Asian asset managers have historically lagged behind Europe and North America in the take-up of operational outsourcing, but the participants in our roundtable say this is changing. They also discuss the cost pressures they face themselves as a result of increased regulation. Chaired by Stefanie Eschenbacher.
Scott McLaren, head of sales and relationship management Asia, Brown Brothers Harriman
Alastair Murray, regional head of asset managers and insurance sector, sales and business development, Asia Pacific, HSBC Securities Services
Brent Reuter, managing director, Hong Kong, RBC Investor Services
Camie West, senior vice president, head of global fund services, Asia, Northern Trust
Fanny Wong, deputy general manager, head of custody, global transaction banking, Bank of China (Hong Kong)
Funds Global: How has the Asian growth story affected the asset servicing industry and how important is it to have a local presence in markets not easily accessible?
Fanny Wong, Bank of China (Hong Kong): Asia is no longer just a destination for investment but increasingly also a place for new funds; Asia is a place where asset managers want to establish a presence and bring their products to the market. Apart from the global players, there are also opportunities for local and regional players. Recent changes in the regulatory environment, especially when it comes to China, have given us the opportunity to offer specialised services. This includes, for example, servicing renminbi-related products.
Brent Reuter, RBC Investor Services: Most of our European and American customers have expanded within Asia from Hong Kong or Singapore. Now we see them developing new products and broadening their distribution in various Asian markets. The capacity for the provider to service them in multiple markets throughout Asia is therefore increasingly important. We also see a trend emerging that Asian asset managers want to grow within the region, seeking a pan-Asian capability. Providing base core services – custody, transfer agency and fund administration – is critical. As our customers grow their presence and expand their product range, they may look to other services – middle office, foreign exchange and securities lending.
Scott McLaren, Brown Brothers Harriman: Changing preferences for fund jurisdictions and products will probably determine the optimum business model and expansion strategy. Ucits funds, for example, are heavily distributed in the region; therefore, Ucits is one type of product that requires a global service model. Many of our global clients operate in Asia and, as such, the provider’s ability to service their global footprints can be key to their success. Asset servicing is becoming increasingly complex. European asset managers have been expanding into Asia for some time now; however, Asian managers are now increasingly looking at Europe as well. Custodians and administrators need to be able to cater to, say, the complex needs of a Chinese asset manager that manages money in Hong Kong but is also trying to set up a fund in the Cayman Islands or Luxembourg. Basically, Asian regional asset managers want providers who possess the capability of providing service in multiple markets, if their strategy is a combination of a Ucits distribution with a domestic fund strategy in some markets.
Alastair Murray, HSBC Securities Services: Local representation means having a presence in each of the markets – not just Hong Kong and Singapore, as many global players do. One of the key features asset managers desire is a bank which can provide a range of services locally. Unlike the more mature markets of Hong Kong and Singapore, the selection of asset servicers in many emerging markets is tied to distribution.
Wong: Asset managers do use multiple servicers – be it brokers, custodians or other types of service providers. We will have to be ready for this sort of multiplicity and all the requirements it entails. Foreign banks that do not have any local distribution capability in China have a major handicap.
Murray: Acting as a master custodian in China is tied to distribution. We would like to work with fund managers and provide fund administration services to them. We are not allowed to do that in China, owing to regulatory constraints. When the qualified domestic institutional investors (QDII) scheme first started, we started acting as overseas custodian and assisted the master custodian with the valuation of these overseas assets. We have now onshored this activity for the QDII funds in China. I believe it is only a matter of time until the regulator will allow us to administer local funds as well.
McLaren: Some domestic Asian markets have multiple custodians tied into distribution relationships. We could see a gradual change in this scenario as the trend for more outsourcing emerges for fund administration and transfer agency: a case in point is the Taiwanese market.
Murray: As markets evolve, asset managers look more closely at the quality of services – such as increased governance – they are getting from their custodian. Korea is a good example. Funds investing overseas from there are almost entirely using international banks based in Korea as their master custodian. These custodians won the mandates based on their global custody capability, not local distribution.
McLaren: Asset managers entering a new market will need a distribution partner in order to get the fund launched. A Chinese asset manager, for example, needs a solid distribution network when it enters the Hong Kong market. Well-known managers who own, and thus offer the benefit of, an established brand, tend not to be so reliant on the distribution channel.
Camie West, Northern Trust: Asset servicing is now a single, global market. This means players have to have all the global capabilities, in combination with local expertise. Another trend we have seen in recent years is that our clients are increasingly looking for increased governance and transparency.
Funds Global: The past couple of years have seen the launch of dim sum bonds, a renminbi-denominated exchange-traded fund and reniminbi-denominated real estate investment trusts. What issues does the Chinese currency raise for asset servicers?
