Notional pooling is a mechanism for calculating interest on the combined credit and debit balances of accounts that a corporate parent chooses to cluster together, without actually transferring any funds between the accounts. It is ideal for companies with decentralized organizations that want to allow some autonomy to their subsidiaries, including their control over bank accounts.

The advantages of notional pooling are:

• Single liquidity position. It allows each subsidiary company to take advantage of a single, centralized liquidity position, while still retaining daily cash management privileges.
• Local allocation of interest income. Each account in the pool receives an allocation of interest income at the end of each month that is based on the contribution of the account to the total balance being invested during the investment period.
• No inter-company loans. It avoids the use of cash transfers to a central pooling account, so there is no need to create or monitor inter-company loans for tax purposes.
• Short-term commitment. A notional pooling arrangement does not require a long-term commitment with a bank; on the contrary, it is relatively easy to back out of the arrangement.
• No cash transfer fees. There are no bank fees related to cash transfers, since there are no transfers between accounts that would normally trigger fees.
• No overdraft lines. It largely eliminates the need to arrange overdraft lines with local banks, since cash is retained locally.
• Increased interest income. Interest earnings tend to be higher under a notional pooling arrangement than if investments were made separately for smaller individual accounts, since pooled funds can be invested in larger instruments that generate higher returns.
• Agreeable to minority owners. It offers a solution for partially-owned subsidiaries whose other owners may balk at the prospect of physically transferring funds to an account controlled by another entity.
• Reduced foreign exchange transactions. Where global notional pooling is offered (usually where all participating accounts are held within a single bank), the pool offsets credit and debit balances on a multi-currency basis without the need to engage in any foreign exchange transactions.
• Local autonomy. If a parent company wants to preserve the operational independence of its subsidiaries, notional pooling allows them to retain cash balances in their local bank accounts. This also makes it easier to conduct bank reconciliations at the local level, since there are no cash transfer transactions to a central account, as would be the case with a cash sweeping arrangement.
• Reduced interest expense. It allows a company to reduce its interest expense to the minimum level, since debit and credit positions are offset.

Once a company earns interest on the funds in a notional pooling account, interest income is usually allocated back to each of the accounts comprising the pool.  For tax management reasons, it may be useful for the corporate parent to charge the subsidiaries participating in the pool for some cash concentration administration expenses related to management of the pool.  This scenario works best if the corporate subsidiaries are located in high-tax regions where reduced reportable income will result in reduced taxes.
The main downside of notional pooling is that it is not allowed in some countries. It is difficult to find anything but a large multi-national bank that offers cross-currency notional pooling.  Instead, it is most common to have a separate notional cash pool for each currency area.

Cross-Border Cash Pool
A cash pool is a cluster of subsidiary bank accounts and a concentration account into which funds flow from the subsidiary accounts. If a pooling arrangement includes accounts located in more than one country, this is known as a cross-border cash pool.

Cash Sweeping
A cash sweeping system (also known as physical pooling) is designed to move the cash in a company’s outlying bank accounts into a central concentration account, from which it can be more easily invested. By concentrating cash in one place, a business can place funds in larger financial instruments at higher rates of return. Cash sweeps are intended to occur at the end of every business day, which means that quite a large number of sweep transactions may arise over the course of a year.


Cash sweeping can be fully automated as long as a company keeps all of its bank accounts with a single bank, where the bank can monitor account balances. Since several banks now span entire countries, it is not especially difficult to locate banks that can provide comprehensive sweeping services across broad geographic regions.
The Zero Balance Account
One way to implement a cash sweeping system is the zero balance account (ZBA). A ZBA is usually a checking account that is automatically funded from a central account in an amount sufficient to cover presented checks. To do so, the bank calculates the amount of all checks presented against a ZBA, and pays them with a debit to the central account. Also, if deposits are made into a ZBA account, the amount of the deposit is automatically shifted to the central account. Further, if a subsidiary account has a debit (overdrawn) balance, cash is automatically shifted from the central account back to the subsidiary account in an amount sufficient to bring the account balance back to zero. In addition, subsidiary account balances can be set at a specific target amount, rather than zero, so that some residual cash is maintained in one or more accounts.
There are three possible ZBA transactions, all of which occur automatically:

• Excess cash is shifted into a central account
• Cash needed to meet payment obligations is shifted from the central account to linked checking accounts
• Cash needed to offset debit balances is shifted from the central account to linked accounts

