ISE21/15-16

• Hong Kong has a rather concentrated fund distribution market, with banks having an estimated market share of 78% while brokers accounting for only about 3%.^{1Legend symbol denoting See Securities and Futures Commission (2015) and Financial Services and the Treasury Bureau (2016).} In December 2015, the Financial Services Development Council published a paper entitled "Strengthening Hong Kong as a Retail Fund Distribution Centre", expressing its support for the diversification of fund distribution channels in Hong Kong. At the meeting of the Panel on Financial Affairs on 22 March 2016, the Government unveiled its plan to establish an exchange-based fund distribution platform in collaboration with the Hong Kong Exchanges and Clearing Limited, with aims to, among others, introduce more competition in the fund distribution market and further the development of the asset management industry in Hong Kong.
• Distribution of fund products through platforms operated by exchanges is also seen in some other financial centres. For example, in Australia, with the support of its government and the financial regulator Australian Securities and Investments Commission, the Australian Securities Exchange ("ASX") has launched a fund distribution platform known as mFund Settlement Service ("mFund") to provide an alternative channel for investors to subscribe and redeem unlisted investment funds. This issue of Essentials provides a brief overview on the present situation of the retail fund distribution market in Hong Kong, followed by a discussion on the mFund model in Australia and its developments.

Hong Kong's retail fund distribution market

• Distribution of retail funds in Hong Kong is fairly concentrated in the banking sector. As fund distributors, banks collect trailer fees from asset managers as compensation for their distribution expenses and as a reward for selling of the fund products. Trailer fees paid by asset managers are passed on to investors and embedded in the fund management fees. Due to the concentrated market, banks are usually in a stronger negotiating position on the level of trailer fees. In Hong Kong, trailer fees paid to banks typically range between 30%-60% of the fund management fees. For those small and new asset managers with less negotiating power, the trailer fees can be around 70% of the management fees. According to the Securities and Futures Commission, some small and new asset managers have expressed difficulties in securing top-tier banks to distribute their products. This has led to a concern that there are limited investment choices offered by the leading bank distributors to retail investors.^{2Legend symbol denoting See Securities and Futures Commission (2015).}
• To broaden the fund distribution network, the Government is planning to establish an exchange-based fund distribution platform for primary subscription and redemption of funds, with aims to deliver the following benefits: (a) raising the cost and administrative efficiency by centralizing and aggregating order routing and cash transfers on a single platform; (b) broadening investors' choices and driving down investment costs through increased competition; (c) expanding the distribution channel for the asset management industry; and (d) diversifying brokers' traditional stock-trading business.
• While asset managers are supportive of adding a fund distribution channel, they have expressed that the new channel might only be attractive to them and investors if the fees are lower than those paid through the current bank distribution channel.^{3Legend symbol denoting See Securities and Futures Commission (2015).} Besides, investors may act in a more self-directed manner under the new distribution channel. This is in contrast to the traditional way of relying on banks for advice. In the report of the Financial Services Development Council, it pinpoints a need for the financial regulator to publish clear industry guidance such as guidance on execution only transactions to enable firms to better understand their obligations.^{4Legend symbol denoting See Financial Services Development Council (2015) and Financial Services and the Treasury Bureau (2016).}

mFund platform in Australia

• In Australia, retail investors buy unlisted investment funds mainly through financial planners, and they are required to complete an application form attached to or distributed with the relevant Product Disclosure Statement, the process of which is traditionally paper-based.^{5Legend symbol denoting Under the Corporations Act, fund issuers can only accept subscription from retail investors when the application is made using an application form attached to the relevant Product Disclosure Statement, or a licensee form that is issued by a financial services licensee (e.g. financial planning firm) and distributed with the Product Disclosure Statement. Product Disclosure Statement is a document prepared by product issuers for each investment fund. It must include information about the product's key features, investment risk, fees, etc. See Australian Securities and Investments Commission (2013a).} With a view to raising the operational efficiency of the fund industry and providing a more convenient way for investors to access unlisted investment funds, mFund was launched by ASX in May 2014 in cooperation with over 70 fund managers, brokers, and unit registrars.
• Under mFund, investors who wish to buy or sell fund products may simply place orders through their broker's online client order system or by phone, fax, or email. Their broker will then take steps to execute the instructions by placing an electronic order through the mFund platform, and transactions are processed by ASX's Clearing House Electronic Subregister System.
• Notably, market participants and fund products placed on mFund are subject to certain requirements, which include the following:
  
  

