A look at the key developments needed for Hong Kong to solidify its position as a global fund domicile.
With China liberalizing its capital markets, the support of Hong Kong’s policymakers, and the creation of a cross-border fund passport between Mainland China and Hong Kong, many in the industry predict that Hong Kong is poised to become the next global fund domicile. Leveraging its position as a gateway to Mainland China, Hong Kong has been making a strong push to become a leading cross-border fund hub. We’ve been keeping an eye on Hong Kong’s development, and there have been green shoots that indicate that its efforts have paid off. Since 2010, the number of Hong Kong funds has more than tripled, from 200 to more than 700 at the end of December 2016.¹ Nevertheless, the size of the market has not experienced significant growth over the same period. This has led some to wonder if Hong Kong will ever turn the corner and become a true cross-border fund hub.
Clear Enthusiasm from the Industry
The industry is certainly optimistic that Hong Kong will turn the corner in the next decade. At the end of last year, we conducted a survey of global asset managers to understand their opinion on Hong Kong’s prospects of becoming a leading cross-border domicile and the key headwinds and tailwinds to Hong Kong’s success. There is clear enthusiasm for Hong Kong as 80% of respondents believed there is a medium to high probability that Hong Kong will be a leading Asian cross-border fund domicile by 2025. Furthermore, 68% of the respondents indicated that Greater China was either extremely or very important to their firm’s global strategy. Interestingly, 72% indicated that less than 20% of their assets under management (AUM) come from Greater China today.
Hong Kong’s Fund Market Will Approach $1 Trillion by 2025
To quantify the potential for Hong Kong, we asked respondents to predict the size of the local Hong Kong fund market by 2025. At the end of 2015, the market stood at $146.6 billion. 50% of respondents thought the market size will at least double by 2025, putting it between $500 and $999 billion.
We believe the pace of liberalization will continue to accelerate in China. In the medium term, we expect Hong Kong and Taiwan will finalize negotiations over reciprocal access to each other’s fund markets. This will give Hong Kong funds a critical route to increase asset size and grow its footprint in Mainland China through the Mutual Recognition of Funds program. Given these tailwinds, we agree with the 20% of respondents who anticipate that the local fund market will be approaching $1 trillion by 2025.
Remaining Challenges: Broader Distribution and Continued Policymaker Support
Despite the enthusiasm, Hong Kong must focus on two key areas to solidify its position as a cross-border fund hub: broader distribution and continued policymaker support.
Broader distribution opportunities were identified as key to Hong Kong’s chances of becoming a cross-border hub. 31% of our survey respondents cited expansion of links with other Asian domiciles as key to solidify Hong Kong’s position, while 26% of respondents identified the lack of distribution channels as a significant obstacle for Hong Kong’s chances. This is hardly surprising since Hong Kong funds can only be distributed in a couple of jurisdictions right now. In order to be considered a cross-border fund hub, asset managers need to be able to sell Hong Kong funds to a wide array of investors in multiple countries. The more widely distributable Hong Kong funds are, the more attractive Hong Kong will be as a fund domicile. While exclusive access to Mainland China is important for Hong Kong, to become a true cross-border hub it needs to have distribution in other jurisdictions.
Continued Policymaker Support
Regulation and speed of fund registration are constant ongoing of the industry, not only in Hong Kong but in other cross-border jurisdictions. Combined, these two concerns were identified by 56% of the respondents as potential stumbling blocks for Hong Kong. Common complaints from the respondents were about timeliness of new fund approvals and having the right balance on local substance requirements to support the growth of the industry. These concerns highlight the critical role that policymakers play in developing Hong Kong into a leading fund domicile.
Thankfully for the cross-border industry, local policymakers have undertaken some key initiatives to address concerns about the lack of distribution channels. In December 2016, the Hong Kong Securities and Futures Commission announced it had reached agreement on a mutual recognition of funds with Switzerland. The deal, which is the first of its kind between an Asian and European jurisdiction, allows registered funds to be sold freely in each other’s markets. This action directly addresses one of the industry’s key concerns by expanding the available distribution markets for Hong Kong funds. Another project underway that is designed to increase distribution opportunities for Hong Kong funds is the proposed ETF Stock Connect. When completed, ETF Stock Connect will allow Hong Kong ETFs to be freely sold into Mainland China. Hong Kong is also set to introduce an Open-Ended Fund Company (OFC) initiative this year. Over the last two decades, corporate fund vehicles have become increasingly popular for cross-border funds because OFCs tend to export better to jurisdictions where unit trusts do not exist. Corporate fund vehicles also may avail of double taxation treaty benefits on their underlying investments in a manner unit trust structures cannot, making them more attractive to investors. The introduction of the OFC brings Hong Kong into alignment with the rest of the global cross-border market.
If Hong Kong policymakers can continue to improve the attractiveness of Hong Kong and expand links with other domiciles, it will go a long way to cement its place as a leading fund center. Nonetheless, Hong Kong’s journey will be a marathon-not a sprint. Much will depend on the speed at which Mainland China liberalizes and how widely Hong Kong funds can be distributed. Given the important role that policymakers will play in Hong Kong’s development, we will continue to monitor the regulatory developments in the region.
¹Hong Kong Securities & Futures Commission, December 2016
Note: This article is an excerpt from our whitepaper Cross-border 2025: The Rise of Hong Kong. Visit bbh.com/crossborder2025 for the full report of our findings and more insights on the cross-border fund market.