Reuter: I expect a much broader proliferation of the types of products for both institutional and retail investors.
McLaren: There is the possibility of more renminbi currency share classes emerging or of a currency overlay strategy being used. The appreciation of the renminbi has paused momentarily, which explains a bit of the current slowdown. However, demand is likely to increase. Renminbi-denominated products are also attractive from a diversification point of view. Investors are showing a preference towards diversifying away from the US dollar, the Hong Kong dollar and the euro.
Murray: The renminbi itself does not create any particular challenges for asset servicers; it is an opportunity. Considering the privileges awarded to Hong Kong, it has evolved as the main offshore renminbi centre. The schemes that facilitate the cross-border flow of renminbi – the QDII and renminbi qualified foreign institutional investors (RQFII) programmes – are interesting for us. China has recently announced a quota for renminbi sovereign bonds to be issued in Hong Kong and this provides us with even more opportunities for the custody business.
Wong: One of the challenges we face is the limited availability of renminbi outside China and few hedging tools because derivatives are not well developed yet. The yield curve is not well developed either, not to mention that we have different onshore rates and offshore rates, which make valuations difficult. However, the entire industry is working on various initiatives to overcome them so there is indeed great potential for us.
Murray: There are challenges around the actual products managing QFII, RQFII and the QDII because of the various regulatory constraints.
McLaren: Opportunities can increase only after international fund managers are allowed access to the RQFII products, not while only Chinese asset managers are allowed to function in this space.
Reuter: Chinese asset managers may have a competitive advantage for a certain period of time, but it will be interesting to see how long this lasts.
Wong: The QFII and RQFII schemes have different requirements, but the Chinese regulator is aware of the fact that they need to narrow the gap between these two groups of fund managers to ensure it becomes a more level playing field.
Funds Global: Which products or services have been most in demand from the fund management community for the past couple of years? What is likely to be the next big advancement?
West: We have seen a traditional take-up of fund administration and custody services over the past couple of years and, more recently, we have seen an increase in demand around outsourcing services. Asset managers focus on their core capabilities – investment decisions and client servicing – so they are looking for efficiencies in their operational processes. Asian asset managers have historically lagged behind Europe and North America in the take-up of operational outsourcing but current cost pressures are changing that.
McLaren: Some Asian markets are generating high volumes of transactions. Everyone operating in these markets has had to add resources to handle the volume of manual trades, and the risk resulting from manual processing is ever-present. We have seen a lot of interest in Infomediary, Brown Brothers Harriman’s technology product, which converts manual trades into Swift formats to enable straight-through processing. With the support of the industry players, we expect the Taiwan market to move towards trade automation this year.
Murray: Taiwan is a challenging market because people sell in and out of funds quickly. Even though investors in Taiwan trade frequently, distributors are averse to automation and still prefer fax machines. This has been a challenge for many years. There is, however, a certain momentum in terms of automation now. Elsewhere in Asia, markets are at a different stage. Customers push us to automate; we want to automate as much as possible.
McLaren: Regulation, as well, can drive product development. Everyone needs to have a strategy for the Foreign Account Tax Compliance Act (Fatca). Insurance companies, pension funds, private banks, banks, asset managers, transfer agents and administrators – all need to start the process now in order to meet deadlines by January 2013, which allows for only a short space of time.
Funds Global: Apart from Fatca, there are also stricter depository requirements under the Alternative Investment Fund Managers Directive and Ucits, which increases the liability for depositary banks. How does this affect business?
Murray: In some respects we are ahead of Europe because we already have that concept in Asia. In the bigger Asian markets and common law jurisdictions – Hong Kong, Singapore and Malaysia – a custodian already is acting as a fiduciary, as a trustee. Other emerging markets in Asia have followed that pattern. Korea, for example, is not a common law jurisdiction, but a civil law jurisdiction. They do not have trust law per se, but they have imposed responsibilities of a trustee onto the custodian. Those include the responsibilities of oversight. If something goes wrong, they are responsible for bringing the matter to the attention of the regulator. Thailand, Vietnam and Indonesia are similar. Custodians operating in these markets are familiar with these fiduciary responsibilities and nothing has changed as a result of what is happening in Europe. There is no doubt though there are other areas of increasing regulation that is making asset servicing more expensive.
Wong: As service providers, we are aware that we now face increased liability. We need to exercise more control, we have to do more due diligence, more closely monitor what is happening. We have to buy more insurance cover to allow for more indemnity. In addition, we need to educate customers about the need to be compliant. Increased liability requirements result in higher costs, but these cannot be easily passed on to customers. In their perception, they need something tangible that would justify higher costs. Asset servicers will face a challenge convincing their customers that they have to pay more for the same services.
