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Regulatory uncertainty and the ‘China coupon’ give Hong Kong fresh impetus

 In recent years one of the biggest success stories of the Asia hedge fund industry has been the rise of Singapore, whose financial regulator, the Monetary Authority of Singapore, belied the c

 In recent years one of the biggest success stories of the Asia hedge fund industry has been the rise of Singapore, whose financial regulator, the Monetary Authority of Singapore, belied the city-state’s reputation for micro-regulation by throwing open the doors to hedge fund managers under an exempt regime that frees firms from various aspects of regulation if their business is limited to a relatively small number of investors.

In recent years the ranks of Singapore’s hedge fund industry have been swelled by a wave of start-up managers (including a number driven from Japan by legal and fiscal constraints) who appreciated the lack of red tape and relatively low costs involved in setting up their business. Prime brokers – many of them part of international banks already with a foothold in the Lion City – and more recently fund administrators have followed.

This has left Hong Kong, the traditional centre of the financial industry in Asia outside Japan, somewhat out of the spotlight, although it would be a gross exaggeration to say it has been eclipsed. The Special Administrative Region of China was home to 245 hedge fund managers with USD22bn in assets at the end of 2008, according to the Alternative Investment Fund Association, which has also estimated the size of the industry in Singapore as 138 managers with USD35bn in assets.

Managers in Asia do not see a great difference between the rival centres. “The Asian hedge fund industry sees Hong Kong and Singapore as the same place, separated by a four-hour flight,” says Peter Douglas, principal of Singapore-based hedge fund consultancy and investment advisory firm GFIA and a long-time analyst of the industry across the region. “However, I believe Hong Kong will always be bigger than Singapore because of China. Hong Kong business is clipping the China coupon and that’s not going to change.”

Paul Li and Rolfe Hayden, respectively country head and a partner at law firm Simmons & Simmons in Hong Kong, argue that Hong Kong also benefits from a particularly advantageous fiscal environment, with a 16.5 per cent rate for taxation of corporate profits and no VAT, capital gains tax or tax on interest, as well as the existence of a comprehensive service infrastructure encompassing law firms, accountants and auditors, fund administrators, prime brokers and custodians.

In addition, they say, the territory’s stable regulatory infrastructure is probably seen as more of an asset by fund investors (and by extension, managers) than it might have been a few years ago. “Growing investor sophistication places compliance and regulation at the crux of any successful investment strategy,” says Li, arguing that in the wake of the Madoff scandal investors are more attracted to managers based in jurisdictions that insist on compliance with well-defined standards and regulations.

This is something that has occurred to the authorities in Singapore too. As early as November 2008 the regulator began to talk about regulatory change, and the MAS launched informal consultations with the industry last December, with the exempt regime clearly a key focus. At present hedge fund managers are exempt from holding a capital markets services licence if they manage funds on behalf of 30 or fewer qualified investors.

However, apart from announcing last year that it would adapt its regulatory regime “as appropriate”, the MAS has not clarified the changes it envisages, and Douglas suspects that the uncertainty may be slowing the flow of new hedge fund managers to Singapore. Last year saw 26 hedge fund start-ups in the city-state compared with 33 in Hong Kong, according to Singapore-based consultancy and data provider Eurekahedge.

Says Hayden: “Hong Kong’s edge over rivals in Asia is due to its existing and stable regulatory framework. It has had a robust licensing regime for fund managers for some time, and while it may previously have lost out to Singapore’s more relaxed approach, clients now see value in being supervised in a centre with regulatory certainty.”

Douglas says of the situation in Singapore: “Everyone knows the regulations are going to change, but nothing formal has come out yet. There’s certainly no exodus of managers, and at the margin a few new managers are coming in, but it appears that some managers who might come to Singapore are holding back because they don’t know what the regulatory environment will look like. Hong Kong is probably picking up a bit of business as a result.”

He notes that in Singapore the regulator also fulfils the function of a financial sector promotional agency – a combination of roles that a number of prominent international jurisdictions have separated, in some cases under pressure from international bodies such as the International Monetary Fund, because of the potential for conflicts of interest such an arrangement can give rise to.

“The MAS is explicitly a promotional agency as well as a supervisor, so there’s the implication that part of its job is to be nice to people, whereas the SFA in Hong Kong does not have the job of promoting the industry,” Douglas says. “Secondly, Singapore still has the exempt regime, which allows firms effectively not to be regulated if they are running a pure business-to-business operation. Personally I believe this is probably the most sophisticated approach to hedge fund regulation anywhere in the world, but I do think the exempt regime is going to change.”

However, there is a widespread belief that both cities will remain significant centres for the hedge fund industry in Asia. Despite the enthusiasm for the hedge fund management clusters growing up in Shanghai and Beijing, many analysts and investors see benefits in the international culture of compliance and transparency that guides financial industry professionals in Hong Kong and Singapore.

