A new perspective on Taiwan's real money and its role towards a healthier and sustainable financial system

Taiwan's Onshore Fund Market's Asset Under Management: US$178.8bn

(March 2022)

ETF boom on domestic lifers' investments

Taiwan's onshore mutual funds aggregate asset under management was $178.8bn at end-Mar 2022. The volume of growth has increased substantially in 2019 with a whopping 56% yoy growth from the previous year, driven by domestic life insurances' direct investment. This is followed by 13% and 10% year-on-year increases in 2020 and 2021, respectively. This investment strategy of life insurers to increase position in funds is driven by structural issues. Life insurers were inevitably forced to increase their assets in ETFs and mutual funds, on high risk capital charge of equities, as well as, over concentration of its investments in financial bonds and Formosa bonds. Formosa bonds are foreign currency denominated debt raised in Taiwan; alternatively, they are also called international bonds.

There is high concentration of assets in Formosa Bonds, as well as, ETFs which may be of concern, albeit moderating.

In Taiwan, asset or fund managers are called "Securities Investment Trust Enterprise or SITE." To date, there are 39 SITEs.

Onshore SITEs by Market Share

Yuanta | Cathay | Capital | Fubon | Fuh Hwa

Domestic players dominate Taiwan onshore funds market

These top 5 players comprised 50% of the total onshore AUM and are the industry leaders in offering diversified and competitive product offerings. These are Yuanta ($28.7bn, 16% market share), Cathay ($19.4bn, 10.8%), Capital ($15.3bn, 8.6%), Fubon ($14.2bn, 7.9%) and Fuh Hwa ($12.0bn, 6.7%). The quality and sophistication of their product offerings are at par with global fund managers, such as BlackRock, Value Partners, among others.

Change of hands in mid-tier fund managers; FHC-backed fund managers benefit from the synergy with the group

While the top players have basically remained market leading position, evident shakeup of market position in the mid-tier levels can be seen from 2017-2018. SITE players who were able to capture the growth and demand in ETF had seen tremendous increase in their market share. These were KGI, CTBC and Shin Kong; these SITEs also benefitted greatly from the cross-sell synergies with their financial holding group parents.

Bespoke? Discretionary fund mandate? Initial Public Offering?

Tailoring of funds for life insurance companies were also another key success factor for the increase in AUM. Note that some of the "bespoke" funds do not qualify as discretionary fund mandates, as they are issued as a normal mutual funds or ETF offering of the SITE. Key difference between these are the signing of investment management agreement or IMA between the SITE and the life insurance company/corporate (private fund or discretionary fund mandate, "DFM") vs. issued for either retail or institutional clients through initial public offering (public fund).

Overheating of exchange traded funds and a regulatory pause button

The regulators were concerned on the overheating of the ETF market and started to clamp down new issuances. FSC required asset managers to issue new active funds and alternate it with ETFs to diversify the product offerings of the market. Other times, FSC was not keen on approving new ETFs and was proactive in its identification of significant single client concentration of these passive funds. These passive funds normally are dominated by at least 1 or 2 life insurers, which made the fund large, but are also prone to redemption/liquidity issue. This was regulated through having single client concentration of about 30%, to limit risks arising from redemptions.

Global asset managers' varying strategy and potential exits

Subsidiaries of global fund managers such as AllianceBernstein, Allianz, Neuberger, Invesco, etc. have employed several strategies, often niche strategies to capture fund flow. Meanwhile, Aberdeen and Blackrock are two of the SITEs that might be considering to exit the Taiwan market, given their small AUM and market share. Two SITEs had exited from the market - Ontario and BNP.

Typical fund strategy and restrictions

Most funds are allowed to borrow for redemptions, though with a certain cap as disclosed in the prospectus of the fund. Borrowing to leverage or gear up the fund is not allowed. Typically, funds are well diversified with single name concentration capped at 10% for corporates and up to 30% for sovereigns.

Increasing complexity of funds

Taiwan's real money continues to be vibrant with increasing complexity in its product offerings in recent years. Product offerings have diversified from typical money market funds, equity/fixed income balanced funds to REITs, Principal Protected, ETFs and leveraged/inverse funds.

See charts below one over a time series and the other current composition as of March 2022.

Fund types of Taiwan real money

Below shows current composition of Taiwan real money as of March 2022. ETF comprised majority of fund type at 45.3% of total onshore AUM, followed by equities (16.8%), money market (16.3%) and fixed income funds (11.0%). REITs and principal protected funds are growing in popularity and can provide both retail and institutional investors with diversity in their portfolios.

