A Greater Gateway:

Hong Kongs Future as a Fund Management Centre

Issue 1 - December 2016

ASSET SERVICING
As mainland China moves to relaxing
controls over flows of capital across
its borders, Hong Kongs prime
position as a fund management
centre presents new opportunities
for asset managers across the world.
The city faces increasing competition
for its HK$17.4trn (US$2.2trn) 1
fund management business. But
its position as a gateway to China,
combined with its reliable physical
and legal infrastructure, will continue
to give it a crucial advantage.
Hong Kong has long been of
paramount importance as an
offshore RMB hub, with a pool of
over RMB1trn in 2015.2 Now, as
mainland regulators take steps to
give international investors more
direct access to Chinese assets and
Chinese investors greater access
to the outside world, Hong Kongs
importance in fund management is
being magnified. Landmark schemes
like Stock Connect, linking the
Hong Kong equities market with
that in Shanghai and Shenzhen (to
be launched on 5 December 2016),
and the Mutual Recognition of
Funds (MRF) program that allows
funds domiciled in Hong Kong to be
distributed in the mainland, and vice
versa, are potentially game-changing.
In light of these developments,
international asset managers are
re-evaluating their presence in
Hong Kong and considering the best
means to seize the opportunities
that its evolution as a gateway to
Chinas capital markets present.
Against this background, BNY
Mellon is examining some of the
fundamental issues shaping Hong
Kongs future as a fund management
centre and what they mean for
fund managers keen to tap growing
capital flows to and from China.
How will the industry develop and
how can asset managers globally
position themselves to capitalise?
1 Source: Hong Kong Securities and Futures Commissions Fund Management Activities Survey 2015 report, published July 2016
2 Source: Hong Kong Securities and Futures Commissions Fund Management Activities Survey 2015 report, published July 2016
3 As of October 2016. Source: ETFGI
4 As of September 2016. Source: ETFGI
5 Source: ETFGI
6 Flows will still be subject to daily quotas in the Stock Connect schemes, although aggregate quotas for both schemes will be abolished.
Source: Hong Kong Stock Exchange, presented by Charles Li, HKEX Chief Executive on 16 August 2016.
7 Source: Hong Kong Stock Exchanges ETF and L&I Product Market Perspective report (August 2016)
ETFs in Hong Kong:
Poised for Growth
Though the pace of adoption of exchange
traded funds (ETFs) in Hong Kong has so
far been moderate, impending changes
to cross-border investment schemes,
combined with a more accommodating
regulatory environment, mean this asset
class is set to take off.
Globally, ETF assets have exploded
in recent years, growing at over 24%
annually for the past decade to reach
US$3.3trn. 3 While the lions share
of these funds are still in Western
markets (with US$2.4trn in the US
alone), Asian markets have also seen
a steady growth of institutional and
retail funds flow into ETFs.
Hong Kong already leads in Asia
(excluding Japan) in terms of market
size, with 124 ETFs totaling some
US$37.8bn in assets - versus
US$34.4bn in mainland China and
US$23.2bn in South Korea, the next
biggest regional markets. 4 Globally
these are modest numbers (the US
and Europe each had over 1,500 ETFs
by October 2015 5 ), but there are
several reasons to suggest the market
for such products in Hong Kong is set
to expand dramatically.
The Stock Connect Effect
The likely inclusion next year of ETF
products in the Stock Connect schemes
linking the Hong Kong exchange to those
in Shanghai and Shenzhen is the biggest
impetus. Regulators announced the
move in August 2016 that ETFs would
be included in both schemes after the
Shenzhen link had been in operation
for a period of time and upon the
satisfaction of relevant conditions.
Though several practical questions
about the move are yet to be answered,
the inclusion of ETFs in Stock Connect
could transform the Hong Kong market.
This is the first opportunity that
mainland investors will have to invest
directly in foreign ETFs, says
Alan Fong, APAC Product Segment
Manager at BNY Mellon. This stands
to be transformational for the Hong
Kong market, making it considerably
more diverse and international.
[The inclusion of ETFs in
Stock Connect] stands to
be transformational for the
Hong Kong market, making
it considerably more
diverse and international.
Alan Fong
APAC Product Segment Manager
BNY Mellon
Fund managers in Hong Kong
providing ETFs based on
international indexes are likely to
be the biggest winners, as Chinese
investors seek greater (and quota-
free 6 ) exposure to overseas assets.
Currently, the majority of Hong Kong
ETFs are vanilla equity products,
with mainland A-share based
products accounting for around one-
third of the average daily turnover,7
but the demand for exposure to more
diversified assets will intensify.
Southbound flows will also be
boosted by greater capital flows from
mainland institutional investors.
Significantly, in September this year
the mainland insurance regulator
announced that insurers could buy
equities through Stock Connect,
which could unlock a large amount of
capital into Hong Kong listed stocks
including ETFs when they are allowed
into the schemes.
The Importance of
Increasing Innovation
While mainland demand for exposure
Active ETFs could be particularly
popular among mainland investors.
Many dont hold funds for long
periods, preferring to trade in and

