Global Hedge Funds Push Back Against China Draft Rules

Some global hedge fund firms are pushing back against China’s proposed new rules for the sector, saying the measures will increase costs and erode competitiveness in the 6 trillion yuan ($822 billion) market.

(Bloomberg) — Some global hedge fund firms are pushing back against China’s proposed new rules for the sector, saying the measures will increase costs and erode competitiveness in the 6 trillion yuan ($822 billion) market.

The draft regulations by the Asset Management Association of China, released in April, require that quantitative hedge funds set up risk controls and other internal systems in China, separate from their offshore operations.

Some international companies have expressed their concerns to AMAC, seeking exemptions or revisions to the measures, according to people familiar with the matter who declined to be identified discussing private communications. They didn’t name the firms seeking changes.

The draft rules could be changed based on sector feedback before being implemented, based on past practices in China. AMAC, which self-regulates these funds under the guidance of the China Securities Regulatory Commission, said in a reply to Bloomberg that it will “fully absorb” the industry responses and optimize the rules.

The new measures come amid a wider push by China to restrict the flow of data over national security concerns, forcing Wall Street banks and money managers to adapt their operations. Morgan Stanley shifted more than 200 technology developers out of mainland China after the country tightened access to troves of data stored onshore, Bloomberg News reported in July.

Read more: Morgan Stanley Moves 200 Tech Experts From China on Data Law 

China’s bid to enhance scrutiny of the loosely-regulated hedge fund industry adds to challenges facing global players, even as the overhaul is expected to benefit bigger funds by reducing competition. Thousands of small managers face closure as regulators seek to raise the minimum fund-size threshold and cap leverage levels.

For the largest foreign funds in China, including Bridgewater Associates LP, Winton Group Ltd., Two Sigma Investments LP and D.E. Shaw & Co., the changes would make it harder for them to leverage their global expertise and may drive up expenses. Representatives for the four firms declined to comment. 

“Some Chinese private fund managers have offshore parents, and we believe clear guidelines for these relationships are essential for ensuring a level playing field and protecting the interests of investors,” said Kher Sheng Lee, Asia-Pacific co-head of the Alternative Investment Management Association, a global industry group. “We look forward to working with the AMAC to develop a regulatory framework that promotes transparency, fairness, and investor protection.”

Some 38 global firms have set up wholly-owned hedge fund units in China after the nation eased rules in 2016. They managed a combined 67 billion yuan as of Dec. 31, led by Bridgewater, which has boosted assets to more than 30 billion yuan. Quant giants Two Sigma, D.E. Shaw and Winton each run more than 5 billion yuan, according to the data. 

Read more: Bridgewater Widens Lead in China Race as Returns Outclass Rivals

While all foreign-backed hedge funds have been required since 2016 to make their own investment decisions and trade locally, they’ve also tapped their parent companies’ resources in other areas, including research and strategy. The foreign models often differ from local offerings, helping diversify risk and reducing volatility. This is the “core competitiveness” of these global funds in China, Shenzhen PaiPaiWang Investment & Management Co. said in a report.   

Two Sigma, for example, has more than doubled the number of underlying models for its flagship China onshore fund, which in July posted the biggest monthly gain since its inception in 2020, Bloomberg reported in August.

Read more: Two Sigma China Fund Surges in July as Quant Firm Taps Investors

While some global firms already have local systems or plan to spend more to adapt, requiring foreign funds to make these changes will push up costs and suppress profits, since it takes time to gather assets. China’s foreign-backed hedge fund sector has 57 players, with more than 70% of them managing less than 500 million yuan, according to PaiPaiWang data.

Another proposed requirement — that quants store transaction records, strategy source codes and algorithms for at least 20 years — poses risks to these firms’ trade secrets that are often kept at headquarters. Storing every source code is costly because these strategies are upgraded constantly and the codes keep changing, according to a local firm that declined to be identified. 

Foreign companies also recommend scrapping a draft proposal to impose a minimum six-month lock-up period on funds, arguing it would curb investor interest, the people said.

“Fund managers should have the flexibility to set lock-up periods that are appropriate for the underlying investments and the needs of their investors,” Lee said.

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