Asian attention turns towards domestic growth

Rather than investment flowing traditionally from western-based portfolios to the east, Asia’s rebirth as a highly liquid, stress-tested and regulatory savvy finance hub means it is the local investor base – especially the rising middle class and wealth accounts of China – where providers of back office support will be concentrating their efforts in 2010. It is no longer a question of decoupling from the contagion of the US or western Europe for many asset servicers, but a loosening of ties almost completely. Certainly the appetite of global fund houses in setting up distribution and service capabilities in Asia has not shown any signs of diminishing because of events of the past two years. “If you do not have a footprint in Asia, or at least some kind of anchor, you will become an irrelevant institution within 10 years,” predicts Dominic Barton, worldwide managing director, McKinsey & Company. According to Mr Barton, who was the consulting firm’s chairman in Asia between 2004 and 2009 advising on a number of fund set-ups in the region, the rising wealth of Asian populations, especially China’s middle class, against a backdrop of falling consumer spending in the US and Europe (and reluctance to take on further leverage in those markets) has transformed the landscape with more local opportunities than ever before. “There’s going to be 900m middle-class consumers in Asia by 2015,” he says. “It’s not going to make up for the loss of the US consumer and it’s not going to solve the problems of the world. But Asia’s governments are now much more focused on domestic growth. And we’ll see Asia’s sovereign wealth funds shifting more of their portfolios back into the region. We’re entering a very different world.” In the case of China, it will embrace financial product innovation to drive consumer spending to the levels needed to maintain recent period of double-digit GDP growth, explains Huiman Yi, vice president, Industrial and Commercial Bank of China (ICBC). Mr Yi is confident that Chinese financial institutions’ risk management practices, which have been developed over an extended period of rapid economic growth, would support the country’s financial system in avoiding the excesses experienced in the west. “We have attached great importance to handling the growth in our credit business and in risk management,” he says. “On the whole, I believe risk is controllable.” And if risks in the Asian marketplace can be managed, then some local institutions see no reason why an element of ‘danger’ within their plain-vanilla product range can’t be introduced for the investor. “Wealthy investors are tired of the near zero interest rate products,” says Tetsuya Kubo, senior managing director of Japan’s Sumitomo Mitsui Bank. “They are asking financial institutions to provide structured products that can give higher returns. Banks have to meet those customers’ financial needs, but we should not forget the lessons learned from this financial crisis.” In south Asia, there are concerns that zealous funds regulation could stifle structured product innovation, just as the domestics markets are beginning to recover. Ranee Jayamaha, adviser to the president of Sri Lanka on banking, says: “Regulatory guidelines should not kill the industry rather they should prevent bubbles that could cause problems. Stable economic fundamentals in many Asian countries should allow banks and asset management firms breathing space to develop innovative services to support consumer demand.” India has so far been reluctant to open up its financial centres to either outside influence or internally-driven innovation; on the other hand Malaysia is quickly shuffling to become the Islamic financial centre within the region. Custody battle Recently Aberdeen Asset Management Asia sought to consolidate its middle and back office functions under one roof “to minimise both costs and risks” according to Low Hon-Yu, a director at the funds house. “This was of utmost importance as, in a fragmented region such as Asia, the front-office relies heavily on the local expertise of the middle and back-office,” he says. BNP Paribas Securities Services in Singapore picked up the mandate. The scramble for fund custody business in Asia has also intensified this year particularly given the strength of money flows from high net worth Chinese and sovereign wealth accounts. RBC Dexia Investor Services, which administers around $2000bn in global custody mandates, says it is targeting funds in Greater China and south Asia as changes to local regulation continues to support the flow of cross-border funds in the region. “We have identified emerging segments – what we are calling ‘custody ports’ – and these would be sovereign wealth funds, government institutions, and corporates with large holdings looking to invest more overseas,” says Scott McLaren, head of Asia Pacific sales and distribution at the Hong Kong-based RBC Dexia Trust Services. According to Mr McLaren, an increasing number of domestic institutional investors, in addition to retail funds, are reducing their home bias and investing in overseas securities, lifting the scope for new custody and sub-custody business in the future. “We already have government institutions on our books in Asia,” he adds. “In this case, we’re seeing portfolio flows from east to west and this is a trend likely to persist.” Hong Kong’s status as a predominately offshore funds centre has been maintained, with a combination of Ucits funds and hedge funds staying loyal. Fund managers newer to the region are also setting up small sales offices on the island, selling products to banks or through investment channels in the surrounding markets. “First movers in China have been quite successful but it has been more challenging for