2019.11.06 XIE, Qing (Natasha)、ZHANG,Chi、QIN,Tianyu、FANG,Hao
The opening-up of China’s financial markets appears to offer unprecedented opportunities for global asset managers. Compared with policies to open up the banking and insurance industries, which have gone relatively unremarked, the asset management policies that have been gradually released over the course of the past three years have drawn greater attention from the global asset manager community, which remains eager to explore potential opportunities to enter the Chinese market. Below we analyse recently introduced policies of relevance to global asset managers’ market access, cross-border transactions and services, and discuss some of the opportunities and challenges for global asset managers in China.
Between 1998 and 2016, the China Securities Regulatory Commission (CSRC) granted approvals for 44 Sino-foreign joint-venture (JV) securities investment fund management companies (FMCs). With the exception of Hang Seng Qianhai Fund Management Co., which was approved under the framework of the Mainland Hong Kong Closer Economic Partnership Arrangement, foreign investors of the aforementioned FMCs had been restricted to minority equity status. Many large global asset managers were eager to acquire wholly owned or majority-owned FMC licences, but were unable to do so due to policy restrictions.
In April 2018, the CSRC announced that it would accept applications to increase foreign equity ownership of FMC to 51% to establish new foreign majority-owned FMCs, and further proposed to allow wholly foreign-owned FMCs after three years, i.e. in 2021.
More recently, in July 2019, at the opening ceremony of the 13th Summer Davos Forum, Premier Li Keqiang announced that the removal of the foreign equity cap on FMCs would be brought forward from 2021 to 2020.
Given the difficulties that global asset managers may face when attempting to negotiate an increase in their equity stake in FMCs with Chinese shareholders, this policy change would probably encourage them to consider establishing a wholly owned FMC, in addition to their attempt to increase their equity in an existing JV FMC. Indeed, with only limited time before the CSRC starts accepting applications, it is our observation that some global asset managers are already expediting their preparations to submit such applications to set up wholly owned FMCs.
When setting up an FMC, a global asset manager will usually apply for both a publicly raised securities investment fund management licence, which targets retail investors, and a specific client asset management licence (i.e. a private asset management licence), which targets institutional investors and high-net-worth individuals, and over the long term, aspire to provide services and products for institutional investors, such as domestic social security funds, pensions, enterprise annuities or insurance funds.
In setting up wholly owned FMCs, global asset managers are likely to face two main challenges. Firstly, in terms of business operation, a global asset manager must ensure that its wholly owned FMC satisfies all regulatory requirements concerning the independence of operation, while at the same time leveraging and maximising the global resources of its group by implementing effective global asset management practices in its daily operation, such as investment management and risk control, IT services and support. Secondly, in terms of business development, a global asset manager will need to determine how its wholly owned FMC can differentiate its businesses and compete with local FMCs.
As well as the opportunities for FMCs, the China Banking and Insurance Regulatory Commission (CBIRC) has also been encouraging the local asset management institutions regulated by it to set up JVs and/or to cooperate with foreign investors. On 20 July 2019 the Financial Stability and Development Committee of the State Council announced 11 measures to further open up China’s financial sector, three of which are the types of market access regulated by the CBIRC, namely:
•Foreign financial institutions investing in the wealth management subsidiaries of commercial banks.
•Foreign asset management institutions setting up a majority owned asset management company with the subsidiaries of Chinese banks or insurance companies.
•And foreign financial institutions setting up or investing in pension fund management companies.
However, it remains to be seen how the above three measures will be implemented. The first two measures may depend on various business considerations, such as whether a commercial bank would have incentive to introduce foreign investors to invest in its wealth management subsidiaries, and how a jointly owned sub-subsidiary established by a wealth management subsidiary of a bank or insurance asset management company and by foreign investors might gain support from its shareholders and develop a differentiated business.