  (a)	product admission: in addition to obtaining approval from the Australian Securities and Investments Commission, fund products placed on mFund must also be admitted by ASX under the AQUA Rules and fulfil certain disclosure requirements.6Legend symbol denoting For instance, they are obliged to disclose the net asset value of their mFund products at least quarterly. Meanwhile, any other information which is required to be disclosed to the Australian Securities and Investments Commission or investors must also be disclosed to ASX at the same time. See ASX (2014b). At present, mFund products are confined to "simple managed investment schemes" with at least 80% of investments in liquid assets7Legend symbol denoting Based on the mFund website, mFund products range from Australian equity funds, mixed-asset funds, to global equity funds and global fixed-income funds.;
  (b)	provision of fund product information: before placing an electronic order to subscribe for fund units on behalf of a client, the broker has the duty to provide the client with a Product Disclosure Statement in respect of the fund product. In addition, in submitting the electronic order on mFund, the broker must include a confirmation message affirming that the latest Product Disclosure Statement has been given to the client. Upon receipt of the order, product issuers must contact the investor within five business days to confirm issuance of the fund units and inform the investor that he or she should have received the Product Disclosure Statement from the broker. The product issuer must notify ASX within 10 business days if it becomes aware that the investor was not given a Product Disclosure Statement before making a subscription application on mFund;8Legend symbol denoting See Australian Securities and Investments Commission (2013b) and ASX (2015). and
  (c)	service charges: ASX does not charge investors for using the mFund service. Instead, it charges (i) product issuers for placing their fund products on mFund, (ii) brokers for participating in mFund, and (iii) settlement participants appointed by product issuers to settle transactions on ASX's clearing system.

Expected benefits

• mFund serves as a new way for investors to access investment funds and provides an additional channel for brokers to conduct business. Key benefits are outlined below:
  
  

  (a)	removal of paper-based applications: under mFund, there is no need for investors to complete the lengthy paper-based application. Investors can simply place order via their broker, who then passes on the clients' instructions on mFund for processing after confirming that the clients have received the relevant Product Disclosure Statement. This largely reduces the paperwork and hassle while making the transaction process more efficient and transparent;
  (b)	lower-cost channel for product issuers and investors: product issuers place their products directly on mFund for distribution and pay ASX issuer fees. Since the distribution no longer goes through financial institutions which may incur higher distribution costs and/or trailer fees, product issuers are expected to generate cost savings. Meanwhile, investors, especially those more self-directed, may opt to access fund products on mFund via their broker instead of going through financial planners or other financial intermediaries for the avoidance of being charged various administration and/or service fees;9Legend symbol denoting See Australian Securities and Investments Commission (2009) and Credit Suisse (2014). and
  (c)	enhanced broking services: brokers typically provide services in relation to buying and selling of shares. With the mFund platform, brokers are able to provide a greater choice of products for their clients and earn brokerage fees on mFund product subscription and redemption.

Developments after two years of operation

• At the time of the launch of mFund in May 2014, there were 45 investment funds admitted to the platform. After two years, the number has grown to 161 with an aggregate market value of about A$141 million (HK$799 million) at end-May 2016. Yet the number is not considered high given that there are over 2 000 unlisted investment funds in Australia. One possible reason is that admission of unlisted investment funds in the initial stage is confined to "simple managed investment schemes" and those with substantial direct investments in less liquid assets such as real estates and mortgages are not eligible. Hence, the total number of transactions stayed between 13-32 per day on average during the period from January to May 2016.
• Indeed, the introduction of mFund is seen to be a challenge to the traditional distribution channels run by financial institutions, especially those large domestic banking groups which on the one hand own large fund managers and on the other hand run the investment administrative services (in the form of master trusts or wrap accounts)^{10Legend symbol denoting A master trust allows investors to hold a portfolio of investment funds under one umbrella, which is usually held by a trustee on behalf of investors. A wrap is similar to a master trust but it allows investors to hold investment funds together with other direct investments such as shares and term deposits under one single account in their own name. Both master trusts and wraps are generally referred to as "platforms" managed by financial institutions which usually charge investors various fees for the administration services. See Australian Securities and Investments Commission (2009) and the website of the Australian Securities and Investments Commission.} featuring prominently their in-house investment fund products.^{11Legend symbol denoting See Direct Funds Marketing (undated), Financial Review (2015), Financial Review (2016), and The Sydney Morning Herald (2015).} As such, companies of major domestic banking groups have reportedly not participated in mFund either as product issuers or brokers for the protection of their own distribution channels.^{12Legend symbol denoting Based on the mFund website, fund managers and brokers owned by leading domestic banks such as Commonwealth Bank of Australia, ANZ Banking Group, and Westpac Banking Corporation are not mFund participants. National Australia Bank is the only leading domestic bank on the list, which participates through NAB Asset Management as fund manager and nabtrade as broker. See, for example, Financial Review (2016), The Sydney Morning Herald (2015) and the website of mFund.} Nevertheless, mFund is still new to the industry. There is a belief that these banking institutions are just taking the "wait and see" approach. As mFund develops further with greater acceptance, their resistance to deploy the platform may possibly change.^{13Legend symbol denoting See Credit Suisse (2014).}

Observations

• mFund developed by ASX in Australia is an exchange-based distribution channel, enabling more efficient processing of fund subscription and redemption. Yet after operation for about two years, it appears that investors' utilization of the platform remained weak. This may be attributable to the relatively small range of fund products and the absence of brokers owned by the leading banking groups with large client base. While the fund industry structure in Australia has its uniqueness, the observations may suggest that strong support from industry participants is crucial in realizing the benefits of the new fund distribution channel.
• Besides, investors' adherence to the traditional fund distribution channels and the readiness of brokers may also affect the market acceptance of a new distribution channel. For any new investment service introduced, it will likely take some time for investors and market participants to build the knowledge and capability. As such, investor education and industry guidance are considered the core parts in the course of the platform development.

Prepared by Tiffany NG
Research Office
Information Services Division
Legislative Council Secretariat
12 July 2016