Financial Services Quarterly Report - Fourth Quarter 2013: Widening Distribution Channels for Mutual Funds in China

by Dechert LLP

Prior to 2013, the door to the People’s Republic of China’s domestic mutual fund market was closed to outsiders. Foreign fund managers had only one choice: to team up with local Chinese managers in joint ventures, controlled by the Chinese manager. But even these joint ventures faced a daunting challenge when distributing their products, as fund sales heavily depended on establishment of a robust distribution network.

Two recent developments in China not only crack open the door for some foreign financial institutions – they offer tangible evidence of the maturation of the mutual fund market in China. For the first time in recent history, foreign banks are now permitted to distribute mutual funds on their own, without a local partner. Second, the early success of new online fund marketplaces in China may lessen the need for a physical distribution network. These changes, taken together, could create a novel approach for foreign managers looking to sell their investment products in China.

Recent Regulatory Changes Finally Permit Distribution of Funds by Foreign Banks

On June 25, 2013, eight non-Chinese financial institutions were awarded new licenses to sell mutual funds in China. The financial institutions, including HSBC Holdings, Citigroup Inc. and Standard Chartered Bank (China), were the first to take advantage of a 2011 initiative to allow commercial banks to apply to the China Securities Regulatory Commission (CSRC) for qualification to sell mutual funds in China. This initiative, set forth in the Administrative Measures for Sale of Securities Investment Funds (Administrative Measures), represents a new avenue to target the growing Chinese domestic fund market.

Eligibility Requirements

Article 9 of the revised Administrative Measures specifies various corporate governance, internal control and financial stability requirements. The Administrative Measures also require that eligible banks:

    • Have appropriate facilities for a “fund sales business,” including technical facilities for processing fund sales that meet CSRC requirements. Fund sales must be routed through the China Securities Depository and Clearing Corporation for testing, and the test results must meet certain standards;
    • Adhere to a “sound” process for fund liquidation, ensuring that the fund’s assets are distributed in a timely, safe and efficient manner to its investors when the fund is terminated (either by way of termination of the fund contract or decision of its investors);
    • Implement a “know your customer” system that evaluates fund investors’ ability to bear risk as well as a process to grade the risks of fund products;
    • Establish a proper management system for business processes and emergency response measures that meet CSRC requirements regarding the internal controls of fund sales institutions; and
    • Implement internal controls that satisfy PRC legal and regulatory requirements, as well as any other conditions as prescribed by the CSRC.

The Administrative Measures also contain several specific administrative and personnel requirements. The fund sales business must be set up as a specialized department. Personnel in the department must meet certain professional qualification requirements.1 Every eligible bank must employ at least 20 employees that meet these qualifications. Managers must also be familiar with the fund sales business and have over two years’ experience in the funds business, or more than five years’ experience in other relevant financial institutions. Finally, an eligible bank’s capital adequacy ratio must conform to relevant regulations of the banking regulatory agency of the State Council and have no record of major administrative penalties or criminal penalties within the past three years.

Process to Obtain the Qualification

Banks that meet the above requirements must complete a three-part application process.

First, the applicant must obtain a user ID and code for the CSRC’s online application system. To do this, applicants must send the CSRC: (i) an Institutional Code Certificate; (ii) the results of the interrelated test between the information system of fund sales and the central exchange platform for registration data of mutual funds; and (iii) the contact information of the applicant.

Second, after receiving the user ID and code, the applicant can log into the CSRC’s online application system to complete an online application and print out relevant materials. Alternatively, the applicant can fill in a written application form and the relevant appendices, which can all be downloaded from the CSRC website.

Finally, originals and soft copies of all of the materials must be submitted to the local branch of the CSRC (Local Bureau) where the bank is registered. Before accepting the application, the Local Bureau may require that the applicant make supplementary submissions. Once the Local Bureau has accepted the application, it will examine the submitted documents and consult the relevant authorities and institutions, such as the CSRC and China Banking Regulatory Commission, and may request further information.