joint ventures,” says Mr McLaren. “Not a lot of the funds business there is outsourced or in Taiwan apart from some custody activity recently, but China remains a massive asset gatherer.” Regulation on the Chinese mainland and in Taiwan “is still evolving and playing catch up” with developed regimes like Hong Kong and Singapore, he adds. New hub on the block In seeking status as a bona-fide domestic hub for Asian funds, especially centred in the north of the region and including trying to grab a share of China’s lucrative wealth base, Taiwan firmly believes the introduction of recent capital market reforms will provide a timely tonic. Restrictions on domestic investing in China have been lifted this year, including the removal of a 40 per cent investment cap and relaxing restrictions on fund transfers and remittances. Investments can now be made in Chinese stocks via exchange traded funds (ETFs) and, significantly, barriers to capital inflows from the mainland have been lifted. This includes permission for Chinese funds to invest in manufacturing, real estate and Reits and the cross-listing of ETFs and Taiwan Depositary Receipts (TDRs). The government is also expected to offer tax breaks for domestic investors who transfer overseas-based savings back to Taiwan. “Our capital market is in better shape now than in the 1990s, when we slumped from 14th to 20th in our total share of fund flows,” reflects Dr Chi Schive, chairman of the Taiwan Stock Exchange (TWSE), who has overseen something of a return to form for the local bourse in his first year in the office. For instance, through changes to inheritance tax, cut from a prohibitive 50 per cent to a uniform 10 per cent, Dr Schive says more Taiwan companies based in China “are now coming home for good”. Foreign inflows “We are hoping that 2010 will see newly listed companies from abroad outnumber domestic listings for the first time, and we certainly encourage inflows from Korean and Japanese companies to list here,” explains Dr Schive. “The market is responding positively and suddenly we realise we can attract funds to the exchange,” he adds. The number of funds being redirected across the Taiwan Strait and into Taipei also delights TWSE’s chairman – around $15bn of foreign fund flows “have returned” this year. “We want to build up Taiwan as a funds centre and also as a wealth management hub,” says Dr Schive. “While the Taiwanese are rich, nowadays our Chinese brothers are richer.” In recent months there have been a number of market reforms which have helped to boost liquidity in the domestic exchange, develop a sophisticated product line (including extending the futures and options range, new structured products and ETFs), and broaden the investor base, both in the institutional and high net worth space. According to Rosemary Wang, deputy director general of the securities and futures bureau at the Financial Supervisory Commission (FSC), the industry regulator, establishing Taiwan as an asset management centre in Asia requires the right products and vehicles to attract overseas investors, especially Chinese funds. “We need more options for funds and diversified sources for raising capital here,” she says. In April, the FSC granted permission to Mainland Qualified Domestic Institutional Investors (QDII) to invest in securities, fixed income and conduct futures trading in Taiwan. Under the existing agreement being negotiated by regulators on the mainland and in Taipei, QDII funds can launch $900m in Taiwan investments. Ms Wang adds: “Though allocations from QDII represent a small amount of total liquidity, it serves as an important milestone for future Chinese investment. Inflows of capital from these investors are expected to expand in the longer term, as QDII investors become more familiar with opportunities in Taiwan.” Other recent developments at the TWSE have the seen the extension of structured products, including the cross-listing of ETFs and the introduction of market maker mechanisms for ETFs and warrants. Its chairman Dr Schive says ETFs, for instance, are another vehicle for investors to gain exposure to liquidity, especially the three ‘offshore’ ETFs listed on the Hong Kong Stock Exchange which tracks the underlying performance of the Hang Seng China Enterprises Index. “These overseas-style ETFs are of special interest to foreign investors giving them access to markets more cheaply and they all have Chinese stocks as their underlying,” he adds. Hit the North Based in Hong Kong, Standard Chartered veteran Neil Daswani, ex-securities services chief and now head of transaction banking for the north Asian markets, including Greater China (mainland China, Taiwan, and Hong Kong), Japan and Korea, says the learning he did in the aftermath of 1998’s financial crisis “has put him in an ideal position today”. The bank derives around 80 per cent of its revenues from non-US/non-European markets, with Hong Kong “the gateway to China” and the single largest market for commercial banking and asset servicing in north Asia. But the flow of new funds in north Asia is not just restricted to Chinese firms and QDII, as one might expect. “Japanese money in India has been a theme for the last five years and a number of joint ventures have been set up. Also Korean corporates are starting to base their operations in the region,” he notes. Suggestions that Hong Kong could lose out as more funds flow through the cross straits between the mainland and Taiwan as a result of series of initiatives instigated by Shanghai and Taipei doesn’t wash either, according to Mr Daswani. “Will the island lose out because it was once the third side of the triangle? I don’t think so. Business flows have increased and I see no reason why all both channels can’t flourish,” he says.

Scott McLaren, RBC Dexia Trust Services