Prop traders switching to Hong Kong hedge funds boost industry

Viren Vaghela, Asia Risk Source: Hedge Funds Review 30 Mar 2011

Proprietary traders moving from banks to Hong Kong hedge funds have helped the industry turn a corner. A Securities and Futures Commission report indicates the industry is bouncing back in Asia.

Proprietary traders moving from banks to hedge funds in Hong Kong as well as international hedge funds setting up offices in Asia have helped the industry rebound following a sharp contraction in the aftermath of the bankruptcy of Lehman Brothers in 2008, according to market participants.

The Hong Kong Securities and Futures Commission's (SFC) recently released annual Hong Kong hedge fund survey shows assets under management (AUM) are increasing. By September 2010 hedge funds assets in Hong Kong reached $63.2 billion, up from $55.3 billion at the end of March 2009. Total AUM is still below the March 2008 peak of $90.1 billion.

"We think it is genuine growth. 2008-09 was a difficult period for the Asian hedge fund industry," said Giselle Lee, executive director at Man Investments in Hong Kong.

"The industry is now in a growth phase evidenced by two things. Firstly, lots of proprietary traders from investment banks. Some banks have eliminated these desks or they have shrunk dramatically, so lots of prop traders have set up their own shops. And lots of global funds which run Asian books have decided to open an Asian office," noted Lee.

Historically many hedge funds have been happy to trade Asia from London or New York. "Increasingly people see there is potential to leverage off local information only available from within the region," Lee added. "Seven of the top 10 equity markets by trading volume are now in Asia, which is quite surprising for a lot of people, but shows the trend."

Andrew Gordon, head of alternative investment services in Asia at BNY Mellon in Hong Kong, says he is seeing a similar picture. "In many cases you are seeing a second generation of managers leaving hedge funds and large banks to set up themselves," he says. Sultan Arif, a Singapore-based hedge fund researcher at Eurekahedge, expects further growth with more launches and asset flows. "We expect the size of the industry to reach an historical high by the end of the year," he said.

Despite some positive sentiment, however, not everyone is convinced. "Even if the numbers are technically true, the industry is not particularly upbeat about flows. It has been more upbeat since September 2008, but that's not saying much," commented Singapore-based Stephen Diggle, a founder of Vulpes Investment Management. Assets there fell rapidly between September 2008 and September 2009 and since then it has been sideways.

The most popular strategies, according to the SFC survey, were equity long/short, a traditional favourite in Asia, and multi-strategy. Acording to Eurekahedge arbitrage/fixed income gave the best return in 2010 at 13.97%. Lee at Man Investments thinks in future the most successful managers will be those seeking alpha extraction.

"In the Asian hedge fund industry during 2005-07 when markets were very bullish, there was a lot of beta chasing… as lots of funds are Asian long/short funds," Lee stated. "But really they are 100% long funds and so returns were easy. But in difficult times, as the saying goes, ‘when the tide goes out you know who is swimming naked'. So going forward, for those setting up shop or having survived the crisis, they should seek alpha extraction rather than just beta," she added.
Gordon at BNY Mellon believes that the ability to attract institutional investors coupled with performance is important. He also said this is increasingly achieved by demonstrating adequate risk management and transparency. "Several managers have gone from small to relatively large within 12-18 months due to setting up an institutional infrastructure and attracting institutional investors. For example, not just superior alpha but also operational infrastructure, procedures, management of risk and transparency," noted Gordon.

"This trend is likely to accelerate in 2011 as a number of high-profile funds folded during the first half of 2010 and a multitude of insider trading cases emerged in the latter half," continued Gordon. "Before, managers preferred to operate in a 'black box' – 'don't worry, I will manage your money and tell you what the return is'."

The results of the SFC survey highlight the importance of institutional investors to hedge funds. Pension plans, financial institutions and other investment funds comprised 53% of investors. Most investors are from the Americas and Europe, which combined represented over 60% of AUM in Asian-located funds.

The competition between funds for investors may lead to a further industry shake-up. Lee predicted that mid-sized managers may find themselves squeezed by the burdens of increased regulation to the benefit of large and boutique funds.

"After 2008 we saw some consolidation – bigger managers are getting bigger or you have niche boutique managers with a focused strategy," she commented. "These two will survive but mid-size managers (typically a few hundred million to a billion US dollars in size) will struggle as they find they are increasingly being regulated and need to add more infrastructure around their business. They will struggle in terms of these higher costs to run their business."