The net result of a ZBA is that a company retains most of its cash in a central location, and only doles out cash from that central account to pay for immediate needs.
Sweeping Rules
A number of rules can be set up in a cash sweeping system to fit the cash requirements of the business entity using each account, as well as to minimize the cost of the system. Rules usually address:

• Frequency. Cash can be swept from some accounts at longer intervals than for other accounts. Some accounts accumulate cash very slowly, and only require an occasional sweep.
• Threshold sweeps. Cash can be swept only when the cash balance in an account reaches a certain level. This minimizes the cost of initiating sweeps for very small amounts of cash.
• Target balances. A designated amount of cash can be left in an account to ensure that a certain balance is always available. This may require that cash be sent into an account, rather than the usual outbound sweep. Target balances are useful when day-to-day operating needs are being met locally through an account. For example, a local bank may automatically extract its monthly service fee from an account, and will charge an overdraft fee if the account contains no cash with which to pay the service fee.

Sweep Problems
Cash sweeping is not to be engaged in lightly when cash is being moved among the accounts of multiple business entities, and especially when cash is being moved across national boundaries. Cash sweeping can cause the following problems related to interest:

• Recognition of interest income. Some local tax jurisdictions will take exception if a business recognizes all of its interest income at the corporate level, since the cash that generated the interest income is located at the subsidiary level. To offset this problem, all interest earned should be allocated back to the subsidiaries based on the amount of their cash that was used to generate the income.
• Recognition of interest expense. As was the case with interest income, some tax jurisdictions want to see an interest charge recorded against those subsidiaries that required a cash infusion to avoid an overdraft situation. The interest charge should be based on the interest rate paid by the company for its debt; in the absence of any debt, use the market interest rate.

Much has been written about China’s economic slowdown in the past year. And while it is widely accepted that the nation’s leadership has deliberately cooled its burgeoning economy in favour of long-term growth, some commentators maintain that China’s economic advancement has stalled.
What is sometimes overlooked, however, is the sheer size and scale of the nation’s economy and the breadth of opportunities it presents to foreign companies. Indeed, even with lowered growth forecasts, China’s outlook dwarfs almost all other markets worldwide.
“China is trying to shift from breakneck growth to a more sustainable model in a way that no other country has tried to do before,” explains Stuart Gulliver, HSBC Group Chief Executive. “That it is trying to do so whilst undertaking a comprehensive programme of financial reform only makes that task harder. As it is, Beijing has managed a gradual deceleration from double-digit growth in a measured and controlled way.”
According to Gulliver, China has steadily opened up its economy to outside investors, and has let market forces steer change. While the nation faces significant challenges within this process, the Group Chief Executive believes China has the ability to overcome present-day hindrances. “If anything, we think that 7% is more a growth floor than a target, and signs indicate that Beijing is preparing to cushion China’s transition through further easing,” adds Gulliver.


RMB’s role
Playing a central role in the nation’s economic development is China’s currency, the RMB. To date, it has predominantly been used to settle international trade, accounting for 22% of China’s total trade in 2014[i]. From near-zero usage in 2010, the RMB has become the world’s number-two trade finance currency[ii] and is among the top-five payment currencies globally[iii].
According to HSBC’s RMB Internationalisation Survey 2015, which examines the views of international companies that currently do business with China, RMB usage for cross-border settlements amongst Singapore-based companies remained at the same level as last year, at 15% of total trades. Of the 100 Singapore-based companies surveyed, around 41% are expecting to increase their cross-border trade with China in the following 12 months. Of the non-users, the survey found that 32% of Singapore businesses are planning to start using the currency in the future. The principal drivers behind today’s usage include reduced foreign exchange risk; access to cheaper trade pricing; and an anticipated increase in trade with China.


“The implication is that businesses are trading in RMB because it offers a number of practical benefits rather than for short-term speculation,” says Joseph Arena, Head of Global Trade and Receivables Finance, HSBC Singapore. “We expect that the continued liberalisation of the currency will help spur awareness and greater usage among corporates globally,” he added.


