MRF, ARFP and opportunities for Australian fund management
MRF: a “game changer”
One of the recent steps in China’s gradual programme of capital account deregulation was the Mainland- Hong Kong Mutual Recognition of Funds (MRF) initiative, sealed by the signing of a memorandum of understanding between the China Securities Regulatory Commision (CSRC) and Hong Kong Securities and Futures Commision (SFC). The programme, which went live in July of this year, had attracted nine Hong Kong based funds as of August, even despite the surge in global stock market volatility. Under the MRF programme, funds meeting preset criteria respectively established by the CSRC and SFC are offered streamlined access to distribution in their respective markets, up to an initial flow of funds quota of RMB300bn. According to law firm King & Wood Mallesons, MRF “could be a game changer for all global fund management groupswhich want retail fund distribution in Asia.” The arrangement however offers Hong Kong a distinct advantage, most poignantly in the access it gains to the massive Mainland retail market, as yet off limits to Luxemobourg-domiciled UCITS funds, the structure currently dominant within the cross-border retail fund market.
“Luxembourg of Asia”
King & Wood Mallesons goes on to contextualise the momentousness of the MRF in what it sees as an industry shake-up in the Asian retail investment market that encompasses two new funds passporting schemes, including the ASEAN CIS Framework and the Asia Regional Funds Passport (ARFP), due for launch in 2016. Australia is a signatory of the latter, alongside New Zealand, The Philippines, South Korea, Thailand and Japan. Singapore has also signed a statement of intent on the latter. All three of these schemes give markets reasons to hope for enhanced cross-border access to funds within the Asia Pacific region, yet KWM points out that the programmes might also create fierce competition among financial centres to prevail as the region’s premier investment centre – the “Luxembourg of Asia”, alluding to the small European nation’s outsize share of Europe’s fund management business. KWM argue that the centre best able to achieve a trifecta of favourable conditions – accessibility and ease of business, robust regulation and familiar fund structures and finally tax treatment for the fund, the manager and investors – is likely to rise to prominence. The firm argues that among ARFP participants, Singapore and Australia are serious contenders for this title. The Financial Services Council similarly argues that ARFP is a “key element of Australia’s ability to compete as a regional financial services centre”. However, although Hong Kong has not signed on to ARFP, the MRF framework, with its newly established access to the Chinese retail market (also a non-signatory of ARFP) could mean that Hong Kong gives Singapore and Australia a run for their money.
Even a small rise in Australia’s share could mean a boost to services, jobs
One determinant of Australia’s prevalence is the success of ARFP itself. On the upside, given the low base of foreign investors accessing Australian funds, even a moderate increase in Australia’s share of foreign-sourced funds could bear dividends in terms of trade in services and importantly, local jobs. According to Nikko Asset Mangement only four percent of assets under Australian fund management are sourced from overseas, and should this double to eight percent, Australia might be recipient of an additional inflow of A$100bn into its fund management sector, currently near A$2.6trn in size.
Australia’s first challenge – tax regime
Still, even if the first $100bn comes easily, Australia’s prevalence may be limited not only by competing regional arrangements other than ARFP but also due to hurdles in other areas. Given overseas funds would be offered into Australia under ARFP such that flows would be two-way, Australian fund managers would potentially need to prove their mettle to maintain their share of the domestic market. As KWM mentions above, a competitive tax regime for investors is one important criterion. After all, one reason for Asian investors to embrace ARFP is to achieve greater cost efficiencies in fund management, as an APEC study points out (estimating regional cost savings of up to USD20bn from implementation of ARFP).
However, the Johnson enquiry of 2009 took aim at the Australian dividend imputation system, which offers favourable tax treatment to domestic versus overseas investors as one comparatively weak spot; if unchanged, the disparity in tax treatment could potentially prove a detriment to Australian competitiveness in a situation of greater cross-border two-way fund flow.
That said, there are some signals of change. Recently, the Australian government has made motions in the direction of leveling out the barriers to inward investment in the form of its ongoing investment manager regime legislation. Still, the implications of such revision for Australia’s competitiveness vis-à-vis regional competitor financial centres remain far from straightforward. Regulatory regimes are far from uniform in the region, giving rise to disparate regional approaches to compliance with international anti money laundering agreements, for example. Comparative regulatory compliance remains a significant influential factor in regional governments’ ability and desire to offer incentives for foreign inward investment.
Other Australian challenges: real returns and allocations
There are other outstanding points that might hold Australia back in its quest to achieve regional financial hub status. Firstly, as stated in the APEC study cited above, one desirable aspect of funds passporting is potential for higher return for lower risk due to better portfolio diversification. When however we examine real pension returns in Australia, they are among the least competitive in the OECD, even despite typically higher nominal yields that accompany Australian funds’ comparatively high equity bias. This might indicate a lack of protection in existing pension portfolios against declines in purchasing power (for instance, due to comparatively higher inflation or declines in the Australian dollar):
Chart 1: Pension Real Return (Source: OECD)
When in regard specifically to Australia’s capability to capitalise on Chinese deregulation and internationalisation of the RMB, Australian funds’ asset allocation shows a comparative dearth of fixed income investments, which might miss out on China’s drive to substantially increase the depth and liquidity of its bond market, a prerequisite to an increase in RMB assets in sovereign portfolios in particular:
Chart 2: Pension asset allocation (Source: OECD)
There are, of course other leading Australian product offerings indeed contain products that could provide good diversification value (infrastructure, for instance, and private equity funds), which however might not be popular enough however (in the face of a deregulating and growing Chinese bond market) to cement Australia’s position as the fund management capital of the Asia Pacific region.
Lastly, as the Johnson report points out, assets under management as a whole within Australia appear far from balanced, demonstrate significant home country bias and might benefit from inclusion of overseas assets, perhaps to a greater extent than Asia requires Australian assets.
In sum, we cannot take Australia’s imminence as a regional financial hub as a given. Nonetheless, we have clear indications as to changes that could help Australia rise to greater prominence as mutual recognition and funds passporting progress, offering prospects of more integrated funds management in the region.
Please join us at the Thomson Reuters – Europacifica RMB Thought Leadership luncheon on 18 November for further discussion of the implications of Australia of ARFP and fund passporting as China deregulates its capital account.