By James Williams – Hong Kong might be a tiny island but it’s a financial colossus. Long regarded as a global financial hub, its dynamism, unique geographic location and stable socio-economic climate has helped it become Asia’s leading hedge fund centre over the last ten years.
Recent industry figures show that, as of end-2010, approximately USD38billion in hedge fund assets were being managed out of the city, corresponding to a 25 per cent market share. Even more revealing is the growing number of billion dollar funds, which have doubled to eleven year-on-year: still a way off New York (128) and London (63) but winning market share nonetheless.
According to the Hong Kong’s regulatory body, the Securities and Futures Commission (SFC), as of end-September 2010 the number of funds had increased to 538, or seven times that of 2004. Between March 2006 and March 2011, the total number of SFC-licensed hedge fund firms and staff had grown by almost 180 per cent from 1,100 to 3,100.
“Since the global financial crisis we continue to see global managers coming to Hong Kong as well as start-ups,” explains SFC CEO, Martin Wheatley (pictured). “Today, a sizeable number of the largest global managers in the world have established a presence here. Also, many of the Hong Kong managers have demonstrated their ability to weather the storm and are poised for growth.”
There are several reasons why Hong Kong is viewed as a favourable jurisdiction according to Phil Tye, AIMA Hong Kong Exco. “Firstly, Hong Kong has the capital market flow. It’s a gateway to China for capital going into that country and for Chinese foreign investment. Secondly, there’s a broader depth of talent here. Start-ups and global players are basing their Asian market teams here because strategies managed in the markets they trade often perform better. Thirdly, Hong Kong has a certain regulatory environment. It’s a very open and transparent process.”
Whilst many global regulators reacted to the financial crisis in a knee-jerk manner, the SFC remained on an even keel and refrained from over-reacting. It brought confidence and reassurance to market participants, and Tye thinks they came out of it looking stronger as a global regulator: “They resisted pressure to ban short selling activity. They already had a good framework around such activity.” He notes, however, that the SFC are implementing enhanced short selling disclosures, though they’ve yet to be bedded down: “We see them as inherently sensible.”
Many then, welcome Hong Kong’s stable regulatory regime, but it would be folly to think of it as light touch in any way. Compared to Singapore it is more rigid. Any hedge fund manager providing asset management services is generally required to be licensed and as Wheatley explains: “All SFC-licensed hedge fund managers are subject to conduct and operational requirements such as internal controls over investment process, risk management and client disclosure.”
Wheatley believes having a transparent and balanced regulatory framework is critical to maintain Hong Kong’s position as a world-class financial centre.
Singapore grants Exempt Fund Manager status, and could be perceived as having a competitive edge, particularly with respect to start-ups, but Hong Kong’s SFC has simplified the licensing process. Various initiatives have been introduced since 2007 including: clarification on the type of office premises that can be used by licensed hedge fund managers; and, granting exemption from passing regulatory examination to seasoned investment professionals.
Hong Kong has long been overly concentrated in equity long/short strategies but Paul Smith, Chairman and CEO of Triple A Partners, a Hong Kong-based hedge fund advisory firm, sees a greater breadth to strategy selection today: “There’s more variety now in liquid fixed income, distressed debt. I think there are more CTAs now than there ever have been, more RV managers and probably more volatility managers.” Tye agrees that there’s a wider base but adds: “More than 65 per cent of managers are running equity long/short and multi-strategy portfolios.”
Strategy diversification and a deepening talent pool are drawing investors back to Hong Kong. Smith says that in the last three months “there’s been a huge improvement to the tone of the market” with respect to capital raising. People are looking seriously at how they can get invested. Smith’s Triple A Partners advises European family offices looking to allocate USD50million upwards. “Anyone with more than USD150million to USD200million invested is likely to have their own person on the ground or at least be a regular visitor. I’d say our sweet spot is USD50million to USD200million,” explains Smith.
Nevertheless, a strange paradox still exists in Hong Kong. The fund industry, indisputably, is vibrant. But whereas investing into smaller hedge funds was previously the preserve of FoFs, the paradigm has shifted. Now, large institutional investors like US pension funds are coming into play. Many of Hong Kong’s numerous “boutique” funds, however, are unsuitable.
