China’s Wealth Management Connect — an investment initiative connecting mainland China to Hong Kong, and viewed by many as a liberalisation of China’s strict capital controls — attracted a surge of inflows into high-interest-rate deposits earlier this year. These flows from China came after regulators broadened the range of products that could be offered, following years of underwhelming take-up of the Connect initiative.
However, the programme has begun to lose momentum again, as the US Federal Reserve embarks on a cycle of interest rate cuts — causing market participants to urge a further relaxation of the rules, to boost its appeal.
Launched in 2021 as a pilot scheme, Wealth Management Connect allows residents of Hong Kong, Macau, and nine cities in the southern Guangdong province — a population of more than 86mn — to invest directly in wealth management products across borders.
It is an addition to existing schemes that connect bond and equity markets in Hong Kong and the mainland, and was aimed at helping large numbers of mainland Chinese investors to build up more global asset exposures. Typically, mainland investors are subject to strict quota controls governing the movement of funds in or out of the country.
For the first few years, the response to the scheme was slow, according to banks and industry insiders. Therefore, in February, regulators rolled out an enhanced version called Wealth Management Connect 2.0, which tripled individual investor quotas: from Rmb1mn ($142,000) to Rmb3mn ($427,000), and expanded the range of offerings to mutual funds and deposits.
It had a marked effect. The southbound flow of funds — ie, mainland Chinese investors’ inflows into the scheme — reached more than Rmb68bn ($9.7bn) between March and July this year, according to official data, which is more than 4.5 times the total southbound flow from the launch of the scheme in 2021 up to the end of February this year.
These enhancements to Wealth Management Connect also supercharged the proportion of the southbound flow limit — which is Rmb150bn at any given time — actually used by investors: it rose from less than 2 per cent to about 10 per cent after the changes were made. But interest in northbound investments — where Hong Kong and overseas investors are allowed to buy mainland products — remained lacklustre.
Bank of China (Hong Kong), the territory’s leading player in scheme — which now makes more than 350 financial products available via the southbound scheme — says client numbers have surged by more than 50 per cent in the first half of this year
Joyce Leung, assistant general manager of the bank’s personal digital banking product department, believes the enhanced measures are having a positive impact: the bank has found that the proportion of fund transactions with value over Rmb1mn via the southbound scheme has increased.
At China Asset Management, one of the leading Chinese mutual fund houses, investors have shown significant interest in offerings ranging from multi-currency money market funds to bond funds, equity funds, and exchange traded funds, according to the company.
However, while China initially aimed to open up cross border investment channels, market participants highlight the growth limitations of the Wealth Management Connect scheme — for example, its over-reliance on foreign currency denominated deposits.
“That tells you two things,” explains Ajay Mathur, head of the consumer banking group and wealth management at DBS Bank Hong Kong. “First, it’s clearly driven by rate arbitrage, and second, there’s a lack of active investment advice.”
Mathur warns that this reliance on arbitrage opportunities is unsustainable because they only last for a short period of time. “Now, with the [interest] rates coming down, and with the Fed rate changes . . . the arbitrage might drop,” he says.
A drop in rate arbitrage transactions could push investors into other solutions, though. For example, they may seek bonds or multi asset products after their current fixed-term deposits mature, suggests Freeman Tsang, head of Intermediaries at Asia ex-Japan of Pictet Asset Management.
“In the short run, you won’t see too much of the flows to go back into [rate arbitrage],” he says. “But what we do see is that, if the interest rate continues to come down to a certain level, people will start to think about diversification into other investments to achieve their expected returns.” It will, however, take time for that to mature into reality, Tsang adds.
Restrictions on the way banks can sell products through their branches still draw criticism, however, as they limit active marketing and the provision of active investment advice to clients in mainland China.
Standard Chartered, one of the participating banks in the Wealth Management Connect scheme, says that while many Greater Bay Area clients are interested in the products on offer — with a lot of them keen on overseas investment funds — a substantial number lack knowledge of overseas markets.
“A typical investment portfolio structuring involves a two-way conversation,” stresses Mathur. “The current restrictions prevent banks from interacting proactively, which is why most of the funds end up in deposits.”
Nevertheless, there is optimism about the program’s future. A further increase in inflows could be triggered by the forthcoming expansion of distributors — a group of at least five to six Chinese securities firms with presence in Hong Kong that have a wider client profile and will be better able to identify suitable clients for *investment products*, according to Tsang.
“I hope they can continue to expand into bigger cities like Shanghai and Beijing,” he says. “We always want to tap into the bigger cities and we do see demand from them. Having said that, there’s a lot more work to be done.”
Authorities have been considering further relaxations for a possible Wealth Connect 3.0. A Hong Kong government spokesperson says local officials and regulators have been in close communication with the industry and China’s regulatory authorities on the implementation of the wealth link.
The spokesperson adds that it would “continue to work with the industry to step up investor education in the Greater Bay Area . . . so as to enhance investors’ knowledge” and explore further enhancement measures to increase investors’ choices.
Industry leaders are in favour. Speaking at a Bloomberg event in June, senior executives from UBS and HSBC called for deeper ties between Hong Kong and mainland China to meet the evolving needs of private banking clients.
China’s macroeconomic slowdown could lead to more “people to consider moving money out”, warns Mathur, “and that is where it gets difficult . . . [In terms of] how the regulator perceives the Wealth Connect.”
But, importantly, the Wealth Management Connect scheme operates as a so-called “closed-loop” system — meaning the scheme will not allow investors to eventually move cash out of China to other countries.
“If money comes into Hong Kong, the pipe at Hong Kong does not open and does not allow money to suddenly move to Japan, America, Switzerland, or into different products than what it was intended to cover,” points out Mathur. “From a capital control point of view, there is much less fear that money is going to exit the country.”
“Open up it will — it’s not a matter of ‘if’, it’s a question of ‘when’,” he says. “With each incremental enhancement, you will see an opening up of the sales process, [of] the product suites . . . of marketing rules and marketing processes — these are [the] things that play a [big] part.”
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