GFIA caused a flurry of international interest in February when it was reported that the firm had ended its coverage of and investment with managers based in mainland China. Douglas says the truth was rather less dramatic, but nevertheless illustrates cultural differences between some members of the investment industry in China and investors, especially institutions, elsewhere in the world.

Says Douglas: “In fact, we made an internal decision that for our China exposure, which remains around the level it always has done, we will only use managers where the principals were trained in Western or otherwise recognised institutions. However, this does not make a big change – we are excluding ourselves from no more than a dozen managers, maybe even fewer. There’s a big universe of China managers, and we don’t necessarily need those based in the country to get the exposure we want.

“Since we started covering the Shanghai and to a lesser extent Beijing universe more than five years ago, we have suffered continuous frustration that we couldn’t get the information that we thought we were entitled to, and that the quality of the information flow was variable. Since we are looking after other people’s money, we didn’t feel it was safe. Within China, there is no longstanding cultural DNA of corporate governance, and it will take another generation to get there. However, this is not a qualitative judgement about Chinese portfolio managers – there are some great managers there.”

Nevertheless, Douglas acknowledges that attitudes toward the perceived requirement among international investors for greater ‘institutionalisation’ of Asian management firms have been affected by the managers’ experiences during and after the financial crisis, which saw substantial redemptions from hedge funds investing in the region.

“We are seeing a complete polarisation,” he says. “Asia has always had a spectrum of managers ranging from the big institutional asset-gatherers to small boutiques, but now it’s becoming black and white. On one side are big managers with the resources to gather assets, with a lot of redundancy in the organisation, which are very organised about marketing and have multi-billion-dollar, multi-product businesses. On the other are boutiques that don’t have a large amount of assets and don’t want to deal with large numbers of investors, and consciously intend to stay at a modest size.

“Throughout the world but especially in Asia, a lot of the flakiest investors turned out to be institutions. The mantra was always that managers wanted to attract big institutional money because those investors were stable and credible. A lot of those supposedly long-term investors who were writing big tickets to Asian hedge funds were requiring managers to put in place redundancy within their organisations in the form of governance and due diligence.

“But when the crisis came many of them pulled their money out anyway. A lot of managers are now asking why they need 30 people in their organisation when they are capable of running the money with just 10. The principals no longer have management issues and can spend their time focusing on the portfolio; they don’t have to talk to 25-year-old analysts, just people they know well. For some managers, that’s a business model that suits them better.”

However, that does not mean that hedge fund investment in Asia is becoming less sophisticated – quite the contrary, according to Meredith Jones, managing director and head of global marketing at investment software specialist PerTrac Financial Solutions. “There is recognition of a need for more information and for the ability to understand what’s going on,” she says.

“The investors we’re working with in Asia are more sophisticated than ever before and have more understanding of the risks they face. They are increasingly demanding tools that will allow them to fully research and vet managers, to construct and track portfolios, and to collect and manage all the information that greater transparency is bringing them.

“On the manager side, someone has to respond to all these requests from investors. The need for first-class investor relations and marketing efforts has been growing over the course of a decade, but it has accelerated dramatically over the past 18 months. This is particularly an issue for Asian managers that previously might have had a smaller infrastructure in place for dealing with client requests and marketing efforts. They are beefing up that side of their business, and looking for tools that will enable them to do more without having to inflate their organisation unduly.”

Jones says that in general Asian management businesses are smaller and leaner than their counterparts in Europe and North America. “Having the right tools means they can be more efficient and more proactive, and have higher-quality communication with fewer staff,” she says. “Nor should the marketing aspect be ignored. With still about 18,000 active funds in existence at the end of 2009, hedge funds managers in Asia are really focused on making sure that they showcase their competitive advantages. Part of that is producing compelling performance reports, which you cannot do efficiently without the tools to produce effective peer group analysis, distribute the reports and conduct an effective follow-up.”

Amid all these developments, industry members are confident that a combination of attractive investment opportunities, growing professionalism among managers and the ongoing development of a sophisticated support infrastructure will underpin the Asian hedge fund sector as the world emerges from the economic downturn and investors regain confidence in markets beyond their front door.

For example, specialist credit manager Income Partners reports that demand is already gathering steam. “The Asian credit market continues to grow as companies tap the market to fund their regional expansion,” says director of investments Suvir Mukhi. “On the demand side, we see increasing appetite for Asian credits from funds, insurance companies and private clients – who are attracted by the regional growth story, strong credit fundamentals and favourable valuations.”

Last year multi-jurisdictional fund administration firm Apex Fund Services launched what it says is the first private fund administration service in mainland China with the opening of an office in Shanghai, in addition to its existing operations in Hong Kong and Singapore. Says managing director Anthony D’Silva: “With growing investment opportunities and excellent growth figures, Asia will be the most sought-after region among developing markets. With its technological, infrastructure, regulatory and legal framework, Asia has the capabilities to cater for any fund strategy and manager.”


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