Cross-border liquidity management
Early-2014 saw HSBC China roll out its cross-border RMB cash pooling programme in the Shanghai Free Trade Zone (SFTZ). Subject to some restrictions[iv], the facility was a first for China, enabling domestic and foreign businesses to recoup RMB from the offshore market back to the mainland, as well as centralise treasury and cash management operations globally – tasks that were previously unavailable, preventing foreign businesses from repatriating their Chinese earnings overseas.
“Companies doing business in the zone now have access to a number of pilot schemes,” says Rohit Joshi, Head of Global Payments and Cash Management, HSBC Singapore. “These include two-way cross-border sweeping, which allows onshore entities to directly inject cash into offshore affiliates, and vice-versa; intra-group netting, where companies can conduct multiple RMB-denominated cross-border transfers performed as a single transaction; and access to cross-border RMB loans, where locally registered businesses can obtain additional liquidity from offshore centres.”
China’s cross-border initiatives are supported by several offshore clearing hubs, which are located across Europe, North America, Middle East and Asia Pacific, including Singapore. Furthermore, China’s State Council recently announced plans to develop an additional three free trade zones in Fujian, Guangdong and Tianjin[v].


Payments infrastructure
A notable development in the liberalisation of cross-border RMB flows is the China International Payments System (CIPS). To be rolled out in late-2015, CIPS is designed to speed up RMB-denominated international payments from the offshore market, as well as reduce transaction risks and increase cost efficiencies.
 Currently, cross-border RMB payments are cleared through mainland-based correspondent banks or via clearing banks located in offshore hubs. The introduction of CIPS, however, will allow overseas businesses to clear RMB transactions with China-based counterparts directly.
“The introduction of CIPS will speed up the payments process for Singaporean companies that trade with China in RMB, rather than using a nominated clearing bank to execute such transactions. Businesses will soon be able to pay Chinese suppliers directly using their own bank accounts,” explains Rohit.


Investment instruments and reforms
As an investment currency, however, the RMB is less developed. The majority of advancements in this space have focused on foreign players investing in China, rather than Chinese investors looking overseas. Current RMB-denominated initiatives available to investors include the various qualified investor “Q” schemes – namely the Qualified Foreign Institutional Investor, Qualified Domestic Institutional Investor and RMB Qualified Foreign Institutional Investor programmes – as well as the Shanghai-Hong Kong Stock Connect initiative, all of which act as testing tools to monitor the performance of cross-border capital flows.
Significant reforms to China’s capital account are nonetheless expected in the near-future, which will encourage equally weighted two-way flows. Schemes likely to be rolled out include a new stock connect between the Shenzhen and Hong Kong exchanges; international access to mainland corporate bonds through the Shanghai Free Trade Zone; expansion and merger of the qualified investor schemes; and completion of China’s interest rate liberalisation programme, with the lifting of its deposit rate ceiling. Furthermore, China’s State Council recently launched a deposit insurance scheme for business and consumer savers.


HSBC predicts full convertibility of the RMB to take place by 2017[vi], allowing the RMB to be granted reserve currency status by the International Monetary Fund (IMF). Given China’s commitment to further open its capital account in 2015, however, the RMB will likely become a reserve this year. At present, some countries already hold the RMB for this purpose including several Asian and African central banks.


Global integration
While there is some way to go for China’s currency to be fully integrated with the global financial system, its breakneck development – coupled with the nation’s wider reform agenda – will ensure greater harmonisation of the RMB with the world’s foremost economies. In order for China to realise its full potential, however, the nation will also need the support of all actors, whether the private sector, financial institutions or state governments. “China cannot do it alone. Global and central banks, national governments and international institutions all have a part to play by inviting China to play a fuller role in the global economy. If they do so successfully, we will all benefit,” concludes Gulliver.

MTS B2SCAN is a web-based pre-trade information tool that matches buyers and sellers of credit instruments. By aggregating bank inventory, runs and axes, it enables asset managers to search for the bonds they wish to trade, identify an appropriate counterparty in an efficient and effective manner and execute the trade on MTS BondVision.

MTS B2SCAN provides a powerful search engine that allows buy-side traders to search for axed bonds while at the same time keeping control of the information they share. Clients can search MTS B2SCAN’s database to identify a bank that is willing to buy or sell a particular bond or list of bonds. With over 3,000 bonds axed on average every day, MTS B2SCAN significantly increases the probability of a successful trade and improves the efficiency of the execution workflow process.

Buy-side benefits from:

• Access to 15 dealers providing axes, with more in the pipeline
• Comprehensive database of 9,000 liquid bonds
• Powerful search engine
• Overview of market liquidity
• Pre-trade inventory discovery
• Axes history
• Choice of access options 

Banks benefit from:

• Full control of who receives your information
• Tier 1 buy-side focus on your inventory, runs and axes
• Efficient and light touch distribution system
• Ability to compare metrics with competitors (e.g. number of axes sent, average axe size by sector, average turnover by sector) 
• No connectivity costs

The majority of the 33 live electronic corporate bonds trading platforms, and the eight due to launch, will have failed in three years time according to consultancy GreySpark.

