June 2011
Viewpoint Emerging trends in Asia Pacific
This paper sets out to identify the key hot topics and high-level concerns currently generating discussion among asset management leaders in the Asia Pacific region. Some of the themes identified include regulation, innovation, cost inflation, investor skepticism, revenue pressures and changing patterns of distribution. We also touch on the outlook for asset servicers, and conclude with some over arching observations about the challenges facing asset management firms in the region.
A number of topics are generating discussion among industry leaders in Asia‑Pacific This is our third asset management Viewpoint to focus on the asset management industry in the Asia Pacific region. The first paper explored the impact of Dodd-Frank on asset managers in the region, and the second examined tax competition between Asia Pacific investment hubs. Forthcoming issues of Viewpoint will explore the future of distribution in the region. This paper takes a step back, identifying the high-level issues that are currently generating discussion among industry leaders across the region. Drawing on our conversations with clients and industry professionals, we aim to highlight the challenges facing firms in the short to medium term, rather than attempt to predict the future. The goal is to give asset management leaders a chance to benchmark their strategic thinking against that of their peers. We have grouped the issues preoccupying the industry under topic headings, but, in practice, it is unlikely a firm would consider any of them without also taking a view on the others. The main focus is on asset management, but we also mention the challenges facing asset servicers in the region. Broadly, these themes will not come as a surprise to those in the industry but we expect that, by highlighting the specific ways they affect Asia Pacific firms, our insights will help asset management leaders to put their own thinking into context for their firms.
Firms across the region are facing a range of local regulatory developments Asset managers the world over are preoccupied with regulation and, despite the measured approach of many Asia Pacific governments, firms in the region are no exception. Local developments are a concern for firms in several territories, and nowhere more so than in Australia. In a market where mass market investments are dominated by four large banks, independent asset managers are heavily reliant on advisor-driven sales. The recommendation of the Ripoll inquiry to ban commission payments to financial advisors should benefit the quality of investor advice and, in the long term, the savings industry as a whole, but in the short to medium term it represents a potential threat to many firms’ business models. Australian asset managers are also weighing the implications of inquiries into the competitiveness of Australian financial services, the federal tax system and the national superannuation industry. However, a congested parliamentary agenda means that the final shape of new regulations remains far from clear. As a result, Australian asset managers are being forced to make decisions on the basis of patchy information. Australia is not the only territory in Asia Pacific where asset managers face fresh regulation. In Hong Kong, new regulations coming into force in June 2011 will require investment funds sold and marketed to retail investors to produce a new key facts statement. A one-week cooling-off period is being introduced for structured product sales, and the Securities and Futures Commission (SFC) is more strictly enforcing the need for professional investors to provide evidence of their wealth. The new rules are a response to the mini bonds mis-selling scandal of 2008 - which affected investors in Hong Kong, Singapore, Indonesia and Taiwan - and follow similar regulatory action in Singapore.
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International regulatory initiatives are adding to uncertainty — and cost inflation Firms in the region also face regulation originating from further afield, such as the US FATCA rules and Dodd-Frank Act, and the UK Bribery Act. Dodd-Frank is a particular source of uncertainty. US regulators have yet to finalize implementation details, and the SEC has recently indicated that the fast-approaching compliance deadline of July 2011 may be deferred by six months. In the absence of dependable information, firms are relying on legal advice, but they are all too aware that this may change, which is not a conducive basis for effective strategic planning. Whatever its source, regulatory change often generates uncertainty. For instance, some asset managers in Hong Kong feel that investment sales are being affected, as investors and advisors react to the actions the SFC have taken against firms with poor or inappropriate sales practices. The impact of market uncertainty may be hard to measure, but the costs of new regulation are easier to quantify. These begin with the direct requirements of compliance, but include the need to attract and retain skilled employees, the costs of investment in IT and other systems, and the need to set up adaptable compliance frameworks that can respond to future changes and reporting requirements. All are pushing up asset managers’ expenses.
Investors are becoming more demanding, and some firms are struggling to expand their revenues Asset managers in Asia Pacific not only face pressure on costs but also, in some cases, on revenues. In Australia and New Zealand, firms face a particular challenge to overcome skepticism among the investing public. As markets stabilize and fund inflows accelerate, retail and institutional investors are demanding transparency and value for their money. Asset allocation is putting further pressure on fee income. Despite the recovery in regional equity markets since the first quarter of 2009, Australian superannuation trustees remain hesitant to allocate funds to equities. Some funds are flowing into alternative investments and overseas assets, but a large percentage are still allocated to bonds and cash, generating far lower fees for managers. Revenue pressure is accentuated by the fact that Australian markets have been trading in a tight band since late 2009. Investment demand is more buoyant elsewhere in Asia Pacific, and retail investors in developing markets are more likely to invest in equities. Even so, competitive pressures are intensifying. This reflects the growing number of independent Asian asset management firms, the ever-increasing interest in Asian markets from European and North American firms and — as in other regions around the world — a stronger focus from investors on the link between management fees and actual investment returns. In some markets in the region, alternative investment managers and other small firms are feeling this pressure when trying to raise capital. Institutional investors allocating funds to alternative assets are increasingly favoring larger hedge fund managers, with small firms in markets such as Hong Kong and Singapore expected to meet far higher standards of risk management and governance than would have been the case just two or three years ago. Institutions are also increasingly likely to impose covenants over investment powers, investment types or fund operations, as they search for a combination of reassurance and investment returns.
