A memorandum of understanding between Ireland and China looks set to breathe new life into the republic’s investments funds industry – possibly at the expense of rival domicle Luxembourg.
A recently signed agreement with China has exposed Irish-domiciled investment funds to one of the world’s largest pools of private capital. And with closer links between China and rival Luxembourg already in place, Ireland’s funds industry is hoping that a memorandum of understanding (MOU) signed at the end of last year will protect its position as one of the key domiciles of choice.
It certainly has a lot at stake. Figures from the Irish Funds Industry Association (IFIA) state that Ireland has in excess of $2tn (£1.31tn) of assets under administration. “An MOU was noticeably absent here for some time, given that our competitors already had agreements with China,” says Dillon Eustace partner Brian Dillon. “So there was significant pressure from the Irish funds industry to get a similar arrangement set up.”
Barry McGrath, a partner in the Dublin office of Maples and Calder, agrees. “Luxembourg was clearly stealing a march in being able to offer their funds, or managers of those funds, access to a very large market which is only going to grow and grow,” he says.
However, according to lawyers in Luxembourg, the grand duchy’s own MOU with China has not progressed or resulted in any Luxembourg funds being sold in China since its signing in 2007. Unlike the Irish agreement, the Luxembourg MOU now requires amendment by side letter to reflect the Qualified Domestic Institutional Investors (QDII) regime (see explanation below), and the execution of this side letter has been put on hold by the Chinese regulator for several months while its attention is focused on issues relating to the current economic climate.
With Luxembourg seemingly out of the race on a technicality, and providing the Chinese economic situation allows, Ireland is well positioned to regain an advantage.
Despite the deteriorating global economy, law firm partners in Ireland are optimistic that the agreement signed on 23 October 2008 between the Irish Financial Services Regulatory Authority and its Chinese counterparts the China Securities Regulatory Commission (CSRC) and China Banking Regulatory Commission (CBRC), which will allow Chinese investors to invest in Irish-domiciled funds for the first time, will herald a new era of cooperation between the two countries.
At present, Chinese investors can only operate through the QDII scheme introduced in June 2006. “The scheme permits Chinese-domiciled investors to invest in foreign securities markets via certain fund management institutions, insurance companies, securities companies and other asset management institutions that have been approved by the CSRC,” explains Dillon. “Originally, any investment by a QDII was restricted to fixed-income and money market products, but the scope of the scheme was widened in May 2007 to include investment in equity products.”
Any stocks or investment funds a QDII invests in must be listed on a stock exchange or regulated by a financial regulator – such as the Irish financial regulator – that has signed an MOU with the CSRC and CBRC.
The size of the potential investment up for grabs is hard to establish. But according to a report published in International Custody & Fund Administration magazine, figures from China’s State Administration of Foreign Exchange (which every QDII holder has to approach to buy the foreign currency to invest outside of the People’s Republic of China) put the total overseas investment quota allocated to Chinese financial institutions under the QDII scheme at $52.7bn (£34.59bn) at the beginning of 2008, with six fund management companies and one securities house having received allocations totalling $29bn (£19.03bn), the remainder being split across 21 commercial banks and 14 insurance companies.
In addition, information from the Association of the Luxembourg Fund Industry states that according to global asset managers, during 2007 more than 50 per cent of total net sales of EU funds were realised in Asia.
‘A global fund brand’
Michael Jackson, a partner in the Matheson Ormsby Prentice (MOP) asset management and investment funds group and vice-chairman of the IFIA, sees the situation as follows. “If you look at the subscription figures for undertakings for collective investment in transferable securities [Ucits] – pan-European investment funds – over much of last year the majority of investment came from Asia rather than Europe. This is a clear sign that Ucits have become effectively a global fund brand rather than simply an EU one,” he says.
MOP established the first Irish fund authorised to invest in China ‘A’ shares even prior to signing of the MOU. Many lawyers here are predicting that this trend is very likely to continue, with increased investment into Ucits from Asia and also the Middle East.
“The MOU is just part of a bigger story of the success of the Ucits brand,” says Brian McDermott, head of A&L Goodbody’s investment funds group.
