November 2011, Lynn Yang, James Zhang, Ai Tong
Compared to the growing income investment, retirement and insurance needs of increasingly affluent Chinese nationals, China’s mutual fund industry has been largely stagnant over the past three years due to stock market volatility and increasing competition. However, China is still viewed as a key area for the future growth of the asset management industry. In particular, media sources have speculated that China’s mutual fund industry will continue to witness rapid growth over the long term with the value of assets under management (AUM) of the securities investment fund management companies (FMCs) potentially set to triple to RMB 6 trillion within five years. It is also worth noting that alternative investment schemes which provide either higher returns (with equally high levels of risk) or extremely conservative allocations have taken market share at the expense of the FMC offerings in recent years. With this trend set to continue, it is critical for foreign investors to understand properly not only the public fund industry but also the alternative investment opportunities in order to formulate a robust strategy for investment in China’s asset management sector.
This briefing provides an overview of the key features of major types of asset managers in China and key regulatory issues required to establish an asset management business in the China.
Current Chinese law does not provide a crystal clear definition of the term “asset management.” Based on separate pieces of legislation, only limited categories of regulated institutions in China can offer certain kinds of asset management products, act as professional service providers and manage clients’ funds in the investment of publicly traded stocks, bonds and other underlying assets.
Generally speaking, depending on the nature of their activities, asset managers (i.e. the product launchers) and their relevant products may fall under the supervision of different regulators in China. For example:
- the China Securities Regulatory Commission (CSRC) (the Chinese securities market regulator) is responsible for supervising and regulating the launch of securities investment funds (SIF) by FMCs and asset management schemes by securities companies;
- the China Banking Regulatory Commission (CBRC) (the Chinese banking market regulator) is responsible for supervising and regulating the relevant investment trusts managed by trust companies and banks’ wealth management products; and
- the China Insurance Regulatory Commission (CIRC) (the Chinese insurance market regulator) is responsible for supervising and regulating the insurance asset management companies.
Foreign investment in the Chinese asset management market is generally restricted. China’s commitments to the World Trade Organization do not permit foreign funds / asset managers to provide cross-border fund/asset/investment management services direct to clients in China. The establishment of, or the participation in, the asset management industry in China by foreign investors is normally subject to stringent qualification requirements and foreign ownership restrictions.
Fund management companies
Setting up (or investing in) an FMC is the primary route for foreign investors to participate in the Chinese fund management business. As of 30 June 2011, 66 FMCs in China manage more than 900 funds with a total AUM of approx. US$ 370 billion.
FMC is regulated and supervised by CSRC. It can launch and manage SIF products for subscription by public investors and manage such funds’ investment in the securities market (similar to mutual funds in the USA). In order to provide flexibility for the FMCs to broaden their business models and develop distribution channels outside the bank-dominated retail market, CSRC has also gradually allowed FMCs to manage enterprise annuities and multi-client segregated account business, known locally as Yi Dui Duo, for institutions, corporations and high net worth individuals.
An FMC is a limited liability entity with a perpetual term of operation in which the foreign equity investment must not, by law, exceed 49 per cent.
Trust companies incorporated in China can offer on a private placement basis “Collective Investment Schemes” (CIS), being unit trusts, to “qualified investors”. Such funds managed by trust companies can invest in various underlying assets (including publicly traded stocks, other securities, equity and real estate).
This CIS structure is subject to supervision by CBRC and constitutes an alternative to the SIF structure of CSRC-regulated FMCs. This structure in practice may be referred to as a “sunshine hedge fund” asset management structure or “sunshine private equity” (in Chinese: 阳光私募, Yang Guang Si Mu).
Currently Chinese law imposes a very strict foreign ownership restriction on trust companies. Specifically, the shares held by a single foreign investor in a Chinese trust company may not exceed 20 per cent and the aggregate foreign shareholding is capped by law at 25 per cent.
Significantly, trust companies have the right to engage “third-party investment advisers” for providing advisory services and assisting them in their CIS securities investment business. Recently, some foreign asset management companies have been exploring opportunities to set up a third-party investment adviser with the purpose of indirectly participating in the Chinese market through contractual arrangements with Chinese trust companies.