The timeline for approval varies depending on the Local Bureau’s assessment of the quality of the documents submitted and supporting explanations. Among the first group of successful applicants, approval times ranged from approximately three months to seven months.

Prospects for Foreign Banks

For foreign banks with commercial banking operations in China, the Administrative Measures represent an opportunity to gain a foothold in China’s domestic fund market. But challenges remain – the most established domestic banks have well-developed distribution platforms, and local investors are most familiar with domestic asset classes. Foreign banks, in contrast, have a relatively small number of local branches and may need to concentrate on certain market segments (for example, high net worth individuals) in order to compete.

Internet Distribution

Online distribution of funds may provide a partial solution to the challenges of fund distribution in China. Recent events suggest that the near-term potential for online distribution is significantly greater than previously assumed.

Online distribution of funds in China falls into two different categories: (i) distribution operated by fund companies – which is not new and is common practice; and (ii) online distribution operated via a
third-party e-commerce platform covered by the Rules on Securities Investment Funds Distribution via
Third-Party e-Commerce Platforms (Online Distribution Rules) released by the CSRC on March 16, 2013.

Online Distribution by Investment Funds

Chinese law does not provide clear guidance regarding the types of funds that can be distributed online. However, under the Securities Investment Fund Law of the PRC (PRC Fund Law), only publicly raised securities funds are allowed to engage in online distribution.

There appear to be limited requirements for fund sponsors interested in online fund distribution. Such institutions can be fund managers or other properly licensed intermediaries (such as commercial banks, securities companies, securities investment consulting institutions and professional fund sales institutions). But the funds themselves must be legally registered in China, and their online distribution I.T. system should also be located in China. Online fund agreements are subject to further requirements regarding risk allocation, fund disclosure and dispute resolution mechanisms.

Finally, the online distribution system must be operated and managed by fund companies themselves, leading to additional costs. In case any third party is involved, confidentiality agreements should be executed with such third party to protect investors’ personnel information.

Online Distribution Operated via Third-Party E-Commerce Platform

The Online Distribution Rules allow fund companies to cooperate with online shopping websites and
e-commerce platforms to sell their funds. Alibaba became the first Chinese online retailer to apply for and obtain a license to sell investment products via the Taobao Marketplace, and online payment processor Alipay followed shortly thereafter. Thirty-two fund managers had reportedly established flagship stops on Taobao, and fifteen on Alipay, by the beginning of November.

This distribution channel has taken the Chinese fund industry by storm. Alipay’s Yu’E Bao product managed by fund manager Tianhong Asset Management is reported to have amassed more than Rmb100 billion (approximately USD 16.4 billion) in assets since its June 2013 rollout. This makes it China’s largest retail mutual fund to date – and certainly one of the larger launches in the world in 2013. The fund is essentially a money market fund, and it remains to be seen whether other types of funds, with different risk characteristics, can enjoy comparable success. The market can expect to welcome even more entrants – as Chinese internet giants Baidu and Tenpay have also received regulatory approval to launch products with fund companies.

General Chinese law principles and restrictions and CSRC legal requirements applying to other distribution channels will apply equally to e-commerce platforms, including requirements covering clearing and investor suitability. In addition, fund companies are expected to implement internal controls necessary to safeguard investors’ interests. A fund company and its e-commerce platform operator must enter into an agreement specifying their respective rights and obligations with respect to sales, investor services and data safety. This agreement must also contain a “termination plan” to outline how business would be concluded in the event of termination. Certain information should also be published in a prominent location on the third-party operator’s e-commerce platform, including the fund company’s business registration information and sales qualification, as well as a reminder that the fund distribution service is provided by the fund company and not the third-party e-commerce platform operator.

At this stage, the sudden success of the online marketplaces has taken many industry participants by surprise, and development is too recent to evaluate how effectively it can be used by foreign asset managers. However, it demonstrates that managers can raise an impressive amount of assets in China, even without a brick-and-mortar distribution network.


1. All managers and at least half of all personnel in the fund sales department must have obtained the “funds practice qualification.” This qualification is obtained by, among other requirements, passing the “Fund Qualification Exam” administered by the Securities Association of China.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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