SHANGHAI/SINGAPORE (Reuters) -New rules for Chinese active funds unveiled this month that are set to drastically change fund flows in the country's stock markets have prompted immediate action from some of the biggest players in the industry to introduce fresh products.

China Asset Management (ChinaAMC), China Merchants Fund and E Fund Management Co said they have applied or will soon apply to launch so-called variable-fee products, where fees are tied to the performance of investments.

Variable-fee investment products - currently rare in China - more closely align the interests of fund managers with investors. Fees can rise if a fund does well and fall if it underperforms.

The new rules, which are in the words of China Securities Regulatory Commission Wu Qing, aimed at promoting Warren Buffett-style longer-term value investing, represent the biggest overhaul of China's $4.5 trillion mutual fund industry in decades.

Chinese active funds have long been criticised for chasing profits from fees and focusing on short-term investments rather than concentrating on performance and creating longer-term value.

"Previously, many mutual fund managers put their own interest ahead of investors ... contributing to irrational market fluctuations," said Dong Baozhen, chairman of Beijing-based asset manager Lingtong Shengtai.

In addition to forcing the introduction of variable-fee structures, the rules mandate big pay cuts for portfolio managers who underperform benchmarks by 10 percentage points or more in a three-year time frame.

"This would nudge a fund manager to switch to a more suitable benchmark....or build a more balanced portfolio" to avert outsized underperformance," said Yu Zhanchang, a fund manager at Penghua Fund Management.

High pay at funds and China's broader business world has been under scrutiny for some time since authorities began a crackdown in line with President Xi Jinping's "common prosperity" drive. Some fund managers began capping annual income and clawing back excessive pay last year.

Under the new rules, the success of a fund will also no longer be ranked by profit or assets under management, but by its performance and investor satisfaction.

Dong at Lingtong Shengtai said he expects the new rules "will trigger a major, directional shift in fund flows, toward index heavyweights such as banks." 

Banks accounted for 3.8% of Chinese active funds' portfolios at the end of the first quarter, far below the sector's 13.7% weighting in the CSI 300, a widely tracked benchmark。

Regulators aim to complete the reforms in three years, with changes being enforced at big companies this year.