Funds: Heading in the right direction

Meanwhile, firms in the business seem to believe that the traditional players (major domestic banks) will still dominate the scene for quite a while and it will easily take at least three to five years before the new entrants would make a significant impact in the scene, if at all. But all agree that the CSRC is moving in the right direction, and the new regulations are expected to eventually bring about a positive impact on China's fund industry.

Summary of the changes and their implications

1. Loosening of qualification restrictions

This is one of the most important changes introduced by the Measures. Currently, China's fund sales market is dominated by commercial banks, and fund management companies and securities companies have limited market shares. Because of the bank's hegemony over fund sales and the sluggish growth of independent fund sales entities, investors have limited choices when purchasing funds. Testament to this is that since the enactment of the original version of the measures, only one single investment consulting firm successfully obtained fund sales qualification, out of a total of 136 qualified fund sales institutions at the end of 2010. The CSRC described its policy intention as to “lower requirements unrelated to professional qualification and raise professional qualification-related requirements”.

Under the revised Measures, fund sales entities can now be established either as limited liability companies or as partnerships. Foreign banks can now also apply for fund sales licences given that they fulfill the same requirements imposed on Chinese banks (for example, sound corporate governance structures, internal risk control systems, etc.). Also, professional individuals in China suitably qualified (primarily judged by years of experience) can now also be shareholders in independent fund sales entities. Furthermore, the revised measures reduce the minimum number of personnel in an independent fund sales entity who are required to have obtained fund practice qualifications from 30 to 10.

Interestingly, although one of the main reasons attributed to the slow growth of independent fund sales entities is that the registered capital threshold was set too high (at Rmb20 million), this threshold was eventually maintained even though at one point in time the 2010 draft sought to drastically reduce the threshold to Rmb5 million, which would have served to almost completely remove the capitalisation-related entry barriers. This indicates that the CSRC still wishes to preserve the scene for the more established, “more serious” firms at this stage.

2. Allowing a flexible fee structure for value-added services

Under the original Measures, fund sales entities were prohibited from “charging high commissions”, which deterred them from providing higher quality services and from offering an array of differentiated services to investors. This resulted in many boutique entrants lacking a viable business model to provide higher-end, more customised services, such as individual wealth management. The revised Measures will now allow charging fees for “value-added services,” and are silent as to permissible fee rates - essentially opening the door to flexible and creative fee structures that are found in more developed markets.

Meanwhile, from the consumer protection point of view, the Measures are silent as to regulatory guidance and minimum conduct standards for the value-added service providers while they charge flexible service fees; hopefully this would be supplemented with future regulations.

3. Clarification on ownership of fund sales settlement capital

Though the PRC Securities Investment Fund Law (中华人民共和国证券投资基金法) made explicit that “fund property” is independent, it did not have a clear definition of the term. More specifically, it did not clarify the status of the settlement capital contributed by investors that are in the middle of the fund sales and settlement process. In practice, settlement capitals are placed in special accounts under the names of fund sales entitles, and it was theoretically possible for the settlement capital to be considered part of the fund sales entity' assets. As such, not only was there a risk of improper disposition, in the event of the liquidation of the entity, the settlement capital would potentially be included in those proceedings.

The revised Measures clarify that such funds remain as the investor's property - and would therefore be excluded from proceedings, thereby providing investors with greater assurance of the security of their funds.

4. Supervision of fund sales entities

With the increased number of entities obtaining qualifications to sell funds, the CSRC wishes to gradually shift its focus from “controlling market entry” to “continuous supervision”. To this end the CSRC has expanded the degree and scope of supervision and has introduced more stringent standards of conduct, clarified issues as to merger and de-mergers of entities, and introduced the following reporting lines to help in its supervision:

n The fund sales entities themselves will be responsible for supervising and auditing their personnel, checking the legality of their sales, and completing annual personnel audit reports.

n The entities must report each of their branches that engage in fund sales to the local CSRC office, and needs to regularly update their basic information.

n The entities must provide the CSRC with data in real time.

n All qualified entities must register to become members of the industry business association and accept the industry rules and self-regulation.

5. Other changes

In addition to the major changes summarised above, the revised Measures also amended rules regarding fund sales promotional activities, and adjusted penalties for illegal fund sales. The revised Measures also provided more detailed operational requirements such as standards for personnel management, qualifications of fund holders, operations of the registration organisation, and online sales.

Finally, the revised Measures also implement standards for the clearing of funds in order to ensure the safety of fund sales capital, the movement of funds, payment transactions, and account management.

Potential impact

International banks and boutique firms have developed more experience and expertise in providing such value-added services, but cannot initially match the domestic banks in terms of existing network coverage. Therefore it is reasonable to expect that initially, as in other markets, there would likely be a market bifurcation, with the existing major domestic banks continuing to primarily offer what they have been offering, and the new entrants trying to enter and survive by finding currently underserved niche-markets. With time, however, as in other more developed countries, the dividing lines between these two markets would likely start blurring, and eventually the markets would likely merge back into a single, overall more developed market. Should this indeed happen, this would be good for the industry and the consumer as a whole.

By addressing many of the issues in the original Measures, relaxing the barriers of entry, allowing flexible fee charges for value-added services, and introducing other improvements, the revised Measures are significant in its attempt, and may well have a lasting impact on China's fund market. It would be interesting to see how fast the revised Measures will practically change the landscape of China's fund industry and shape its future.

Richard Lee and Kristie Chung, Allbright Law Offices, Shanghai