Fund Passporting in Asia Pacific: A long journey

The ASEAN Collective Investment Scheme (ASEAN CIS), Asia Region Funds Passport (ARFP) and Mutual Recognition of Funds (MRF) will not become brands in the short-term, but over the course of many years – as was the experience with the Undertakings for Collective Investment in Transferable Securities (UCITS), a cross-border mutual fund based in the European Union (EU), in its formative years from 1985 to 1992.

Some of these schemes may end up merging or consolidating, creating fewer but more select and popular fund structures. These structures will likely co-exist with established UCITS products, although one day they may succeed UCITS as the brand of choice in APAC, or at least that is the hope among their proponents.

Standard Chartered reviews the progress so far of these regional fund structures in APAC.

A slow start

A look at how each of the schemes is doing, reveals a slow start for those already launched and a challenging journey for those about to launch.

The ASEAN CIS covering Singapore, Malaysia and Thailand will celebrate its third anniversary later this year; however, reports suggest only 13 funds have launched under the scheme. [1]

The Mutual Recognition of Funds (MRF) passport providing cross-border mobility between asset managers in Hong Kong and Mainland China has existed for almost two years, and there is some limited momentum behind it. Data from December 2016 revealed 47 southbound (Mainland China domiciled) funds, and six northbound (Hong Kong domiciled) funds are using MRF. [2]

The ARFP is a multilateral fund passporting framework which is spread across Australia, New Zealand, Singapore, Thailand, Korea and Japan, and will come into effect later this year.

In addition, the Monetary Authority of Singapore (MAS) is in the early stages of asking for industry consultation on its proposed Singapore Variable Capital Company (S-VaCC), a new fund structure available to a wide range of asset classes.

What is holding back the flows?

Two major factors are impeding the growth of these fund passporting initiatives: the fragmentation of the Asian market, and competition from other products, especially UCITS.

There are different aspects to fragmentation in the APAC region, all of which create drag for the new passporting schemes.

The APAC region is growing strongly, with Russell Investments estimating full-year 2017 real Gross Domestic Product (GDP) growth of just under 5% [3] whereas in comparison, the European Commission is forecasting euro-area growth of 1.6% in 2016. [4]

However, the speed of development is not consistent across the APAC region. It is much harder for funds to attract capital in markets where GDP and investor awareness is relatively low, and while all regions have pockets of economic strength and weakness, those that have harmonized aspects of law and practice have a clear advantage.

To that point, the continuation of FX and capital controls in various Asian markets has hindered the progress of passport schemes. For example, currency restrictions in Malaysia and Thailand make it difficult for cross-border funds to offer foreign currency share classes in those jurisdictions and with its offshore investors.

Arbitrage around tax rules is another obstacle. Unless regulators and governments in the region reach an agreement on tax neutrality or harmonize tax rules for these initiatives, it will be complex for firms to distribute cross-border.

Regulation across APAC is not harmonized either, which means operators of the ASEAN CIS are dealing with different regulatory regimes in Thailand, Singapore and Malaysia, and this presents logistical and cost issues.

Harmonization of rules within the EU single market is still incomplete, but efforts – including through UCITS IV – to introduce more streamlined cross-border distribution conventions and standards have been actioned, and this has made it much easier for managers to passport UCITS products. Synchronization of legislation and regulation in APAC will likewise make it simpler to passport regional fund products cross-border at lower cost.

ASEAN CIS managers, for example, presently need to be audited in each country, and supply the necessary fund documentation in all three jurisdictions in the local language rather than just providing the relevant information to the home regulator. Differences in cross-border regulation are likely to pose a similar problem for ARFP when it launches, too.

In terms of fund structures and initiatives, the APAC market has become crowded with a greater range of products for investors to choose from such as exchange traded funds, then fund passporting, and now S-VaCC in Singapore. There also appears to be limited appetite – particularly from risk-conscious investors – to allocate into these nascent fund passport schemes in contrast to UCITS which has been operating since 1985 and has gained significant traction, having undergone numerous iterations and consultations since.

Even Australia, which has been an enthusiastic advocate of ARFP, is seeing its substantial superannuation scheme market take interest in Luxembourg UCITS.

Indeed, the ASEAN CIS has significant restrictions that make it hard for some ASEAN managers to wrap their products around it, including limits on stock lending and repurchase transactions, constraints on derivatives use, an outright ban on performance fees, curbs on delegation and stringent (five years) track record requirements.

UCITS, however, took many years to develop as a product and lose some of its initial constraining features, so advocates of the local passports should not be disheartened.

ARFP is yet to launch, although it is modelled closely on UCITS III but appears to have greater flexibility than the ASEAN CIS, in addition to better access to more mature markets. An ARFP can participate in securities lending and repurchase transactions, while fund managers can charge a performance fee, and it seems to offer a better competitive structure than the ASEAN CIS.

But it is still early days

The oldest Asia regional passporting initiative only came to life in 2014, so it is difficult to accurately assess at this stage how successful these schemes will be.

Tracing UCITS’ development since it first launched in 1985, we see that the brand only took off with UCITS III in 2002 when the eligibility of underlying investments and instruments was expanded. The European Fund and Asset Management Association (EFAMA), for example, found UCITS’ AuM grew from €3.7 trillion in 2003 to €6.8 trillion in 2013. [5]

Furthermore, EU markets underwent significant harmonization during this time-frame, something which has yet to happen in APAC.

For these regional schemes to capture investor interest, APAC regulators should look to the narrative chronicling UCITS’ progress. These APAC passporting schemes will succeed as and when there is harmonization of tax structures and regulation. But proponents of these APAC initiatives will have to be patient – it has, after all, taken UCITS almost 32 years to amass €8.8 trillion. [6]