Taiwan is granting asset managers greatly expanded powers.
By Kazuhiko Shimizu
November 2000
Institutional Investor Magazine
Two caveats: The government will still be involved, and the process won't be short.
An official from Taiwan's Securities and Futures Commission was on the line: "The SFC does not think this is a good time to invest in high technology. We think it is much better to invest in traditional industry. Your application for a high-technology fund is not appropriate. Just look at the valuations. Are you going to buy 40-times-P/E technology stocks rather than five times traditional industry stocks? How can you justify that? Your application for a technology fund is not appropriate. You had better withdraw it."
Recounting the phone conversation a year later, Albert King, executive vice president of China Securities Investment Trust Corp., recalls that he put the receiver down and got ready to scrap his plans for a new technology fund.
Taking advice from a government bureaucrat (even if, in light of recent market events, it turns out to be prescient) may seem a sure road to ruin, but for fund managers in Taiwan, it's the only path. As King notes, "There is no official letter decreeing what kind of fund you can launch or what to invest in, but the government encourages you about what to do." It's best to pay attention, because you undoubtedly will need approval for something else at a later date.
Such informal government guidance is one of the main reasons that until about two years ago, just two foreign companies, Jardine Fleming Asset Management and American International Group, were operating full-fledged fund management firms on the island. In addition to governmental interference, the licensing process was interminable, investment and sales guidelines were restrictive, and anything that affected capital flows into or out of the country was likely to be forbidden.
Why then have some one dozen global money management firms piled into Taiwan, seeking expanded investment powers, setting up subsidiaries, buying local firms and arranging joint ventures? And why are Taiwanese firms merging with one another? At least by previous yardsticks, the government is giving fund managers much wider latitude in handling investments. In June the Legislative Yuan passed an amendment to current stock exchange law to enact the Discretionary Account Business Management Law. The new powers will for the first time allow local fund companies, some of them foreign owned, to manage discretionary pools of money for such institutions as listed companies, banks, insurance companies and pension funds, as well as individual investors. Previously, the firms could only sell mutual fund products. The legislation, approved by the cabinet, was enacted by the Finance Ministry in early October.
The law is the first of a number of liberalizing measures that have been under discussion. Industry executives and politicians also talk about a nationwide defined contribution plan and, much further down the road, the opening of a larger portion of Taiwan's $113 billion in foreign exchange reserves to foreign managers operating on the island. The overriding question is whether a government given to lengthy reviews and occasional interference will permit managers enough room to make the new system work and earn a profit in the foreseeable future.
"We want good foreign fund management companies to come into Taiwan," says Kung-Wha Ding, vice chairman of the SFC, who, like other Taiwanese officials, minimizes previous instances of the government's meddling with money management outfits. "They can help our local fund management industry and also help investors manage their money better." In his view, "It would be more efficient in the longer run if Taiwan's financial institutions tie up with other foreign institutions." In a bit of bureaucratic doublespeak, Ding adds, "We do not have any restrictions, but you need to apply to us if you want to launch a fund."
Few veterans of the Taiwanese markets have any illusions about the government's continuing role. But they also seem to think that the recent round of changes will have a real impact. "A lot of things going on in the government convinced us that Taiwan is serious about deregulating its market," says Douglas Naismith, senior director of institutional business at Fidelity Investment Management (HK). Fidelity, which has operated solely in a financial advisory role in Taiwan for more than a decade, is now seeking additional powers to sell funds and manage money there.
Fidelity and a growing number of major global fund managers, including Prudential Insurance Co. of the U.S., State Street Global Advisors and UBS see a very attractive marketplace in Taiwan. With GDP per capita in 1999 of $13,300, the island nation ranked behind Hong Kong ($23,500) and Singapore ($37,000) and ahead of South Korea ($8,500), the Asian countries with which it is most frequently compared. Its individual savings rate of about 26 percent is among the highest in the world. And although no official figures are kept, individual assets are estimated to total about $1.1 trillion; just $42.6 billion of that is in domestic mutual funds.
