On July 1, the Mainland-Hong Kong Mutual Recognition of Funds (MRF) officially kicked off. What does this mean for the two markets? At a recent AmCham luncheon, Securities and Futures Commission’s Christina Choi explains the exciting developments and discusses he future of the scheme

By Tsering Namgyal

The much-awaited mutual fund recognition scheme between Hong Kong and China went into effect on July 1, finally allowing Hong Kong and China registered mutual funds to cross-sell across two jurisdictions. The new regime would help Hong Kong move from what was predominantly a capital raising center for China into an asset management center for the mainland and the Asia Pacific region, according to Christina Choi, senior director of investment products at Hong Kong’s Securities and Futures Commission (SFC).

Beneficial to Both Sides

In the works since 2009, the MRF scheme would do to the asset management industry what the Shanghai-Hong Kong Stock Connect has done to stock markets of the two regions, paving way for the further integration of the two markets, Choi explained at a recent AmCham talk.

Through this measure, nearly 2,000 Hong Kong public funds (with a total asset size of a staggering US$16 trillion as of 2013, nearly double than in 2009) can now be directly sold on the mainland, providing Mainland Chinese investors with an opportunity to allocate their assets into a wide range of sophisticated investment products.

“If they buy Hong Kong funds, they can be investing globally. This could give them a direct access to professionally run fund products,” Choi says.

In the same vein, the new scheme will help boost the competitiveness of both Hong Kong and mainland fund management firms. For a start, the Hong Kong fund managers will get an opportunity to expand their marketing and sales network to other parts of the mainland, while the mainland firms will be exposed to international best practices.

Choi says that for Hong Kong as a whole, this will help promote the city as a preferred fund domicile and investment management center for funds, as seen from the sharp increase in the number of foreign funds that have been seeking to be registered in Hong Kong.

“The industry is seeing this as a high-growth area and more and more businesses are being set up in Hong Kong,” she says, adding that among all sub sectors in the financial industry, asset management has been seeing the sharpest growth.

Indeed, the MRF would provide a shot-in-the arm for Hong Kong’s fund management ecosystem that is already highly geared towards distribution (as nearly 70 percent of its 30,000 people employed in the asset management industry are currently employed in sales and marketing roles). The government is also moving to beef up its infrastructure and regulatory regime through, among other things, tax incentives and also by developing an open-ended fund company structure.

Christina Choi
Christina Choi

“Home rules apply”

With regards to the implementation, the basic maxim is that “home rules apply,” in recognition of the fact that the two sides have fairly different operational systems.

“If it is Hong Kong funds, Hong Kong rules will apply, and if it is mainland funds, they will be managed according to mainland rules,” she says. This applies to everything from disclosure and marketing materials to professional conduct requirements.

Different fund infrastructures in China and Hong Kong call for an enhanced regulatory cooperation between the two sides since “a lot of technical issues need to be resolved.” To use one example, mainland system requires registration down to the end-users, while in Hong Kong they use nominee accounts.

In terms of disclosure, besides basic approved documents, additional documents might be needed to meet the local jurisdictions’ investor expectation and market practice, not to speak of the different linguistic requirements. Mainland uses simplified Chinese, whereas Hong Kong rules require both English and traditional Chinese documentation.

Generally speaking, the sales and distribution will be governed by the local jurisdiction’s licensing and sales requirements while mainland funds distributed in Hong Kong must be done so by Hong Kong SFC-licensed firms and will thereby be subject to local regulations.

“We have emphasized with CSRC (China Securities Regulatory Commission) … that we have to maintain fair and equal treatment to investors in both jurisdictions,” she says.

Meeting the Requirements

With investor protection on the top of the agenda, it means some funds, such as synthetic and highly leveraged ones, may not be eligible to be marketed in Hong Kong under the new rule.

In terms of the amount of funds that can be sold, the authorities have set a RMB 300 billion macro quota, split evenly between the two sides.

According to Choi, the key rationale behind the macro quota is to avail some flexibility to the industry since allocating quotas only at the individual firm level might distort the system. Some firms might not be able to use their quota while reallocating those to others might involve complications.

As for registration, funds should be a public fund, must have a track record of at least one year and a minimum fund size of RMB 200 billion. While the funds must be domiciled in the home jurisdiction, the product must not invest more than 20 percent in the host’s jurisdiction.

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“What it means is that Hong Kong funds must not invest more than 20 percent in A-shares or mainland fixed income securities, or mainland firms should not invest more than 20 percent in the Hong Kong market,” Choi explains.

The logic behind this requirement, she points out, is that since mainland authorities hope to introduce non-mainland products into their jurisdiction, giving them back, say, A-shares products, would be defeating the purpose of the new scheme.

The other requirement, which is aimed at reciprocity and balance, is that Hong Kong funds should not have more than 50 percent of its assets sold to mainland investors, and vice versa.

Besides, funds would require local representative, or a “master agent,” to represent the management of the funds.

On the whole, the funds must meet the common requirements, and some of the funds may not be commonly accepted under respective laws. She says that the mainland authorities have been making changes in their own laws over the past few years while the discussion on the MRF scheme was in progress. For instance, their investment trust law now has a more explicit leverage limit. “I think they are also working on the money market funds which they need to do some reform there,” she says.

As for the quota, no daily limit has been set, aside from the RMB 300 billion gross limit. China’s State Administration of Foreign Exchange (SAFE) will regularly publish the stage of the quota while Hong Kong’s SFC would closely monitor the quota, so that they would seek ways to expand it once it reaches 70 percent or so.

Asia’s Asset Management Center

Choi notes that, on the whole, the new fund management mechanism would help further solidify Hong Kong’s role as a fund management center while also serving as a model for further integration of asset management systems in the region.

“The time has now come for Hong Kong to think about a different role,” she says. Given the rising wealth in China and its high savings rate, she can see Chinese investors are now looking for more international products as they diversify their investments.

The new scheme, which comes at a time when Hong Kong is already becoming an asset management hub, gives mainland investors access to Hong Kong’s nearly 2,000 mutual funds, up 27 percent year-on-year as of the end of March 2015. Testifying to its role as a regional hub, nearly 70 percent of all the funds in Hong Kong are owned by international investors, according to SFC data.

This underscores the importance of openness of Hong Kong and the trust of the international community, professionalism, regulatory and legal system in managing the assets and money, Choi says.

“The US has a very strong mutual fund industry and Europe has a very successful fund industry usage platform,” she says. “There is nothing in Asia. Asia is very fragmented, but we think that with mainland and Hong Kong to start from, we have a base to work on a longer-term integration in the region.”

Tsering Namgyal has been a writer specializing in business and finance for roughly two decades. A graduate of the University of Iowa and University of Minnesota, his articles have appeared in Asia Asset Management Review, Fund Strategy, IPE Real Estate, The South China Morning Post, amongst others.

MRF Eligibility Requirements

Key operators

Fund managers
– Registered, operate and licensed in the home jurisdiction
– Have not been the subject of any major regulatory actions in the past three years

– Qualified to act as custodians for publicly offered funds pursuant to home jurisdiction laws and regulations
– Local representatives
– Appoint a qualified firm in the host jurisdiction to be the fund’s local representative and process agent

– Established and managed at home jurisdiction
– Registered / authorized for offering to the public in the home jurisdiction
– Established for more than one year Minimum fund size of RMB 200 million
– Not primarily invest in the host jurisdiction
– The value of shares/units sold to host jurisdiction investors should not be more than 50 percent of the value of the fund’s total assets
– Eligible fund types: Regular/simple products, e.g. equity funds, bond funds, mixed funds, unlisted index funds and physical index-tracking ETFs