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Viewpoint Emerging trends in Asia Pacific
Product development and marketing are receiving investment, but performance is not the whole story
More functions than ever are being outsourced, but many asset servicers still struggle to turn a profit
In a push to reinvigorate fund inflows, asset managers in Asia Pacific are working to refresh their product ranges. Passive products that provide equity exposure at relatively low cost remain popular. Exchange-traded funds (ETFs) are in particular demand, with the range of market exposure available via ETFs expanding rapidly. As wealth creation continues in the region, demand for alternative investments is growing. At the other end of the risk scale, products incorporating some element of guarantee are also increasing in popularity.
As firms in Asia Pacific struggle to balance the costs of regulation, risk management and product development with the need to generate value for their owners, outsourcing is returning to the top of the industry’s agenda. Firms are increasingly willing to outsource non-core capabilities, including not only back-office functions, but also middle-office processes. There is growing demand for consistent cross-border service, and alternative investment managers are increasingly seeking specialized support.
The growing amount of Chinese trade priced in renminbi is also generating interest in renminbi-denominated investments. In Hong Kong, renminbi deposits have grown fast since 2010’s clearing agreement, and some yuan-denominated bonds have been successfully issued. Although demand is high, only a handful of renminbi investment funds have been launched, due to the lack of bond issuance. Beyond product innovation, firms in Asia Pacific are hoping to stimulate demand through better marketing and communication. In the current environment, even firms with strong brands need to tell a good story to generate capital inflows. This will become even more important as advisor commissions come under closer regulatory scrutiny. Some multi-asset firms are even considering whether to narrow their focus to concentrate on their best-performing area, but for most medium and large firms, the preferred approach is to highlight recent successes while maintaining a broad range of capabilities.
This is not always good news for asset servicers, which operate in an industry ruled by brutally simple economics. First, the market fluctuations of recent years mean that levels of assets under administration are likely to be lower than they were three years ago. New clients driving tough bargains and existing clients renegotiating their rates are also putting fee levels under pressure. Second, asset servicers are under continuous pressure to invest and upgrade their systems and services, further squeezing their margins, and to remain up to date with the latest regulatory requirements. Delivering new services such as middle-office functions is a rare chance to generate value for customers and to support or even increase pricing levels, but only firms with spare capital to invest will be able to take advantage of this opportunity. In some cases, firms are only remaining in certain countries in an effort not to miss out on potential future growth. The resulting pressure on profitability means that, in many markets, only the largest asset servicers are creating value for shareholders.
Even so, there is a growing awareness that track record, however good, is not enough. Investors are looking for good performance, strong risk management and reasonable fees — a combination that is putting asset managers in the region under increasing profitability pressure.
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Some firms are trying to overcome established distribution patterns — often by looking overseas
High-growth markets are the most popular, but there is no standard approach to foreign expansion
In the search for stronger growth, asset managers in Asia Pacific are trying to develop new patterns of retail distribution. In some cases, this is a response to banks’ dominant shares of mass market investment sales, which make it hard for independent asset managers to grow. This is a particular problem for independent firms in Australia, where market growth rates are low and managers rarely have direct relationships with their ultimate customers. The situation is similar in Hong Kong, where three international banks and a handful of local banks control a large proportion of retail investment sales.
Even if many firms are undecided over the best approach to overseas expansion, they tend to agree on which markets are most attractive. Growth potential is the crucial consideration. For some firms, developed markets such as South Korea or Taiwan can offer attractive growth within a particular niche. In most cases though, it is market growth that generates the greatest interest. This is usually seen as a function of demographics, savings ratios and levels of investment penetration. Markets such as Vietnam and Indonesia, that combine strong growth potential with a large population, are particularly attractive, but mainland China remains the greatest prize.
As already discussed, asset managers in markets such as these are working to improve their attractiveness to distributors. However, where this is proving to be a challenge, or where domestic growth rates are slowing, firms are also looking to broaden their crossborder distribution. Australian asset managers are particularly keen to expand overseas. Encouraged by the recent reduction in withholding tax, many feel they should be able to leverage their expertise and innovative products across the region. Even though they do not face the same distribution challenges, many of the larger traditional firms in Singapore also are looking to develop their distribution networks in the region. Japanese firms are seeking growth overseas too, illustrated by Nikko’s recent acquisitions in Australia, New Zealand and Singapore. As a result, there is growing discussion in the industry about the feasibility of achieving rapid expansion in overseas markets. Entering a new market requires presence on the ground, something that takes time to develop in a region where even the largest firms traditionally have a mainly domestic focus. Even though alternative investment managers and other boutiques are having some success raising offshore funds, only a minority of mainstream houses are actively engaged in regional expansion. In the longer term, Asian fund passports could help, but this important development still needs significantly more refinement before it becomes a viable option.