Frederic Ponzo, managing partner, and Russell Dinnage, senior consultant, capital markets intelligence at GreySpark said in the “Rebooting the Corporate Bonds Market” report that, until recently, the new corporate bond trading platforms have either tried to replicate mechanisms in the equitymarket or to disintermediate banks.

“So far, none of the proposed trading solutions can demonstrate their viability without the active involvement of broker-dealers,” said the report. “In 2015, the role of banks in the corporate bonds market appears irreplaceable when it comes to managing the time mismatch between buyers and sellers, or to generating fair and tradable prices.”

The consultancy said that 82.6% of the annual corporate bonds turnover in the US still goes though the top 20 dealers, and 84.8% in Europe, despite banks reducing their balance sheets. Before the financial crisis, the largest Wall Street dealers held $33bn of corporate bonds on their trading books, which has fallen to $15bn this year due to capital constraints from regulators.

Greyspark said: “Severely undermined by the recent regulatory reforms, the market structure must evolve or be completely overhauled in order to support the healthy secondary trading that, in turn, is required to support the primary issuance financing the real economy.”

Instead of trying to remove banks, some smart data solutions are helping the broker-dealers to do more with less by optimising the deployment of their capital to the benefit of their key clients.

“If they integrate themselves into the existing credit trading workflows, these venues could help to significantly expand the amount of risk netted between dealers and free space in the bank inventories to service their customers,” said Greyspark.

For example, Algomi, which builds social networks for the corporate bond market, formed its first partnership with an exchange in January. SIX Swiss Exchange is launching an electronic platform for trading large blocks of corporate bonds in the first half of 2015 with Algomi as a technology partner.

Other European exchanges have also launched their own bond trading initiatives. MTS, the London Stock Exchange’s fixed income trading business, has joined up with B2SCAN, a French platform which makes it easier for asset managers to search for a particular bond, or list of bonds, and then electronically execute their trades on MTS BondVision. B2SCAN allows banks to advertise the bonds they want to buy or sell to selected asset managers and users include Bank of America Merrill Lynch, HSBC, UBS Citi and Societe Generale.

Last year Deutsche Börse, the German exchange operator, acquired a minority stake in Bondcube, a London and Boston-based electronic fixed income trading system, which is not based on a buy-side request for quote to the sell side. Instead Bondcube is an all-to-all market where users post indications of interest and the platform finds matches and also analyses historic orders to find matches in infrequently traded bonds. In December Bondcube received regulatory approval to trade in 31 European countries and in January became a Finra broker/dealer member in the US.

The Greyspark report found that in 2015, there are already at least 33 live electronic corporate bonds trading platforms, and at least another eight are reportedly in various stages of pre-launch development.

“The majority of the new trading platforms discussed in this report will no longer be trading in three-year’s time,” added Greyspark.

SIX Swiss Exchange is to launch an electronic platform for trading corporate bonds in the first half of 2015.

This platform will allow SIX Swiss Exchange to provide market participants with a more efficient trading of larger blocks also in less liquid issues. The new platform's innovative trading model was developed in close cooperation with current sell-side market participants.

The launch of the new trading platform in the first half of 2015 will result in the creation of a multilateral liquidity pool for the trading of large order of corporate bonds. This will help eliminate the disadvantages of inefficient off-exchange trading: insufficient liquidity, small trade sizes, timeconsuming price negotiations, as well as the worry that prices could be negatively influenced by premature disclosure. An innovative matching logic brings market participants together and ensures a regulated market is created in which protection against information leaks is assured, pricing and volumes are agreed electronically and execution is completed without any negative market impact.

The new trading platform is part of SIX Swiss Exchange’s “Over the Exchange initiative”, which offers new exchange services to the exchange’s broadly diversified client base. SIX Swiss Exchange is therefore providing an alternative to the highly fragmented bond trading arena, most of which is conducted outside an exchange infrastructure and is therefore inefficient. The new trading platform will facilitate efficient, competitive execution particularly for less liquid corporate bonds and large trades of at least two million in EUR, GBP or USD.

The platform will be domiciled in Switzerland and subject to regulatory supervision by the Swiss Financial Market Supervisory Authority (FINMA). SIX Exchange Regulation will be responsible for the market supervision. Algomi Ltd. was selected as the technology partner for the development of this industry-leading solution.