Although its per capita wealth trails that of Hong Kong and Singapore, Taiwan's population is much bigger and offers more potential for growth. "Taiwan is a wealthy country with 22 million people. Hong Kong is a wealthy market of 7 million," says Christopher Andrews, director and regional head of retail asset management for Asia Pacific SSB Citi Asset Management Group in Singapore. "Singapore is also wealthy, but has just 3 million people. Taiwan is clearly a much bigger market and represents much greater opportunity to raise assets." SSB Citi has expanded its Taiwanese presence.
With changes in the laws, foreigners will have a shot at managing more than $3.2 billion from Taiwan's four major pension funds as well as billions more from companies, financial institutions and individuals. If, as expected, 401(k)-type programs get under way, it is estimated that as much as $61 billion in new money will flow into fund coffers over the next few years.
To be sure, history argues that Taiwan's government will be slow to make these opportunities available, particularly to foreign-owned entities. Although the country has long interacted with the outside world (there were Spanish and Dutch settlements in the 17th century), much of it has been difficult, in particular the Japanese occupation that extended from the late 19th century to the end of World War II. More recent history has been dominated by threats from the mainland. Fleeing the victorious forces of Mao Tse-tung in China, Chiang Kai-shek arrived with 900,000 Kuomintang party compatriots and 600,000 soldiers between 1945 and 1949, increasing the country's population by nearly 25 percent. Chiang and his party imposed martial law, which was not lifted until 1987. The first free election for Parliament was not until 1991, and the first presidential election did not occur until 1996. During
the Kuomintang's often repressive reign, the country faced repeated military threats from the mainland and was ultimately supplanted in the United Nations by its much larger neighbor. Even its staunchest ally, the U.S., pursuing its one China policy, in 1979 recognized the mainland and downgraded the status of Taiwan accordingly. Since Hong Kong's reversion to Chinese sovereignty in 1997, China has stepped up pressure on Taiwan to reunify with the mainland.
With centuries of foreign intrusions behind it, the Taiwanese government is vigilant about protecting its economy, particularly against the sort of destabilizing capital outflows that swept all Asian nations in 1997'98. To keep control of fund flows, the government has been very deliberate about allowing offshore funds to operate in the country. It does not want too many Taiwanese dollars going to foreign-owned mutual funds investing abroad. Nor does it want huge amounts of foreign cash coming into local markets, potentially disrupting its money supply. Officially sanctioned overseas funds are estimated to total $4 billion in assets. An illicit offshore-fund business is said to thrive beyond the government's control.
"Taiwan is a small, open economy, and financial stability is the most important goal for the central bank," says George
A-Ting Chou, who runs the foreign exchange department at Taiwan's central bank, explaining the government's reticence to license offshore funds. "If we allow free capital movement, we will have volatility in our financial markets, and that will have a negative effect on the Taiwan economy."
The fear of hot money leaving the country is never far away. Says King about China Securities Investment Trust's attempt to launch an offshore fund: "The government did not want us to invest overseas because they are afraid of the impact of the Asian financial crisis and of capital flight. The central bank cares only about the stability of the forex market and does not care about the development of the mutual fund industry." Indeed, the central bank even banned local fund management companies from launching offshore funds (those raised in Taiwan and invested overseas) from mid-1997 to the end of 1999; for 2000 it set a quota of $1.9 billion.
Unhappy, local fund managers have complained to the government about the restrictions. "Why should a foreign fund management company be able to sell offshore mutual funds in Taiwan, while the government controls us by limiting what we can launch," asks Mark Duh, president of Fuh-Hwa Investment Trust Co.
THE GOVERNMENT'S CAUTIOUS APPROACH AND foreign exchange controls have also led to an extremely measured expansion of the financial services business. Long after opening its stock exchange in 1961, the government established the country's first fund management company, International Investment Trust Co., in 1985. The next year it created Kwang Hua Securities Investment & Trust Co., National Investment Trust Co. and China Securities Investment Trust Corp. In a bid to bring foreign money into the markets and gain expertise, the government required each of these trusts to have at least 20 percent ownership by foreign institutions. Then regulators waited six years before granting 11 more licenses in hopes of bringing more institutions into a stock market dominated by speculative individual investors. Today there are 38 fund management companies.
