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Marking the Second Anniversary of Pilot “Buy-Side Mode” Fund Investment Advisory Services

2021.11.26 XIE, Qing (Natasha)、 QIN. Tianyu、 LUO, Danchen

About two years ago, in October 2019, the Chinese Securities Regulatory Commission (CSRC) issued the Circular of the Pilot Program for Investment Advisory Service Business for Public Securities Investment Funds (the “Pilot Program Circular”), unveiling the pilot program of so-called “buy-side mode” fund investment advisory services, as opposed to the existing “sell-side mode” fund distribution business services. To date, at the second anniversary of the implementation of the pilot public fund investment advisory services (“Pilot Fund Investment Advisory Services”), a total of 60 institutions have been granted a pilot qualification. According to public sources, those include 26 fund management companies (FMC) or their subsidiaries, 28 securities companies, three commercial banks, and three third-party distribution agencies or their joint venture subsidiaries.


Over the past two years, the fund investment advisory service business has been prudently tried as a pilot (which, if deemed successful, is expected to provide a model for future expansion), while the regulatory framework has also been gradually improved. Below we review the development of the fund investment advisory service business so far and what we expect to see in the future.


1. Legislation on Fund Investment Advisory Service Business Steadily Improves


1.1 The Pilot Program Circular


Even before the Pilot Program Circular was issued, certain institutions had provided investors with the so-called "artificial intelligence investment advisory services (‘AI Advisory Services’)" under their own fund distribution license or securities investment advisory service business license or that of their business partners, where they conducted a risk assessment for the investors and then derived asset allocation recommendations to the investors (i.e., building a diversified fund investment portfolio) based on the risk assessment. The Pilot Program Circular has the first clarification of the definition of a fund investment advisory service business and explicitly stipulates that institutions providing fund investment advisory services shall be registered with the CSRC.


Pursuant to the Pilot Program Circular, institutions providing fund investment advisory services (“pilot institutions”) may provide clients with fund investment portfolio strategies upon their entrustment and in accordance with the terms of their agreements and seek direct or indirect economic benefits by doing so. The Pilot Program Circular further clarifies that the target investments proposed by the fund investment portfolio strategies must be public funds or similar products approved by the CSRC. 


Under the Pilot Program Circular, pilot institutions may conduct discretionary and non-discretionary fund investment advisory business. As for “discretionary fund investment advisory services”, pilot institutions may decide the scope of the underlying fund types, quantity, and trading time on behalf of the client within the scope of the authorization designated by the client and in accordance with the investment portfolio strategies agreed upon with the client; and may apply for the purchase, redemption, and transfer of the fund units on behalf of the client. “Discretionary fund investment advisory services” is similar to a “managed account”, where a client first opens a fund account at the pilot institution, and then delegates the investment decision-making and trade execution power to that pilot institution, thereby the pilot institution may exercise the designated power in accordance with the agreements entered with the client.


The Pilot Program Circular also sets forth other detailed requirements for fund investment advisory service providers, which concerns with the fund investment portfolio strategies, fund investment advisory service charges, investor suitability and risk tolerance level assessment, information disclosure and marketing of fund investment advisory business, must-have clauses of a fund investment advisory service agreement, and internal risk control, etc.


1.2 The Administrative Measures for Securities and Fund Investment Consultancy Businesses (Consultation Paper)


In May 2020, the CSRC issued the Administrative Measures for Securities and Fund Investment Consultancy Businesses (Consultation Paper) (“Administrative Measures”), which is superior in authority to the Pilot Program Circular in terms of the applicability. The Administrative Measures unify the fund investment advisory service business into the “securities and fund investment consultancy businesses” and provides a higher-level statutory basis for the fund investment advisory service business. Thus far, the final version of the Administrative Measures has not yet been released.


Further to the Pilot Program Circular, the Administrative Measures improve the definition of “fund investment advisory services business.” According to the Administrative Measures, “fund investment advisory service” refers to business activities that provide clients with, upon their entrustment and in accordance with the terms of their agreements, investment recommendations to assist clients in making investment decisions or in executing trades on behalf of clients subject to the applicable provisions for securities investment funds and other investment products approved by the CSRC. Moreover, Article 7 of the Administrative Measures provides that a fund investment advisor may offer discretionary investment advisory services to clients.


1.3 The Guidance on Fund Investment Advisory Service Agreement and Risk Disclosure Letter (Consultation Paper)


The Asset Management Association of China (AMAC) released two relevant guides on November 5, 2021, namely, the Guidance on Content and Format of Investment Advisory Service Agreements for Public Securities Investment Fund (Consultation Paper) (“Guidance on Investment Advisory Service Agreements”), and the Guidance on Content and Format of Risk Disclosure Letters for Investment Advisory Service for Public Securities Investment Fund (Consultation Paper) (“Guidance on Risk Disclosure Letters”), which marks a significant step toward improving the regulation of the fund investment advisory service business.


