Magazine issues » Winter 2012

CHINA DISTRIBUTION: What’s in store?

Fortune cookiesThe quasi-monopoly of Chinese banks is starting to crumble as foreign banks and independent financial advisers are seeking approval to sell mutual funds to the public. Stefanie Eschenbacher takes a closer look at the country’s clogged fund distribution channels following the once-in-a-decade leadership change.

By 2050 the world’s economic centre of gravity will have shifted eastwards to lie somewhere between China and India; in 1980, it was in the middle of the Atlantic.

Danny Quah, a Kuwait professor of economics and international development at the London School of Economics, came to this conclusion using a theoretical measure of the focal point of global economic activity based on GDP.

“In the wake of the 2008 global financial crisis, China became the single largest contributor to world economic growth, adding to the global economy three times what the United States did,” Quah says.

And there is a wealth of other China-related research that has caught the imagination of those trying to establish a fund distribution network in China.

Frank Knight’s Wealth Report, for example, forecasts that China’s GDP, adjusted for purchasing power parity, will have grown to $80.02 trillion by 2050. Two years ago, it was
$9.98 trillion.

Economic growth does not necessarily lead to more high-net-worth individuals, but it does provide opportunities for large-scale wealth creation in the longer term.

After the once-in-a-decade leadership change in China has been completed– Xi Jinping has been appointed as the new head of the Communist Party and together with six other members of the Standing Committee of the Poliburo now rules over a fifth of the world’s population – it is unclear how much room there is for reform.

Ken Yap, a director and head of Asia Pacific research at Cerulli Associates, says changes to the economy are likely to happen managed and controlled.

Today there are 73 asset managers in China, 41 of which are joint ventures. “There is still no majority ownership,” says Yap. “Much has happened on the manufacturing level, but it remains to be seen what will happen to the distribution structure.”

Yap says he expects more involvement from international players through the qualified domestic institutional investor (QDII) and qualified foreign institutional investor (QFII) schemes.

“Most asset managers would probably target high-net-worth individuals in larger cities, not the mass retail market. China is a competitive market and there are still restrictions as to what products asset managers can bring into the country.”

Yap adds that QDII funds, which allow Chinese money to be invested internationally, have lost half their assets since they were first launched.    

The Chinese market has traditionally been characterised by a culture of short-term trading, rather than long-term investment. There is, however, a growing consciousness that it needs a more stable investor base to address volatility and, ultimately, performance.

China has also one of the most rapidly ageing populations in the world, creating a need for long-term financial planning. By 2050 more than a quarter of the population is predicted to be over 65 years, placing a huge burden on the younger generation and the social welfare system.

China has recently established a private retirement plans, called enterprise annuities, which resemble 401 (k) plans in the US. If the experience in the US is anything to go by, these will lead to longer-term savings.

So far, uptake of these plans has been slow. Theresa Hamacher, president at the National Investment Company Service Association, and Bob Pozen, senior lecturer at Harvard Business School and senior fellow at the Brookings Institution, say this was not surprising considering their minimal tax incentive.

In an opinion piece, published by the Brookings Institution, an independent research organisation, they argue the Chinese government – given its low levels of debt – could offer much larger tax benefits to Chinese workers who save through private retirement.

Such plans, they write, could provide a supplement to the financially weak government pension system that does not extend to many rural areas.

Today about 60% of China’s mutual fund sales are still made through banks, according to statistics by the Standardization Administration of the People’s Republic of China. One of the problems with banks being the main distributors, however, is that these have little incentive to offer value added services because they cannot charge higher fees.

In contrast, in the West, sometimes more than 60% of funds are sold through independent financial advisers.

There are 170 entities with fund distribution licenses in China, according to Beijing-based law firm Linklaters. Among those were nine are independent fund distributors and five are securities investment consultancy institutions. Another 62 were commercial banks and 94 securities companies.

Annabella Fu, partner at Linklaters, says none of the foreign investment banks had such a license at the end of September.  “We understand that several foreign investment banks have been in the process of applying for such a license,” she says.

Fu says independent fund distributors can in some cases offer the advantage of being able to provide more tailored services, but it is a more challenging for them. Regulators, she adds, are keen to continue to open up the distribution market to other financial institutions such as insurers and futures companies.

“The competitive advantage that these financial institutions have in their broad distribution network would need to be met with bespoke service, online distribution capability and/or lower fees if smaller institutions are to compete effectively,” says Fu.

Foreign banks have stepped up their efforts to break up – or at least weaken – the quasi-monopoly of Chinese banks in fund distribution.

Fund sales used to be restricted to Chinese banks, asset managers and brokers. Independent financial advisers and foreign banks were practically barred from the market.

The China Securities Regulatory Commission states it has aims to encourage competition and raise overall quality of asset management and is gradually loosening restrictions – or at least it has promised to do so.

The latest regulation of fund ­distribution was announced in June last year and became effective a few months later, in October.

Companies that have a registered capital of renminbi 200 million ($32.1 million) and at least ten fund professionals could apply for such a license, according to the proposal issued last year. This extends to foreign banks, which could also apply for such a license.

Quoting local media sources, Shanghai-based consultancy Z-Ben Advisors reported at the end of last year that at least 100 institutions were waiting for the opening of third party fund sales.

“Commercial banks are particularly concerned because they have dominated the fund distribution business for so long,” one of its research notes said. “However, even though [the regulator] has allowed third-party sales entities to sell fund products, it is unlikely for them to overtake bank distribution channels in the near future.”

