Caroline Higgins of Northern Trust tells George Mitton about A-share inclusion, ETF Connect and why Cayman funds predominate in the region.
It so happens that the date I meet Caroline Higgins, head of global fund services, Asia for Northern Trust, is June 1, the day after the first tranche of mainland-listed China A-shares join the MSCI Emerging Markets index.
The addition of A-shares has been trumpeted for as long as I have been visiting the region. But as the day arrives, market reaction is muted. Higgins, who has been busy behind the scenes to meet what she describes as “some aggressive timelines”, admits the response to the inclusion has hardly been explosive. But she urges me to see the event in context.
“It’s a catalyst,” she says. “Once there’s that initial movement in the market, others are pulled along with the flow.”
Her attitude to A-shares reflects a general perspective on Asia’s capital market development: each piece of the puzzle contributes to the overall picture. Progress is gradual but steady. It is a long-term game.
That certainly seems to be true of the inclusion process. MSCI, compiler of the widely followed Emerging Markets index, has managed the A-shares’ entry to ensure the market is not rocked by a spike in trading. The first step adds 2.5% of A-shares to the index; a second step, on September 3, will add the same proportion again.
Besides not wanting to disturb the market with a dramatic shift in investor allocations, MSCI says it has structured the inclusion this way to ensure investors can buy the necessary equities without exceeding daily trading limits on Stock Connect. This scheme, which links the stock exchanges of Hong Kong, Shanghai and Shenzhen, is expected to be the main route by which international investors raise their allocations to mainland-listed equities.
Higgins approves of the index provider’s approach and agrees that Stock Connect is likely to be the main channel for international flows. This increase in interest in the Connect scheme is of benefit to her firm, too. Managers that may not historically have participated in Connect, such as hedge funds, are now taking part, prompted, in part, by the MSCI move (another motivation is to partake in Bond Connect, the parallel version of the scheme that allows foreign investors to buy mainland-listed fixed income instruments via Hong Kong).
For Northern Trust, hedge funds’ increased desire to trade through the Connect schemes is good for business. Higgins says many of these funds are opening accounts with custodians, such as her firm, because the likes of Northern Trust can offer better integration with the Connect scheme than prime brokers.
There is another extension of the Connect programme planned in which exchange-traded funds (ETFs) will become accessible under the scheme. The proposed ETF Connect will allow investors in mainland China to buy Hong Kong-listed ETFs, while Hong Kong investors will be able to buy similar funds listed in Shanghai or Shenzhen.
The scheme has been hailed as another sign of China’s liberalisation of its capital markets. ETF providers with funds listed in Hong Kong are particularly optimistic – they hope for a inflow of investor money as mainland Chinese buyers access their products for the first time.
Higgins expects Northern Trust to play a role in facilitating fund flows under the scheme; however, her perspective as a custodian gives her a insider’s view of the obstacles associated with the scheme.
“Standardisation and harmonisation is always the key challenge,” she explains, noting that “even between Shenzhen and Shanghai”, which is to say, even between the two principle stock exchanges on the mainland, “there are different practices for ETFs”.
“Some of the challenges of the Connect stories have been coming up with a best practice that doesn’t favour a north or southbound channel,” she adds. “As we move to ETF Connect, these operational issues will become more obvious.”
Perhaps because of these problems, some commentators are forecasting that ETF Connect will not go live by the end of the year, as had been anticipated. Higgins also notes that across the region, ETFs have yet to gain the level of popularity among investors that these products enjoy in the US or, to a lesser extent, Europe. Asian retail investors, in particular, have not demonstrated a great desire for ETFs, which may be explained by the structure of fund distribution in the region.
“I always think the challenge with ETFs is, how do you get them into the general public or the market,” she says. “Banks still dominate retail distribution. How do ETFs, which offer little or no commissions, get sold to the mass retail segment?”
Higgins’ observation about the ETF market links to another view of hers – that European Ucits and Cayman Islands-domiciled funds will continue to be the preferred choice in Hong Kong for some time yet. Although the mutual recognition of funds (MRF) scheme offers opportunities for Hong Kong-domiciled funds in China, the limitations built into the programme mean it is less attractive than had been hoped. Meanwhile, the established jurisdictions – Luxembourg and Ireland in Europe and the Cayman Islands outside – offer well-understood regulatory regimes and, typically, a quick route to market.
Higgins is particularly sanguine about Cayman Islands funds, despite the attempt by some European regulators to sideline the jurisdiction. She argues that local, Hong Kong-domiciled funds are relatively heavily regulated, meaning their competitors are typically Ucits funds. Cayman Islands funds, in contrast, are lightly regulated, which makes them suitable for sophisticated investors, such as wealthy individuals and institutions.
“The infrastructure to support Cayman funds, such as law firms and consultants, is well established in the Hong Kong market,” she says. “You need to ask, why would you not use that? I see an opportunity for global and regional names to grow their Cayman ranges in the alternative space. I see that expanding in Asia around private equity, real estate and funds of funds.”
Clearly, the growth of the Asian funds industry is happening not in a burst, but gradually. Service providers such as Northern Trust are along for the ride.
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