation, it helps when it is part of a broader agreement on free trade. This is where it now stands and it is the reason we are more optimistic about the future of these schemes.

At the initial stage, each scheme is likely to come with varying degrees of limitations.  Announced in September 2013, the Asia Region Funds Passport incorporates a mix of countries from Korea, Singapore, to Australia and New Zealand.  Given the differing regulatory regimes and tax treatments for investors, there are significant challenges in coming up with a common standard that each eligible fund must abide by.  The scheme has recently completed its consultation stage, but a formal launch is not expected until 2016. 

The ASEAN CIS Is Now Operational
The ASEAN Capital Markets Forum (ACMF) has announced that the ASEAN Framework for cross-border offering of collective investment schemes (CIS) became operational for the South East Asian countries of Singapore, Malaysia and Thailand in August 2014.   The CIS, being the first launched, offers the most clarity in terms of eligible criteria from minimum AUM, track record to types of investments allowed.  Now established, the market will watch closely to see how the plan evolves with other ASEAN countries, e.g. Indonesia, Philippines, Vietnam, potentially joining the framework in future years. 

Hong Kong and China Mutual Recognition
Amongst the three fund passport schemes announced so far, the mutual recognition of funds between Hong Kong and China is arguably one of the most keenly watched developments within the Asian fund management industry in 2014.  It is understood that an agreement has been made between Hong Kong’s Securities and Futures Commission (SFC) and the China Securities Regulatory Commission (CSRC), however a formal announcement is still to be made.

As the name suggests, the mutual recognition scheme opens up the potential for Hong Kong domiciled funds to be sold in China, as well as Chinese domiciled funds to be sold in Hong Kong.  For Hong Kong domiciled funds, which include around 300 mutual funds and 30 exchanged traded funds (ETFs), it is believed that they can potentially be sold in China as long as they meet certain parameters, some of which believed to be related to track record and AUM. 

For global asset managers, this represents a significant opportunity to tap into a market which is to-date, a largely closed market with a population of 1.3 billion people looking for additional ways to invest their growing savings pool.  We understand that a number of asset managers have already established working groups to examine issues surrounding operations, tax, product strategy and distribution, and a growing number of Hong Kong domiciled funds can be expected as the launch date draws closer. 

For asset managers in China, the scheme provides the scope to use Hong Kong as a gateway to expand into international markets.  Relative to their international peers, many Chinese asset managers have more established track records on domestic equities and fixed income strategies and are well positioned to offer differentiated strategies for investors in Hong Kong.

Most importantly, from an investor standpoint, fund investors in China can benefit from additional choice and diversity that was not available to them previously, while Hong Kong investors gain an additional avenue to invest into China, over and above funds and ETFs that are currently available through existing QFII and RQFII schemes. 

Challenges Ahead
While the size and attractiveness of the opportunity may lead to strong enthusiasm for many, there are significant challenges in realising the potential that a fund passport scheme offers. 

Firstly, in order for funds to be sold under a fund passport scheme, a common framework is required.  This can be easier to achieve between two regulators with little differences between them, but it can prove to be a challenging task when it involves multiple parties and each having a vastly different regulatory regime.

The treatment of tax is another hurdle that countries will need to overcome when they enter into a mutual recognition agreement.  First announced in 2008, the lack of traction in the Australia – Hong Kong mutual recognition scheme was a good example of how poor tax treatments from an investor standpoint can inhibit the scheme’s potential to succeed. 

For asset managers, the biggest challenge is likely to come from the difficulty in putting together a strategy that takes into consideration a range of factors, from the types of products that would appeal to investors in each market, to the appropriate distribution model and where funds should be domiciled.  Each would bring unique challenges to asset managers, especially those without the reach, scale and experience operating in the region. 

Lastly, although fund investors are likely to benefit from greater choice and diversity, it is unclear if a fund passport scheme would necessarily lead to lower fees.  If we take Hong Kong as an example, despite a smaller target market, funds domiciled in Hong Kong have proved to be overwhelmingly cheaper than their Ireland or Luxembourg domiciled UCITs peers (figure 1).  Although there are minor differences in how certain expenses are charged, it is often common to see an annual total expense ratio differential of between 0.2% and 0.3%. While the UCITS framework promotes consistency and provides synergies for participants, there is no evidence that it leads directly to cost savings for managed fund investors as pricing is more likely to be impacted by other factors including distribution practices and competition.

Morningstar’s Role
With 30 manager research analysts located across seven fund markets in the Asia Pacific region, coupled with an extensive global database of managed investments, Morningstar’s expansive manager research coverage means that we are well placed to support financial institutions, investment advisers and individual investors in making better informed cross-border investment decisions.

Figure 1: Fee Comparison between funds ^domiciled in Hong Kong, Ireland and Luxembourg

^ Funds available and authorised for sale in Hong Kong by the Securities and Futures Commission (SFC)
Source: Morningstar Direct

Chart 1: Strong Growth in Cross Border Growth Rates

Source: Morningstar Direct. 2013 Global Flows Report