Global hedge fund firms are raising concerns over China’s proposed new regulations for the sector, arguing that these measures could significantly raise costs and undermine competitiveness in the $822 billion market, equivalent to 6 trillion yuan. The draft regulations, issued by the Asset Management Association of China (AMAC) in April, mandate that quantitative hedge funds establish risk controls and internal systems within China, separate from their offshore operations.

Unnamed sources familiar with the matter have revealed that several international companies have expressed their apprehensions to AMAC, seeking exemptions or revisions to the proposed measures. While these firms remain undisclosed, their concerns highlight the widespread unease within the industry regarding the regulatory changes. It’s important to note that these draft rules could undergo alterations based on industry feedback before being formally implemented, aligning with past practices in China. In response, AMAC, which regulates these funds in collaboration with the China Securities Regulatory Commission, has stated to Bloomberg that it will “fully absorb” industry feedback and work to optimize the rules.

This development comes amid China’s broader efforts to tighten controls on data flow, citing national security concerns, a move that has forced Wall Street banks and money managers to adapt their operations. In July, Morgan Stanley relocated more than 200 technology developers out of mainland China following increased restrictions on access to onshore data.

China’s attempt to enhance oversight of the loosely-regulated hedge fund industry adds to the challenges faced by global players. Although the overhaul is expected to benefit larger funds by reducing competition, it poses a threat to thousands of small managers as regulators aim to increase the minimum fund size threshold and cap leverage levels.

For major foreign funds operating in China, including Bridgewater Associates LP, Winton Group Ltd., Two Sigma Investments LP, and D.E. Shaw & Co., these changes could complicate their ability to leverage their global expertise and potentially lead to increased expenses. Spokespersons for these four firms have declined to comment on the matter.

Kher Sheng Lee, Asia-Pacific co-head of the Alternative Investment Management Association, a global industry group, emphasized the importance of clear guidelines for the relationships between Chinese private fund managers and their offshore parents, stressing the need for a regulatory framework that promotes transparency, fairness, and investor protection.

Currently, 38 global firms have established wholly-owned hedge fund units in China since the country eased regulations in 2016. As of December 31, these firms managed a combined 67 billion yuan, with Bridgewater leading the pack with assets exceeding 30 billion yuan. Quantitative giants Two Sigma, D.E. Shaw, and Winton each oversee more than 5 billion yuan in assets, according to available data.

While foreign-backed hedge funds have been required to make their own investment decisions and trade locally since 2016, they have relied on their parent companies’ resources for various purposes, including research and strategy development. This model has diversified risk and reduced volatility, a crucial aspect of the “core competitiveness” of these global funds operating in China, according to Shenzhen PaiPaiWang Investment & Management Co.

Some global firms have already adopted local systems or plan to increase their investments to adapt to the proposed changes. Nevertheless, mandating foreign funds to implement these adjustments is expected to drive up costs and suppress profits, as it typically takes time to accumulate assets. Currently, China’s foreign-backed hedge fund sector consists of 57 players, with over 70% of them managing less than 500 million yuan, as reported by PaiPaiWang data.

Another contentious requirement in the proposed regulations is the stipulation that quantitative hedge funds store transaction records, strategy source codes, and algorithms for at least 20 years. Critics argue that this poses risks to trade secrets, which are often maintained at the firm’s headquarters, as constantly evolving strategies require frequent code updates.

Foreign companies have also recommended scrapping a draft proposal that would impose a minimum six-month lock-up period on funds. Their argument is that this restriction could deter investor interest.

Photo Source: Google

9th October, 2023
Delino Gayweh
Serrari Financial Analyst