Foreign-owned firms were allowed to open so-called securities investment consulting enterprises, or SICEs, in 1987. They could offer mutual fund investment advice to individuals and institutions but could not actually sell funds. The other option is securities investment trust enterprises, or SITEs, which run more like traditional mutual fund companies. When the second round of licenses were granted in 1992, the stipulation of 20 percent foreign ownership was dropped. Of the 11 new SITEs, all but one -- Jardine Fleming -- were Taiwanese. Five years later the government approved AIG's application to open a SITE. The SITEs had to raise their money domestically and invest it domestically.
Setting up either type of enterprise is a long-term endeavor whose pace is often dictated by external events. Companies that want to open a SITE must wait a year for approval of the license and then a year or more to launch their first funds. Government regulations stipulate that the first offering of a fund management company must be a domestic equity fund, raise at least NT$3 billion ($96 million) within 45 days and attract no less than 3,000 investors.
If a fund has an overseas component, the hassles can be even worse. SICEs have to register offshore funds with the SFC, which is not easy. Given the still-fresh memories of the Asian contagion, "the government has become very restrictive about registering offshore funds in the past two to three years," says Frances Chang, who heads ABN Amro Holding's Taiwanese effort. And with Taiwan's stock market down more than 35 percent through late October, the government's fears of uninhibited fund flows are not expected to abate any time soon.
Despite the labyrinthine process and weak market, foreign firms have begun pushing into the market in the past year or so, encouraged by the reformist atmosphere. Jardine Fleming and AIG have been joined by nearly a dozen other global powerhouses. In 1999 ING Group and SSB Citi Asset Management created SITEs. This year ABN Amro, Dresdner Bank, Fidelity Investments, the U.K.'s Prudential Corp., Prudential Insurance Co. of the U.S., State Street Global Advisors and UBS either set up joint ventures or 100 percent wholly owned fund management companies, or bought into existing local fund management companies. Alliance Capital Management, Franklin Templeton and Zurich Insurance Co. plan to start similar ventures by year-end.
For those who wish to get in on the action, the domestic firms offer an attractive way to enter the market, since they already have the needed government licenses and a track record. As a result, those firms are being snapped up. "Everyone in the industry agrees that in the next two to five years more foreign fund management companies will acquire more local fund management companies, and there will be even more mergers and acquisitions among local fund management companies," says Chang, president of ABN Amro Asset Management Taiwan, the product of ABN Amro's $149 million acquisition this June of local fund manager Kwang Hua Securities Investment & Trust Co. ABN Amro outbid Allianz of Germany, UBS of Switzerland and U.S. insurer Prudential for Kwang Hua.
Yet for all the expectations, veterans of Taiwanese fund management don't expect liberalization to proceed quickly. Jardine Fleming, which arrived in 1985, waited until 1992 before getting a license to start the first foreign mutual fund management company. "We found it quite difficult to launch funds according to government policy, not by market and investor demand," says Christina Sung, who heads Jardine Fleming Taiwan. "They also do not want you to move money out of Taiwan."
China Securities Investment Trust Corp.'s outspoken King says his company waited two and a half years for approval of its second offshore fund. The process took so long that the fund name changed from Greater China Fund to Pacific Rim Fund before it was finally approved. Fidelity set up its SICE, Fidelity Investments (Taiwan), in 1986. It held off until this June, however, before establishing a 100 percent wholly owned mutual fund company, Fidelity Investments Securities Investment Trust Co., persuaded that after more than a decade the government was likely to finally move ahead with stronger compulsory pension legislation.
THE TORTUOUS REGULATORY PROCESS means that it can easily take four years for a company, starting from scratch, to launch offshore mutual funds. Thus the rush to pair up with local firms, says Chang. That way the newcomers can sidestep the registration delays and move on to producing a line of fund products and creating an investor base. "It is not a problem for foreign fund management companies like Jardine and Fidelity, which have been here for 14 or 15 years, but it is now very difficult for a newcomer to register. That is why ABN Amro decided to buy Kwang Hua, and other new foreign fund management companies are buying SITEs," says Chang.