Many global asset managers have expressed significant interest in the third measure, setting up or investing in pension fund management companies, which, when implemented, will provide them with a licence to undertake pension fund management. As was indicated in a CBIRC media Q&A, pension fund management companies are still at the pilot stage, and the approval for setting up pension fund management companies is currently granted on a case-by-case basis.
Generally speaking, when compared with the relatively mature FMC licensing scheme, the aforementioned CBIRC measures on foreign investors’ market access are at a preliminary stage, and global asset managers will need further details to make a full assessment of the opportunities.
In China, asset management businesses fall into two main categories: public fundraising (i.e. retail) and private fundraising. Private fundraising is further divided into business conducted by licensed financial institutions and business conducted by non-licensed institutions, with the latter normally referring to private fund managers (PFMs). In this latter type, there are three further subgroups: securities-type PFMs targeting investment in the public market, including the trading of listed products, such as stocks, securities and derivatives; private equity-type PFMs aiming at investing in the primary market, such as unlisted equities; and PFMs involved in other types of investment activities.
In practice, the so-called wholly foreign-owned enterprise (WFOE) PFM policy refers to the wholly foreign-owned or JV securities-type PFMs, while QDLP managers would be considered as a special type of PFM under the third category above.
Unlike an FMC, which is permitted to issue publicly raised products by raising funds from the public, a securities-type PFM is restricted to raising funds from no more than 200 qualified investors. Strictly speaking, PFMs are unlicensed institutions whose establishment requires registration with self-regulatory organisations rather than requiring administrative approval. Once registration has been completed, a PFM may engage in private fund investment and management. Compared with the strict regulatory requirements faced by FMCs, regulatory control over private fund management is relatively loose and flexible.
Despite the explosion in numbers of PFMs established over the past few years – as of June 2019, there were approximately 8,875 PFMs registered in China – there has been some variation in their quality, with the bulk of assets under management (AUM) concentrated within the very few top PFMs.
In June 2016, China issued its WFOE PFM policy, allowing foreign investors to establish wholly foreign-owned PFMs and through issuing private funds, to invest in domestic stocks, securities, bonds and derivatives markets. Distinct from “grassroots” domestic private funds, which have grown organically, WFOE PFMs have been more carefully crafted, emerging as policy outcomes during the eighth Round of US-China Strategic and Economic Dialogue and also receiving attention during two rounds of the China-UK Economic and Financial Dialogue (the eighth and tenth, respectively).
The continuing growth of the WFOE PFM community during the past three years is an indicator of their “noble” origins: publicly available information from the Asset Management Association of China (AMAC) indicates that, as at 22 August 2019, 21 WFOE PFMs had been registered with the AMAC, all established by prominent global asset managers (see a list of managers in Appendix I).
Existing WFOE PFMs can be categorised according to the nature of their shareholders into foreign large mutual fund managers and foreign large hedge fund managers. Foreign public fund managers have tended to establish their WFOE PFMs to gain local securities-trading experience, to expand local businesses, and to save time entering the Chinese market prior to obtaining a wholly foreign-owned FMC licence. Foreign large hedge fund managers focus more on developing products and strategies tailored to the Chinese market and to their business performance, and may not actually be considering applying for an FMC licence.
Both types have shown a tendency towards product diversification. By 22 August 2019, the 21 registered WFOE PFMs have issued a total of 51 products.
To save on costs and labour, almost all WFOE PFMs outsource their transfer-agency and fund-administration activities to qualified third-party service providers, and engage distribution agents rather than distribute funds by themselves. The number of direct employees of the 21 approved WFOE PFMs is relatively small, ranging from three to 28 people per firm: eight PFMs have less than 10 employees; four PFMs have 10 to 15 employees; and nine PFMs have more than 15 employees.
Although there has been considerable growth in the number of registered WFOE PFMs and in the issuance of products, WFOE PFMs continue to face various challenges:
•Regulatory limits on multilayered products have made it difficult to get a wrapped product to invest in a private fund on a one-on-one basis.