Subject to supervision by CSRC, a fully-licensed Chinese securities company may also launch collective asset management schemes through private offerings.
Foreign investors are now permitted to hold no more than one third of the total equity interest of a Sino-foreign securities joint venture (Securities JV), while a securities company with a foreign stake of less than 25 per cent is still considered as a domestic one. Up until now, only a handful of foreign investors have made investments in Chinese securities companies. Various media sources have speculated that CSRC may consider raising the ownership cap on foreign investment. However, it remains unclear if and when CSRC will liberalise foreign investment in a Securities JV.
Compared to a fully-licensed domestic securities company, a Securities JV remains restricted to limited areas of business. It is generally prohibited not only from engaging in Chinese A-share brokerage and trading but also from tapping into the asset management business. There is speculation that CSRC might consider allowing Securities JVs to engage in a broader range of business (including asset management business), though so far no specific timeline has been mentioned.
Insurance asset management companies
Traditionally, insurance asset management companies (Insurance AMCs) in China only provide asset management services to their insurance group companies. With a view to widen the investment functions of such insurance asset managers, CIRC now regards Insurance AMCs as professional third party asset managers, whose responsibilities are to manage funds entrusted to them by principals. Foreign investors are permitted to make equity investment in Insurance AMCs but the aggregate foreign shareholding is capped by law at 25 per cent.
In addition to the reform on the establishment of Insurance AMCs, CIRC has also liberalised investment restrictions on insurance funds managed by Insurance AMCs (Insurance Funds) and provided greater flexibility in asset allocation. Through a series of regulations issued in recent years, CIRC has not only specified the ratio of Insurance Funds in new asset categories such as the real estate market, unsecured corporate bonds and unlisted companies, but also increased the maximum allowed exposure of Insurance Funds in infrastructure projects and equity investment.
Commercial banks in the PRC are generally prohibited from dealing in securities or entering into commodity future transactions. However, by complying with specific regulations, commercial banks may become indirectly involved in certain types of securities trading or derivative transactions by offering wealth management products to retail clients in China.
Due to stock market volatility combined with pervasive market uncertainty in the past three years, bank wealth management products have been one of the major beneficiaries of investors seeking liquidity management.
Capital inflow and outflow
The Qualified Foreign Institutional Investors regime (QFII) under Chinese law refers to a market opening mechanism that allows foreign investors to invest in the Chinese capital markets while China’s capital accounts are not fully opened to the global market.
Foreign fund companies, insurance companies, securities houses, commercial banks and other asset management companies (including foreign pension funds, trust companies, charity funds, and sovereign investment funds) can qualify to be a QFII after approval by CSRC. Based on CSRC’s approval, the China State Administration of Foreign Exchange (SAFE) will allocate a quota to a qualified QFII for its investment in China up to a maximum of US$ 1 billion. The QFII’s scope of permitted investment covers all RMB denominated securities and financial instruments, including stocks, bonds and warrants traded publicly, SIFs, stock index futures and other instruments permitted by CSRC.
The Qualified Domestic Institutional Investors regime (QDII) creates a parallel regime to the QFII whereby qualified Chinese financial institutional investors are permitted to invest in overseas capital markets, by either using foreign currency already held by the participating inventors or by raising RMB funds from Chinese individuals and institutions.
Chinese commercial banks, trust companies, FMCs, securities companies and insurance companies may qualify to become QDIIs. Each category of QDII is required to meet certain qualification standards as set out by its relevant regulator. The investment scope of a QDII differs depending on the categories in which it falls into.
It is also worth noting that, other than QDIIs, Chinese sovereign wealth funds (such as China Investment Corporation, National Council for Social Security Fund and SAFE Investment Company) are key players in investment into overseas markets.
This capital outflow regime provides opportunities for foreign financial institutions to act as investment managers and advisers for, and distribute their financial products to, qualified Chinese onshore investors. Together, QFII and QDII establish a two-way channel for capital to flow in and out China for financial investments via major institutional investors.
For the purpose of this briefing, China means the People's Republic of China which excludes Hong Kong and Macau Special Administrative Regions and Taiwan.