How Chinese asset managers drive innovations in offshore asset servicing
T+0 money market funds and tranche funds are coming to the offshore market
The small and medium-sized enterprise (SME) market segment is highly coveted by banks wishing to expand their transaction banking franchise. After all, SMEs account for more than 96% of all Asian businesses, according to Asian Development Bank (ADB), and sustain two out of three private sector jobs in the region.
As Chinese asset managers continue to break into the offshore Hong Kong market, asset service providers have also started revamping their legacy models and systems amid changing market conditions and client requirements. Similar to leading technology companies such as Alibaba and Tencent, Chinese asset managers are replicating their onshore practices with offshore asset service providers while complying with offshore regulations at the same time.
The Hong Kong market, as the hub for Chinese offshore asset managers, has seen innovations such as T+0 money market funds and tranche funds over the past few years. The growing sophistication of Chinese asset managers, especially in the alternative space, has given rise to more complex and customized requirements with custodian banks.
“Some Chinese asset managers have very innovative ideas and come up with some hybrid products. That requires asset service providers to have flexibility and strength,” says a senior executive at a Singaporean custodian bank in an interview with The Asset. “It is easy for Chinese alternative fund managers to raise US$100-200 million. There is no lack of clients. It is just about how fast we can process and onboard them.”
T+0 money market funds and tranche funds are not novel to the mainland China market. But they are relatively new to offshore custodian banks and fund administrators who are regarded as slow-moving when compared to their Chinese counterparts since most standard services and products they provide are able to fulfil the needs of their clients. In the case of money market funds in Hong Kong, for example, investors are used to the T+2 settlement while in mainland China, money market funds are normally settled on a T+0 basis.
“If you think about Chinese clients, what are the money market fund services they enjoy in mainland China and in Hong Kong? They would ask why mainland China has quicker subscription and redemption mechanisms than Hong Kong,” says a senior executive at E Fund Management (HK) in an interview with The Asset, “So our motivation is very simple - to make our services in Hong Kong as competitive as they already are in mainland China.”
In November 2017, E Fund Management (HK) launched its US dollar money market fund with a management fee of just 0.05% per annum, which is quite low compared to other cost structures. This then led to robust demand from Chinese institutional investors. The other distinctive feature of the fund is its T+0 settlement cycle, which is in line with mainland China’s industry standards, but shorter than the international average. China Construction Bank (Asia) was appointed as the custodian bank and was then trained by E Fund Management (HK).
“As a Chinese asset manager, we know our clients better in terms of what they like and their service requirement,” says E Fund Management (HK).
Since the inception of the money market fund, the fund has grown its AUM to HK$1.9 billion (US$0.24 billion) as of August 2018. The successful growth of the money market fund also enabled China Construction Bank (Asia) to market its asset servicing capability.
For Hong Kong subsidiaries of Chinese asset managers, servicing offshore Chinese clients is still their core business, although it may not be profitable due to its relatively small scale. “Our strategy is long term. The money market fund is just a gate opener for further collaboration in the future. At this point, we are still building up our reputation and brand overseas,” says E Fund Management (HK).
The other distinctive products dominated by Chinese players are tranche funds. In the past, tranche mutual funds were popular among mainland Chinese investors. However, in the offshore market, the tranche fund, normally domiciled in the Cayman Islands, is usually a private product that is mostly invested in by professional investors. Chinese asset managers and securities companies such as Haitong Securities are major issuers in the offshore tranche fund market.
In a typical tranche fund, a senior tranche and a subordinate tranche are structured by the asset managers or securities firms with different risks and returns. Senior tranche investors, whose investment amount is normally two or three times that of subordinate investors, are guaranteed fixed returns, and compensated by the subordinate tranche investors if the fund return is less than the guaranteed return. Subordinate tranche investors are subject to the fluctuation of the fund value and are the first to absorb any losses if the tranche fund principal loses value. In return, the subordinate enjoys any extra return on top of the guaranteed return.
Typical Tranche Fund Structure:
As a tranche fund is considered an alternative investment product, not every asset service provider is interested in or capable of servicing this unique structure due to its complicated valuation calculation. Thus, the cost of providing fund administration to a tranche fund is normally higher.
“For example, the Haitong tranche fund is used as a liquidity management tool with different tenors with different coupons,” says an executive director at a Chinese asset manager based in Hong Kong in an interview with The Asset.
Chinese offshore custodian banks such as ICBC and Bank of China have first-mover advantage in servicing Chinese alternative asset managers. While Chinese banks are not able to compete with international custodian banks at a global level, they are familiar with onshore asset servicing standards and practices. Yet, with Asian banks like DBS also looking to expand business with Chinese alternative asset managers, it is expected that the level of service quality of asset service providers will further improve in the offshore market.
“A lot of Chinese managers are not familiar with international standards,” says an Asian custodian banker, “But at the same time, Chinese (asset managers) are also introducing some practices. The tranche fund is a very typical Chinese structure which you didn’t see in the past.”