The first Asian and European mutual recognition agreement has been struck. What could this mean for the global cross-border fund market?
On 2 December there was a minor stir in the normally sedate world of cross-border funds. The Hong Kong Securities and Futures Commission and the Swiss Financial Market Supervisory Authority announced that they had signed an agreement on the mutual recognition of funds. The agreement is the first fund passport between an Asian and European jurisdiction to allow registered funds to be sold freely in each other’s markets. Given the significance of the deal, it’s worth looking at the potential implications for asset managers and the leading cross-border product, UCITS.
A Big Deal for Hong Kong?
The deal is an important milestone in Hong Kong’s ambitions of becoming a leading global cross-border fund center. It is Hong Kong’s first formal agreement with a jurisdiction other than Mainland China. Expanding the number of jurisdictions that Hong Kong funds can be sold into is critical for Hong Kong’s ambition to become a successful cross-border fund center.
This may be a significant development because of Hong Kong’s ace in the hole: its exclusive MRF (Mutual Recognition of Funds) deal with Mainland China. Much like the Swiss agreement, MRF allows for Mainland and Hong Kong funds to be sold to investors in each other’s markets. However, unlike the Swiss deal, there’s a catch: there’s a cap on investors. Under the MRF scheme, investors from the host jurisdiction (i.e. where the fund isn’t domiciled) are restricted to having no more than half of the fund’s total assets. This limitation favors larger Hong Kong funds because they have greater capacity to absorb new Mainland investors. The ability to distribute Hong Kong funds into Switzerland means asset managers can theoretically increase the amount of assets they raise from outside of Mainland China; which, in turn, will allow managers to raise more assets from Mainland investors.
What’s in it for Switzerland?
Historically, Swiss funds have been used exclusively for domestic distribution and have not been exported to other jurisdictions. So, for Switzerland, the big appeal of the deal with Hong Kong is that it creates a new distribution market for Swiss domiciled funds. It also levels the playing field with EU UCITS funds, which are freely sold into Hong Kong. However, as significant as the deal is, it is important to note what it does not accomplish. Namely, it does not create a route into Mainland China for Swiss funds. Access to Mainland China, via the MRF scheme, is still exclusive to Hong Kong funds. The new agreement between Hong Kong and Switzerland does not change this.
What does this mean for UCITS?
The Swiss-Hong Kong deal won’t have any immediate effect on the distribution of UCITS into Hong Kong or Switzerland. UCITS can already be sold into either jurisdiction and the EU isn’t obligated to offer reciprocal access rights to Hong Kong or Swiss funds. So, there’s no pressure on the EU to strike a similar deal (though, there are signs that Hong Kong would like to revisit this arrangement). For the time being however, it seems that UCITS is set to remain the leading fund product in both Hong Kong and Switzerland. However, the deal is indicative of the pressure that UCITS is facing, in particular in Asia, as jurisdictions look to develop their domestic fund markets.
Using history as a guide; it’s unlikely that there will be a rush of funds seeking to avail of the new passport or that there will be an immediate groundswell of investors moving into these newly available funds. While changes to fund distribution patterns won’t happen overnight, this agreement is a milestone in the evolution of the cross-border fund market. It could also foreshadow future agreements between Hong Kong and other jurisdictions, as its policymakers continue to work to build the Hong Kong into the leading Asian cross-border fund center.