Regulators are tightening the screws on offshore fund managers in an effort to strengthen the asset-management sector at home.
Taiwan punches above its weight in the asset-management sector. The island of 23 million people had over US$167 billion assets under management (AUM) at the end of 2014, according to the Taipei-based consultancy Keystone Intelligence.
Offshore funds – funds domiciled outside of Taiwan issued by foreign asset management companies – dominate the burgeoning market, comprising about US$105 billion, or 65% of AUM, compared to roughly US$63 billion for onshore funds, Keystone says. Onshore funds are registered in Taiwan by domestic groups as well as by foreign managers with onshore subsidiaries.
Taiwanese investors have tended to prefer offshore funds because they offer a wider variety of products and the expertise of global fund managers, experts say. They are also widely believed to offer more consistent returns than onshore funds. “Foreign fund managers are more capable of adopting a multiple income strategy or managing a global fund,” says Derek Yung, chairman of AllianceBernstein Investments Taiwan.
But from the perspective of Taiwan’s Financial Supervisory Commission (FSC), offshore funds have benefited disproportionately to their contributions to the Taiwan market, while onshore funds have faced stricter regulations. “The FSC’s goal is to narrow the current gap of operating conditions between offshore funds and onshore funds and ensure that operators develop on a fair and equitable basis,” says Thomas Tien-mu Huang, vice chairperson of the FSC. “The FSC will keep communicating with offshore fund institutions, and encourage them to devote more resources in Taiwan and endeavor to develop the asset management industry,” he adds.
Ironically, it was an earlier government policy decision that allowed the offshore funds market to flourish beginning in the mid-2000s. The 2004 Securities Investment Trust and Consulting Law, which formalized the registration and distribution of cross-border funds, established a system under which asset managers could act as master agents, allowing them to avoid the costly process of building local distribution networks.
The savings accrued by offshore fund managers enabled them to reward the major distributing banks with higher commission fees, sometimes up to 3% per sale, compared to 1.5-2% for onshore funds. As a result, banks now account for almost 60% of offshore fund distribution, but for only 30% of onshore fund distribution, according to Keystone Intelligence. This differential has led to complaints from onshore managers that banks give priority to offshore funds because of the higher commission fees.
“The Taiwanese regulators feel they made it too easy for cross-border business,” says Thomas McGowan, a Taipei-based attorney at the law firm Russin & Vecchi and an expert in banking and finance law. “It has been very successful, but the skill sets for everything besides sales are outside of Taiwan.”
More stick than carrot
As it seeks to build a stronger Taiwan-based asset-management sector, the FSC is using a carrot-and-stick approach. “On the one hand, the system works like a platinum card for an airline,” says McGowan. “Offshore entities who move business into Taiwan can cash in points for benefits.” Those include fewer restrictions on new product launches and the ability to apply for more fund authorizations, McGowan notes, adding: “When you combine that with arm twisting, you see there are a number of pressures to come onshore.”
Thus far, restrictions outnumber incentives. For instance, in 2013 the FSC reduced the number of offshore funds permitted to be included in a single registration application from three to one, with applications taking three to six months to complete. As a result, latecomers to the Taiwan market now need three to five years to build a complete product line. “It’s effectively creating an oligopoly for the offshore market players who are here,” McGowan says.
The FSC has also placed restrictions on high-yield bond funds, which can offer yearly returns of 7-8% and are among the most popular offshore funds with Taiwanese investors. The regulations favor onshore funds, which can launch multiple high-yield bond funds yearly as long as two such funds are not introduced in succession. But for offshore funds, a master agent is permitted to distribute only one high-yield bond fund in Taiwan per year.
“The regulator doesn’t want investments concentrated into one asset class,” says Andrew Wang, chief investment officer of Manulife Asset Management (Taiwan). “If there is a monetary tightening cycle and liquidity falls, high-yield bonds and the investors holding them will be hurt disproportionately.”
Some older Taiwanese investors like to buy high-yield bond funds and use the regular dividend payments as a major source of income, notes Donna Chen, president of Keystone Intelligence. “But it can be a bit distorted in that they don’t know whether the dividend comes from their principal,” she says.
Still, global high-yield bond funds remain popular with Taiwanese investors. They were among the top-selling offshore funds in Taiwan in 2014, with net sales of US$6.2 billion, according to Keystone Intelligence. High-yield bond funds also comprised 36% of total offshore AUM – a figure amounting to US$38.43 billion – as of the end of 2014, according to the Taipei-based Securities Investment Trust and Consulting Association (SITCA).
