All dressed up

If you're trying to track down the business development head of a foreign fund management firm in north Asia these days, don't call his headquarters in Hong Kong – try Mainland China instead. For many heads of institutional investment houses, the Mainland has become a second home as the race to set up the first foreign fund management joint venture in China gathers speed. New regulations governing domestic and foreign partnerships in the industry became effective on July 1, opening the way for what many hope will be a flood of new participants.

"For foreign companies like us, it's turned from strategic planning to a much more solid effort towards establishing the business there," says Eleanor Wan, head of fund distribution, Greater China, with SG Asset Management.

A subsidiary of France's Societe Generale with US$272bn in funds under management, SG Asset Management in July signed a joint venture agreement with Fortune Trust & Investment Co, a unit of state-owned steel giant, Shanghai Baosteel Group Corporation. It is now awaiting regulatory approval.

For SG and many other foreign houses, the lure of the Chinese market lies in the country's high savings rates and low mutual fund penetration.

The domestic industry remains small. There are only about 15 licensed fund managers operating 53 closed-end funds (funds in which investors can only redeem their money at the end of a fixed period) and six open-ended funds (redemptions can take place at any time). Together, the value of the funds is about US$12bn, or 7 percent of the free float of China's US$500bn local currency Ashare market, according to Stuart Leckie, senior advisor to Hewitt Associates ImagineChina in Greater China and co-author of a new book, Investment Funds in China.

China needs professional institutional investors to help with the orderly development of its capital markets and to manage the proceeds of its growing retirement fund industry. Like other countries, it is facing rising pension liabilities as the population gets older – currently estimated at between US$700bn and US$800bn. In 1997, Beijing began moving towards a fully funded retirement system under which urban workers and their employers are required to pay for their own pensions through regular contributions.

The government currently manages most of these retirement funds, which are invested in low-yielding deposits and bonds. But experience overseas shows that private sector management of pension funds produces better returns. "As a result of China's WTO commitments, Sino-foreign fund management companies are expected to rapidly become involved in China's pension fund management," Leckie wrote in his book. The industry has some way to go, however, before this can happen. China began experimenting with investment funds in the early 1990s, but it was not until 1997 that the China Securities Regulatory Commission (CSRC) issued national regulations on the sector.

The following year, the leading Chinese investment houses launched a series of large closed-end funds. These initially produced high returns, but in 2000 the industry was exposed as a hotbed of insider trading and price manipulation.

To counter this, the CSRC encouraged the development of open-ended funds, leading to the launch of the Huaan Innovation Fund, run by leading domestic provider Huaan Fund Management, and another fund in September 2001. These are seen as more accountable because investors can redeem their funds at any time.

The next step for the industry is to encourage greater foreign involvement, to bring in new technology and skills and higher standards of governance. This process began in earnest at the end of last year, when China joined the World Trade Organisation. Under the rules, foreign companies can own a maximum of 33 percent of a fund management joint venture, rising to 49 percent after three years. This was followed by the joint venture guidelines that took effect in July.

Hong Kong Investment Funds Association chairman Joseph Silva predicted last year that at least 12 foreign fund houses would enter the market shortly after China's accession to the WTO. However, while foreigners have rushed to the Mainland to pursue deals, official approvals have so far taken longer than expected.

Early applicants
Aside from SG Asset Management's joint venture, other early applicants have included Dutch-Belgian firm Fortis Investment Management and its joint venture partner Haitong Securities, and JF Funds, a unit of JP Morgan Chase, and its partner Huaan Fund Management.

"As of today, no joint venture fund management company has actually come into existence or been licensed," said Hewitt Associate's Leckie. "This is a little bit surprising – people had thought things would happen earlier."

One reason for the hold-up could be disagreements over pricing. Fund management remains a highly lucrative business in China, reducing the incentive for local partners to sell. A domestic fund manager might have US$1bn in assets under management with annual fees of 1.5 percent. Its headcount might be only about 50 people on an average salary of US$10,000 per year. Taking into account other overheads, it is still "a pretty profitable business," according to Leckie.

The other hold-up could be caution and inexperience at the CSRC. The body, which already has its hands full trying to sort through the new rules, is expected to carefully scrutinise newcomers. There is talk that some fund managers have had to wait a month just for the CSRC to agree to consider their applications.

Others have complained that the rules are too tight, pointing to a ban on foreign investors setting up new asset management companies with existing domestic fund managers – a move that would have been a first choice for many. Instead, foreigners must either buy into an existing fund manager or set up a new company with a trust or securities firm.

The rationale for the ban is that Chinese law requires the founding shareholders of a fund management company to be either securities firms or investment trust companies. Industry participants, however, insist everything is still going well. The price on the JF Fund/Huaan deal has already been agreed, sources say. As a complex agreement between a total of seven partners, it is simply taking time to get the paperwork together.

"I'd describe it as like a party where the invitations have gone out for an 8pm start and everybody has decided they will show up. But it will be more like 10pm by the time they get there," says one source.

Nevertheless, any prolonged hold-up would be embarrassing for China, which is keen to demonstrate it is fulfilling its WTO commitments, says Leckie. "What the Chinese would like to see, if not by the end of this third quarter then by the end of this year, is half a dozen joint venture licences in existence. Then they can say: 'There you are, we kept our word,'" he says.