•The institutional investors with whom WFOE PFMs may cooperate are relatively limited in number, and even if WFOE PFMs were permitted to extend their cooperation to the wealth management subsidiaries of commercial banks, they would be seldom considered as viable partners by such institutional investors due to their lack of trading track records.
•And it takes time for WFOE PFMs to build up their own investment teams, and taking the approach of acquiring local private fund teams may not be feasible due to the lack of suitable acquisition targets.
These challenges may cause other global asset managers to hesitate when deciding whether to set up a WFOE PFM, although they may not be insurmountable barriers for a global asset manager committed to injecting resources into the Chinese market over the long-term or able to compete with local institutions in terms of product strategies.
Global asset managers proposing to establish a WFOE PFM may consider various strategies. They could form a local investment team, thereby gaining relevant business experience and await future opportunities to provide investment management services for local and foreign institutional investors. Another approach would be to consider injecting resources into both WFOE PFM and QDLP schemes simultaneously to benefit from the shared resources and reduced costs.
So, while global asset managers will be able to apply to set up FMCs as of next year, given less regulatory burden over PFMs compared to FMCs and the fact that, similar to FMCs, PFMs are also potentially capable of providing investment management or advisory services for onshore and offshore institutional investors, we anticipate a steady increase in the number of WFOE PFM applications in the next few years.
A WFOE PFM considering applying for a wholly foreign-owned FMC licence should follow the current practice of converting from a PFM to an FMC licence, i.e. when a foreign shareholder sets up the FMC while simultaneously transferring the business of the WFOE PFM to the FMC to avoid potential conflicts of interest arising from an overlap of businesses.
Despite the fact there are no specific restrictions imposed on foreign investors applying to set up private equity-type PFMs, as for securities-type PFMs, the company name and business scope of a private equity-type PFM registered by a foreign investor will be subject to strict review, as would be the case with a domestic investor.
In practice, an endorsement of a pilot qualification (i.e. the QFLP pilot) by a local government is a must-have for a global asset manager wishing to establish a foreign-invested partnership-type private equity fund. Indeed when compared with conducting foreign direct investment (FDI) using US dollar funds raised overseas, a QFLP pilot is more flexible in terms of foreign exchange settlement and the permissible investment scope.
Since Shanghai first took the initiative in 2010 to issue its QFLP pilot programme, other localities including Beijing, Tianjin, Chongqing, Shenzhen, Qingdao, Zhuhai and Guangzhou have developed their own local QFLP pilot programmes to encourage foreign investment. As the Chinese government is likely to continue encouraging the inward flow of foreign capital, we anticipate that QFLP pilot programmes may attract ever greater attention from global asset managers.
QDLP and QDIE are pilot programmes being sponsored by Shanghai and Shenzhen local governments, respectively, enabling global asset managers to form a fund by privately raised RMB from qualified investors to invest in foreign markets within a permitted quota. The QDLP pilot in Shanghai has been well received by global asset managers, with many prestigious asset management institutions, including prominent hedge, alternative fund and large global mutual fund managers, participating in the pilot (see a list of QDLP managers approved in Shanghai in Appendix II), creating synergies to attract WFOE PFMs in Shanghai.
Pursuant to the current policies of the AMAC, for a WFOE PFM and a QDLP manager structured under a parent-subsidiary arrangement and located in Shanghai (i.e. where the WFOE PFM is the parent entity, with the QDLP manager being a wholly owned subsidiary of the WFOE PFM), there will be no special requirements for the personnel and registered capital of the QDLP manager, and the QDLP manager may be registered at the address of the WFOE PFM.
Setting up a WFOE PFM and applying for a QDLP pilot qualification simultaneously would be a cost-effective and attractive proposition for a global asset manager interested in engaging in both types of business, since all capital, staff and office space could be shared between the two entities.
It is worth noting that both QDLPs and QDIEs are subject to the restrictions on foreign-exchange quotas. The State Administration of Foreign Exchange (SAFE) has adopted a macro-prudential management approach to the QDLP/QDIE pilot programmes, taking into account the current balance of cross-border payments, the development of industry and outbound investment, and the steady advancement of the QDLP/QDIE pilot programmes.