In terms of the content and drafting style, the Guidance on Investment Advisory Service Agreements and the Guidance on Risk Disclosure Letters both refer to the contract templates for public funds and private funds contracts and have refined the required contents of a fund investment advisory service agreement, of which the following aspects are noteworthy:


(1) The Guidance on Investment Advisory Service Agreements requires a fund investment advisor to clearly define and explain the legal terms in an investment advisory service agreement. It also provides certain definitions of such legal terms, of which the definitions of “fund investment advisory service” and “discretionary fund investment advisory service” remain consistent with those stipulated in the Administrative Measures. Moreover, the Guidance on Investment Advisory Service Agreements for the first time provides that “fund investment portfolio strategies” shall include, without limitation, the scope of the underlying fund types, quantity, and trading time, which are, the specific contents of fund investment recommendations.


(2) The Guidance on Investment Advisory Service Agreements requires a fund investment advisor to state in the investment advisory service agreement that the fund investment advisory services are different from fund distribution services. Specifically, a fund investment advisor may provide clients with, upon their entrustment and in accordance with the investment advisory service agreement, fund investment advisory services and seek direct or indirect economic benefits by doing so. The Guidance on Risk Disclosure Letters also requires a fund investment advisor to disclose the differences between the fund investment advisory services and fund distribution services. In particular, the fee schedule for fund investment advisory services is quite different from that of the fund distribution services. In other words, a fund distribution agency or any other institution without a fund investment advisory license shall not provide investors with fund investment advisory services directly or in a concealed manner.


(3) For discretionary fund investment advisory services, the Guidance on Investment Advisory Service Agreements requires the risk control measures and relevant mechanisms for client protection to be explicitly provided in the agreement, in addition to the requirement for providing a clear definition of the discretionary fund investment advisory services.


(4) The Guidance on Risk Disclosure Letters classifies risks related to the fund investment advisory services into general risk, risks associated with discretionary investment advisory services, and other risks, while highlighting certain typical risks closely associated with the fund investment advisory service business, which includes (1) the likelihood that the risk level of a constituent fund in a fund portfolio strategies is higher than that of the fund portfolio strategies, (2) the risk that the pilot institution loses its qualification for the fund investment advisory services, and (3) the risk of position adjustment of a managed account.


At present, both the Guidance on Investment Advisory Service Agreements and the Guidance on Risk Disclosure Letters are still open for public comments. With the rapid development of the pilot fund investment advisory service business, we expect that the guidance will be officially released shortly.


2. Crackdown on Unlicensed Fund Investment Advisors


With the steady improvement of laws and regulations governing fund investment advisory service business, unlicensed fund investment advisor activities are facing crackdowns from the regulators. It is reported that the securities regulatory bureaus of Shanghai, Beijing, and Guangdong have released the Circular of Regulating Fund Investment Recommendation Activities (“Circular”) to their respective jurisdictions. The Circular aims to further regulate the activities of providing fund portfolio strategy recommendations – i.e., fund investment advisory services.


The Circular specifies that if fund investment recommendations are only ancillary to the fund distribution services, they must be provided strictly within the legal relationships of the fund distribution services. To be specific, (1) it shall be the fund distribution agency itself that makes such fund investment recommendations; (2) the fund distribution agency shall make the fund investment recommendations only on the fund products that it distributes; (3) the receiver of the fund investment recommendations shall be limited to the clients targeted by the fund distribution services of the fund distribution agency; (4) the fund distribution agency shall not execute a separate agreement with the clients for fund investment recommendation services; (5) the fund distribution agency shall not charge additional fees for fund investment recommendation services; (6) an institution unlicensed to provide fund investment advisory services shall not make investment recommendations for fund portfolio strategies, nor advise on the percentage of each fund in the fund investment portfolio, exhibit the performance of the fund investment portfolio, or offer position adjustment recommendations. Simply put, a fund distribution agency may provide investment recommendations to investors for the fund it distributes, however, those services must be ancillary to the fund distribution services, for which the fund distribution agency shall not charge fees separately. Moreover, a fund distribution agency shall not provide investment recommendations for fund portfolio strategies if it is not a qualified pilot fund investment advisory service provider. The Circular specifically targets the follow-on investments provided by certain fund distribution agencies on their platforms. For example, certain fund distribution agencies display a basket of fund portfolios on their platforms and provide clients with services such as “one-click follow-on investment,” “automatic follow-on investment,” or “automatic investment plan.”