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As a result, many asset managers in Asia Pacific without a point of access to the Chinese market are urgently looking to develop one. In recent years, joint ventures (JVs) with local firms have become the standard approach, but forming a successful JV is not easy. The strongest Chinese firms are either in partnership with a foreign firm already, or are seeking a high price for their involvement. Weaker local players are more open to partnership, but are a less compelling proposition for the new entrant. A third but slower option is to wait for foreign firms already in JVs to withdraw. Faced with these difficulties, some firms are looking to cooperate with local partners on a product-by-product basis. Others are approaching the growth potential of Asia Pacific from a different perspective, by chasing European capital seeking exposure to faster-growing markets. Some firms in Hong Kong and Singapore are looking into setting up UCITS IV-compliant fund structures that can be further developed once the new regime comes into force in July 2011. Meanwhile, Chinese asset managers are opening up offices in Hong Kong in growing numbers. One motivation is clearly to learn from the depth of experience in Hong Kong’s asset management industry, but this could also be the beginning of a wave of regional – or even global – expansion. Whatever the chosen approach, it is worth remembering that overseas expansion plans are rarely unique. Asia Pacific markets are becoming increasingly congested with regional players, global groups and European and American entrants, and every firm expanding overseas becomes a new entrant in a market it does not know as well as its own.
Viewpoint Emerging trends in Asia Pacific
The challenges facing asset managers in Asia Pacific One distinguishing feature of the Asia Pacific region’s investment markets that we have not explored in this paper is their sheer diversity. It follows that none of the observations we have made are entirely true for all markets or firms in the region, but they do reflect the tone of conversations we have had with a variety of clients and industry professionals. Although the Asia Pacific region includes many fundamentally attractive asset management markets, the industry is not immune from the challenges asset managers face in other parts of the world. Depending on the territory, these can include the side‑effects of regulation, investor skepticism, revenue pressures, segmented distribution and rapid cost growth. Looking across the region as a whole, growing levels of competition from local, regional and global players are also a source of increasing concern.
In response, many asset managers are investing in innovation and communication, considering greater use of outsourcing and engaging in foreign expansion, especially in the region’s faster-growing markets. A number of firms in the industry are finding their profitability squeezed by demands for stronger risk management, more consistent investment performance and lower management fees. In some markets in the region, this will inevitably lead to stronger arguments for greater scale. In others, the speed of growth means that pressure to consolidate is unlikely to become strong in the foreseeable future. It is this diversity that makes the industry in Asia Pacific so interesting — and that makes over-simplification so dangerous.
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For more information, please contact:
Ernst & Young
Authors
Assurance | Tax | Transactions | Advisory
Mike Buxton
Partner, Hong Kong Ernst & Young Group Ltd Direct: +852 2849 9288 Email: michael.buxton@hk.ey.com
Graeme McKenzie Partner, Australia Ernst & Young
Direct: +61 2 9248 4689 Email: graeme.mckenzie@au.ey.com
Mark O’Sullivan Partner, Australia Ernst & Young
Direct: +61 2 8295 6044 Email: mark.osullivan@au.ey.com
Brian Thung
Partner, Singapore Ernst & Young LLP Direct: +65 6309 6227 Email: brian.thung@sg.ey.com
Global Asset Management Center Leigh Pennington
Global Implementation Director Direct: +27 31 576 8266 Email: lpennington@uk.ey.com
About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 141,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com How Ernst & Young’s Global Asset Management Center can help your business The asset management industry is facing a number of fundamental challenges. These include changing customer demand, the need to innovate, downward margin pressure, the rising tide of regulation and investors’ increasing focus on governance. In response, the industry is restructuring, developing new products, improving risk management and seeking greater efficiency. Ernst & Young’s Global Asset Management Center analyzes these themes and assesses their implications for individual firms. We also draw together a worldwide network of nearly 35,000 industry-focused professionals with deep knowledge of asset management and a range of technical experience in assurance, tax, transaction and advisory services. If you run an asset management company, we can provide you with consistent, high-quality service wherever you are located. We can help you respond to the challenges facing your business and increase your competitive advantage. If you want to compete powerfully in your market, we’ll help you achieve your potential today and tomorrow. © 2011 EYGM Limited. All Rights Reserved. EYG no. EH0076 In line with Ernst & Young’s commitment to minimize its impact on the environment, this document has been printed on paper with a high recycled content. This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor. 1133970.indd (UK) 06/11. Creative Services Group.