Characteristics of Taiwan's ETFs

In terms of ETF, there is significant concentration in Formosa Bond-related investments at 26.3% of total onshore AUM. Given structure of Taiwan's Formosa Bond, there is risk of early recall of these bonds and thus, reinvestment risk normally at 5 year or 10 year of the underlying bonds' option to call.

Redemption risk from single fund subscriber

Aside from reinvestment risk from Formosa bond, the industry's sizeable investment in the domestic stock market also poses under a scenario where the global economy moderates. Furthermore, disruption in the tech supply chain and lack of ability of Taiwan corporates to service the tech demand can also be a negative for the funds' industry, in general, as these can prompt redemption by life insurance companies, foreign institutional investors and equity-investment savvy retail investors. That said, these are moderated by better-than-expected economic growth of Taiwan, relatively low/stable commodities prices, current account surplus and low unemployment rate. These macroeconomic indicators can be early warnings signs on significant redemptions or withdrawals in Taiwan markets' financial system.

Potential Opportunities from a Bank Perspective

With sizeable onshore industry AUM, there are also potential opportunities for both domestic and global banks in FX and custodian space.

Capturing FX swaps and hedging market

In FX space, active funds comprised 55% of total AUM. Normally, these funds will have one to three FX banks to trade spot, forward or swaps. Assuming active funds hedge about 50-70% of their FX positions and excluding domestic funds, the total FX market of the funds will be at 28.5% of total AUM.

In terms of dollar amount, this is about $25-36bn business of swaps and spot/forward. Swap points vary on the market condition and can produce recurring revenues if swaps are to be rolled-over.

The Catch - custodian cross-sell is critical.

There is a catch. To be able to capture such juicy market share in FX, one has to be the master custodian bank of the fund. Funds with smaller fund size (i.e. <$50MM) will definitely only trade FX with the bank's master custodian and to certain extent global custodian. Being a master custodian at the onset provides first move advantage for the bank.

Caveat! These terms Master Custodian and Global Custodian must be understood clearly as they are NOT interchangeable in Taiwan market.

Master custodian and its fiduciary duties

Master Custodian in Taiwan has fiduciary duties and will need to indemnify the fund of any losses arising from the operational risks of the bank's day-to-day settlement and operations. The Master Custodian can appoint a global custodian and outsource the capabilities on overseas markets, which most master custodians don't have license. Should there be issues on the services of the global custodian, the master custodian is required to indemnify the fund of losses. Thus, from an operational perspective, higher risk capital charge will need to be set aside for banks acting as Master Custodian for funds.

To offset such risk, Master Custodian often receives a higher portion of the custodian fees and has a larger bargaining power in designating the global custodian and fees negotiation. Fees of Master Custodian typically range from 15-25bps.

Outsourcing? Disadvantaged and subordinated position of global custodians

Global Custodians were at a disadvantage with pricing in the recent ETF boom. Fees were as low as 1-2bps for ETF funds, given highly competitive market and large size of ETFs. However, due to the clamp down on ETFs, ETFs have had low net asset value and resulted in negative returns. Thus, employing a Global Custodian strategy only may not be a sustainable business model in the long run.

Path forward - Development of REITs, MBS in Taiwan Market

My opinion is that the underdevelopment of Taiwan's REITs and MBS market is the reason for the inefficiencies in the market's absorption of liquidity. If these structured finance and credit securitizations can be developed in Taiwan, I expect a trickle down in wealth accumulation of common people and will lead to a better and sustainable financial system overall.

Furthermore, this can lead to deepening of the primary and derivatives market, such as the development of CMBS and CMBX products which can be very helpful in Taiwan's case. The market has a large mortgage exposure, however, these have high single name concentration. The risk of default can be further mitigated through securitization of these mortgages.

Learning from past experiences of the Global Financial Crisis, we are now able to appropriately capture the risks involved with issuing and underwriting CDOs and MBS. Global banks have the product knowledge and risk expertise and capabilities in these areas and can certainly add depth and breadth to existing financial products being offered in Taiwan's financial market.

Of course, regulatory discussions must be held and local banks, lifers and asset managers must be equipped with such capabilities as well. This is a very exciting new chapter for the financial industry and structured credit/finance in the next 3-5 years.

Hopefully, this wealth accumulation through property is trickled down to the common people and that the financial system is able to be more socially inclusive in its middle-class development whilst narrowing the gap between the rich and the poor.

#sustainablefinancing #taiwanfunds #taiwanassetmanagement #realmoney #REITs #structuredcredit

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Useful References:

Please find link here for relevant regulations on SITEs.

Thank you!