The past five years have been extremely healthy ones for the funds industry in Asia.

The number of funds, total funds under management, and sophistication of investment products have all seen a fast-growth curve, as Asia increases in appeal for managers.

The law firms that dominate the market have been beneficiaries. The likes of Sidley Austin, Clifford Chance and Deacons have all experienced solid growth in the sector, as have the offshore firms, as funds make more use of offshore jurisdictions.

The future looks just as promising for the funds industry. As interest in Asia continues to awaken in markets such as the US, a huge growth in fund capital is expected, and hot growth markets India and China, as well as the recent about-face in the fortunes of the Japanese economy, continue to seduce more institutional investors.

US investors look to Asian funds
In recent years, the funds industry has become increasingly global. The funds flow into Asia has broadened out and also dramatically increased from overseas markets.

The US in particular is a growth investor. Recent years have seen the growing duality of US capital looking increasingly for Asia fund managers, and Asian funds fuelling this growth by coming up with more global offers to tap US capital.

It seems acceptance of Asia has grown among investors; institutional clients in the US, like managers of pension funds and university endowments, have less reluctance to allocate a larger portion of their portfolio to emerging Asian managers. Interestingly, the majority of funds flow has been from institutional sources, with large managers more interested in institutional rather than retail money.

Sidley Austin partner and head of investment funds, Effie Vasilopoulos, says the firm was doing 50% more retail work five years ago. She says retail hedge funds have not taken off to the extent that was expected, as fund managers see more advantages in sourcing capital from private sources rather than the retail market.

The growth in funds is evident in the offshore world. The Cayman Islands Monetary Authority recently announced more than 8,000 hedge funds are now registered in the jurisdiction, an increase of more than 2,000 funds compared to the beginning of 2005. More than 1,000 new hedge funds were authorised in the jurisdiction in the first half of 2006 alone, which is a record for any six-month reporting period in the Cayman Islands.

While there have also been funds that have been terminated in that same time-frame, the ratio of registration to termination is still three to one. Offshore firm Walkers says the surge in hedge funds is the result of non-traditional applications of hedge funds and increased interest in emerging markets.

Growth in the funds sector has been evident in private equity, says Philip Culhane of Simpson, Thacher & Bartlett. Culhane is a partner and private equity fund formation specialist in the firm's Hong Kong office. Over the past three years as China has really begun taking off, there has been a lot more attention on Asia and a lot of fund raising for Asia-specific funds, Culhane continues.

"There have been a number of factors coming together so that institutional investors, which are the mainstay of investors in private equity funds, have dramatically increased their interest in Asia and China specifically," Culhane adds.

The growth has meant more work for law firms. Sidley Austin's Vasilopoulos says US investors in Asia need advice in areas such as local regulatory and tax requirements, while Asian fund clients need to develop an international platform and structures that will make them more attractive to US investors.

However, law firms have had to step up to the plate in order to capture the increased business. The increasingly global nature of the funds industry is being reflected in the demands being made of the law firms acting in the space. More and more, funds are choosing to work with one firm that has global capabilities, so their requirements in multiple markets are covered consistently. They are also requiring firms to have a high level of understanding and sophistication in regard to the sector itself. Funds want firms who are in the business for the long term, and this acts as a barrier to entry for new firms, perhaps more than in other sectors.

The top three firms in the market have been involved for some time, have high-calibre funds specialists and have each developed their own special client base. Sidley Austin's practice, headed by Vasilopoulos, deals with a traditionally US client base. Clifford Chance, with James Walker at the helm of its asset management practice, has its dominance in the UK market reflected in the Asian market, and Deacons, who has Rory Gallaher as head of funds, dominates on local law requirements.

Together, these firms have captured much of the new work in Asia. However, with most future growth predicted to come from the US, Sidley Austin is perhaps better positioned to take advantage of funds that are tapping this huge market.

A complex picture
Growth in the funds industry has occurred in tandem with an escalation in the complexity and diversity of funds products being offered by managers and demanded by investors.

Five years ago, investment products in Asia tended to be plain vanilla products, focusing on a specific asset class in pursuit of returns for investors. However, in the last three years, there has been a significant growth in hybrid investment products, which span widely different asset classes, such as a combination of listed equities and real estate. This has demanded the development of product structures never seen before.

There has also been an explosive growth in the sophistication of investment strategies, away from the standard long/short equity products common a few years ago.

