The changing face of distribution in China
04 May 2016
The liberalisation of China continues to rumble on. The Mutual Recognition of Funds (MRF) initiative, which permits Hong Kong domiciled fund managers to sell their products to mainland Chinese retail investors, and conversely Chinese managers to distribute into Hong Kong, has gained traction. The rules permit Hong Kong managers to sell into China without having to go through the hassle of entering into an equity partnership with a mainland financial institution. Traditionally, the added operational due diligence requirements and heightened risk of going into a mainland joint venture (JV) was off-putting for Hong Kong managers. The market volatility in China hindered the speed of fund manager regulatory authorisations initially although approvals are coming in gradually. Since December 2015, a handful of managers in both Hong Kong and China have attained authorisation. This trend is likely to continue.
Investment restrictions into China are also being rescinded. The Hong Kong-Shanghai Stock Connect scheme finally initiated same day delivery versus payment (DVP) which has enabled regulated fund structures such as UCITS to more easily transact in Chinese A shares. Historically, the divergences in trade settlement times between Hong Kong and China meant foreign investors were exposed to overnight broker risk, which could often be a regulatory barrier to investing into China through Stock Connect. Simultaneously, the China Interbank bond Market (CIBM) has opened up to more institutional allocators. When the CIBM rules were eased in 2015 giving major institutions exposure to the country’s $5.4 trillion domestic bond market, it was only available to public bodies such as central banks and sovereign wealth funds. This has since changed and now fund managers, commercial banks and securities firms can obtain exposure to CIBM. At present, hedge funds are still prohibited. This market liberalisation ultimately enables greater access for foreign investors into China.
This is all happening at a time when the dynamics around regional distribution are changing dramatically. High net worth individual (HNWI) numbers are swelling in Asia-Pacific (APAC) and the modus operandi of traditional distributors is having to evolve with it. The majority of distributors have recognised that their investor demographics are getting younger. This younger audience will typically be more tech savvy as evidenced by the explosion of WeChat. As such, distribution models will have to cater to this, and embrace technology, such as online distribution platforms. Distribution has historically been a fairly manual process. Panellists at Fund Forum Asia acknowledged this will need to change, and distributors must start engaging with prospective younger clients in real time with easily accessible reports provided online. While relationship management teams will still play a major role, distributors need to embrace technological change if they are to retain clients, particularly millennials, moving forward.
Perhaps one of the most significant trends for distributors is likely to be the growth of robo-advice. Robo-advisors will dramatically impact distributors but they ought not to be viewed as a threat, but rather an opportunity. A handful of distributors have purchased or acquired stakes in robo-advisors, which typically provide investors with access to index tracking funds. Nonetheless, human relationship management particularly with HNWIs will remain an important function for distributors. The challenge for distributors will be ensuring the robo-advisor provides appropriate advice for clients and mitigating the risk of technological failure. If investors are given unsatisfactory or inadequate advice that is not conducive to their risk profile by a robo-advisor, this could incur regulatory consequences, particularly under the Markets in Financial Instruments Directive II (MIFID II). As such, firms must make sure their robo-advice is in line with best practices.
It is not just technology that distributors should be mindful of. Distributors must ensure they give their end clients exposure to the correct investments. APAC investors are moving beyond regional equities and fixed income and looking to gain exposure to global asset managers. Traditional alternatives exposure is also changing. APAC HNWIs have historically preferred to allocate into illiquid asset classes such as private equity and real estate but this is transitioning into multi-asset strategies such as hedge funds. While hedge funds remain a small component of their portfolios, this could grow. This is evident in China where the Qualified Domestic Limited Partnership Programme (QDLP) permits a limited number of foreign hedge funds to sell to mainland Shanghai HNWIs. This initiative has been on-going since 2013 and it is highly probable these early adopters will reap first mover advantage. While restrictions on outbound capital have hindered QDLP, these are likely to be temporary. Hedge funds could yet take off despite regional stereotypes of the asset class. Distributors therefore need to be cognisant of evolving investor appetites.
APAC is an exciting market and it is changing quickly. Distributors must ensure they are not playing catch-up in the region but continually evolving with their clients’ needs and interests.