In part two, the panel talks about the long/short funds, the recovery of the securities lending and their priorities for the next two years.
Andrew Law (HSBC Security Services), Siu Chan Kwan (Citi),
Sam Lam (JP Morgan Security Services), Michael Chan (BNY Mellon Asset Servicing)
Part 2: Derivatives, securities lending and strategic priorities for the future
Funds Global: Do you think that Ireland damaged the Ucits brand? Or is that going too far?
Chan: No, absolutely not. The issue was more that you had all these different European countries, like Ireland and Greece, going down one at a time like dominoes. Then you have regulators in Hong Kong, Taiwan and Singapore whose citizens were buying these funds. So they had to ask the question, ‘Should we be concerned?’ I think global investment managers are already ahead of the game and I’ve seen a lot of them, not re-domiciling, but creating new funds out of Singapore and Hong Kong. Some people argue that it’s a matter of time, say five years or so, before there is a mini Asia passport between Hong Kong, Singapore, maybe Korea and Taiwan, where people are familiar with Ucits products. But that’s not the end game. The end game is to prepare for when the China and India funds markets start investing outside of their domestic markets. But the players want to start small and demonstrate to the rest of the region that they could help do this [create an Asian passport] a lot quicker. It took Ucits 25 years or so to get to where it is today and some of the thinking is that Asia will get it done in the next half decade.
Law: Different markets are at different stages of development. For outward investments, most of the investments would be in Hong Kong, Singapore, Taiwan and South Korea. Ucits has been recognised as a global brand name in the region, and the outflows in other countries may be restricted. Instead of setting up new funds for global investments, it would be easier for other countries to tap into the Ucits product range. We have been talking about the Asia passport for a number of years, but now we’re seeing some development. In Hong Kong and Taiwan there is a memorandum of understanding, and China QDII tends to go through Hong Kong to invest overseas. For now there is some cross jurisdiction activities in North Asia, but it will take some time before we have a pan-Asian passport that is recognised across Asia. Obviously Ucits may have different varieties and different types of funds, but I see a trend for a specialised group of Asia focused products that could be set up and domiciled in Hong Kong or in an offshore centre. These could be, for example, greater China focused funds or ETFs [exchange-traded funds].
Chan: If an Asian passport existed today, does that mean the average retail investor is going to rush out and buy these funds? It’s like saying just because you built a highway people are going to drive it. In my opinion, retail funds growth will be very much dependent on the ‘sandwich class’ that is the people who are going to invest for the longer term. People in Asia are generally punters, they’re into churning and making a quick profit rather than buying a product and holding it for the long-term. Generally, most people think Ucits are funds meant for the longer term. Therefore, market development has to be coupled with investor education for Ucits to be a success. You could build the passport, but just creating one isn’t good enough. If people don’t buy into it then the industry’s never going to grow.
Lam: To take that further, it’s not just confined to the funds industry. We’re also talking about a pan-Asian exchange for fixed income and for equities, so there’s a lot of discussion in terms of pan-Asian development. But we haven’t seen a lot of these plans materialising yet and even if there is a pan-Asian infrastructure, would people rush into it? Probably not.
Furthermore, there are multiple challenges associated with these infrastructures including the lack of a pan-regional regulatory body, so we’re not at that stage yet.
Funds Global: These funds have gone off the boil now but 18 months ago there was a lot of talk about 130/30 funds, 120/20 funds, at least in Europe. Has there been demand for long/short funds in Asia or has it been affected by regulators questioning the use of derivatives?
Chan: I don’t think the sole cause was the regulators coming up with more stringent regulations. I think after the global financial crisis, people developed a herd mentality and went back to the basics. They wanted to take their cash and put it in the bank. Then when the sun came out again, they peeked out from under the covers and went into something they could understand.
Law: In Hong Kong and Singapore there are two market segments – one is for retail authorised funds, which are regulated, and then you have the alternative products, which are likely set up as offshore funds and are less regulated. The long/short strategies have always been popular. There is a market for that approach, but from a retail, regulated fund perspective in Hong Kong and Singapore you will have ‘codes of collective investment funds’ to cover alternative funds. Regulators are likely to approve your product if you follow these specifications. In the early days the regulator approved some alternative funds, which could be sold to retail investors and that range of funds didn’t do well. So when people try to invest in more innovative products, they are likely to be more knowledgeable.
Kwan: We have seen new funds being launched in the past twelve months or so, but these are private arrangements and are not for retail distribution. As a result they do not need to go through the regulator for approval. They are distributed through private banks or other channels for professional and high-net-worth individual investors.
Law: Long/short funds have been out there for as long as we can remember in the alternative fund space; it’s just that it’s a different segment of funds, open to more knowledgeable investors. Look at RMB [renminbi] funds as well, there’s only one fund that’s been authorised while there have been quite a large number of privately placed RMB funds of significant size.
However, we are seeing other authorised RMB funds in the pipeline. The current limitation on the range of offshore RMB investment options does mean that caution is being employed for retail funds. Therefore, sophisticated investors are leading the development of product.
Lam: If you look at the development of the Ucits regulations over the past few years, they are mainly focused on investment strategy and investment techniques or types of investable assets. However, for Ucits to continue to be successful in Asia, they should focus more on increasing distribution through easing the registration process of fund structures. We will continue to see more local managers in the Asia Pacific region launching Ucits products and structures so it’s kind of going the other way around.
Kwan: Sam made a very good point. I think the EU authorities need to recognise that although Ucits is very much a European arrangement, there is an increasing amount of money coming from outside Europe. Some of these new arrangements may not be in sync with the developments in Asia. For Ucits to continue to be successful internationally, the authorities there should pay more attention to the slightly different needs of Ucits investors outside the European community.