As a part of the investment mix, one of the hottest growth sectors has been real estate, which has seen a rise in popularity as an asset class. Though there has been a large number of offers in Chinese and Indian real estate in the last two years, these have typically been oversubscribed, and have seen interest from the US and Europe.

The REIT market has been the most talked-about example, after the ground-breaking Link REIT at the end of last year. Although investor sentiment in the REIT market has cooled somewhat in Hong Kong, with questions over yields available from these products when compared with other products on offer, most predict their continued growth.

As in the real estate sector, China in general inspires continued faith from the funds sector. There is optimism that regulations governing investment in Mainland-listed A share stock might be further relaxed in the next year or two, giving more access to fund managers.

Over the past year, India has also captured the imagination of global institutions, with many different funds now having an India theme. Singapore has been a particular beneficiary of this. The jurisdiction has been developing double tax treaties that have made it an attractive funds management centre, particularly in regard to cross-border in-bound investment into India.

Japan is also returning to favour among fund pundits. "Increasingly, our clients are looking at Japan optimistically. With the country turning the corner economically, they are developing products with Japan as a theme," Vasilopoulos says. Traditionally, Japan has been an economy of savers. With trillions of dollars in savings put away, managers are hoping they will emerge as a new community of investors. Fund managers have been opening offices in Japan in expectation.

The combination of these factors leaves the outlook for the sector very positive, with Asia's funds industry really only beginning to take off. As it develops and becomes more a part of the global funds management and investment market, with US and European investor acceptance, rapid growth can only continue.

Firm Profile: From the ground up
For nearly 10 years, Simpson Thacher & Bartlett has been focused on building both its regional private equity fund formation business and the success of the funds themselves

In the small but bourgeoning business of private equity fund formation in Asia, there is only a handful of legal names that crop up when it comes to sourcing an individual with a reputation and track record gained from building funds based in the region. At the top of that list is Philip Culhane, partner with Simpson Thacher & Bartlett.

In Asia now for eight years, Culhane arrived in the region with the task of building Simpson Thacher's fledgling regional PE fund formation business from the ground up. Since then, the firm has established itself as an essential port of call for anyone looking to start up a new Asia-based private equity fund. Much of this success has been built on Simpson Thacher's strength in this practice area in the US, where it boasts a number of heavyweight PE clients that have all become Asia players in recent years - Blackstone, KKR and Carlyle.

Culhane has built a solid middle-market fund formation practice, made up of local managers that tend to be first time, start-up funds rather than established names, as most billion-dollar-plus funds are headquartered elsewhere. Culhane usually works on funds in the US$100m - US$500m range, although he is in currently working on a fund for a Japanese buyout group looking to raise over a billion dollars

"We have really had a first mover advantage. We have now got an eight-year track record of having helped get people in business," Culhane says. "We are reaching a point where we have done successor follow-on funds for existing clients, so as that gets going, it is a virtuous circle."

In this niche practice area for law firms in Asia, much of the work has been sourced through Culhane's reputation and track record in helping build funds. As a result, relationship building has been the key to growth, and it has required a long-term commitment and vision from Simpson Thacher to grow the business in Asia. "You have to build the relationship up across years. In one year you'll be helping set up a fund, and in the next year you'll be doing more transactional-related things, or advising them with respect to new challenges that pop up for them," he says.

It is the variety inherent in the role that keeps Culhane interested. He says a lot of middle-market funds do not have in-house general counsels, so he ends up working very closely with the founders of the business to do this type of work. "It is an exciting practice area for me, because there is something very attractive in representing people as they are putting a new business together and being able to add value as they figure out how to structure their organisation internally and how to approach certain external issues," he says.

The firm is anticipating a new phase of growth in its fund formation business. At present, there are three associates working under Culhane, with another one being hired, and the firm aims to open a Beijing office in six to nine months. "Our view is that private funds formation, and then the resulting M&A work for PE funds, is at a point where it is going to take another big incremental step forward."

Over the next five years, the firm plans to take more advantage of the relationships that it has developed in other areas, such as capital markets and M&A, to increase the amount of fund formation business that is sourced laterally. "It is a practice where you need some luck, you need a firm reputation, and you need your partners and your firm to have strong relationships across the board," Culhane says.

Philip Culhane
Simpson Thacher & Bartlett LLP
ICBC Tower, 7/F, 3 Garden Road, Hong Kong, China
Tel: +852 2514 7623
Fax: +852 2869 7694
pculhane@stblaw.com