Who will win online fund distribution in Hong Kong?
The SFC has settled on the rules for online sales of investment products, but distribution dynamics may prove hard to disrupt.
The new, recently concluded rules for online distribution of investment products in Hong Kong open a door to Big Tech, in particular Chinese internet companies, to challenge the dominance of banks as distributors of investment products.
Discussions with funds industry experts and lawyers suggests, however, that to make inroads will require those tech companies to make serious adaptations to how they operate.
For asset managers, the battle to win Hong Kong’s $1.3 trillion retail funds industry will therefore revolve around determining the right partnerships with platform operators, be they tech companies or banks.
(The consultation does not impact the $133 billion in Hong Kong’s provident and corporate pension schemes. The entire consultation document from the Securities and Futures Commission can be read here.)
Loosening the stranglehold
In Hong Kong, over 90% of retail funds are sold through banks. This has led to concerns by the regulators that the industry lacks competition or innovation. The lack of exchange-traded funds (ETFs), for examples, demonstrates that bank sales teams push products that deliver commissions, and deny consumers access to ultra low-cost, efficient products.
This has been one driver behind the SFC’s desire to extend fund sales to the online world, a process that it kicked off in 2016.
A handful of tech companies such as 8 Securities and Yunfeng Securities are licensed to offer robo-driven portfolios of either ETFs or authorized mutual funds, but industry officials suggest these direct-to-consumer efforts have not yielded big results. 8 Securities and Yunfeng do not break out their AUM or size of customer base.
Could the ability of online platforms – such as Ant Financial’s Alipay and Tencent’s WeChat, or online brokers like TDAmeritrade or Charles Schwab – make a difference if they’re allowed to sell products over smartphones?
Enter the virtual banks
Over time, the likely answer is yes, particularly when online sales are combined with the expected issuance of virtual banking licenses by the Hong Kong Monetary Authority.
The virtual bank is not part of the SFC consultation, but executives and lawyers interviewed for this story agree the two regimes are sure to intersect. HKMA is expected to formalize its application rules by the end of the year, and issue as many as 10 licenses.
Whoever wins such a license is unlikely to be satisfied to act as mere e-wallets of stored value: providers will want to push loans, credit cards, insurance, and investments. The SFC’s new rules will now make it easy to add investment products to any online platform.
Moreover, the HKMA has established minimum capital requirements that will weed out startups and small players, and ensure only well-funded institutions play the role of online distributor.
From that point, it seems the degree to which banks’ stranglehold on fund sales is disrupted will depend on the speed with which China’s internet companies ramp up.
“Big tech companies have the capital to get the virtual banking license,” Jolyon Ellwood-Russell, partner at Simmons & Simmons, told DigFin. “They have access to investors as customers. To broaden into online distribution seems the logical direction.”
Another lawyer, Mark Shipman, partner at Clifford Chance, said, “Big tech companies that get a license will benefit, as will some of the larger asset managers that buy into these tech solutions.”
Not so fast!
But industry participants say it could take a while for even deep-pocketed Chinese internet companies to steal meaningful marketshare from the banks.
Stewart Aldcroft, chairman at Cititrust, acknowledges these regulatory changes now give internet companies the chance to export some of their platform business to Hong Kong, if they can meet local requirements. “But is it a way to break banks’ fund dominance? No. This gives banks another way to sell.”
The SFC’s new guidelines graph existing rules for selling investment products offline into the online world. It leaves intact the process, unique to Hong Kong, that differentiates between “complex” and “non-complex” products, with any act deemed a solicitation triggering a suitability review.
In the offline world, suitability requires a lengthy, face-to-face interview between distributors and potential investors. It can be waived for “professional” investors, meaning rich people, financial institutions or corporations.
During the consultation process, a lot of the comments involved concerns this would not translate well to online dealings, but the SFC insists platform providers can design systems to meet its suitability requirement.
“The application of offline suitability requirements to online distribution will make it difficult for online platforms to offer anything beyond vanilla products,” at least at initial stages, said Helen Fok, counsel at Simmons & Simmons.
So what constitutes non-complex products? For now, it is limited to SFC-authorized funds, in which derivatives comprise less than 50% of net asset value and are meant to hedge, not generate alpha.
Given the reliance of many robo-advisors on ETFs, the rules therefore are biased toward ETFs that are listed or cross-listed in Hong Kong. One global asset manager says the challenge is to find a way to allow overseas listed ETFs to participate without being deemed “complex”.
“We will work with platform operators to see if we can come up with a solution,” one buy-side exec told DigFin. “Can we include a proportion of global ETFs in a platform portfolio?”
ETF access still a struggle
His firm is also concerned that SFC standards around ETFs may not account for how portfolio algorithms are constructed or tested. He is concerned these could be biased to exclude ETFs listed overseas.
The market cap of Hong Kong-listed ETFs is $43 billion as of June, 2017, according to the SFC. There are 156 SFC-authorized ETFs listed on the Hong Kong bourse, of which 92% are equity products.
Hong Kong is the second-largest ETF market in Asia, after Tokyo – but Asia as a whole lags the US and Europe because distribution has been largely left to online brokers.
Renminbi-denominated ETFs accessing China’s A-share market account for about a fifth of the market, and mainland fund houses are among the major players, along with benchmark ETF such as State Street Global Advisor’s local tracker fund and iShares’ MSCI China index product.
The upshot is that ETFs are an important part to constructing robo portfolios, as well as cost-effective tools that are not being made available to the broad investor base in Hong Kong. The SFC’s decision to let distributors – banks, tech platforms – to now sell funds online opens new channels, and common sense holds that ETFs would play an important role. But definitions of “complex” products and suitability triggers mean that, right now, it doesn’t look as though this will enable a major opportunity for ETFs.
New blood but old rules
Because “complex” products will trigger suitability requirements, they will be hard to sell online, so these will remain the purview of banks. If banks decide to own the online space for simple products, they might be able to compete against Big Tech as well.
Any distributor will need more than a license: they’ll need to appoint responsible officers and ensure controls and safeguards are in place. Banks are already organized this way. “Tech companies underestimate these things,” a fund exec told DigFin. Asset managers won’t be able to get far on a tech platform unless the governance is sound.
Once the SFC officially gazettes its new guidelines, the industry will have a 12-month period to get ready before the first products can be distributed online. Those awaiting HKMA virtual banking licenses may take longer.
So this year will see a lot of behind-the-scenes negotiating between banks, tech companies, robo advisors and asset managers. These new regulations finally open the door to internet giants to enter wealth management in Hong Kong. This is good: it means competition, fresh blood, and a better investor experience.
But from the way the rules are now set, it will not greatly expand ETF choice or access – the building blocks for most robo services – and it could be several years before any tech platform makes a meaningful dent in banks’ grip over funds distribution.