An expansion in the region continues, it is China that is underpinning the funds industry's horn of plenty. Consequently Asia is enjoying untrammelled growth in markets old and new. ALB reports

Asia's fund industry is booming. Although fears of a credit crunch leave the short- to medium-term future uncertain, the last two years in Asia have been literally explosive. Figures for both Hong Kong and Singapore show that the funds industry grew rapidly in 2006 - 36% in Hong Kong. This rate of growth was in fact outpaced by Singapore.

"It has been a record year for us," said Effie Vasilopoulos from Sidley Austin. "We did as much business to 30 June as we did the year before, and last year was a year in which we doubled on the year before - the last two years have been a sustained bull run for us." Sidley's being a US-focused hedge and private equity fund formation practice, the growth of the firm's Asian practice is due to an aggressive US investor appetite for Asia.

China has fuelled much of this growth, as investors look for yields unavailable in developed markets. Changes to the China's QDII regime are also generating work for funds-focused firms, as Chinese managers can now invest in funds offshore.

"The Chinese are very keen to get a better understanding of the funds industry. I would say right now it's in its early stages, but with people's motivation and ambition and keenness, I think they will get there at some point," Woo said.

Gallaher names China as the key investing trend in Asia, popular amongst established fund managers. The firm closed the HSBC China Dragon Fund this year, which was the first closed-end authorised fund investing in China from Hong Kong.

East follows West
As the industry grows in size, it also grows in sophistication. This year has seen a blending of East and West, as local-born professionals, trained overseas, bring back to Asia more advanced structures pioneered in the US and Europe.

A good example of this is the special situations fund. Sidley Austin recently represented Hong Kong-based hedge fund manager Abax Global Capital in the first globally offered hedge fund to launch in Hong Kong with investor demand exceeding US$1bn. The launch was a highly anticipated hedge fund start-up, being the first mega-launch of the new special situations "hybrid" fund in Hong Kong. Such funds, investing in both listed and unlisted equity, exhibit elements of private equity functionality but in some ways are traditional hedge players. "Most of our funds are hybrids now," Vasilopoulos said. "When you look back it is completely different from a year ago and then again a year before that. The last couple of years have been a watershed of ideas," she said.

Gallaher says Deacons was also involved in launching new products into Hong Kong this year, on the back of a flexible view from the Securities and Exchange Commission (SEC). A particular case was the first 130-30 fund, which puts 100% of funds into an index, then sells short 30% in stocks likely to perform worse than the market. The manager then takes proceeds from the short sales to go long in stocks likely to beat the index. The strategy is designed to add returns and decrease volatility.

Asia's new horizons
Although China might be the irresistible magnet bringing many funds to Asia, the last 12 months have also seen a freeing up of Asia's market, as funds look to new horizons.

Vietnam is a case in point. The emerging economy has presented a theme in the past six months, particularly for private equity players and emerging market hedge fund managers who can now base themselves on the ground there and get licences. Korea's regulations are also changing to allow funds to promote themselves in Korea, as well as allow them to set up on the ground and construct offshore funds for investment. Markets such as China, India and Singapore are now being regarded as "emerged" markets.

"Traditionally, investment has been focused in a couple of developed markets, but there has been a general freeing up, with a lot more clients based in places such as Malaysia, Thailand and Indonesia," Vasilopoulos said. "We are now quite interested in Malaysia. A number of clients are looking at Malaysia, and we have one of our partners on secondment to a Malaysian-affiliated law firm."

The firms and the fees
This year has seen to major changes to the international firms most active in the funds sector in Asia, with most legal talent concentrated in the Hong Kong SAR. Sidley Austin still dominates on funds work out of the US, Deacons dominates the local Hong Kong market, particularly on the retail funds side, while Clifford Chance tends to be the high-end firm of choice for UK and European funds, and boasts a strong China and regulatory practice. Sidley's practice is headed by Effie Vasilopoulos, Deacons' by Rory Gallaher, and Clifford Chance's funds area by James Walker.

