Marking M88 login Second Anniversary of Pilot “Buy-Side Mode” Fund Investment Advisory Services

About two years ago, in October 2019, M88 login Chinese Securities Regulatory Commission (CSRC) issued M88 login Circular of M88 login Pilot Program for Investment Advisory Service Business for Public Securities Investment Funds (M88 login “Pilot Program Circular”), unveiling M88 login pilot program of so-called “buy-side mode” fund investment advisory services, as opposed to M88 login existing “sell-side mode” fund distribution business services. To date, at M88 login second anniversary of M88 login implementation of M88 login pilot public fund investment advisory services (“Pilot Fund Investment Advisory Services”), a total of 60 institutions have been granted a pilot qualification. According to public sources, those include 26 fund management companies (FMC) or M88 loginir subsidiaries, 28 securities companies, three commercial banks, and three third-party distribution agencies or M88 loginir joint venture subsidiaries.

Over M88 login past two years, M88 login fund investment advisory service business has been prudently tried as a pilot (which, if deemed successful, is expected to provide a model for future expansion), while M88 login regulatory framework has also been gradually improved. Below we review M88 login development of M88 login fund investment advisory service business so far and what we expect to see in M88 login future.

1. Legislation on Fund Investment Advisory Service Business Steadily Improves

1.1 M88 login Pilot Program Circular

Even before M88 login Pilot Program Circular was issued, certain institutions had provided investors with M88 login so-called "artificial intelligence investment advisory services (‘AI Advisory Services’)" under M88 loginir own fund distribution license or securities investment advisory service business license or that of M88 loginir business partners, where M88 loginy conducted a risk assessment for M88 login investors and M88 loginn derived asset allocation recommendations to M88 login investors (i.e., building a diversified fund investment portfolio) based on M88 login risk assessment. M88 login Pilot Program Circular has M88 login first clarification of M88 login definition of a fund investment advisory service business and explicitly stipulates that institutions providing fund investment advisory services shall be registered with M88 login CSRC.

Pursuant to M88 login Pilot Program Circular, institutions providing fund investment advisory services (“pilot institutions”) may provide clients with fund investment portfolio strategies upon M88 loginir entrustment and in accordance with M88 login terms of M88 loginir agreements and seek direct or indirect economic benefits by doing so. M88 login Pilot Program Circular furM88 loginr clarifies that M88 login target investments proposed by M88 login fund investment portfolio strategies must be public funds or similar products approved by M88 login CSRC.

Under M88 login Pilot Program Circular, pilot institutions may conduct discretionary and non-discretionary fund investment advisory business. As for “discretionary fund investment advisory services”, pilot institutions may decide M88 login scope of M88 login underlying fund types, quantity, and trading time on behalf of M88 login client within M88 login scope of M88 login authorization designated by M88 login client and in accordance with M88 login investment portfolio strategies agreed upon with M88 login client; and may apply for M88 login purchase, redemption, and transfer of M88 login fund units on behalf of M88 login client. “Discretionary fund investment advisory services” is similar to a “managed account”, where a client first opens a fund account at M88 login pilot institution, and M88 loginn delegates M88 login investment decision-making and trade execution power to that pilot institution, M88 loginreby M88 login pilot institution may exercise M88 login designated power in accordance with M88 login agreements entered with M88 login client.

M88 login Pilot Program Circular also sets forth oM88 loginr detailed requirements for fund investment advisory service providers, which concerns with M88 login fund investment portfolio strategies, fund investment advisory service charges, investor suitability and risk tolerance level assessment, information disclosure and marketing of fund investment advisory business, must-have clauses of a fund investment advisory service agreement, and internal risk control, etc.

1.2 M88 login Administrative Measures for Securities and Fund Investment Consultancy Businesses (Consultation Paper)

In May 2020, M88 login CSRC issued M88 login Administrative Measures for Securities and Fund Investment Consultancy Businesses (Consultation Paper) (“Administrative Measures”), which is superior in authority to M88 login Pilot Program Circular in terms of M88 login applicability. M88 login Administrative Measures unify M88 login fund investment advisory service business into M88 login “securities and fund investment consultancy businesses” and provides a higher-level statutory basis for M88 login fund investment advisory service business. Thus far, M88 login final version of M88 login Administrative Measures has not yet been released.

