What does the UBS and Guotai MOU mean?

This type of memorandum of understanding at once says a lot, and says nothing.

UBS Asset Management and Shanghai-based Guotai Asset Management jointly announced over the weekend that they had signed a memorandum of understanding providing a basis for UBS to explore a possible acquisition of an equity interest in Guotai.

It is not the first such MOU but it comes at a time when scepticism about foreigners successfully establishing a joint venture with a Chinese fund management company (FMC) is on the rise. This agreement is important because it affirms that this strategy is far from dead.

On the other hand, while an MOU also highlights the commitment of Guotai's management led by CEO Li Chun-ping to forge a joint venture, it doesn't really shed light on the views of the powers that really count: Guotai's five owners.

The China Securities and Regulatory Commission (CSRC) has ruled that under China's commitment to the World Trade Organization, it will allow a foreigner to acquire up to 33% of a domestic fund management company, with the stake able to 49% after two years.

But it has also said that domestic a domestic FMC's local owners can only be securities companies or investment trusts. This means a local FMC cannot create a JV with a foreigner to create a brand new company; if a foreign partner wants an equity stake, it must buy it from the existing shareholders. Foreigners dealing with local securities companies, on the other hand, can start a greenfield JV in fund management.

The height of euphoria over JVs came when the first open-ended mutual funds were launched, before the fine print of CSRC's rules was released. JF Asset Management (a unit of JPMorgan Chase) was the first to announce an MOU with its local partner, Shanghai-based Huaan Fund Management.

But the first JV has yet to materialize. Meanwhile a recent survey by PensionsAsia magazine (Summer 2002 issue) of domestic FMCs in Shenzhen found that no one took the idea of a JV involving a local fund manager seriously. This is partly because local FMCs are lucrative and the owners don't see any point in selling. It is also a matter of complexity: the CSRC, by requiring local FMCs have at least four owners, has made the job of negotiating an equity stake - under any circumstance difficult - four times as difficult.

Knowing this, it is exciting to see UBS forge ahead. But the MOU, an agreement to agree, doesn't answer the hard questions.

Fu Teh-hsiu, executive director and head of Greater China business strategy at UBS Asset Management in Hong Kong, says the firm's short-term goal is to participate in the domestic funds business, working with a good local partner to create mutual funds for the local investor. Long term, it wants to introduce the firm's global capabilities and product to China using its domestic partnership as a distribution point.

The two firms have been cooperating for nearly three years, and in September 2001 signed an investment and business cooperation agreement. UBS Global Asset Management has been training Guotai staff in matters such as investment management, portfolio construction and risk management, while Guotai has assisted UBS people in learning about the financial markets in China. UBS also provided technical assistance to help Guotai launch its first open-ended mutual fund.

So now both sides have decided to discuss moving things forward, but no promises have been made. "The MOU is not a deal but a basis for further agreement," Fu says.

This will require more interaction not just with Guotai but its shareholders: Guotai-Junan Securities, Shanghai AJ Trust Investment Company, Zhejiang Provincial ITC, Hongyuan Securities and China National Electric Power Finance.

(Guotai-Junan Securities has its own cooperation agreement with a foreign fund manager, Dresdner RCM Global Investors.)

At this point Fu declined to get into details. For example, he wasn't able to talk about whether UBS will pursue the full 33% it can acquire under WTO rules. Nor could he discuss the possibility of UBS personnel being seconded to Guotai should an equity stake be finalized. He also declined comment about the individual shareholding companies and their relationships with UBS, except to note that Guotai is run independently.

"We are comfortable working with Guotai," he says, "but this is uncharted territory. It's a new industry in China with a culture and management style that is different to ours. We and Guotai will have to find a balance between international best practice and the relevant entry point for us given the domestic financial market situation."

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