“You can find good managers with good investment theses in Asia, but what you can’t find is very good businesses,” says Smith. “A lot struggle to raise capital.”
“US institutional investors tend to need the capacity that large hedge funds offer but Asian funds tend to be smaller in size and therefore less attractive to some extent,” observes Tye. “We’re bouncing back (with respect to industry AUM) but it’s taking us a bit longer in Asia than expected because of the size issue. Furthermore, European HNW individuals are tending to invest more in UCITS and that’s taken away some of our investor pool.”
“The problem is you’ve got institutions looking to allocate capital here but Asia, of all the global markets, is a place where fund size really is the enemy of performance,” explains Smith. Asia capital markets are not that deep, or liquid. Seasoned Asia investors, according to Smith, find it difficult to have confidence in strategies with more than USD500million. “The more money you have to place in Asia, the harder it is to generate returns. Whilst not impossible, it’s not an easy thing to get USD1billion invested in Asia,” adds Smith.
For fund managers wanting to establish themselves in the city, AIMA’s Tye says that the SFC are “very open” to discussion and have helped create a welcome framework in which to set up a hedge fund business: “I’ve been here 15 years and I’ve seen the SFC spend a lot of time since early 2000 getting to understand the hedge fund space. They are transparent as to the timelines for dealing with applications and they stick to them.” The SFC’s Wheatley confirms: “The average time for approving a hedge fund firm’s license application has been reduced from 15 weeks to less than 10 weeks.”
Another obvious benefit to Hong Kong is its favourable tax regime. Top rate corporate taxation is 16.5 per cent: a far cry from taxation levels elsewhere. It’s legal framework is modelled on British law, which is another huge advantage. And, its proximity to the booming markets of mainland China gives it an undeniable edge when it comes to location. “Thanks to its location Hong Kong has unrivalled investment banking, broking, legal, administration and custodial services,” notes Smith.
“With tax rates lower than most of its regional competitors, Hong Kong is an attractive location for fund managers,” says Thomas Granger, a partner with law firm Walkers Hong Kong.
As a jurisdiction, however, Hong Kong is not without its challenges. The key concern facing its fund managers presently is the impact Dodd-Frank will have. Given that more US assets, as a percentage of total assets, are beginning to flood into the region, the likelihood is that many managers, will, as a matter of right, be required to register with the SEC. Meaning they’ll be subject to additional regulation. “For Asian fund managers there will be costs of compliance, that’s the concern. It’s an increased burden on what is a relatively small asset base,” says Tye. AIMA is paying close attention to the situation with Tye confirming that a network of lawyers and consultants would help them through the final guidelines when they’re published.
The SFC is also doing its bit and is keeping tabs on the issues surrounding the EU’s AIFMD. “We will work with the EU authorities to put in place in the necessary cooperation arrangements,” says Wheatley. Welcome reassurance, no doubt, to Hong Kong’s hedge fund managers that rely on European assets.
This illustrates the SFC’s active role in international policy developments. Wheatley himself chairs the task force which focuses on regulatory reforms to short selling. The SFC also provided important input to discussions with major regulators focusing on developing the IOSCO template for collecting data from hedge funds on systemic risk. Having a regulator that sits at the global table is a reassuring factor for fund managers thinking of setting up in the city.
The one bugbear that Smith has with Hong Kong, for all its myriad positives, is that Hong Kong thinks too parochially. Rather than think of it as Asia’s financial centre, he thinks people should be thinking about how to make it Asia’s global financial centre.
Central to achieving this is China and helping it globalise. “I believe passionately that Hong Kong should change its corporate and taxation laws to become the domicile of choice for everything China does both inward and outward. We should be making sure that as Chinese asset management companies and regulators think about how to introduce international product into China, we present Hong Kong as the onshore domicile for that product.” If it can, says Smith, Hong Kong will become Asia’s global financial centre because “in 20 years China will dominate the region”.