To maintain competitiveness,
Hong Kong fund managers
to international assets is likely to out quickly, Alan Fong says. So and regulators need to
lead to greater diversification, the having active ETFs in the Hong Kong consider more than just the
stage is also set for the launch of a market at lower cost than traditional
citys position as a conduit

wider range of product structures.
These include inverse and leveraged
ETFs (which allow going against the
market and are designed to multiply
price changes in the underlying
assets), as well as actively managed
and smart beta products.
Hong Kong regulators have
understandably been cautious
in allowing new ETF structures,
with concerns over investors
understanding of the risks and the
potential volatility caused by their
daily unwinding of positions. South
Korea, for example, already has 39
leveraged or inverse ETFs, worth
15.4% of the market,8 while Hong
Kong is only starting to approve such
products this year (excluding, for
now, those focused on Hong Kong
and mainland stocks). 9
Still, as increasing variety of ETF
products becomes more popular in
other markets, the outlook for their
adoption in Hong Kong is positive.
Active ETFs 10 have taken off in
Europe in particular (thanks in part
to the existence of an active UCITS
share class), while new rules to
rationalise the listing process for
actively managed funds issued in
the US in July this year will greatly
managed funds could be very
attractive to mainland investors.
Another potential avenue for
diversification is in Smart beta
funds that are benchmarked
against factors other than
market capitalisation. These have
proliferated worldwide, in part
because they offer investors an
appealing middle road between
passive index-tracking funds and
pricier active management. Their
greater adoption in Hong Kong
will to some extent depend on
deepening investor education
which may also make regulators
more relaxed about approving newer
and more complex structures with a
more informed investors base.
There is no doubt that an openness
to innovative new fund structures
and forms is equally as important
to Hong Kongs fund management
industry as the citys links to the
mainland.
To maintain competitiveness,
Hong Kong fund managers and
regulators need to consider more
than just the citys position as a
conduit to and from mainland China,
says Steve Cook, Managing Director,
Structured Product Services at
to and from mainland
China.
Steve Cook
Managing Director
Structured Product Services
BNY Mellon
Getting Ready
The impending inclusion of ETFs
in the Stock Connect programs
and the adoption of more varieties
of exchange-traded products
mean the outlook in Hong Kong for
exchange-traded products, and
fund management in general, is
increasingly bright.
Of course, asset managers in the
city offering such products will
have to contend with the realities of
maintaining increasingly complex
ETF portfolios, with new structures
requiring much more advanced
custody, fund accounting and
administration services. As ETFs
come to play a crucial role in the
movement of capital across Chinas
borders, having these services
available in Hong Kong, in real
time, will be increasingly vital to
maintaining competitiveness.

speed up their approval. 11

BNY Mellon. They must keep an eye
on innovations and best practices
among their peers, while also
Having active ETFs in the leveraging Hong Kongs central role
Hong Kong market could be in the opening of Chinas capital

markets.
very attractive to mainland
investors.
Alan Fong
APAC Product Segment Manager

BNY Mellon

8 Additionally, it has 5 ETFs leveraged inverse ETFs. As of September 2016. Source: ETFGI
9 Source: Financial Times article on 13 June 2016 titled First leveraged ETFs launch in Hong Kong
10 Actively managed ETF is an exchange-traded fund that has a manager or team making decisions on the underlying portfolio allocation or otherwise not following a passive
investment strategy. An actively managed ETF will have a benchmark index, but managers may change sector allocations, market-time trades or deviate from the index as
they see fit. This produces investment returns that will not perfectly mirror the underlying index. Source: Investopedia
11 Source: Bloomberg article on 23 July 2016 titled SEC Clears Rules For Speedier Approval of Actively Managed ETFs
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