On 25 Nov 2020, ATC Initiative co-organized “Allocating to Chinese Alternatives – Offshore and Onshore Options” Webinar with Standards Board for Alternative Investments (SBAI).
1 December 2020
In this 3rd ATC-SBAI joint annual event, we are pleased to see leading investors, managers and other key market players together to discuss the latest development in China alternative investment sector, with a focus on changing regulatory environment including the new QFII rules and the opportunities and challenges for foreign investors looking to allocate in China.
A few key findings at the event:
- Leading global allocators with exposure to China alternative markets prefer “foreign local” and “local local” managers, valuing their on the ground network and local understanding;
- Hurdles in allocating to local managers include language barrier, cultural difference, difficulty in performance evaluation with a global standard, and lack of transparency in operations.
- New QFII rules provide a useful channel for global allocators to invest into Chinese PFM (Private Fund Manager) funds.
Expectations and challenges in allocating to Chinese managers
Other interviews in our ViewPoints Series
Yin Ge, Partner of Han Kun Law
- China PFM market has a relatively short history. Only since 2012, after the issue of the new PRC Securities investment funds Laws, the private securities investment funds have been given legal status. However, the AUM of Private Funds has grown significantly. In 2016, for the first time, private fund AUM was comparable to (if not slightly more than) public fund AUM.
- The regulatory environment in China continues to evolve. Between the PRC regulators and industry players, there is always a two-way communication channel.
- The financial regulatory environment in China is scattered. Mutual fund managers, bank wealth management subsidiaries and insurance asset management companies all provide asset management services but are overseen by different regulators and are subject to different rules and regulations. There is no unified asset management license. This is unlike the regulatory framework in Hong Kong or Singapore. The regulators are making efforts to reform this regulatory framework.
- There is no safe harbour for distributing foreign funds to onshore China investors in general; however, there are practical exceptions to this e.g. general relationship visits and reverse solicitation enquires.
- Private funds can be offered to Qualified Investors like in many other jurisdictions, but China has its own definition of a Qualified Investor that may differ to other regimes.
- Chinese asset management industry continues to open up. Regulators appear committed to giving the market, and the international investor community in particular, increased confidence in long term investment in China.
Bonnie Yu, Director and External Portfolio Management of CDPQ Asia-Pacific Ltd.
- CDPQ is the second-largest Canadian pension fund with total AUM of USD 255 billion. 13% invested into an emerging market, and out of this, USD 6 billion invested in Chinese equity.
- The rationale why we allocate to onshore manager is that:
- China onshore market is a large and liquidity market with a huge number of listed companies and strong retail investor presence, provides great potential for alpha.
- A talent pool of competent portfolio managers who can generate sustainable returns for investors.
- There are also some hurdles for us to allocate to onshore managers:
- Language barrier.
- Culture difference. We focus on investment philosophy and investment process while local managers may put more emphasis on performance.
- Performance analysis. Where there are multiple series of the same funds this can lead to a risk of “cherry-picking” the best series to use as a track record. This can be further compounded by relatively few Chinese asset managers being GIPS compliant.
- Hurdles on the ODD side. We always encourage our managers to have the best practices. On the operational side, we look at technology, compliance, risk management, governance, ownership structure, etc.
- We find three types of the asset manager in China and we had a preference for the last two types who would typically have a wider on the ground network and understanding of the local environment:
- Foreign Foreign: Asset managers based outside of China investing in China.
- Foreign Local: A Chinese manager who has investment experience outside of China but has moved back to China to invest.
- Local Local: Home-grown Chinese asset managers.
Theresa Han, Managing Director of Hedge Fund Strategies (GCM Grosvenor)
- GCM Grosvenor is a dedicated alternative investment platform with AUM of USD 57 billion.
- We have been active in investing in China due to the strong alpha, increase capital market activities and the dynamic of regulation change.
- We also prefer home-grown asset managers and foreign local managers, because we think they have the best networks and better local understanding. Whether they are onshore or offshore is not the key point.
- Language is not a major issue for us. The main issue is the middle-back office due diligence. Our due diligence team will hold Chinese asset management firms up to the same standards they apply globally during ODD. This means that allocators will need to spend time understanding where the gaps are likely to be due to different jurisdictions and regulatory environments. Chinese Asset managers should look to regulatory requirements in Europe and the US to gain an understanding of the standards that would be expected.
- In terms of the track record, we have seen a lot of funds for different mandates with a similar investment objective and it is difficult for foreign investors to understand the track record. Managers looking to expand their strategies to offshore funds should be wary of using onshore track records without a full investigation into the differences in tradeable assets and costs.