Pan Gongsheng, the deputy governor of the People’s Bank of China, remarked at the 11th Lujiazui Forum that making the QDLP pilot in Shanghai a normalised practice should be a priority on the government’s work agenda. It is anticipated that with the gradual stabilisation of the RMB, SAFE may gradually release more quotas, achieving a changeover for QDLP from pilot to permanent status.
At the same time as developing policies relating to market access, the Chinese government has also been introducing policies to facilitate cross-border trading and services.
The key objective for cross-border trading initiatives is to facilitate foreign institutions to invest in China’s stocks, bonds and derivatives markets via different channels. Currently, the main investment channels include QFII/RQFII, direct access to the interbank bond market, Stock Connect, Bond Connect and specific futures products that can be traded by foreign investors directly.
It is worth mentioning that on 31 January 2019, the CSRC issued its long-awaited consultation paper regarding the reform of the QFII/RQFII regime (QFII/RQFII Consultation Paper), which proposes to further expand the scope of the underlying assets available for investment to simplify the application procedures and minimise any problems associated with submitting the application. In a speech delivered at the China Development Forum in March 2019, the governor of the People’s Bank of China, Yi Gang, stated that foreign investors will be allowed to hedge the foreign-exchange risks arising from their investment in China’s securities and bond markets, emphasising the importance of providing sufficient hedging tools for foreign investors. The CBIRC’s aforementioned newly issued 11 measures to further open up the financial sector also mention that China will facilitate foreign investment in the interbank bond market. In summary, it appears that the regulatory authorities are continually exploring and introducing a range of measures to attract foreign investors.
In terms of cross-border services, local investment research teams assembled by global asset managers may have the opportunity to serve foreign institutional investors within a compliant framework and facilitate their investment in China. Under the QFII/RQFII Consultation Paper, a QFII/RQFII may designate a domestic private securities fund manager related to it as its investment advisory service provider with no need to meet additional qualification requirements. This means that after the new regulation is formally implemented, a WFOE PFM will be allowed to provide investment advisory services for a QFII/RQFII within its group company. As the next step, it may be useful for the Chinese regulators to consider the feasibility of expanding the permissible advisory service recipients to include all foreign institutional investors, beyond just QFII/RQFIIs, and for the permissible scope to be extended from only providing investment advisory services to also offering discretionary investment management services.
It appears that the opening up of China’s financial markets continues to make steady progress. On the one hand, the Chinese government has been promoting a gradual opening-up, encouraging global asset managers to enter into China’s market and facilitating their investment activities in China. On the other, the Chinese government is holding firm to the principle of prudential regulation and has indicated two key objectives: serving the real economy and preventing systemic risks.
It is likely that regulators will continue to provide market access for high-quality institutions, but they will also maintain their cautious approach on issues such as cross-border capital flow to avoid the type of risks that might be triggered by reckless policies.
CSRC: list of FMC joint ventures (April 2019) available at www.csrc.gov.cn/pub/newsite/gjb/sczr/wzcgjjglgsylb/201906/t20190628_358351.html.
QDLP, the Qualified Domestic Limited Partner regime, is a local pilot programme first implemented in Shanghai. Under the Shanghai QDLP policy, qualified foreign institutions may, by establishing an overseas fund management company and launching private funds in China, privately raise RMB funds in China and then invest in offshore primary or secondary markets. QDLP policies of different cities may differ from each other.
QFLP, the Qualified Foreign Limited Partnership, is a local pilot program in which a qualified foreign investor, upon being approved by the local government, may set up a foreign-invested equity investment management company (i.e. QFLP fund manager) and a foreign-invested equity investment company (i.e. QFLP fund) to raise funds from domestic or foreign investors through private offering and invest in domestic private equity or debt investment by using RMB, subject to local QFLP policies.