Funds Global: Are securities lending services in a growth phase in Asia and, if so, why? What other services or products are in a growth phase?
Chan: In answer to the first part: I think securities lending is more in a recovery phase, not in a growth phase, globally. During the financial crisis, everybody put the brakes on, but the bigger players quickly realised that it wasn’t securities lending that created the crisis. The supply is back but I think with all the challenges globally - slow US recovery, Middle East, etc -, the demand is still limited at this stage. But the players are back in the game.
Lam: That’s interesting and I’m going to look at this from two angles. On one side you have the institutional investors in Asia Pacific who are looking at the lending programmes. I agree with Michael, this business is coming back as clients are reviewing the programmes and looking to get back into it after being on the sidelines for a few years. On the other side you’ve got the Asia Pacific equities lending market which I think is in a growth phase. A recent survey by Data Explorers covering global securities lending practitioners said that the Asian equities market share as a percentage of global equities available for loans will continue to rise from 17% in 2010 to as much as 25% in 2011. In terms of what’s driving the demand for equities lending in Asia, there is still a lot of demand for securities that are hard to get which when combined with expected dividend growth and buoyant M&A and IPO activities over the coming year, will make the market even more robust from an equities lending perspective for local Asian equities.
Law: There are two angles to the securities lending business in Asia. From a funds perspective, especially in the regulated funds, you hardly see any of them take on securities lending. I would say it’s more on the alternative side as well as the institutional side of the business. For Asia, there are more markets now open to securities lending, but the take-up rate has been slow. In Hong Kong and Australia there is more supply than demand, but it is true that more countries are looking at it and are open to the idea. It’s worthwhile to note that none of the ETFs in Hong Kong are actually lending securities.
Chan: There are two things there. One is the ETF segment, which was just alluded to, and that segment is picking up. Going back to the securities lending issue, prior to the crisis, lenders were very passive in nature. Lending was more driven by the back office. The thought process was, ‘We have these billions sitting here, why don’t we get a little kick on the yield? And we’ll review it periodically.’ After the crisis they became more aware of the risk vs return component - there’s no more free money, and many have moved that to the front office to look after because securities lending should be part of the overall investment strategy. As I said, they’re coming back into the market and people I speak to now are very much from the front office side of a business and are looking at the whole strategy.
Lam: I think that’s a very good point. We’re seeing institutional investors increasingly looking away from absolute returns to risk adjusted returns. Our clients’ front offices and investment teams are more involved in the process and focused on topics such as counterparty exposure, reinvestment guidelines and so forth. Therefore, we’ll see this trend continue in 2011.
Law: About securities lending for ETFs; while there aren’t any funds, at least in Hong Kong, using a securities lending service, I understand there are sponsors looking at it from time to time and considering whether it should be used. Hong Kong is becoming the largest ETF market in Asia, or the second largest, depending on how you look at it. If you have a securities lending programme with it, the Nav will increase naturally. But at this stage sponsors may be more focused on product creation.
Kwan: Across Asia we see a lot of potential. I won’t say that it’s a growth phase but compared with the other regions there is potential for institutions, like insurance companies to do more securities lending.
Funds Global: What are your strategic priorities for the next two years?
Kwan: We will continue to leverage our natural advantage as a full service bank to deliver a one-stop service to clients looking to expand in Asia. I’m not just talking about custody or fund administration but about other aspects of the value chain too. For example, we talked about ETFs. Since we have the markets business, we can help as the market-maker. We also have a consumer and private banking business which means we potentially can help to distribute their products. This is a strategic priority that we will continue to focus on.
Lam: From a product perspective, our priorities include collateral management across different asset classes, be it securities, derivatives or the hottest topic of the moment, commodities. Secondly, while still in the early stages, there is an increasing awareness across the region of transition management as a cost and risk reduction tool for institutional investors. Finally, we aim to continue building our alternative investment capabilities, across different asset classes, such as private equity, infrastructure, real estate, hedge funds and funds of hedge funds. From a client servicing perspective, our key aim is to build up our local teams in each respective country so we can be closer to our clients from a servicing and relationship management perspective. Our priority is also to localise the operations hub for some of the fund services that we currently provide to clients in Asia Pacific.
Chan: The priority is growth in Asia. Europe is expected to grow twice as fast as the Americas and Asia is expected to grow, at least in my budget, twice as fast as our European colleagues. We talked about the reasons why for the last hour and a half. Let’s consider some of these macro numbers. Asia has more than 50% of the world’s population. Its asset management industry probably represents less than 10%. The US alone has less than 10% of the global population but its asset management industry represents more than 50% of the global business. So there is certainly upside potential in Asia. What we’re going to be focusing on in the coming years is location strategy. We will continue to put more knowledgeable people on the ground in the key markets. We’re not going to try to be everything to everybody; we’re going to focus on what we do best. We’re not going to go into retail, we’re not going to go into loans, credit cards and so forth. We’re going to service our institutional clients and work with the regulators from a knowledge-exchange and market- development perspective. We’re here for the long term.
Law: We all know the story of West moving East and the growth in Asia becoming more rapid. We see competition increasing as discussed today. We already have a strong base of assets and we intend to make sure that we service our clients well, to ensure that they work with us when they are expanding into different countries. A trend in this area that we are already working hard to satisfy is the increasing desire for transparency as clients wish to scrutinise the service we are providing in more depth than before. In Hong Kong itself we see a lot of Chinese-themed products taking advantage of the offshore RMB market. We will work with our existing and new clients to create more of those products. We are seeing growth and so it remains a strategic priority from a people perspective to ensure that the teams have the right skill sets and the capacity to support our ambitions.
©2011 funds europe