Christian Katz, Division CEO Swiss Exchange, comments: "With the new electronic trading platform for corporate bonds, we are creating a regulated market that will benefit not only market professionals but also provide greater efficiency for their clients, in other words pension funds and asset managers.

Trading participants in this electronic platform will be able to transact large orders of bonds simply and efficiently via the new liquidity pool and exchange.

LONDON, Feb 13 (IFR) - Around 30 e-trading platforms are currently competing to address the liquidity crisis in corporate bond trading, but market players say most will fall by the wayside in the months ahead.

"There are 30-odd platforms currently looking for a share of activity," Mark Benstead, senior portfolio manager for UK credit at L&G, said at a recent credit conference.

"But there certainly won't be 30 in a year's time."

The surge of platforms comes as fixed income finds itself grappling with a new and confusing paradox: while the ability to conduct large trades has withered, there are more bonds than ever before.

As a result of stricter regulations and higher capital costs, dealers have shrunk their bond inventories dramatically.

According to the Federal Reserve Bank of New York, corporate bond inventories have decreased more than 75% since before the financial crisis, from around US$250bn then to US$57bn today.

But the net total of corporate bonds outstanding has skyrocketed from US$5.2trn in 2007, according to trade industry group Sifma, to some US$7.7trn now.

New platforms, some still just little more than an idea, are stepping into the breach to try to resolve this. [For list of platforms see FACTBOX: ID:L6N0VE553]

DIFFERENT PROTOCOLS

Some of the platforms are promoted by dealers, such as HSBC's Credit Place and PIN from UBS, while there are a raft of independent players, including Bondcube and Electronifie.

"When designing a platform, you are faced with an impossible trinity," says Frederick Ponzo, managing partner at GreySpark Partners, a consulting firm.

"You must pick a trade-off between transparency of price discovery, managing the time mismatch and protecting against adverse leakage of information," he told IFR.

"A corporate bond execution facility cannot achieve all three. In pursuing two, the platform operator must forgo the third."

The long-standing method of liquidity provision, dealer-to-client, where corporate bond investors ask multiple banks for prices on the dominant venues - Bloomberg, Tradeweb, MarketAxess and Bondvision - has hit a hitch.

This request-for-quote (RFQ) model has thrived for smaller transactions since the financial crisis but not larger, which require accurate pre-trade prices from dealers who also need to deploy capital to warehouse risk.

Securities analysis firm TABB Group's Anthony Perrotta estimates that from a low of 7% in 2008, 15%-16% of the notional volume for dealer-to-client trading is executed via an electronic medium.

But the various new platforms spy an opportunity to facilitate larger transactions. They believe investors want to be able to trade which each other but on platforms with neutral ownership structures and where access to the data is restricted.

It is probably for these reasons that early movers from 2012, such as Goldman Sachs's G-Sessions and BlackRock's Aladdin, failed to gain traction.

As it happens, BlackRock has since teamed up with MarketAxess with an offering called Open Trading, which allows investors to trade with other investors, and recently announced an expansion into Europe.

Last summer, Tradeweb launched a US platform on which it promised pre-trade transparency, with live prices and 95% certainty of execution on certain securities - which would be an impressive undertaking by dealers. (Tradeweb is 51% owned by Thomson Reuters, and IFR is a Thomson Reuters publication.)

New approaches

None of these developments has halted the march of new platforms, many of which are replicating exchange trading models, where users can trade with anyone - all-to-all. Only this week, SIX Swiss bourse launched a trade-matching venue, and Bondcube - backed by Deutsche Boerse - went live in December.

Other venues still in conception include Oasis, another all-to-all model created by Deutsche Bank, and Project Neptune, an attempt to link all trading venues, backed by a dozen banks, including Goldman Sachs, HSBC, Societe Generale, BNP Paribas and Credit Suisse.

However, there is a risk that Neptune, which will take at least a year to complete and needs substantial funding, will not be operational in time to act as a conduit for the new platforms. One of the major problems facing new venues is how to build sufficient momentum.

"If we trust the platform enough we would go up in big size in expectation that we'll get matched. But if you're not getting matched then you just give up and go elsewhere," says L&G's Benstead.

One platform that appears to have gained some traction is Credit Place, where investors can deal directly, but anonymously, with each other. This is facilitated by HSBC, which also services these clients with quotes and liquidity. Credit Place's average ticket size is around US$5.4m, versus an average corporate bond trade size of US$200k-$300k, according to HSBC.

