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Exchange Traded Funds (ETF) Regulations in Asia – Now and in the Future
A key component for success in the ETF business has been the “speed to market” of new fund ideas. As market conditions evolve, issuers can launch new products at short notice to enable end-investors to access new markets or sectors.
In Asia however, due to quite stringent Regulatory control, “speed to market” can be significantly longer than in the US or Europe. Typically, a fund seeking Regulatory authorization to list and launch can take up to 6 months in Hong Kong or Singapore from idea to receiving money. Of concern to the industry, has been the restrictive approach taken on allowing non-standard ETFs to be offered. For example, when synthetic ETFs were first proposed soon after the Global Financial Crisis (GFC) in 2008, Regulators said they wanted to study the products in more detail before authorizing them. Eventually, new synthetic ETFs were allowed to be launched (some had been “grandfathered” prior to the GFC concerns arising), but the process took almost two years, but substantial additional “health warning statements” and separate identifier monikers were required.
In the last three years, there has been considerable success in South Korea and Japan, and lately in Taiwan, with Leverage/Inverse (L/I) ETFs using futures and options. These products captured the imagination of retail and active investors, who believe they can use L/I aspects to achieve excess market returns. A number of ETF managers wanted to replicate this success in Hong Kong, where it is perceived there are more sophisticated investors. The Regulators had different ideas.
In early 2016 however, after an extended period of review, both the Hong Kong SFC and the Singapore MAS, as Regulators, began to allow L/I ETFs to be listed on their domestic markets, subject of them meeting some stringent conditions. Most notable of these in Hong Kong, was that no Hong Kong or China indices are allowed to be used, which would otherwise have been the most interesting choice for end-investors.
Another potential change for ETF regulations in Asia is the prospect of opening up the exchanges for more cross-border listings. Seven or eight years ago there were a number of UCITS ETFs from Dublin and Luxembourg that had gained cross-listed status between their home market and Hong Kong and/or Singapore. Many used their umbrella format, were able to add new funds to their aggregate listing without incurring an onerous new fund application process. Following the GFC of 2007/08, most Asian Regulators discouraged cross-listing by making the process more cumbersome and time-consuming.
Now, Asian Regulators are indicating they will review again the process of cross-listing, with a view to attracting some of the biggest global ETFs. The belief is that in doing so, Asian institutional money invested into ETFs listed in New York and London, will instead place trades in Asia, during Asian time-zones.
More exciting however, is the thought that under the Stock Connect arrangements between Hong Kong and China, ETFs will be included during early 2017, thus opening for Hong Kong listed products a massive potential market to make product sales to.
One purpose for making Regulatory changes is to provide new opportunities for sales of ETFs and increase the total market. Throughout Asia (but not in Australia), sales of mutual funds and investment linked insurance products have commission payments to the distributor. As seen elsewhere, if and when a commission ban is introduced, this can provide a boost for sales of ETFs, as distributors and advisers are no longer dependent on the commission. Asia still has this to look forward to.
Many Asian investors can be notoriously short term in their investment horizon. Thus it is perceived the use of ETFs ought to appeal to them however, to date that has not proven to be the case. With the advent of L/I Products, there is a real prospect of this situation changing. Many retail investors in both Hong Kong and Singapore are familiar with the “warrants market” as a way in which to see a multiple (leveraged) return on the movement of an individual stock. The turnover of the Hong Kong and Singaporean warrants markets is very substantial, and for many, it has become a daily trade, with a lot of “round-tripping” as a result. It has been in existence for at least 35 years, is a very “retail” market, mainly of local stocks, and for some has a great deal of similarity with the bi-weekly horse racing days in both locations! But this is of course producing the level of turnover in the securities, sought by the market.
The majority of the ETF market in Asia is dominated by institutional investors, including Sovereign Wealth Funds, Pension Funds and Endowments, hedge and alternative funds, and family offices. It is estimated they account for 90% or more of market share. Yet, these same investors invest even more into ETFs outside the AsiaPac region. The top 5 or 10 funds in Hong Kong and Singapore account for more than 80% or 90% respectively of either the AUM or the ADV. This is why there is a need to attract more retail-type investors to give a better balance to the market.
Asian Securities Regulators are aware of the various issues and in some instances becoming more responsive in allowing change to occur. But they do still remain very cautious in allowing change that may increase risks for investors, which ultimately has the effect of slowing progress.
Stewart Aldcroft, Chairman, Cititrust Limited, Hong Kong
Stewart is the Chairman of Cititrust Limited (Cititrust) in Hong Kong. Also, he is the Managing Director and Senior Advisor Asia Pacific for Citi’s Investor Services business within Citi’s Markets & Securities Services, a business unit of Citi’s Institutional Clients Group. A veteran with deep knowledge of the Asia Pacific funds industry, he has been based in Hong Kong since 1985.