In another move to curtail offshore business, the FSC announced in November 2014 that sales to Taiwanese investors of each offshore fund may not exceed 50% of the fund’s assets, down from the previous limit of 70%. The new rule, which will take effect on January 1, 2016, will affect about 20 offshore funds out of more than a thousand, Chen says. Fund managers affected by the new policy will likely need to suspend or discourage new subscriptions to meet the FSC’s requirements by the end of 2015.
At the same time as it is crimping the offshore fund market, the FSC is rolling out incentives for foreign fund managers to develop their businesses onshore.
An incentive scheme introduced in February 2013 is designed to reward foreign firms that commit to building an asset-management business in Taiwan. The scheme includes faster approval for retail launches and waivers of derivative product restrictions. Other benefits are the ability to apply for more fund authorizations, relaxed restrictions on fund distribution, and permission to launch new products such as index-tracking and fixed-income funds. Participating foreign fund managers are also exempted from the new 50% AUM requirement.
But so far, only two foreign fund managers have been qualified under the scheme: JP Morgan and Allianz Global Investors, which received FSC approval in September 2014. The FSC stated that the performances the two companies delivered in 2013 fulfilled the plan’s criteria, including having AUM among the top third of the industry and operating incomes that exceed the median.
Chen of Keystone Intelligence says few foreign fund managers are likely to qualify under the scheme. “The threshold the regulator has set is very high,” she says.
The FSC is also channeling the allure of the large China equities market to bolster onshore funds. Since 2012, onshore players have been permitted to launch funds that can invest 100% of their assets in China A-shares – renminbi-denominated stocks of companies incorporated in mainland China that trade on the Shanghai and Shenzhen exchanges. By contrast, offshore funds can invest a maximum of 10% of their assets in A-shares. There are eight onshore funds with specific A-shares in their fund names, managing a total of NT$28.2 billion as of this February, according to Keystone Intelligence.
In addition, local asset managers may issue renminbi-denominated funds in Taiwan while foreign fund managers may not. Wang of Manulife says the RMB-denominated fund platform has strong potential to perform well amid the internationalization and appreciation of the Chinese currency. Manulife’s Investor Sentiment Index survey for the second quarter of 2014 showed about 45% of Taiwanese respondents having exposure to RMB-denominated assets. These same investors indicated that RMB-denominated assets comprised 30% to 40% of their total investment allocation.
Looking ahead, opportunities remain abundant for both onshore and offshore fund managers in Taiwan. A major reason is that Taiwan’s pension funds are gradually outsourcing more of their assets to external managers. In March 2014, Taiwan’s Public Service Pension Fund hired BlackRock, UBS, and Allianz Global Investors to manage a total of US$1 billion in foreign mandates.
Reform of Taiwan’s labor-pension plan could help make pension funds a larger source of revenue for asset managers. A proposed reform would entail adopting a “self-directed defined-contribution plan” such as the U.S.’s 401K or Singapore’s CPF. Workers would have the option to stay with the current scheme – under which the fund will be managed by the government with a minimum guaranteed earning equivalent to two-year fixed deposit interest – or select an asset-management company to manage it for them.
“We have high hopes that workers will soon be allowed to decide how they want to invest their pensions,” says Christine Jih, chairman and chief executive officer of BNP Investment Partners in Taiwan. Taiwanese authorities have indicated that the new pension plan, known as the Employee Choice Scheme Pension, could be launched in early 2016, she adds.
In another new initiative, in December 2014 the FSC issued a ruling that allows securities investment consulting enterprises (SICEs) and securities investment trust enterprises (SITEs) with master agent qualifications to sell unregistered funds in Taiwan to institutional investors. The ruling gives such alternative investment vehicles as hedge funds and feeder funds a chance to enter the Taiwan market, notes Chen of Keystone Intelligence.
Overall, however, industry players concur that the FSC will continue working to drive Taiwan’s asset-management business onshore. “The regulator has a deep-rooted strategy,” says Jih of BNP Paribas. “They want to cultivate local Taiwanese investment expertise.”
“It’s natural to want a more vibrant onshore market,” says Yung of AllianceBernstein, who sees Taiwan as having strong potential to become a hub for regional asset-management operations. “The workforce is highly educated, costs are reasonable, and there is a demand for greater manpower on the operations side of the business.”
At the same time, however, many foreign fund managers are less than pleased about the FSC’s push to bring business onshore, says Chen of Keystone intelligence. “Of course they don’t like it,” she says. “But they can’t fight it.”
INDUSTRY FOCUS: Financial Sector