Last year, US$23bn of orders were placed, triggering US$6.5bn worth of trades; the venue currently has 74 clients globally and HSBC estimates that will grow to over 100 by year-end.

"There's a lot of talk about matching platforms, but in credit and illiquid markets generally it is rare to achieve the perfect match," says Niall Cameron, head of markets, EMEA, at HSBC.

Finding the sweet spot

It is hard to shift from the idea that dealer-to-dealer activity is key to bridging the gap to the buy-side, which holds around 91% of corporate bond assets.

"We need to help dealers and not alienate them. The interdealer brokers should have been the winners in this situation and instead they are coming out the losers. So far, we haven't seen an interdealer exchange and this could ease the pain," says Ponzo.

There are several initiatives with dealer-to-dealer functions in the pipeline, including Swiss Exchange, Singapore Exchange and Neptune.

The idea that the existing market structure requires only a re-touch, not a complete overhaul, is behind Algomi's Honeycomb product, which has secured a strong following since it started in late 2014.

According to Stu Taylor, Algomi's chief executive, nine banks are live with the product or soon will be, including Credit Suisse, Deutsche Bank, HSBC and Nomura. The Swiss bourse also installing the system.

"Salespeople need to drag clients/holders into the arena to convince them to sell, and that isn't a 20/30-second protocol," Taylor says, adding that 30 major buy-side firms have already signed up and another 40 are currently in talks.

Despite the millions of dollars ploughed into e-trading, many doubt whether we can ever re-live pre-crisis highs of the financial bubble. It seems unlikely that an inherently illiquid asset can become liquid due to technological advances alone. (Reporting by Laura Benitez, Alex Chambers; editing by Julian Baker and Marc Carnegie)

For global asset managers, China offers up the prospect of huge asset pools – with some predicting that the country will account for one-third of net inflows to mutual funds globally as soon as 2020. This is being helped along by the July 1, 2015 miletone in the loosening of China's tight controls over cross-border investment, as the Mainland China/Hong Kong Mutual Recognition Framework (MRF) gets underway. For Chinese asset managers, this is expected to be the first step in a series of bilateral agreements to allow them to gain access to investors around the world.

The MRF, which introduces a fund passport for approved Hong Kong and Mainland Chinese mutual funds, has been a hot topic in cross-border fund distribution circles, ever since first being proposed publicly by the Hong Kong Securities and Futures Commission and China Securities Regulatory Commission at the beginning of 2013. Several months are sure to pass before it builds up a head of steam, but hopes are high for a healthy two-way flow of funds in the medium term.

As ever, China is taking steady steps as it widens access for international investors into the capital markets of the world's second-largest economy, while also permitting outward investment by high net worth investors and a growing middle class on the mainland. A total initial quota for mutual fund sales under MRF has been set at 600 billion yuan ($97bn), split evenly in each direction. Fund managers seeking MRF approval for locally registered funds will need to apply for a share of the quota. The Hong Kong regulator has made clear that, at the outset, the framework will be limited to established, stable and strongly performing product offerings – and will only later be opened up to new products and to a wider array of offerings to satisfy the different risk/return profiles of investors. "It is sure to enrich the product range in the retail fund market on the mainland and accelerate the expansion of Chinese fund managers connecting to international investors," says Florence Lee, Head of China Sales and Business Development, EMEA for HSBC Securities Services. The two regulators have stated that the MRF will lay the foundation for joint development of a common fund regulatory standard.

The scheme is limited to funds domiciled in Mainland China or Hong Kong. Accordingly, an international fund manager wishing to reach the growing investor base on the mainland cannot simply use an existing cross-border UCITS fund. While some market participants hope that UCITS funds might be brought into the MRF at a later date, this seems a distant prospect given the Beijing government's aim of developing Hong Kong as a major financial services hub in its own right and leveraging off this to expand the asset management industry on the mainland. Furthermore, as a bilateral arrangement, the European Union would have to agree to the distribution of equivalent Chinese funds across member states – something that is highly unlikely in the foreseeable future.

