The Japanese investment house looks at recent legal innovations in China and steps to liberalise access to the Chinese market. It says JVs remain the smartest route forward.

China’s liberalised rules on foreign-owned fund management increase the potential to profit from an estimated $8.22 trillion sector, but the established joint venture model may be still the most effective one to adopt, according to a report by Nikko Asset Management.

The Japanese investment house said regulations announced in 2017 allowing wholly foreign-owned enterprises (WFOEs) had opened a new channel for businesses wanting to tap into the world’s second largest economy. The foreign ownership limit for fund management companies (FMCs) has been hiked from a cap of 49 per cent previously to 51 per cent. The sector is expected to be fully liberalised with restrictions slated to end after three years, or as early as 2020.

New regulations give investors a menu of three broad choices of how to tap the domestic Chinese market, such as in “A-shares. An investor can hire a purely domestic fund manager with no international expertise; or appoint a 100 per cent foreign-owned global asset manager (WFOE) that is now permitted to operate under the latest rules; or recruit a foreign-Sino joint-venture where domestic fund managers combine with the expertise of a foreign partner, a structure that has existed before recent rule changes.

Nikko AM, while applauding China’s moves to free up the system, said that the joint venture approach remained its favoured course.

“We think that this actually has the potential of achieving the best of both worlds - harnessing the advantages of domestic fund managers, plus adopting the global best practices of a reputable foreign house.  JVs have had mixed success, with most not working out well in practice,” it said. 

“This is mainly because in the past, with a foreign shareholding limit of 49 per cent, the foreign manager has mostly played a minority role, with most holding just a 25-30 per cent stake. Hence, many of the JVs have been plagued by the negative perception that they essentially operate like a domestic asset manager, with all the attendant pitfalls such as having high stock turnover, governance issues, and a lack of risk management and controls. Most JVs have not worked out due to a clash of culture between both partners, a lack of integration in processes, and a lack of respect and reciprocity in the relationship,” it continued. 

“However, we think that if both partners are able to work through the relationship, JVs are the best way to gain exposure to the China market, as it can tap the advantages of foreign and domestic parties, while avoiding the pitfalls of both,” Nikko AM said.

China has liberalised rules in part to encourage more capital inflow into the country, and in part to widen use of its renminbi currency, which it sees as becoming a global reserve currency.

Joint ventures
For many years, a standard route for foreign firms/investors into mainland China has been the JV. This approach can raise concerns about whether the non-domestic partner is forced to surrender intellectual property as part of any venture. 

Nikko AM firm said operating JVs sensitively is crucial. 

“We think that to translate these `paper benefits’ into reality requires an understanding of the nuances of the cultural differences, with an emphasis on creating a harmonious relationship built on mutual respect and discussion. A heavy-handed approach where the foreign player imposes what it perceives as global standards or superior investment methods usually backfires, with the local player baulking at such an aggressive interventionist approach. Instead, a lot of time and effort is needed to cultivate the relationship where an early foreign entrant that has helped its smaller domestic partner grow – both on the business as well as on the personnel level – goes a long way,” it said.

“To harness the merits of both parties, we tap the expertise and market intelligence of a domestic partner, which has a large team plugged into the China information network. We then overlay this research advantage with our own portfolio construction process – an investment process held up to the scrutiny of international standards and honed through years of experience with a proven track record,” it continued.

In November 2017, the People’s Bank of China issued a joint statement with other financial regulators to set out new guidelines, unifying the rules covering asset management products (AMPs) issued by securities institutions, banks and insurers, and setting leverage limits for all products. 

These moves were part of the Chinese government’s attempts to rein in the so-called “shadow banking” sector, where off balance-sheet financing by banks makes it harder to control risks in the banking system. Creating a more robust asset management regime is seen as a way of helping to reduce the attractions of “shadow” systems.