In the offshore world - an important sector for funds - Maples and Calder has traditionally dominated, but large offshore providers such as Walkers and Ogiers have come into the market. Also, firms such as fast-growing Appleby have increased their exposure to funds. Conyers Dill & Pearman's practice is second tier when it comes to funds, while Harney Westwood & Riegels works on funds work out of the British Virgin Islands (BVI).

As business has mushroomed, so have legal fees. With clients now more focused on the pot of gold at the end of the rainbow, they are less concerned about paying for legal services, instead taking a holistic view of the returns likely on their investment in Asia.

Will Asia's fund industry go sub-prime?
At a time when debate in Asia is raging over how large an effect the sub-prime crisis in the US will have on the region, Asia's fund industry is waiting and watching to see how the credit squeeze and a possible recession in the US might affect funds in Asia.

However, it looks as if the outlook remains rosy - for now.

"It doesn't seem to have had much effect here really," said Rory Gallaher, Deacons' partner and fund specialist. "I would have expected an adverse impact, particularly on funds that have a bond-related strategy - some, but not catastrophic. There may have been a slight draw down, but nothing that people are running scared about," he said.

Partner in charge of Sidley Austin's US-focused fund practice Effie Vasilopoulos agrees. "At the moment, sentiment here is very optimistic," she said. "No one believes there will be a market crash here, or that the contagion here will be as serious or sustained as in the US."

Offshore firms are also yet to feel adverse effects. "So far, we are not feeling any slowdown in activity, because it is still in the early stages," Appleby funds partner Judy Lee said. "If there is a slow-down in the US economy, and a slow-down in the funds industry, I think our Asia funds practice will feel it sooner or later," Lee says.

And it is this "sooner or later" point that seems to yield some consensus from fund industry pundits. Although the Asian funds engine is still running smoothly and on all cylinders, it is yet to fully feel the impact of the US economic troubles. Lawyers believe that as the sub-prime debacle continues to unfold, there could be increased effects on Asian funds, particularly of US origin and relying on US investment.

"I think the fund industry here hasn't really felt the full effect," Vasilopoulos said.

"Where it will eventually impact us is if it has a significant effect on investor sentiment in the US. If sentiment turns negative and those investors stop investing in Asian product, either temporarily or on a sustained basis, then that could affect the industry."

And this would, of course, flow on to law firms in the region. "Because we are a fund formation practice, there has to be demand for that product. If sentiment turns bearish, it will affect people wanting to set up funds in the short to medium term," she said.

It is likely the effects on the Asian funds industry will not be fully obvious for another three to six months. Funds are still in the middle of transactions that were kicked off before the sub-prime crisis reared its head, so these have been so far unscathed.

Appleby Hong Kong managing partner Frances Woo argues the future effect on Asia could be real. "I think what you will see with a lot of international fund houses that have a major base in the US, if they start feeling the crunch because of their real estate portfolios, or because the general impact on credit has a domino effect on them, then I think they may pull back. This is because if it is a head office mentality then there is only so much you can invest in Asia if your head office is suffering," she says.

Just back from a management conference in Bermuda, Woo says the first signs may already have started to appear that funds are feeling the heat. She said the firm's fund dispute resolution practice is picking up speed, an early indication out of the US.

But Asia has its own counterweight to the US credit problems - China. Most lawyers agree the growth of China, Asia's biggest draw card, will continue to attract investment to the region, and so are investing further in their China practices.

QDII update
The year 2007 has seen China's financial regulatory authorities expand the range of permissible investments that mainland financial institutions may offer to their clients to include a range of offshore equity securities. This expansion is part of the financial program in China known as the Qualified Domestic Institutional Investor (QDII) program, which promotes and regulates the movement of Chinese financial investments offshore. As of 6 July 2007, 19 banks and four insurance companies have been granted QDII licences with investment quotas totalling approximately US$14.8bn and US$5.3bn respectively. Paul, Hastings Janofsky & Walker outlines the key changes this year.