The Circular further prohibits institutions from developing a new business of making recommendations for fund portfolio strategies that do not meet the requirements of the Circular – specifically, they must not: display or launch new fund portfolio strategies, involve new clients in the already launched fund portfolio strategies, or allow existing clients to make additional fund portfolio strategy investments. Moreover, the Circular sets different rectification timelines for institutions with and without fund investment advisory licenses.


In the past two years, the regulators have been stressing that financial business must be conducted with the proper license. Fund investment advisory service business is one of the financial businesses regulated by the CSRC. On the one hand, the Circular outlines that fund investment advisors require a proper license; on the other hand, it clearly distinguishes the fund investment advisory activities that are ancillary to fund distribution services and the standalone fund investment advisory services, all of which aligns with the recent trend in regulating financial businesses.


Our Observations


In the two years since the launch of the pilot program for fund investment advisory services, the applicable laws, regulations, and ancillary rules have been steadily improved, the number of pilot institutions has been continuously increasing, and the assets under management (AUM) of pilot fund investment advisors has rapidly increased. Unlike the traditional securities investment advisory services, the fund investment advisory service business is an investment advisory services specifically for buyers’ interests (i.e. investors). Based on different risk tolerance levels of clients, the fund investment advisory services aim to tailor the fund portfolio allocation for each client’s investment/wealth management needs and goals. Meanwhile, the design of the fee model for fund investment advisory services helps to bind the interests of the fund investment advisor and the clients. Thus, the fund investment advisory service business is in line with the origin of the wealth management industry, that is, so-called “take on clients’ entrustment, perform wealth management duties on behalf of the clients”. For the pilot institutions, the fund investment advisory services are not simply about designing a financial product or selling one or more financial products to investors, but rather they are meant to allocate assets on behalf of the investors based on their investment/wealth management needs and goals, with the focus on providing "advisory services" rather than "sales services" to investors.  


In practice, some of the pilot institutions fail to provide diversified fund investment portfolios based on the investment/wealth management goals of different clients or only provide a limited scope of the constituent funds. That is because these pilot institutions are much more willing to sell their package of fund products rather than making fund investment portfolio recommendations for the clients. Additionally, the increase in the number of pilot institutions has also led to the homogenization of fund investment advisory services provided by some of these institutions. As the fund investment advisors approved are still under the pilot program, the CSRC has one year for testing these early adopters. Pilot institutions that fail to meet the regulatory expectations will lose their qualifications with the expiration of the one-year pilot period. Pilot institutions are advised to pay close attention to its compliance status in this respect.


List of Fund Investment Advisors (not exhaustive)


Batch

Approval Time

Type

Name

1

October 2019

FMCs or their Subsidiaries

1.efunds

2.Southern Asset Management

3.China WM of the China AMC

4.Harvest WM of the Harvest Fund

Zhong Ou WM of the Zhong Ou AMC

December 2019

Third-Party Distribution Agencies

6.Shumi Fund

7.eng An Fund

8.Ying Mi Fund

February 2020

Commercial Banks

9.ICBC

10.China Merchants Bank

11.PingAn Bank

Securities Companies

12.Guitai Junan Securities

13.Huatai Securities

14.Shenwan Hongyuan Securities

15.China Securities

16.China International Capital Corporation Limited (CICC)

17.China Galaxy Securities

18.GuoLian Securities 

2

June 2021

FMCs

19.ICBCCS

20.Bosera Fund

21.GF Fund Management

22.China Merchants Fund

23.Aegon-Industrial Fund

24.China Universal AM

25.HuaAn Funds

26.YinHua Fund Management Co., Ltd.

27.Bank of Communications Schroder Fund Management Co.,Ltd

28.PengHua Fund

Securities Companies

29.Industrial Securities

30.China Merchants Securities

31.Guosen Securities

32.Orient Securities

33.CITIC Securities

34.Essence Securities

35.Zheshang Securities

July 2021

FMCs

36.Huatai-PineBridge Investments

37.Invesco Great Wall

38.Minsheng Royal Fund Management Co., Ltd.

39.FullGoal Fund

40.SWS MU Fund Management

41. Wanjia Asset

42.CCB Principal Asset Management

Securities Companies

43.EverBright Securities

44.PinAn Securities

45.BOC International (China) Co., Ltd.

46.Shanxi Securities

47.Dongxing Securities

48.Nanjing Securities

49.hongtai Securities

50.Huaan Securities

51.SinoLink Securities

52.EastMoney Securities

53.Caitong Securities

54.Huaxi Securities

55.Huabao Securities



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