With the Association of Southeast Asian Nations (ASEAN) ranging from the buzzing and impeccably clean financial centre of Singapore to barely-developing Myanmar, and the economically scatty likes of Thailand and Vietnam in between, it’s no wonder that Asia is often synonymous with fragmentation.
Throughout the continent, the markets vary wildly in their financial robustness, economic status and their very culture. With such little synchronicity, cross-border trading is inevitably tricky, and while Europe presses ahead with the Target2-Securities (T2S) harmonised settlement system, the Asian markets are increasingly in danger of being left behind.
According to Margaret Harwood-Jones, managing director and head of intermediaries and investors for transaction banking at Standard Chartered Bank, this fragmentation could have serious ramifications.
Inconsistency between markets means increased risk, which means increased cost of operations. On top of this, with no one regulatory body, as is seen in Europe, cross-border participants have to contend with differing regulations between markets.
“This means that the costs of entering a market or even continuing to remain in a market may be too high compared to the potential revenue opportunities,” says Harwood-Jones. “Unified standards are difficult to achieve across the region.”
The lack of alignment presents extra complexity, says Philippe Benoit, head of Asia Pacific at BNP Paribas Securities Services. Meeting multiple sets of trading rules and settlement timeframes can lead to additional issues around risk and liquidity management.
“Part of the fiduciary responsibility of BNP Paribas Securities Services, aside from safeguarding assets, is to act as a bridge between regulators and market participants,” he says.
Ryan Cuthbertson, head of product development at HSBC Securities Services, calls Asia a “cluster of markets”, highlighting additional concerns such as currency restrictions, exchange controls and differing tax requirements.
However, he also points to market initiatives that are working towards aligning Asian infrastructure with international standards and enabling funds to be marketed across borders.
The ASEAN Collective Investment Scheme (CIS) funds passport came in to fruition with a memorandum of understanding signed by the relevant authorities in Singapore, Malaysia and Thailand in 2013. The passport was designed to integrate the mutual fund market in ASEAN regions by removing barriers between borders, however it is yet to attract much international attention.
Harwood-Jones points out that “those managers who have funds approved for distribution under the legislation are localised in nature”, while Cuthbertson suggests that a lack of clear direction is delaying action.
He says: “The regulators, based on feedback from the industry, continue to work to clarify on issues and questions. International asset managers, while awaiting clarity on the regime, continue to use local fund structures in Asian markets feeding to their UCITS structures.”
Next came the Asia Region Funds Passport (ARFP). Initial signatories, Australia, Singapore, South Korea and New Zealand, were later joined by the Philippines and Thailand, and the overlap of the countries involved could mean an opportunity to learn from any shortcomings.
Although it’s acknowledged that any move towards common standards will take time and resources, ARFP is being cautiously hailed as the passporting scheme that will succeed.
Harwood-Jones notes its similarity to UCITS III—the version of the UCITS product that she says first achieved global reach. She says: “That was very much focused on retail investors and dealt successfully with the initial teething problems of the earlier versions of UCITS regulations.”
Cuthbertson agrees, saying the ARFP “is certainly shaping up to be an Asian equivalent to UCITS”.
He also likens the ASEAN CIS passport to earlier versions of the UCITS product, which he says “also had limitations on the range of permitted asset classes that the fund could invest in, making it increasingly difficult to promote as an attractive investment opportunity”.
Although reminding that neither scheme has been fully implemented yet, Benoit says: “We think long-term they will both be positive initiatives for the Asia Pacific in becoming globally competitive and growing trading volumes.”
He gives no specification on how long long-term actually is, however it is clear that there are still hurdles for any passporting initiative to overcome. As Harwood-Jones points out, requirements will include audits in each country where a fund is sold, plus translation services, local transfer agency, tax harmonisation, currency exchange and capital controls.
“All of this translates to significant cost for fund managers and promoters, and ultimately depresses the returns for investors in these funds.”
“A passport regime requires scale if it is to work,” she says. “The demographic drivers in the region, such as the pension time bomb and a historically low allocation of wealth into securities, will drive monies into fund structures over time, just as we have seen elsewhere.”