A new rule is now meant to allow foreign banks to distribute funds in China. The regulator issued a draft letter regarding amending the existing fund distribution regulation in July. If the amendment set out in the draft letter is approved, then a number of foreign banks are expected to qualify to distribute funds in China.

As Funds Global Asia went to press it had not been officially approved and issued. It was also unclear how many had applied for such a third-party distribution license.

Shirley Lam is head of north Asia investments at Manulife Asset Management Asia, with headquarters in Hong Kong. Its group company established a Chinese-foreign joint venture with Northern International Trust, part of Tianjin Teda Investment Holding. Tianjin Teda owns a 51% stake in Manulife Teda Fund Management.

While so far no foreign bank has been approved to distribute public funds in China, Lam says she believes at least six banks are preparing for the application.

“It will be a gradual process to change the fund distribution structure,” Lam says. “Foreign banks need to go through an the process of getting a license, we expect the first ones to enter the market next year if the amendments are rolled out in the near future.”

Manulife-Teda’s funds are currently distributed through the major Chinese banks, she says, adding that these have not only the knowledge of local markets but also the distribution network.

Lam says much of her work revolves now around working with overseas banks, for products from the joint venture to be made available through their platforms once they are readyfor fund distribution in China.

Allen Yan is deputy chief executive officer of Shenzhen-based Rongtong Fund Management, which has a joint venture with Nikko Asset Management. The Japanese asset manager holds a 40% stake in the Chinese-foreign joint venture.

“Banking is about having a network, a distribution strategy,” Yan says. “Asset management is more of a people game.”

Joint ventures, Yan adds, have worked well where the local asset manager is managed independently by experienced managers with stable shareholders and an independent board of directors has oversight. Yan says the regulator has encouraged these Chinese-foreign joint ventures, in an attempt to develop the market and learn best practices from global players.

“Cultivating new distribution channels is always a challenge, especially in a country where equity markets have underperformed for an extended period of time,” Yan says. “Over the past two years, product focus has shifted to fixed income.” Banks, however, have a competitive advantage in that space.

squeezed margins
Rongtong Fund Management is adding to its fixed income range with two onshore bond funds.

Lam says the majority of asset growth stems from fixed income. “Tianjin Teda was initially equity focused, but when we entered into a joint venture we beefed up the fixed income team,” she adds. “We have traditionally had a strong fixed income team because of our insurance background.”

Banks, which tend to treat funds as one of the many products they offer, rather than a long-term investment, often take more than half of the fees. This leaves asset managers with margins squeezed.

Yan says even when asset managers that have established a relationship with a large bank and entered a distribution agreement, their funds are not necessarily going to be sold across China.

“China is certainly not a homogenous market,” Yan says. “Product reception varies across the country. Generally, we find low risk products such as fixed income products sell better in the northern part of China whereas in the south, especially in the coastal areas, high risk products have better traction.”

There are some differences in regional preferences when it comes to different asset classes, agrees Li Li, head of marketing at Shenzhen-based Invesco Great Wall.

“We are known for our equity funds and when they perform well, we sell them easily,” Li says, though she adds there has been a general shift into fixed income. “Fixed income has been more popular lately so we want to broaden our range to offer more fixed income funds.”

With home markets currently sluggish – China has had the worst-performing major equity market in Asia – many Chinese asset managers have been looking for opportunities elsewhere.

Invesco Great Wall, for example, tries to develop the separate account business and has recently won several new mandates.

“We have a market that has not been growing so everyone is struggling to maintain their market share,” Yan says. The largest players have started to search for opportunities outside China and 13 have opened a subsidiary in Hong Kong.

“A lot of them have ambitions to become known internationally, but the biggest challenge for Chinese fund managers is brand recognition,” Yan says. They face established global players while competition from other parts of Asia – Hong Kong, Indonesia, Japan, Korea and Singapore – is stepping up, too.

Distrib tableTwelve years ago there were ten asset managers in China; today there are 73. The Chinese government has favoured them with various cross-border schemes, including  the QDII and QFII schemes.

China’s asset management industry is evolving and becoming more mature, but Yan says when it comes to management style, risk management, investment philosophy and other aspects crucial to success, Chinese asset managers have much to catch up on.

Chinese asset managers remain heavily regulated and product launches are a good example. “Any product launch of a publicly offered fund requires regulatory approval, resulting in a typical product launch cycle going anywhere from four to six month just obtaining a regulatory approval,” Yan says.

A few years ago, an asset manager could practically only launch two products a year, but now [the regulator] has recognized that this has created a bottleneck.”

Asset managers were unable to design and launch products the market demanded on a timely manner.

But Yan says over the past two years, there has been further and broader deregulation when it comes to product launches. As a result the number of funds in China has more than doubled.

“We expect this deregulation trend will continue and introduction of new products will become increasingly market-driven,” he says. “Ultimately, this will benefit investors in China as they will find better and broader investment choices.”

Several independent financial advisers received licenses to sell mutual funds in recent months. Three of these firms are based in Shanghai – Noah Holdings, Howbuy Fund Research Centre and Eastmoney Investment Consulting. Another one, Zhonglu Investment Consulting, is based in Shenzhen.

They face a though market, though. They will have to, as Lam puts it, “learn how to get competitive” and build a business model that charges lower commissions.

In an update to the research on third-party distribution, Z-Ben Advisors writes: “The participation of independent financial advisors might significantly increase fund sales in China and could solve the ongoing problem of clogged distribution channels.”

©2012 funds global asia

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