Even that route is hardly problem-free. "It took us at least 18 months to launch the first fund after application for a license," says Mark Ko, president of ING CHB Securities Investment & Trust Co., a joint venture between ING Group and Chang Hwa Commercial Bank that was set up in early 1999. New arrival Dresdner Bank got a license to form a joint venture company (90 percent Dresdner and 10 percent local Lucky Bank) in April 1999 and started operations in March of this year. So far it has only one local equity fund and one local bond fund. "I would say it would take several years to set up a nice line of fund products," says Dieter Hellmann, vice chairman of Dresdner Asset Management (Taiwan). "We may get approval to launch two more funds this year. But we'll need another two years to launch the first overseas fund."
To date at least, the potential continues to more than offset the slow-moving process. There are various forecasts on how big the discretionary accounts for fund management companies could be, but a number of managers offer informal predictions of at least $3.2 billion immediately from four big government pension funds: the $5.1 billion Public Service Pension Fund for government workers, the $6.4 billion Labor Standards Law Pension Fund, the $14.4 billion Labor Insurance Fund and the $77 billion Postal Service Saving Fund. Of their more than $100 billion in assets, these funds ultimately will be allowed to put about $17.4 billion into the stock market.
"We will ask fund management companies to manage about 30 percent of our Public Service Pension Fund starting in January next year," says Chang Ming Ye, vice chairman of the management board of the fund, which expects to more than double in size, to $12.8 billion, by 2005. Chang says both local and foreign fund management companies will be considered, as long as they meet conditions stipulated by law.
Many of the investment firms view this initial loosening of investment constraints as a warm-up to a larger prize: a U.S.-style defined contribution plan. The government is considering introducing a standardized, defined contribution pension scheme along the lines of Hong Kong's Mandatory Providence Fund. The program, which isn't expected to gain approval for at least two years, is projected to result in a total pool of discretionary accounts of as much as $61 billion by 2004.
Like many Asian countries, Taiwan's pension program covers less than half of its workforce, because many small and midsize companies offer no benefits at all. At present, the Labor Standards Law requires employers to contribute an amount equal to between 2 and 15 percent of an employee's salary, depending on the program the employee chooses, to a special reserve account to fund retirement payments for workers. Because of lax enforcement, it is estimated that only about 2 million of the 6 million person workforce are enrolled. Government pension funds cover 600,000 people, and the rest of the rapidly aging population has no pension or other social security safety net.
The fund industry now has its eye on this market. "We have lobbied for the past three years for the introduction of discretionary accounts, and our next target is to lobby for a defined contribution pension system," said David Hsu, chairman of the Securities Investment Trust and Consulting Association.
Still a decade away is another large catch. The island's central bank has pledged to outsource more management of its $113 billion foreign exchange reserve to local fund management companies (at present 2 percent is managed by overseas firms based in London, New York and Frankfurt). The reserve, comprising liquid assets used to settle intergovernmental claims and debts and to intervene in the foreign exchange markets as needed, is the third largest in the world, behind those of Japan and China. "If local fund management companies have ability and expertise, we would like them to manage in the future," says the central bank's Chou.
The opportunities are already changing the competitive landscape in Taiwan, where foreign firms now oversee about $13.5 billion of the mutual fund industry's $42.5 billion in assets. Size and experience have become much more important. Firms with just one or two domestic funds may have a very hard time winning new discretionary business. Blair Pickerell, who set up Jardine's Taipei office 15 years ago and is now head of Jardine Fleming Asset Management in Hong Kong, notes that long-term track records will be important in persuading companies to hand over their business. As he says: "Where are the pockets of the money? They tend to be in large institutions, which are government-driven like the government pension funds." These funds are conservative and will be certain to favor the bigger players with established performance records going back several years. "It is going to be very difficult to build up funds under management on the retail side if you are the 36th guy to arrive," says Pickerell. Without a family of funds and an established distribution network, new competitors may find it hard to survive.