* As a result of China Banking Regulatory Commission (CBRC) Notice No. 114, issued in May this year, the investment scope for offshore wealth management services provided by mainland commercial banks in China has been expanded to include offshore equity investments, including a wide range of products and asset classes previously unavailable. However, commercial banks must meet certain requirements, and prohibitions remain on foreign investments by mainland banks in varied securities, including structured products, derivatives, hedge funds, securities rated grade BBB or below by a ratings agency, or anything high risk.
* The China Securities Regulatory Commission (CSRC) adopted rules in July permitting mainland brokerage houses and fund management firms to invest their clients' money in a wide range of overseas securities. Issued on 5 July, it permits these entities to create investment pools to invest in overseas fixed income, equity and derivative securities, including swaps, warrants, options and futures, although some restrictions remain. Three mainland fund firms have received approval.
* The China Insurance Regulatory Commission (CIRC) issued a regulation in July extending the investment spectrum for mainland insurance companies to include overseas equities (up to 15% of their assets).

Hong Kong funds industry reaches new heights
The health of Asia's funds industry is reflected in its financial centre, Hong Kong, where funds under management experienced continued rapid growth in 2006. Combined funds management business in Hong Kong recorded a 36% year-on-year increase to HK$6,154bn (US$793bn) at the end of 2006 (up from HK$4,526bn (US$583bn) in 2005), and when compared with 2004 showed a combined two-year growth of a healthy 70%.
The results from the latest Securities and Futures Commission (SFC) Fund Management Activities Survey showed that Hong Kong's close economic ties with the Mainland, its regulatory regime and a critical mass of financial talent was paying off for the jurisdiction. The SFC said the Closer Economic Partnership Arrangement with the PRC was also a breakthrough, as Mainland asset managers will broaden Hong Kong's financial intermediary base as they begin to establish and operate in Hong Kong.
The survey results came at the same time that US firm Sidley Austin represented Hong Kong-based hedge fund manager Abax Global Capital in the first globally offered hedge fund to launch in Hong Kong with investor demand exceeding US$1bn.
The launch was a highly anticipated hedge fund start-up, as the fund is the first mega-launch of the new special situations "hybrid" fund in Hong Kong. Sidley funds specialist Effie Vasilopoulos led the Sidley team on the transaction, and the US firm recently collected 'Investment Funds Law Firm of the Year' at the 2007 ALB Hong Kong Law Awards.

Singapore and Hong Kong go tit for tat on funds
The number of fund managers setting up offices in Asia of late has increased rapidly, especially from the US but also from Europe and other areas of Asia. An interesting aspect of this trend has been where they are choosing to be based, and why.

Hong Kong remains the main Asian hub for funds industry expertise, and is still the preferred option for most managers, and almost essential for those looking at investment in China. It is also the main hub when it comes to legal expertise, with most of the industry's respected fund lawyers and teams still based in the Hong Kong SAR.

However, there have been a number of sticking points. First has been the time it takes for a fund licence to be approved in Hong Kong - usually a few months. For most funds it is critical to start up quickly, rather than waste time and money on both human resources and overheads while waiting for licence approval. Also, office space is increasingly harder to find and expensive in Hong Kong's central business district. As a result, funds have been either opting for Singapore, or basing themselves there while awaiting approval.

But Rory Gallaher from Deacons said this is changing, with recent moves to overhaul the regime to create a faster process. "Licensing applications are now going through smoothly and quickly," Gallaher said. "I would say that Singapore was more attractive, until Hong Kong started to make moves in relation to the licensing system here."

In contrast to Hong Kong, Singapore's set-up time is almost immediate, and as a result it has increasingly become a competitive alternative. "I think that Singapore is going to surge - there is a definite theme around Singapore," said Effie Vasilopoulos. Recently, Singapore introduced further tax incentives directly targeted at the funds industry. With environmental concerns always an issue for the people behind the business, Singapore also has an advantage there, as Hong Kong's pollution problem puts managers off.

Singapore's general push to become a regional hub for business in Asia is also helping, and its favourable tax arrangements with India, as well as location, make it the jurisdiction of choice for India-specific funds - an increasing portion of the market. Going against Singapore is that investors are increasingly showing concern that Singapore managers are not subject to any real level of regulation, hampering transparency.