December 14th, 2014

Following the November 2014 launch of the Stock Connect trading links between the Hong Kong and Shanghai stock exchanges, the Hong Kong and Mainland China regulators have now been focusing their attention on the scheme which is to permit distribution of commingled investment funds in each other's market. While there has been no official statement on expected timing, market sentiment is that it may go live in the first quarter of 2015.Reforms such as Stock Connect, use of which to date has proved relatively subdued after the initial euphoria, and mutual recognition, are key components in the steady opening up of Mainland China's capital markets, presenting new opportunities for many firms.

The concept of mutual recognition for eligible investment funds was first proposed by the Hong Kong Securities and Futures Commission (SFC) and China Securities Regulatory Commission (CSRC) in 2013. Given its significance, the Hong Kong Investment Funds Association led an industry delegation on a visit to the CSRC in Beijing, and formed a working group which shared a series of suggestions and recommendations with the SFC, with a wide-ranging remit which extended to fund operations, tax and accounting. Incorporating such representations from the fund management community, the two regulators developed a framework and worked together to reach agreement on fund qualification criteria, manager eligibility and investor protection disclosure requirements.

By April 2014, speaking at FundForum in Hong Kong, Alexa Lam, deputy chief executive officer of the SFC, explained that the two regulators had begun the final run of administrative procedures, which has included putting in place staff secondments to understand each other's approach to authorizing funds.

Hong Kong already has in place a pair of mutual recognition arrangements, with Taiwan (for exchange-traded funds) and Australia. These simplify the process of creating funds, seeking authorization and selling them between the respective jurisdictions. When it comes to Mainland China, however, there is an extra layer of complexity: restrictions on currency convertibility. To date, under the Renminbi Qualified Foreign Institutional Investor (RQFII) scheme, institutions have been able to set up offshore funds for investment into the Mainland, but these have been subject to an aggregate quota, amounting to CNY 270 billion (US$45 billion) for the route from Hong Kong. With this cap almost exhausted, the Hong Kong government has been lobbying the Mainland government for an increase.

The RQFII's success underscores the strong appeal of the renminbi, and the attraction of the Mainland market. Mutual recognition will take things further, adding a fresh channel for international investors to gain exposure to the Mainland and, significantly, opening the gate to mutual traffic flow for the first time. The SFC says it wants as many international fund managers as possible to participate in distributing their funds on the Mainland, just as the new arrangement will also open up huge potential for Mainland fund managers to distribute their funds via Hong Kong.

Under the arrangement, qualifying SFC-authorized funds, domiciled in and operating from Hong Kong, will enjoy the status of 'recognized Hong Kong funds'. Similarly, qualifying Mainland funds will enjoy an equivalent 'recognized Mainland funds' status. With authorization from their regulator, these recognized funds can then be sold directly in the other's market.