 QDIE, the Qualified Domestic Limited Enterprise regime, similar to Shanghai’s QDLP regime, is a pilot program sponsored by the Shenzhen government, which allows qualified institutions to raise funds privately in China and then invest them in offshore markets by establishing a limited liability company or a partnership to serve as the QDIE manager in Shenzhen.
“SAFE: Support Domestic Institutions’ Innovation of Overseas Investment Types and Steadily Push Forward the Reform of QDLP/QDIE Schemes” from www.gov.cn/xinwen/2018-04/25/content_5285750.htm
Pan Gongsheng: Conduct Research to Loosen or Even Remove Restrictions on QFII Quota www.cs.com.cn/xwzx/hg/201906/t20190614_5958224.html.
A QFII, or a Qualified Foreign Institutional Investor, is a qualification scheme for foreign institutional investors investing in China, and RQFII is a qualification scheme for foreign institutional investors investing in China with RMB.
 See “Providing sufficient hedging tools for foreign investors is one key mission for this year” at https://new.qq.com/omn/20190324/20190324A0AYH5.html.
Appendix I: List of WFOE PFMs (22nd Aug 2019)
Appendix II List of QDLP managers approved in Shanghai (22nd August 2019)
(1)Man Investments (Shanghai) Limited
(2)Oaktree Overseas Investment Fund Management (Shanghai) Co., Ltd.
(3)Citadel Overseas Investment Fund Management (Shanghai)Co., Ltd.
(4)Och-Ziff (Shanghai) Overseas Investment Fund Management Co., Ltd.
(5)Canyon Overseas Investment Fund Management (Shanghai) Co., Ltd.
(6)UBS Rui Hua Overseas Investment Fund Management (Shanghai) Ltd .
(7)DWS Investments Shanghai Limited
(8)EJF Shanghai Adviser Ltd.
(9)CBRE Global Investors Overseas Investment Management (Shanghai) Co., Ltd.
(10)GF-Persistent Overseas Investment Fund Management (Shanghai) Co.,Ltd
(11)BlackRock Overseas Investment Fund Management (Shanghai) Co., Ltd.
(12)Value Partners Fund Management (Shanghai) Limited
(13)JPMorgan Overseas Investment Fund Management (Shanghai) Limited
(14)Allianz Global Investors Overseas Asset Management(Shanghai) Limited
(15)Aberdeen Standard Overseas Investment Fund Management (Shanghai) Co., Ltd.
(16)Manulife Overseas Investment Fund Management (Shanghai) Limited Company
(17)AB (Shanghai) Overseas Investment Fund Management Co., Ltd.
(18)Nomura Overseas Investment Fund Management (Shanghai) Co., Ltd.
(19)AXA IM Overseas Investment Fund Managers (Shanghai) Limited
(20)BNP Paribas Overseas Investment Fund Management (Shanghai) Co., Ltd.
(21)Robeco Overseas Investment Fund Management(Shanghai) Limited Company
(22)Neuberger Berman Overseas Investment Fund Management (Shanghai) Limited
(23)Barings Overseas Investment Fund Management (Shanghai) Limited
(24)Morgan Stanley Overseas Investment Fund Management (Shanghai) Limited
(25)Credit Swiss Overseas Investment Fund Management (Shanghai) Limited
(26)Mirae Asset Overseas Investment Fund Management (Shanghai) Co., Ltd.
(27)Legg Mason Overseas Investment Fund Management (Shanghai) Co., Ltd.
(28)Eastspring Overseas Investment Fund Management (Shanghai) Co., Ltd.
(29)PIMCO Overseas Investment Fund Management (Shanghai) Co., Ltd.
(30)UBP Overseas Investment Fund Management (Shanghai) Co., Ltd.
(31)Invesco Overseas Investment Fund Management (Shanghai) Co., Ltd.
(32)Franklin Templeton Overseas Investment Fund Management (Shanghai) Co., Ltd.
(33)Taikang Overseas Investment Fund Management (Shanghai) Co., Ltd.
(34)Prudential Overseas Investment Fund Management (Shanghai) Co., Ltd.