The ASEAN CIS scheme also has specific requirements, which could prove to be a barrier. Fund managers have to register with their home regulator and gain approval from their host regulator before they can start distributing. Predictably, regulations are not harmonised, but there are also differences in tax regimes, and Thailand has currency restrictions in place, too.
Cuthbertson says: “This lack of a common economic union and a common currency has brought its own share of challenges. Incremental rules, clarifications and easing would require all the participant countries to sign up to the changes involving an extended consultation period.”
Although many of these restrictions will not apply under the ARFP, Cuthbertson points out outstanding issues that have not been addressed, such as investor protection rules and issues around tax.
Benoit also highlights tax as a “sticking point”. He explains: “In order for these passporting programmes to develop further, jurisdictions will need to re-examine their tax regimes, with a view to making them more conducive to cross-border fund sales.”
Generally, we are likely to see development, and different versions of both passports in the future, with more participants. As regulators adapt to the demands and become more comfortable with the schemes, service providers must evolve to accommodate them.
Harwood-Jones says: “Demand for more sophisticated investment products is likely to provide a challenge for managers, service providers and regulators, as they try to develop the necessary experience and understanding to manage and oversee the inherent risks in such products.”
Such an environment is rich for those service providers that can help clients make the most of the opportunities at hand. While some institutions will be looking to invest in new technology, others will be looking to outsource their whole back office—although, Harwood-Jones says, this may be easier said than done.
“In some cases the fragmentation we see across the region makes a full outsourcing option less commercially viable from a provider’s perspective,” she says.
“The most successful solutions will likely take a more modular approach, allowing participants to assess specifically which processes they would prefer to outsource in each market.”
She adds: “A winning formula will be one which can bridge market gaps and address regulatory challenges, as well as being a creative solution that addresses the challenges of a fragmented region.”
Cuthbertson suggests that, in the wake of the regulatory onslaught, institutions will be more likely to look for risk containment while also trying to reduce their costs as much as possible. Value-added services such as account operations and third-party clearing will be in demand—along with those that promise to reduce capital costs.
Brokers may move away from their own clearing structures to third-party providers, while, wary of regulatory requirements, banks and custodians will try to gain closer proximity to central securities depositories, mandating account operators.
With the cost burden increasing, Cuthbertson argues that, actually, there is an increasing interest in outsourcing the entire trade processing and enrichment channels. For banks, he suggests that the costs of upgrading systems may not be worth it.
“The cost of running a middle and back office is high and with regulatory change it continues to increase. Most banks and brokers run on very old technology that is expensive to maintain and change.”
According to Benoit, BNP Paribas is already seeing evidence of this—the securities services business recently won a mandate for outsourced clearing and settlement activities in the region.
“Part of this mandate includes optimising liquidity on behalf of the bank at settlement,” he says. “This service is a trend we are continuing to see for banks as they look to optimise capital and reduce their cost of capital.”
Whether they’re banks, brokers or asset managers, Benoit says institutions are looking for long-term relationships with their service providers. “It’s therefore paramount that the providers they choose are adaptable and forward-thinking,” he says. “This is particularly true in Asia, where banks and brokers have the ambition to regionalise and internationalise.”
Cuthbertson adds to this, suggesting that in the market as it stands today, “only strong and committed service providers will be able to sustain the prolonged demand for capital and resource investments”.
He says: “As an investor or a trader moves from emerged markets to emerging or frontier markets, their need to find a trusted service provider and partner increases greatly.”
“The service provider is at the heart of the conversation with infrastructures and regulators over changes in each market. As markets mature, more investors are attracted and trading volumes increase.”
They key potentially lies in a mutually beneficial relationship—and one that is sustainable in the long term. Harwood-Jones highlights the importance of integrity in choosing a service provider.
She says: “Any decision a client makes today in choosing a provider is no longer a private matter. It is not beyond the scrutiny of others, including the regulators, which means the robustness and integrity of the selection process must be of the highest standard and able to withstand the challenge of others.”
She also warns: “Unwinding a broken relationship is both stressful and extremely costly.”
However service providers choose to approach the market, it appears that they have to be prepared to adapt with the industry as it, and its various funds passporting schemes, evolve.
As Benoit concludes: “At the moment, one of the biggest challenges is actually keeping up with the pace of change, as countries move to create greater investment harmony across the region.”