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Hong Kong regulator predicts continued success in attracting hedge fund managers

Author: Margie Lindsay; Source: Hedge Funds Review

With over 300 hedge fund managers and close to $70 billion in assets under management, Hong Kong is in the running to become the main centre for hedge fund management in Asia.

“More and more of what we are seeing today are not just flows of capital looking to support growth of the Chinese economy but the outcome of the outpouring of fund managers and others, and of money moving into Hong Kong looking for investment opportunities,” said Martin Wheatley, CEO of the Hong Kong’s regulator, the Securities and Futures Commission (SFC).

Hong Kong serves many purposes vis-à-vis China. Not only is it a testing ground for economic and financial innovations, it has long been a gateway to China. “Increasingly the movement of money has become a two-way flow. It is not just about money moving in one direction,” said Wheatley.

This is important for the development of the jurisdiction. As more of the world’s funds seek to increase their allocations to Asia and specifically to Hong Kong, the same is happening on the mainland where a flow of funds and expertise is coming out of mainland China.

Over the years Hong Kong has increasingly been a testing ground for economic and financial innovation from mainland China. More recently China has been experimenting with what Wheatley terms “hot and cold taps”. These are policy levers where if the market in the mainland over or under-heats, changes can be made to put things back into balance.

The cold tap is the qualified domestic institutional investor (QDII) schemes that allow money in the mainland to move out of China. A lot of this money has found its way into Hong Kong. The hot tap is the qualified foreign institutional investor (QFII), where the flow of money goes into Greater China. Both schemes have been evolving as a way of allowing mainland money to get exposure to overseas markets while allowing overseas investors to gain exposure to the mainland market.

Hedge fund managers are continuing to move into Hong Kong, attracted by the promise of access to China as well as seeing the territory as a good base to access regional markets.

“Ten years ago Hong Kong put in place a number of measures which have stood the test of the financial crisis better than the regulations of the US and Europe where there have been “huge, enormous and intrusive regulation of hedge funds”, noted Wheatley.

“There is always a problem when regulation is politicised,” he observed. “You get an odd outcome then. Regulation should be pragmatic. Regulators are really technocrats who take account of predictable outcomes. When they have to respond to political pressure, you get a different result,” commented Wheatley.

Hong Kong’s regulator has not had this problem. Because US and European Union politicians wanted a better understanding of leverage at fund level. They also want regulators to be able to intervene at the fund level if things look likely to go wrong.Hong Kong, said Wheatley, has not had to change significantly its existing rules. The regulation does not interfere at the manager level unless it is involved at the retail level.

The existing Hong Kong rules have always required the licensing of hedge fund managers if they are operating as securities businesses, confirmed Wheatley. All managers have opted for registration.

As a full member of International Organization of Securities Commissions (Iosco), the SFC envisages only minor changes to existing laws in order to carry out data collection surveys which require a set of information from hedge funds. “We are going through this data and analyzing it. I do not think additional reporting by hedge funds or more rules specifically for hedge funds will be needed in Hong Kong,” confirmed Wheatley.

One area Hong Kong may be looking at in future is the introduction of a regulatory structure to allow the formation of open-ended investment companies (Oeics). “We are looking into this and one or two other areas,” he said. For Oeics to be established, the SFC would need to look at both company law and tax regulation. “The introduction of Oeics is very complex and throws up a set of issues. We are at a relatively early stage in the process,” said Wheatley.

Meanwhile, Wheatley is happy to continue to see hedge fund managers setting up in Hong Kong using traditional Cayman Islands fund structures. “The traditional, conventional model – we’re comfortable with that. We don’t know if that will change. Our view is that if a hedge fund meets the threshold level of competency and integrity, it can set up in Hong Kong.”

The SFC’s stance on issues such as shorting coupled with its pragmatic approach to regulation will be seen by managers as two more plus points for moving to Hong Kong. It was the only jurisdiction that did not ban shorting at any time throughout the financial crisis.

Wheatley, who chairs the Iosco task force on short-selling, “hopes the outcome will be truly sensible in terms of short-selling regulations”. He believes shorting not only provides liquidity to the market but also helps ensure efficiency. He is not in favor of imposing restrictions. “The only changes we are making are along the lines of what Iosco will require,” he confirmed.