Mutual recognition follows the November 2014 launch of the Stock Connect trading links between the Hong Kong and Shanghai stock exchanges – due to be joined by a similar arrangement between the Hong Kong and Shenzen bourses, perhaps as soon as the second half of 2015. The new initiatives are particularly welcome, as Beijing's cap of 270 billion yuan for Hong Kong institutions under the Renminbi Qualified Foreign Institutional Investor (RQFII) programme is almost exhausted – and lobbying for a higher quota by the Hong Kong government appears to have fallen on deaf ears, while they have been testing the waters with RQFII allocations for the likes of Australia, Singapore, Canada, France, the UK and Qatar – and, most recently, Luxembourg, Chile and Hungary, each granted a 50 billion yuan quota.

As we reported in December 2014, international managers wishing to break into Mainland China face challenging fund distribution economics. The big four banks – Bank of China, China Construction Bank, Industrial and Commercial Bank of China, and Agricultural Bank of China – dominate distribution, making for unattractive pricing and difficult access. A prerequisite for managers is a strong brand, if they are to stand a chance of winning business and negotiating reasonable pricing in the distribution channel.

While distribution into Mainland China is challenging, this is a mature market for fund clearing. Retail positions are recorded through the highly automated infrastructure of China Securities Depository and Clearing Corporation Limited (CSDC). In contrast, Hong Kong operates wholesale omnibus positions with the majority of order instructions being handled manually by fax. "We consider it unlikely that Chinese distributors and fund managers will allow manual orders to and from Hong Kong," Sebastien Chaker, Head of Asia for Calastone, tells us at FundForum in Monaco. "It's equally unlikely that Hong Kong would be able to cope with a large influx of manual retail orders from China."

According to industry sources, the first few MRF approvals may be obtained as soon as the end of July. A steady increase in the volume of trades in Hong Kong unit trusts is expected, which will likely act as a driver for Hong Kong fund distributors to gear up their operating models to automate these trades.

There are parallels to be drawn with the 2012 launch of the Automated Fund Information Transmission Service by the Taiwan Depository & Clearing Corporation (TDCC). This allowed distributors in Taiwan to leverage a single local platform to process both Taiwanese funds and offshore funds. Distributors in China will enjoy the same benefit via CSDC. Hong Kong distributors, on the other hand, face the complexity of processing orders in Chinese funds, unit trusts domiciled in Hong Kong and the mutual fund corporations – principally domiciled in Luxembourg and Ireland – which are distributed in Hong Kong.

"One of the key factors behind the early success of Taiwan's automated order-routing service was that TDCC was able to rely on specialized fund messaging networks with strong cross-border transaction expertise," says Mr Chaker. "This provided the immediate critical mass needed to build offshore fund manager participation."

The impact of mutual recognition 

We speak with HSBC Securities Services' Florence Lee about the impact that the mutual recognition framework is having.

What are the opportunities?

Long-term trends show that China is significantly increasing its share of global financial flows, yet there is no doubt that this market is still relatively untapped. International managers will consider establishing Hong Kong domiciled funds or re-domicile their existing products to Hong Kong in order to access China through the mutual recognition scheme.

There were over 2,000 SFC-authorized funds as at December 2014, of which only 573 were domiciled in Hong Kong. Funds eligible for MRF on day one will be even less than that figure – potentially around 100, compared to around 850 for Mainland China. This clearly gives room for new entrants to the Hong Kong market with potential opportunities for additional retail fund products.

China has been gradually transformed from a savings nation to an investment nation with the emergence of a middle class and wealth building up in the last few decades. There is more demand on investment products in order to preserve investors' capital and diversify their investments. The current size of the mutual funds market in China has recently exceeded the $1 trillion mark and the pace of growth is strong. The MRF will give international fund managers an opportunity to unleash the potential in this new market.

What has been the international reaction so far?

Some leading international fund managers have been preparing for MRF to go live. The key requirement is to have Hong Kong domiciled funds and many European- and US-based international fund managers launched a renminbi share class for locally domiciled funds last year in readiness. Some top players in the China space also added more renminbi share class funds and diversified income products to their Hong Kong retail platform this year to meet increasing investor demand, as one of the MRF requirements is to have at least a one-year track record.

A number of managers have already publicly announced they will participate in the initiative. However, they are expecting regulators to further clarify the operational issues and provide guidance to market participants.

What are the practicalities of participating?

Under the MRF, Hong Kong funds to be marketed on the mainland will have to receive registration from the CSRC and mainland funds will be subject to approval from the SFC before sales can commence. It is therefore important for foreign managers to start early in order to understand the application process and allow for the lead time in regulatory approval when timing their product launch.