- Given the Chinese investor base has historically been retail and HNW individuals, there may not have been the same level of requests for transparency as there will be from institutional investors. This means that whilst the investment teams will consider areas such as stress tests there may not be the same level of formal reporting and disclosure as would be seen in other jurisdictions which can be a challenge for allocators.
Sidney Ma, Managing Director and Head of Investor Relations of Springs Capital (Hong Kong) Limited
- Spring Capital started 13 years ago, focus on Chinese public equities.
- As a Chinese asset manager, we started our business in Beijing, and more than 95% of our clients are from the onshore market back then. Now, we have achieved our goal that is to bring international clients up to 50%. 40% of our staff is on the investment side.
- On the ODD side, we have a very robust institutionalised infrastructure. All of our funds are GIPS compliance, and we have one of the largest compliance team.
- We try to bring alignment of Interests to the highest level, for example, PA Trading is prohibited for our staff; Co-investment by investment teams; monitoring of external business interests/directorships; etc.
- Pre-trade Compliance is important, we have to understand and learn from EU and US systems which have been there for years longer than Chinese asset management industry.
- We also try to prevent Key-Person Risk: Ensuring the company is working as a team with the required transparency.
Mark Dong, Co-Founder and General Manager of Minority Asset Management (HK)
- Minority is a Shanghai-based local fund manager with total AUM of USD 2 billion, started in 2013, focus on the Chinese A-share market with long-only strategy.
- We understand the performance is not the only thing that institutional investors will look at, so we did several preparations before we can really win the trust of global allocators:
- We try to break the language barrier by providing monthly report both for onshore and offshore funds in English.
- We finished our GIPs audit for the whole firm, covering every single product.
- We joined SBAI and spent four months to do internal compliance check to make sure we understand the expectation of a global investor and to find the gaps between our practice and SBAI standard.
- We hired a local independent compliance consultant to do annually compliance check to make sure we at least comply with the Hong Kong SFC Law and other standards we want to adhere to.
Opportunities for onshore private fund managers brought by the new QFII rules
After the panel discussion, Melody Yang, Partner of Simmons & Simmons, delivered her thoughts about the new QFII/RQFII’s ability to invest into PFM funds.
Melody Yang, Partner of Simmons & Simmons
- There are several highlights in the New QFII Measures which became effective at the beginning of November 2020:
- The QFII’s ability to do short sale;
- The QFII’s accessibility to invest into Chinese futures, options and PFM funds. Under this new QFII measures, the QFII regime can be used for the Chinese asset managers to raise capital internationally.
- Any private fund manager (PFM) that has used QFII funding needs to ensure that the scope of its investment universe is aligned with the investments allowed under the QFII regime. This means it can no longer invest in asset classes such as term deposits and OTC derivatives including Total Return Swaps and when it invests into certain exchange-traded futures and options, it can only act as hedger not speculator.
- Why QFIIs are interested in Chinese PFMs and who are they?
- The new QFII licence can be used to make several types of investments into China: the creation of a UCITs or Mutual Fund to invest, creation of an alternative fund to invest, investment through proprietary trading or investments into direct funds.
- We believe the future target of Chinese PFM funds would be pension funds, endowments and fund of hedge funds.
- There has been an increase in interest in allocating to Asia. These investors are also starting to consider China as a standalone market as opposed to being historically part of an Emerging Market allocation reflecting the difference in China’s economy versus other emerging markets.
- With the introduction of reform of QFII/RQFII, Chinese asset managers can have international capital into their onshore RMB fund instead of setting offshore entity and launching USD funds.
- Due diligence on PFMs
- The PFM structure in China has a lot of similarities with a Cayman Corporate vehicle, however, there are some differences too. A PFM is a contractual structure and is not incorporated as a company. It is however unitised, and its units can be subscribed for, redeemed, and transferred in the same way as a Cayman structure. In China, the custodian is required to exercise its duty as co-trustee to supervise and provide checks and balance of the function of managers. So it is very easy to translate all the terminology in the PFM context to the global hedge fund allocators.
- The foreign investors will conduct very robust due diligence on operation and risk management including conflicts of interests, AML KYC, market conduct, inside trading, internal control system, etc.
- Chinese PMF industry is just taking off, but the whole process is evolving, and the regulators have tightened up their relevant regulation to give clear guidance to the local market participants. In the near future, the QFII/RQFII regime will become a very useful channel for foreign hedge fund allocator to invest into Chinese PFM funds.