This mainly concerns position reporting.Like any hedge fund jurisdiction outside the EU, Wheatley is eyeing the repercussion of the alternative investment fund managers (AIFM) directive. “We may need to go through some processes here in Hong Kong. We have a system in place to regulate hedge fund managers and this works,” he notes.

Whatever the requirements the EU may impose on third countries, Wheatley is confident Hong Kong will be able to meet them. He confirmed the SFC is in “close dialogue” with EU regulators as well as those in the US and the UK. He expects to have a good relationship with the European Securities and Markets Authority (Esma) which comes into being in 2011.Wheatley hopes Hong Kong will become the centre for hedge fund managers and other asset management companies.

The jurisdiction is already moving in that direction, although it faces stiff competition from Singapore. Nevertheless, with the prospect of Greater China on its doorstep, Hong Kong is confident of its ability to continue to attract fund management companies and expects to continue to see yearly growth in the industry of around 20% for the next few years.

Martin Wheatley

Martin Wheatley was appointed as CEO of the Securities and Futures Commission (SFC) in Hong Kong in June 2006. His appointment expires on September 30, 2011.Wheatley is a member of the Financial Stability Board sub-committee on standards implementation, as well as the International Organization of Securities Commissions (Iosco) technical committee. Currently, Wheatley chairs the Iosco technical committee task force on short selling. Prior to joining the SAC, Wheatley was deputy chief executive of the London Stock Exchange.Wheatley was also chairman of the FTSE International and sat on the listing authority advisory committee of the UK Financial Services Authority (FSA).

Hong Kong poised to become main hedge fund centre for Asia

Author: Margie Lindsay; Source: Hedge Funds Review

Hong Kong expects hedge fund manager registrations to increase at a rate of at least 20% a year over the next few years, according to the Securities and Futures ­Commission (SFC).

The jurisdiction is fast becoming the favoured location in Asia for hedge fund managers setting up shop to exploit opportunities in the region.

Martin Wheatley, CEO of the SFC, said manager registrations by the end of October already matched the whole of 2009. The territory has over 300 fund managers operating in Hong Kong, he confirmed, speaking in an interview with Hedge Funds Review.

Wheatley said assets under management (AUM) based in the jurisdiction have grown by around 25% this year with an estimated $62 billion now handled out of Hong Kong by hedge fund managers.Most of this AUM is concentrated in what Wheatley calls “simple strategies”. Equity long/short strategies represent 45% of the AUM with convertible arbitrage, macro and event driven accounting for around 5%-10% each.

Given the crackdown on short selling in other markets over the past two years, Wheatley was not surprised managers operating in Hong Kong were more focused on equity strategies.

Hong Kong was the only financial centre that did not ban or restrict short selling in any equities during the financial crisis. Wheatley confirmed the SFC had no plans to restrict short selling in future, although it may impose reporting requirements for managers shorting over a ­certain ­percentage.

Wheatley expects AUM growth to continue in 2011 at a similar or higher rate compared with 2010. Although the jurisdiction experienced high redemptions and closures in the aftermath of the financial crisis, he expects to regain pre-crisis levels next year.

“The new money is sticker,” said Wheatley. As more institutional money flows into hedge fund strategies, Hong Kong is rapidly becoming the favoured jurisdiction for hedge fund managers with many of the world’s largest managers already operating from the territory.

Wheatley said over 60% of the funds raised and managed out of Hong Kong are sourced from abroad with the US and Europe leading the way but with Asia also accounting for a ­significant amount.

“Of the funds managed in Hong Kong, not surprisingly, more than 80% are allocated to Asian markets, particularly China but not only China,” he confirmed. “One of the aspects of fund management in Hong Kong is that you’ll see fund managers allocating to a number of markets around the region through a variety of ­strategies.”

Wheatley continued: “There have been a number of high-profile managers coming to Hong Kong recently. We have seen a huge number of hedge funds looking to establish themselves and grow their business in Hong Kong and into China and the rest of Asia.

“Today we have a record number of hedge fund managers based here. The list is very long and it is made up of funds you would look at as world leaders in other centres around the world. What we’re seeing is large, significant growth of fund‑managers.”

Although growth of AUM is still below the 2007 number, he said Hong Kong was “bouncing back very strongly. That’s the story today.”He said managers were using Hong Kong as a proxy for China and getting allocations from banks to trade directly into China as well.