Setting up a mutual fund in China or India may be appealing to U.S. fund companies because of the growing affluence and high savings rates in those countries. But it is a long and multi-faceted process.
The effort typically requires a joint venture, and as a result "it involves both a corporate transaction as well as setting up a domestic fund product," said Chris Christian, a partner with Dechert, an international law firm with an investment management practice.
Complicating matters further, the Chinese government doesn't allow a U.S. manager to acquire more than 49% of a Chinese asset manager, so the U.S. manager doesn't have control over the joint venture, said Christian.
"In India and China, you need a domestic fund, which requires substantial infrastructure" said Christian. "In Hong Kong and Latin America, customers can and will buy a non-local domiciled fund."
The 49% ownership cap is an obstacle, but that entry barrier is no longer the biggest problem for overseas institutions entering China.
"The Chinese capital market has been increasingly open, and this stance has been once again enhanced in the latest nation's five-year strategic plan,'' Mike Fan, an analyst with Morningstar in Shenzhen, said.
"We do see changes especially when the new China Securities Regulatory Commission (CSRC) governor came to his role last year, the speed of new fund companies rolling out reached almost historical high in 2011 and this year."
The real difficulty, says Fan, is actually running the asset company in China.
"It is not rare hearing that overseas shareholders having conflict with local management, or that CIOs couldn't manage well and achieve good returns in the local markets," he said. "The challenge is really to find the best balance point between insisting the best practices and values in matured markets and finding a successful route in the less developed emerging markets."
American companies have actually not been the biggest foreign players in China, according to Fan.
"My guess for this would be the market in the U.S. is quite mature and big enough," Fan said. "But for the Europeans and especially the Asian companies, they need this market."
Setting up shop in India
Some fund companies that have ventured into India relatively recently have found the going a bit tough. T. Rowe Price, which bought a 26% stake in UTI Asset Management Co., a Mumbai-based investment manager, and UTI Trustee Co., which provides trustee services for mutual funds, for $142 million in early 2010, has reportedly been frustrated because it hasn't been able to agree with the other stakeholders on the appointment of a new chairman.
As a result, UTI Asset went without a top executive for close to a year, leaving the company adrift in a competitive market.
Setting up a fund in India "is not impossible or that difficult but it is not that easy either compared to [doing so in] developed markets,'' said Siddarth Shah, partner, head of the funds practice at Nishith Desai Associates, a law firm headquartered in Mumbai.
The first step is to determine the class of assets that a U.S.-based fund company wishes to target. All four categories of investments are regulated by the Securities and Exchange Board of India (SEBI), but are governed by different sets of regulations.
The four classes are: alternate assets, which include private equity and real estate and require an investment of at least 10 million rupees (or $180,000) per investor; mutual funds, which are targeted at the retail market; portfolio management, which is targeted at high net worth individuals who can invest a minimum of 2.5 million rupees (or $45,000); and collective investment schemes, which are targeted at retail investors and allow an investor to profit from sales of agricultural produce or profits from raising livestock.
The next step, according to Shah, is to set up an entity in India that will act as an asset manager. India restricts and regulates some foreign investment, but allows foreigners to set up an entity in India to carry out investment activity. However, the Indian entity needs to be capitalized to a certain level and that level is determined by the percentage of foreign ownership.
For instance, with 51% foreign ownership or less, the firm must have $500,000 in shareholder capital. For a foreign stake of between 51% and 75%, there must be $5 million in capital. If foreign ownership is above 75%, $50 million in capital is required.
"The $50 million capitalization requirement is why people generally don't set up their own entity and look at joint ventures, but there are firms that have set up wholly owned entities in India such as Franklin Templeton," Shah said.
U.S. firms scouring the market for a joint venture partner typically look for a firm that has a good understanding of the Indian market, or a strong distribution network like a bank, brokerage or loan company, Shah said.
Next a firm needs to apply to SEBI for a license. The regulator will do an audit to ensure that the firm has adequate employees and information systems.
For licenses for a mutual fund or collective investment scheme targeted at retail investors, the level of scrutiny is high. Approval can take from six to 12 months, Shah said. For a portfolio management or alternate investment fund, licensing could take three to four months.
Firms must then comply with an extensive set of regulations governing each type of investment vehicle. These include completing documents such as a key information memorandum, which includes details about the fund and its operations that must be disclosed to the investor.
The entry of foreign players into the Indian market has slowed down a bit lately.
"One big reason has been the stagnation of assets of the Indian fund industry ever since the ban on entry loads (sales loads) in August 2009," said Dhruva Raj Chatterji, an analyst with Morningstar in India. "Distribution of mutual funds has been affected, and financial advisors and intermediaries and are not finding it as lucrative to distribute mutual funds, as before."
Abolished were entry loads of 225 basis points, earmarked for paying commissions to distributors.
Now fund companies provide an upfront commission to distributors in the range of 50 bps to 100 bps for equity funds out of the funds' overall expense ratios, said Chatterji. "As a result, their margins are getting squeezed'' and distribution of mutual funds has been affected because they are less lucrative than before.