After a somewhat bumpy start, the Hong Kong–China Mutual Recognition of Funds (MRF) scheme – the first agreement of its kind with Mainland China – is slowly gaining momentum.
Introduced in July 2015, the new regulatory scheme provides mutual funds in Hong Kong (HK) and Mainland China with cross-border mobility for the first time. Under the agreement between HK’s Securities & Futures Commission (SFC) and the China Securities Regulatory Commission (CSRC), approximately 100 HK domiciled funds and 850 Mainland funds are eligible to apply for MRF status.
Though the initial performance of the MRF has been somewhat disappointing, it is still relatively early days for the scheme and there are signs it may soon turn a corner. Let’s consider some of the key issues.
Minimal northbound approvals
There is a disparity in the funds approved under the scheme. As at 1 December 2016, 47 southbound funds (Mainland funds selling in HK) had been granted MRF status by the SFC, whereas only 6 northbound funds (HK funds selling in the Mainland) had been approved by the CSRC, with a further 13 funds awaiting approval.
While expectations for a 6-month approval process have been met by the SFC, CSRC approvals have been much slower. Many of the initial northbound applications submitted to the CSRC still have no approval date in sight and some applicants have voiced their frustration at the head start given to the 6 approved funds.
Still, it’s expected that the CSRC will approve several more northbound funds in the year ahead, which will serve to increase competition as well as net flows. It’s also likely to bring into play other firms who have been waiting and watching from the sidelines.
Lower than expected net flows
Initial expectations for substantial USD net flows from the MRF have not been realised. Instead, as at October 2016, the scheme has resulted in just US$1.2 billion in northbound net flows and US$13.9 million in southbound net flows – figures well below the quota of US$45 billion (RMB300 billion).
There are several reasons for the poor performance. The northbound figure may have been several billions higher had the most popular fund – JP Morgan’s Asian Total Return Bond Fund – not voluntarily capped subscriptions at the end of August 2016. New Mainland business takes time to roll out and gain traction – for example, Hang Seng Bank is distributing via its joint venture with China Construction Bank across 14,000 branches. Investor confidence has been a slow-burn both ways. Mainland distributors and investors previously limited to a diet of Chinese funds are taking time to become familiar and comfortable with HK funds, while there has been a reluctance by HK based investors to place capital directly with Chinese mainland funds. The latter has seen Southbound net flows fare worse still. Finally, restrictions on fund types have also dampened some investor appetites.
While these early net flows are disappointing, the MRF market is destined to mature and its performance substantially improve as more funds join the scheme, systems are bedded down and investor confidence increases.
Potential for high net flows
In August 2016, there was a huge spike – US$593 million – in net flows from the Mainland into northbound funds (HK funds selling into China). The bulk of the money – a 90 per cent market share – flowed into JP Morgan’s Asian Total Return Bond Fund. JP Morgan has unparalleled distribution strength in China, with the capacity to sell 2 MRF funds via 9 Mainland banks , an online sales platform through their Shanghai-based joint venture with China International Fund Management and its Mainland investment platform Noah Upright. In response to the spike, JP Morgan placed a subscription limit on its most popular fund in order to comply with net flow limits. The decision to pace its northbound net flows is a positive sign for other firms considering entering the scheme.
The spike in northbound net flows was further fuelled by the depreciating Renminbi, which motivated Mainland investors to use the MRF investment route to hedge the Renminbi since northbound funds offer USD and HKD denominations.
Promisingly, the August 2016 spike confirms that the MRF route can produce high net flows.
Need to automate operational flows
Under the fledgling MRF scheme, order processing to and from China has been rather ad-hoc. Some in-house methods are used by transfer agents, while some processing occurs via SWIFT messaging, file transfer, the HK Monetary Authority’s Central Moneymarkets Unit (CMU) and fax. Fundamental to business success, such operational flows are too often overlooked.
In December 2016, HK’s SFC and Switzerland’s Financial Market Supervisory Authority (FINMA), announced another exciting MRF scheme that allows HK Funds direct access to the retail investor base within a European market for the first time. With the advent of the HK-China MRF and the HK-Swiss MRF, HK firms responsible for order processing should seriously consider investing in modern file and messaging solutions. Only centralised, automated solutions can adapt quickly and support various file formats and message types, while simultaneously reducing operational costs and risks. As the MRF market evolves and new markets continue to open up, firms that have right technology in place will be able to take advantage of opportunities as they arise.
While the HK-China MRF has experienced some teething problems and fallen short of initial expectations, there are signs that a potentially lucrative market is beginning to take shape. China is a vast market with a population of 1.4 billion and an estimated US$5 trillion in Chinese capital in play. For HK asset managers seeking to attain MRF status, brand building in China, selecting effective Mainland distribution partners and investing in modern messaging solutions will be the key. HK firms that make these preparations will have a substantial competitive advantage in accessing the large pools of Chinese Mainland capital up for grabs. Firms that adopt a ‘wait and see’ approach may never catch-up.