With more than 4.5 billion persons, Asia-Pacific is home to almost 60 percent of the world’s population. Given disparate regulatory and tax authorities, however, profitably addressing these markets can be economically unfeasible for many fund companies.
Going forward, however, a regional fund passporting scheme could change that. And increasingly, our clients at Calastone, a financial technology company that uses automated solutions to connect trading partners globally, are asking us how it impacts their business.
Complexity stalls implementation
The Asia Region Funds Passport (ARFP) program was first proposed in 2010 by the Australian Financial Centre Forum, a public-private body geared toward making Australia a leading financial services center. The ARFP scheme is still in concept stage and logistical specifics have not been finalized. By next year, though, it aims to make exporting investment funds across participating jurisdictions easier by reducing redundant legal and regulatory requirements.
Australia, Japan, New Zealand, Singapore, South Korea, Thailand, and the Philippines are driving current discussions. Other countries have also expressed interest. With significant local monies currently flowing toward Luxembourg and Irish domiciled UCITS (Undertakings for Collective Investment in Transferable Securities) funds, financial ministers are trying to address capital flight.
The ARFP framework document states that economic benefits include: Providing investors with a more diverse range of investment opportunities; deepening the region’s capital markets; facilitating the recycling of the region’s savings locally; strengthening the capacity, expertise and international competitiveness of financial markets in the region.
The ARFP’s scale is one reason it has taken many years to progress. Participating nations have differing languages, customs, political environments, consumer demands, regulatory restrictions, tax structures, and market agendas. And as additional countries get involved, it becomes more complex to sign an agreement that is palatable to everyone. For perspective, the Mainland-Hong Kong Mutual Recognition of Funds (MRF) program took years to implement and that was only between two parties.
Australia’s Treasury department has solicited industry participants to provide feedback on its proposed framework by September 21st. And by the end of this year, Japan, New Zealand, and South Korea all expect to amend domestic financial regulations in order to be congruent with ARFP requirements.
Deep asset pools
The regional asset base, which is already substantial today, will continue expanding with economic growth. Singapore’s annual GDP per capita, for example, exceeds USD $87 K. Australia’s is $48 K. In Japan, New Zealand, and South Korea, it is approaching $40 K. Incomes are also increasing in the developing economies. Additionally, savings rates in many of these countries are high. Thus, retaining local assets will have real economic impacts.
Despite the fact that it is moving forward gradually, the ARFP will create new opportunities for fund companies, it does not make economic sense for a fund company to manufacture and market five different locally domiciled funds with USD $10 million each. Managing one $50 million fund that is distributed across many markets, however, can be profitable.
Although investors do often hold home biases – preferring to invest in funds domiciled in their own country rather than funds domiciled internationally – many are willing to invest across borders if it increases investment options. Introducing clients to new investment solutions, however, will require fund companies to allocate resources in order to raise awareness.
Preparing for ARFP
Getting the ARFP framework signed will facilitate market development, but it is also important that client facing sales personnel are aware of and understand them. There needs to be training, education, marketing, and able distribution partners.
Beyond introducing new products, clients and distribution partners need to have clear understandings regarding risk-return expectations. In recent years, owing to income payouts and foreign exchange arbitrage, many solutions offered in developing countries have afforded investors higher returns than those available in developed markets. Helping investors in developing markets appreciate not only return profiles, but also the risk aspects and value of diversification will require time and training.
Fund companies need to have patience, perseverance, and local staff who know the market. They need to adapt their IT infrastructures, back-office operations, fund registrations, trade executions, legal agreements, bookkeeping, and fund servicing as the ARFP standardizes many of these procedures across countries.
Multiple industry impacts
Other industry ripples could emerge from the ARFP. Today, fee structures differ across markets. In Thailand, for example, the average total expense ratio for equity funds is approaching 2%. In Australia, it’s closer to 1%. Additionally, fees in developing countries are often front-end loaded, transaction based whereas in developed markets they are a percentage of total assets managed. As markets become more integrated, expense ratios across the region could become more in-line with each other.
Although technology continues making companies more efficient and reducing headcount needs in many areas, the ARFP will create jobs. Fund companies expanding into new distribution markets will need additional back-office operations, marketing, sales, and client service personnel as they enter new markets. And just as Luxembourg became a mutual fund operational center for European-domiciled funds, new centers could emerge in Asia to support the ARFP and other cross-border schemes.
By making it more practical for fund companies to address Asia, the ARFP will raise the region’s profile globally. The ARFP framework document states that “The Passport aims to facilitate the growth and competitiveness of financial markets in the region and the fund management industry.”
Concurrently, it will widen investment options for investors and raise consumer protection. By collaborating with their counterparts across jurisdictions, regulators will be able to more quickly institute best practices, which will particularly benefit parties in developing financial markets.
Although still a work-in-progress, the ARFP is moving forward. And as it gains popularity, that will be a positive for the industry and region.