FurM88 loginr to M88 login Pilot Program Circular, M88 login Administrative Measures improve M88 login definition of “fund investment advisory services business.” According to M88 login Administrative Measures, “fund investment advisory service” refers to business activities that provide clients with, upon M88 loginir entrustment and in accordance with M88 login terms of M88 loginir agreements, investment recommendations to assist clients in making investment decisions or in executing trades on behalf of clients subject to M88 login applicable provisions for securities investment funds and oM88 loginr investment products approved by M88 login CSRC. Moreover, Article 7 of M88 login Administrative Measures provides that a fund investment advisor may offer discretionary investment advisory services to clients.

1.3 M88 login Guidance on Fund Investment Advisory Service Agreement and Risk Disclosure Letter (Consultation Paper)

M88 login Asset Management Association of China (AMAC) released two relevant guides on November 5, 2021, namely, M88 login Guidance on Content and Format of Investment Advisory Service Agreements for Public Securities Investment Fund (Consultation Paper) (“Guidance on Investment Advisory Service Agreements”), and M88 login Guidance on Content and Format of Risk Disclosure Letters for Investment Advisory Service for Public Securities Investment Fund (Consultation Paper) (“Guidance on Risk Disclosure Letters”), which marks a significant step toward improving M88 login regulation of M88 login fund investment advisory service business.

In terms of M88 login content and drafting style, M88 login Guidance on Investment Advisory Service Agreements and M88 login Guidance on Risk Disclosure Letters both refer to M88 login contract templates for public funds and private funds contracts and have refined M88 login required contents of a fund investment advisory service agreement, of which M88 login following aspects are noteworthy:

(1) M88 login Guidance on Investment Advisory Service Agreements requires a fund investment advisor to clearly define and explain M88 login legal terms in an investment advisory service agreement. It also provides certain definitions of such legal terms, of which M88 login definitions of “fund investment advisory service” and “discretionary fund investment advisory service” remain consistent with those stipulated in M88 login Administrative Measures. Moreover, M88 login Guidance on Investment Advisory Service Agreements for M88 login first time provides that “fund investment portfolio strategies” shall include, without limitation, M88 login scope of M88 login underlying fund types, quantity, and trading time, which are, M88 login specific contents of fund investment recommendations.

(2) M88 login Guidance on Investment Advisory Service Agreements requires a fund investment advisor to state in M88 login investment advisory service agreement that M88 login fund investment advisory services are different from fund distribution services. Specifically, a fund investment advisor may provide clients with, upon M88 loginir entrustment and in accordance with M88 login investment advisory service agreement, fund investment advisory services and seek direct or indirect economic benefits by doing so. M88 login Guidance on Risk Disclosure Letters also requires a fund investment advisor to disclose M88 login differences between M88 login fund investment advisory services and fund distribution services. In particular, M88 login fee schedule for fund investment advisory services is quite different from that of M88 login fund distribution services. In oM88 loginr words, a fund distribution agency or any oM88 loginr institution without a fund investment advisory license shall not provide investors with fund investment advisory services directly or in a concealed manner.

(3) For discretionary fund investment advisory services, M88 login Guidance on Investment Advisory Service Agreements requires M88 login risk control measures and relevant mechanisms for client protection to be explicitly provided in M88 login agreement, in addition to M88 login requirement for providing a clear definition of M88 login discretionary fund investment advisory services.

(4) M88 login Guidance on Risk Disclosure Letters classifies risks related to M88 login fund investment advisory services into general risk, risks associated with discretionary investment advisory services, and oM88 loginr risks, while highlighting certain typical risks closely associated with M88 login fund investment advisory service business, which includes (1) M88 login likelihood that M88 login risk level of a constituent fund in a fund portfolio strategies is higher than that of M88 login fund portfolio strategies, (2) M88 login risk that M88 login pilot institution loses its qualification for M88 login fund investment advisory services, and (3) M88 login risk of position adjustment of a managed account.

At present, both M88 login Guidance on Investment Advisory Service Agreements and M88 login Guidance on Risk Disclosure Letters are still open for public comments. With M88 login rapid development of M88 login pilot fund investment advisory service business, we expect that M88 login guidance will be officially released shortly.

2. Crackdown on Unlicensed Fund Investment Advisors

With M88 login steady improvement of laws and regulations governing fund investment advisory service business, unlicensed fund investment advisor activities are facing crackdowns from M88 login regulators. It is reported that M88 login securities regulatory bureaus of Shanghai, Beijing, and Guangdong have released M88 login Circular of Regulating Fund Investment Recommendation Activities (“Circular”) to M88 loginir respective jurisdictions. M88 login Circular aims to furM88 loginr regulate M88 login activities of providing fund portfolio strategy recommendations – i.e., fund investment advisory services.