Reuter: Within certain fee structures, there are legacy fee structures where you have an all-in bundle price. It will be difficult to see an evolution from a pricing perspective. Each provider will probably take their own approach, but be forced by competitive pressures. One solution would be to develop different product categories and those with a higher operational risk will have higher charges.
Wong: We have to be more creative in our pricing of new services to factor in tax-related services, compliance, monitoring or collateral management. Even for over-the-counter derivatives we need to put down some initial margin. These are new service items that we can charge customers for. I hope customers will understand that they have to pay more, unless they have the scale or volumes. We also have to be cognizant of the fact that the world is flooded with liquidity. Most currencies have devalued through quantitative easing so our money is worth less than before.
West: Most asset managers are aware of the potential impacts the proposed changes could have on the business model, but many will see this as additional cost. They may find it difficult to understand why they have to pay more for the same services.
Murray: It is going to be a real challenge trying to pass those costs on to customers in Asia. Additional services are suddenly becoming the norm and it is difficult even to pass those charges on.
Funds Global: Is there scope for regulatory arbitrage in terms of costs?
Murray: There may be some arbitrage for offshore funds between the Cayman Islands and Asia generally. My observation is that Asia is far from a homogenous market, so if asset managers want to launch a fund in Thailand and sell it to the retail market, it has to be a Thai fund. The same applies for Vietnam, Indonesia and Malaysia.
McLaren: With respect to choice of fund domicile, there is scope for arbitrage where different domiciles and fund structures are subject to different regulations, tax profiles and investment restrictions. The question is about the distribution strategy they employ. The need to respond to an institutional investor client base in Europe would lead an asset manager more towards a Ucits structure. For retail distribution in Hong Kong, on the other hand, a Hong Kong fund might be more suitable. There is also the opportunity cost or loss of time to market. Structuring a Ucits fund and then registering it in multiple markets in Asia, which many global asset managers are in the practice of doing, is a lengthy process. A product that currently is right for the market might need to follow a domicile strategy that is quicker to market.
Reuter: The delay in bringing new products to market has frustrated a number of asset managers that were or are trying to bring something to the market that is topical. Some of our customers were looking at gold funds a year ago when there was a lot of volatility in the market. It seemed like an attractive product proposition, but by the time they had worked through the regulations, they had missed the opportunity. We have seen a lot of frustration. Hong Kong and Singapore are saturated – there are a lot of asset classes covered multiple times over – but regulation and the scrutiny of launching new funds will stifle innovation. To a certain extent, a lot of our customers are starting to feel the effects of this. When it comes to regulatory arbitrage, Hong Kong seems to be at the forefront of scrutiny. Singapore is slightly more relaxed and tends to approve new products quicker.
Wong: In Asia, investors like initial public offerings more than anything else and this includes fund launches. It is rare to see existing products being re-launched or restructured. In certain sectors, asset managers face the issue of competition and regulatory requirements. One example was the RQFII funds that all came to Hong Kong almost at the same time in the past few months. This has resulted in keen competition among them. They will also try to refer to the role model so if one company launches a Ucits fund, the rest will follow suit.
McLaren: In Hong Kong, funds authorised by the Securities and Futures Commission (SFC) have seen some rationalisation. For example, the number of funds registered with the SFC was more than 2,100 but declined to 1,850 last year, coupled with a slowdown in the registration process over the past three years. Considering the increasing costs of setting up a fund, asset managers need to make sure that they can raise sufficient assets to make the fund viable. It is both complex and costly to open and close funds, and in some markets, you cannot liquidate the fund or even merge it so easily.
Murray: The first round of RQFII funds and the amount of money they raised was less than expected. Perhaps because Chinese asset managers wanted to bring their funds to the market quickly and there was a lot of pressure to be the first. Another reason might be the structure because 80% of the portfolio had to be invested in fixed income.
Funds Global: Has China managed to avoid earlier pitfalls in its new schemes?
Murray: In the second round of RQFII, the Chinese government took measures to ensure that that does not happen again. Only four managers got approval for their funds – all of which will be exchange-traded funds. These are likely to launch in a sequential order to avoid oversupply and limited demand, as was the case in the first round of RQFII. I don’t expect consolidation among the existing products, despite the limited success. Chinese asset managers still have ambitions to grow these products to the full quota.
Wong: RQFII funds were lukewarm at first, but 65% of the quota has been sold since the launch around Christmas last year. There are also new subscription orders coming along. The market response to the first round of RQFII funds has been slow, rather than disappointing. Another aspect that needs to be considered is that this was a bunch of new asset managers with no track record and no reputation.
©2012 funds global