International fund managers in Hong Kong must appoint a qualified institution in China, either a mutual fund manager or licensed custodian, to be their local agent. The responsibilities of the local agent in China include MRF registration, information disclosure, distribution, data transmission, fund settlement, regulatory reporting, communication, client servicing and monitoring. This will be a key role in the success of MRF distribution in China.

How could this impact UCITS in Asia?

UCITS are very popular as a vehicle for gaining access to Hong Kong. Those domiciled in Ireland and Luxembourg represent approximately 85% of SFC-authorized funds. However, UCITS funds do not have access to Mainland China under the MRF as it stands.

Mutual recognition and the other Asian passport schemes (i.e. ASEAN Collective Investment Scheme and Asia Region Funds Passport) could have a significant impact on the role of UCITS in Asia, but predictions of a decline are wide of the mark. The ability to distribute UCITS around the world means that it will remain a platform of choice for firms in Asia and other regions, helping their clients to invest globally. In the long term, we expect UCITS to develop alongside – and perhaps in conjunction with – local and pan-Asian products. It follows that asset managers need to remain flexible over their use of UCITS in Asia.

What next?

With the introduction of MRF, we expect managers to take advantage of this newly opened channel for fund distribution. The expansion of MRF to other jurisdictions will be an area for managers to watch.

It is also safe to assume that managers which intend to participate will have a huge amount to do in terms of the preparation of: application documents; due diligence visits to local agents/representatives; distribution channels and product marketing. Also, we believe the SFC and CSRC will further clarify the outstanding operational issues to make this a successful passport scheme.

Yesterday we reported that RBS was kicking off a program this week to refer small and medium enterprise (SME) customers who didn’t meet their loan criteria to P2P lenders. The news marked a milestone in that a major UK bank with around 33% of the small business lending market was embracing alternative lending models for its customers.

In a different but similar announcement that shows times are changing amidst the merging of traditional and innovative finance models, the Singapore Exchange (SGX) has announced that it is partnering with Clearbridge Accelerator Pte Ltd. (CBA) to develop a crowdfunding platform. The joint venture crowdfunding platform is aiming to provide a capital raising vehicle for entrepreneurs and SMEs in ASIA.

Under the terms of the partnership, the SGX and CBA will together form a new joint venture company to develop the fund-raising platform. According to the SGX, the venture will seek to form a strategic equity partnership with an experienced platform operator and industry stakeholders, such as financial institutions, in order to operate the new capital-raising platform, as well as solicit other partners to create investor demand. The venture is being assisted by SPRING Singapore, a government-sponsored agency that helps local firms grow.

For the SGX, the partnership marks an extension of using their experience as an intermediary for SME firms to raise capital and extending it to include off-exchange opportunities such as crowdfunding. On this, SGX’s Head of SME Development & Listings Mohamed Nasser Ismail stated, “We are excited about this opportunity to work with Clearbridge Accelerator to help companies access capital more easily and become a pan-Asian platform to support equity crowdfunding. SGX has a long history of supporting entrepreneurs: our Catalist board is a much sought-after avenue for SMEs to raise funds. This new platform will not only expand our suite of fund-raising services but also enable us to support entrepreneurs and SMEs at every stage of their growth.”

Adding to this comment, Clearbridge Accelerator Managing Partner Johnson Chen stated, “Clearbridge Accelerator will work closely with SGX to grow this into a premier capital-raising platform for entrepreneurs and SMEs in Singapore and the region.”

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.

China and Japan are planning to trade directly without the USD as the common currency to determine the “cross-rate”.

Instead, the transactions from trading activities will determine the exchange rate. This is a step to promote trading between the two countries.

This could also be an initial sign of the greenback losing its dominance as a reserve currency. As Zerohedge puts it “when one bypasses the dollar, one commits blasphemy to a reserve currency.”

Here is the full report from Agence-France Presse (AFP):

TOKYO — Japan and China are expected to start direct trading of their currencies as early as June as part of efforts to boost bilateral trade and investment, according to reports.

With the planned step, exchange rates between the yen and the yuan will be determined by their transactions, departing from the current “cross rate” system that involves the dollar in setting yen-yuan rates, Kyodo News said on Saturday.

The two governments are eyeing setting up markets in Tokyo and Shanghai, the Yomiuri Shimbun said.

The yen-yuan exchange system would help businesses in the world’s second- and third-largest economies reduce risks associated with exchange rate fluctuations in the dollar and cut transaction costs, Kyodo said.

It will be the first time that China has allowed a major currency except the dollar to directly trade with the yuan, Kyodo said.