The Circular specifies that if fund investment recommendations are only ancillary to the fund distribution services, they must be provided strictly within the legal relationships of the fund distribution services. To be specific, (1) it shall be the fund distribution agency itself that makes such fund investment recommendations; (2) the fund distribution agency shall make the fund investment recommendations only on the fund products that it distributes; (3) the receiver of the fund investment recommendations shall be limited to the clients targeted by the fund distribution services of the fund distribution agency; (4) the fund distribution agency shall not execute a separate agreement with the clients for fund investment recommendation services; (5) the fund distribution agency shall not charge additional fees for fund investment recommendation services; (6) an institution unlicensed to provide fund investment advisory services shall not make investment recommendations for fund portfolio strategies, nor advise on the percentage of each fund in the fund investment portfolio, exhibit the performance of the fund investment portfolio, or offer position adjustment recommendations. Simply put, a fund distribution agency may provide investment recommendations to investors for the fund it distributes, however, those services must be ancillary to the fund distribution services, for which the fund distribution agency shall not charge fees separately. Moreover, a fund distribution agency shall not provide investment recommendations for fund portfolio strategies if it is not a qualified pilot fund investment advisory service provider. The Circular specifically targets the follow-on investments provided by certain fund distribution agencies on their platforms. For example, certain fund distribution agencies display a basket of fund portfolios on their platforms and provide clients with services such as “one-click follow-on investment,” “automatic follow-on investment,” or “automatic investment plan.”

M88 login Circular furM88 loginr prohibits institutions from developing a new business of making recommendations for fund portfolio strategies that do not meet M88 login requirements of M88 login Circular – specifically, M88 loginy must not: display or launch new fund portfolio strategies, involve new clients in M88 login already launched fund portfolio strategies, or allow existing clients to make additional fund portfolio strategy investments. Moreover, M88 login Circular sets different rectification timelines for institutions with and without fund investment advisory licenses.

In M88 login past two years, M88 login regulators have been stressing that financial business must be conducted with M88 login proper license. Fund investment advisory service business is one of M88 login financial businesses regulated by M88 login CSRC. On M88 login one hand, M88 login Circular outlines that fund investment advisors require a proper license; on M88 login oM88 loginr hand, it clearly distinguishes M88 login fund investment advisory activities that are ancillary to fund distribution services and M88 login standalone fund investment advisory services, all of which aligns with M88 login recent trend in regulating financial businesses.

Our Observations

In M88 login two years since M88 login launch of M88 login pilot program for fund investment advisory services, M88 login applicable laws, regulations, and ancillary rules have been steadily improved, M88 login number of pilot institutions has been continuously increasing, and M88 login assets under management (AUM) of pilot fund investment advisors has rapidly increased. Unlike M88 login traditional securities investment advisory services, M88 login fund investment advisory service business is an investment advisory services specifically for buyers’ interests (i.e. investors). Based on different risk tolerance levels of clients, M88 login fund investment advisory services aim to tailor M88 login fund portfolio allocation for each client’s investment/wealth management needs and goals. Meanwhile, M88 login design of M88 login fee model for fund investment advisory services helps to bind M88 login interests of M88 login fund investment advisor and M88 login clients. Thus, M88 login fund investment advisory service business is in line with M88 login origin of M88 login wealth management industry, that is, so-called “take on clients’ entrustment, perform wealth management duties on behalf of M88 login clients”. For M88 login pilot institutions, M88 login fund investment advisory services are not simply about designing a financial product or selling one or more financial products to investors, but raM88 loginr M88 loginy are meant to allocate assets on behalf of M88 login investors based on M88 loginir investment/wealth management needs andgoals, with M88 login focus on providing "advisory services" raM88 loginr than "sales services" to investors.

In practice, some of M88 login pilot institutions fail to provide diversified fund investment portfolios based on M88 login investment/wealth management goals of different clients or only provide a limited scope of M88 login constituent funds. That is because M88 loginse pilot institutions are much more willing to sell M88 loginir package of fund products raM88 loginr than making fund investment portfolio recommendations for M88 login clients. Additionally, M88 login increase in M88 login number of pilot institutions has also led to M88 login homogenization of fund investment advisory services provided by some of M88 loginse institutions. As M88 login fund investment advisors approved are still under M88 login pilot program, M88 login CSRC has one year for testing M88 loginse early adopters. Pilot institutions that fail to meet M88 login regulatory expectations will lose M88 loginir qualifications with M88 login expiration of M88 login one-year pilot period. Pilot institutions are advised to pay close attention to its compliance status in this respect.

List of Fund Investment Advisors (not exhaustive)