“While there’s still no one global fund product that’s the panacea people have been seeking throughout my 20 years in the funds industry, the appeal and acceptance of the Ucits product has continued to widen at least in part due to the expansion of the range of products that are permitted to be established as Ucits.”
How the unfortunate timing of the MOU’s launch, during a period of unprecedented economic flux, will impact on the speed and level of uptake is less clear. The Chinese economy itself has experienced volatility over the past few months, but several Irish funds lawyers remain hopeful that 2009 will see funds availing themselves of the MOU.
“Of course, the opportunity is somewhat less interesting than it was even a year ago,” admits McDermott, whose firm was the first Irish practice to set up a dedicated China group in 2006.
According to Michael Barr, a partner in A&L Goodbody’s investment funds group: “Chinese investors are leaving the domestic stock market in droves in response to falling stock prices and economic issues closer to home, and the appetite for foreign products in the current environment is much reduced. We have nevertheless had a number of clients making enquiries about the opportunities now available to them under the agreement, which augurs well for when the market does stabilise and pick up.”
The Irish funds industry is also looking to longer-term gains associated with the MOU, rather than simply the availability of short-term investment from China. “We’ve found that most promoters were interested in the Asian market,” says MOP’s Jackson. “And even where they weren’t yet ready to access China, they were still concerned to ensure if they set up a fund in Ireland that they would be able to access the whole market when the timing was right for them.”
The agreement is viewed by many as another step toward Ireland gaining a long-term foothold in China, particularly as the inevitable opening up of the Chinese market continues. “There will hopefully come a time when Chinese managers no longer have to go through QDII institutions to invest because they can do so directly – and likewise investments or funds can be sold directly into China,” says McGrath. “Certainly the better they know us, and become comfortable with Ireland as a jurisdiction from a regulatory point of view, the better placed we’ll be.”
The MOU is only one part of a broader, decade-long effort by the Irish government to get closer to China and position Ireland as the gateway to Europe. The administration has backed numerous trade missions in an attempt to develop understanding between the two jurisdictions, and the Irish and Chinese prime ministers met on the day the MOU was signed and declared an interest in encouraging further links. The two countries also have some interesting cultural associations, with Irish traditional music group The Chieftains being the first-ever group to play on the Great Wall, and a joint Irish-Chinese entry, Green Dragon, taking part in the current round the world yacht race.
From a tax perspective, Ireland also offers one of the best platforms for making equity investments into China, due to a combination of the Ireland-China tax treaty and Ireland’s holding company rules.
Caitriona McGonagle, a partner in the tax group at Matheson Ormsby Prentice, says: “Other established holding company jurisdictions, including the Netherlands, Luxembourg or Cayman Islands, don’t offer the same capital gains tax exemptions for Chinese investments. Under Irish rules investors can exit their Chinese investments through a share sale, without paying any Chinese or Irish tax on their profit, and dividends can be received on Chinese equity investments with the lowest possible rate of Chinese tax and usually no Irish tax.”
With closer links on the cards, it makes sense that Irish firms may be reviewing their own strategy towards China. McGrath of Maples and Calder, which currently has 46 lawyers in its 15-year-old Hong Kong office, believes that before long firms will have to take a view about whether it is worth the more extensive investment of putting lawyers on the ground themselves.
Dillon Eustace’s Dillon, who established the firm’s representative office in Tokyo in 2000, agrees. “Everyone here has their own ideas about how crucial the Chinese market will be and while no one believes it’s the panacea to cure the global economy’s problems, it’s certainly a significant market we want to be as close to as possible. As a firm we feel it’s important to have some presence in the Asian time zone.”
Perhaps the ongoing economic instability may even play in the Irish fund market’s favour. Jackson seems to think so: “In a roundabout way, the EU talking about regulating hedge funds, an increased focus on the Organisation for Economic Co-operation and Development principles in Europe, and even Barack Obama focusing on the question of whether a jurisdiction meets the transparency test, creates opportunities for Ireland. Investors will now be far more likely to focus on regulated product that puts a premium on safety and custody over funds that don’t. For a long time the Irish fund product has been criticised by some competitor jurisdictions for ;requiring ;particular ;custody arrangements in relation to prime brokers, but recent events suggest that shareholders in Irish funds may benefit from this requirement.”