Caution advised on China's hedge fund liberalisation
The liberalisation of China’s hedge fund market should be met with caution by managers, experts have advised.
The Shanghai Municipal Government Financial Services Office (FSO) is currently consulting with experts on its Qualified Domestic Limited Partner Program (QDLP), a pilot scheme which will allow approved foreign hedge funds to raise Renminbi-denominated funds in mainland China although the capital raised must be invested in foreign markets.
“This is obviously a very exciting time as China is opening up its foreign exchange and capital markets to inward and outward investment. However, the exact timing of when the rules will be finalised are still unclear as policy debates in China often tend to be stop-start processes. Nonetheless, managers hoping to tap Chinese institutional money should prepare for the rules,” said Paul Smith, managing director Asia-Pacific at the CFA Institute and former CEO of Triple A Partners, a third party marketing firm in Hong Kong.
The pace of change, however, has been slow and is further complicated by the once-in-a-decade leadership change currently underway in Beijing. One regulatory expert reckoned the government had higher priorities on its agenda. “Creating a hedge fund market in mainland China remains low on the government’s radar screen. Let us not forget the country is still putting in place regulations governing pension funds and long-only investment funds so hedge funds are not that high on the agenda,” said Bill Scrimgeour, head of regulation and public affairs at HSBC Securities Services in London.
Other market participants agreed China still had a lot of work to do in other areas of its economy. “The excitement may well be overblown. It is testing the market by these very small incremental steps. However, in order to maximise participation in flows both in and out of China, it needs to liberalise its currency and domestic markets whereby it lets foreign investors freely participate as they do in US and European markets. I don’t think the full opening of the markets to allow capital flows both ways will be finalised anytime soon. I doubt China will be a fully functioning hedge fund market with the absolute free flow of capital within a decade,” commented Andrew Main, managing partner at Stratton Street Capital, a fixed income emerging markets manager.
According to a Sidley Austin memo, QDLP states hedge funds must submit applications for approval prior to marketing. Furthermore, total capital raised cannot exceed $5 billion initially although this could be increased to $60 billion by 2017. Sidley Austin’s memo added the pilot scheme is likely to be extended to more managers in time. “As things presently stand, only managers with a certain AuM and tenure will be able to enter into the scheme. However, I doubt the Chinese regime will prohibit exotic strategies from participating,” said Smith. It is believed that only the largest managers will meet the initial AuM threshold although there is speculation the threshold could be set at $500 million.
Nevertheless, there is still tremendous uncertainty about what the final rules will look like. Service providers and regulatory experts in APAC are working closely on a pro-bono basis with the FSO on QDLP but are bound by stringent non-disclosure agreements. An expert explained the secrecy as Beijing was loathe to find out about QDLP developments through media outlets rather than the official FSO channels. “A lot of initiatives in China happen on a local level but ultimately have to be cleared by Beijing,” said Smith.
Another local initiative is the Wenzhou Pilot, which will allow residents of the affluent city, to invest in funds abroad. Despite all of these positive soundings, Smith urged managers to exercise restraint when tapping the Chinese investor base. “Any manager who is unprepared for the changes in China will look stupid but hedge funds have to be cautious about unleashing the full force of capitalism on the country, as it could alarm some of the more conservative elements within China,” he said.
China presents exciting opportunities for hedge fund managers hoping to tap into the high net worth (HNWI) and ultra-high net worth (UHNWI) investor base. According to RBC Wealth Management and Capgemnini’s 2012 World Wealth Report, APAC surpassed North America in HNWI population to become the largest HNWI region for the first time. APAC’s HNWI population expanded 1.6% to 3.37 million in 2011 representing an 11% growth over the last two years, said the report.
China is not unchartered territory for hedge funds as the country already has a flourishing albeit immature funds industry. According to data from the China Trustee Association, China has a private trust fund, or sunshine fund asset base totalling RMB 138.3 billion, or roughly $22 billion. Sunshine funds are similar to hedge funds although the majority adopt long-only strategies. Some do, however, use international prime brokers and pursue long/short strategies.
“Sunshine funds are often set up by high-flying CIOs who want to start their own venture and will run money mainly for themselves, family, friends and colleagues. Whether or not these are strictly hedge funds is open to debate but they have mushroomed over the last few years and the authorities have tolerated this growth. There are even some unofficial estimates that sunshine funds’ AuM is not that far off Hong Kong’s AuM,” said Florence Yip, tax leader of the Financial Services Group at PricewaterhouseCoopers and vice chairman of AIMA Hong Kong.