The same formula for success will apply to the defined contribution market, should it arrive. "You need to have a distribution arm, Internet strategy, on-line trading capability and an educational team to do it," Fidelity's Naismith says. "This is a very expensive business to get involved in from scratch, as people in Hong Kong are finding."
Even recent arrivals did not come to Taiwan with visions of big payouts anytime soon. After three years of planning, Zurich Insurance received preliminary approval from the SFC in May and plans to set up its SITE by year-end. But says Dean Chiang, who heads the company's Taiwanese business: "Foreign companies are very aggressive, and the most possible end result is that they dump a lot of money into this market. But initially, there won't be a lot of profit. In the next three to five years, the big players will not be able to make money."
These kinds of obstacles, coupled with concerns about the government's role, may keep some firms from jumping in wholeheartedly. Rex Auyeung, who oversees Asian operations at money manager Principal International (Asia) in Hong Kong, says he's inclined to wait a bit longer: "Once we see more deregulation, then maybe it will be time for Principal to go in and dig a little deeper."
The race for assets in Taiwan is more likely a marathon than a sprint. The growing pressure from Beijing is unlikely to ease the government's obsession with capital flight or end the occasional phone calls to redirect fund managers toward more appropriate investments. Says ABN Amro's Chang: "You need to build up a good relationship with the government in Taiwan." Because it's likely to be long term.
Using the Taiwanese blueprint in China
Mainland China, just 100 miles across the Taiwan Strait, is never far from the minds of the island's government officials. It also preoccupies some foreign fund managers.
With a population of 1.3 billion, China is expected to open its market to foreign fund management firms shortly after it enters the World Trade Organization, likely next year. It will allow up to 33 percent foreign equity investment in local fund companies once it becomes a WTO member. The acceptable investment limit will be increased to 49 percent in three years.
Given the underdeveloped, unruly and tightly restricted financial markets in China, foreign fund managers are treading warily. But they are treading. Jardine Fleming Asset Management, State Street Global Advisors and Schroder Investment Management are all forming technical cooperation arrangements with mainland banks and fund management companies.
A number of firms are hoping to put their experience in Taiwan to good use. Having operated for 15 years in Taiwan, Jardine Fleming has begun to reap the benefits of its prolonged stay. It has the largest customer base in Taiwan -- 334,000 at the end of July, or about a 6.9 percent share of total market funds under management. Now the second-largest firm in Taiwan based on assets under management, it is ready for a prolonged build-up in China. Jardine's senior management team in Taiwan first visited the mainland in 1995 and this year signed a technical cooperation agreement with Huaan Fund Management Co. in Shanghai. Jardine wants to form a joint venture or make an equity investment in Huaan after China's WTO entry. Many rival fund managers expect Huaan to be among the first firms to be approved to launch an open-end fund in China. "We understand not only language but cultural background and even their body language," said Christina Sung, chairman of Jardine Fleming Taiwan.
"We see China as being a long-term interest. It is just like Taiwan 15 or 16 years ago," says Blair Pickerell, who oversees Jardine Fleming Asset Management in Hong Kong.
In turn, Chinese companies and regulators have been studying the Taiwanese model for foreign participation as they put their own plan together. "We feel that we can learn a lot from Taiwan's fund management development over the past 15 years," says a senior official at the China Securities Regulatory Commission. "It is easier for us to learn from Taiwan because we share the same culture and language. However, we're also learning this new fund management business from U.S. and European fund management companies. Our industry is so young that we have to learn from the outside."
Some firms, including Fidelity Investments, are not inclined to move quite yet. "I think that it is too early," says Douglas Naismith, senior director of institutional business at Fidelity Investment Management (HK). "I say, euphemistically, that 1.3 billion people, each earning $15,000 a year, would be a very interesting market for us -- certainly, a big enough market to support every fund manager in the world." The only problem is that the average annual per capita income still hovers at about $600 per year. -- K.S.
