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Build the ETF market in China and they will come

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Stock exchanges and ETF issuers in China have been encouraged to move ahead with changes that will enhance the ETF market on the mainland. Graham Bibby of Richmond Asset Management in Hong Kong has encouraged product development executives in China  to move quicker in creating a more open and diverse market for ETFs in China.

Speaking at the ETFs China 2011 conference in Shanghai, Bibby said, “The market is in Asia, and the rest of the world is looking to see what Asia can do. I disagree with the view that you should move slowly on this. You need to get the expertise in now. The key market is overseas investors. There is huge interest from overseas managers in buying local ETFs on all of these stock exchanges (in Greater China). Just because the industry is new, that is not a reason to move slowly. If you want to increase the depth of your market, why don’t you encourage the large institutions to invest in these products?

Tang Xian, head of product development at the Shanghai Stock Exchange commented: “The speed of change in China is actually very fast. We are all working to develop the market and the number of new products. We see the amount of QFIIs increasing so there will good support for ETFs.” He also mentioned that Shanghai and Shenzhen stock exchanges are working together to develop new products for launch later this year.

Fan Yue, head of fund supervision at the Shenzhen Stock Exchange said that differences between the western model for ETFs and the Chinese model have caused the market some difficulty with regards to arbitrage and the restriction on how ETFs can be utlised: : “Because we don’t have hedging tools, we need to pay more attention to market and basket movements. The best solution would be to change the environment for ETFs, which is something the exchanges are discussing.

Apart from making the market more attractive for issuers and market makers, the industry players are considering whether ETFs can be used as an underlying asset for securities lending, and whether to allow day trading of ETFs? “We don’t see that as a problem,” says Fan.

At the moment, in China ETFs represent around 1% of daily trading. In Taiwan it is even less. Julian Liu, president and CEO at Taiwanese group Polaris says ETF business has been best when markets are booming: “In a bull market, the arbitrage is especially attractive. We can use short selling too, so the asset management company has an advantage in terms of asset retention.”  In Taiwan, ETFs can also be used for securities lending.

“Investors want to know what are the benefits to using an ETF,” says Liu. “So we explain how they are a good tool for arbitrage. The premium is often 10% higher in China, so this is a way for approved entities to participate. Cross-border listing also creates a currency arbitrage. We see this in Hong Kong where the dollar peg presents a window for arbitrage, because there is one hour overlap between Hong Kong and Taiwan trading.”

Overall, Liu says Taiwanese ETF traders have suffered in the last two years because most investors want to buy individual securities. Stock futures and warrants are a particular focus.  “Investors want a comprehensive service, which would eat into our profits on the ETFs. In Taiwan and China, there are not very many issuers, so we don’t have the scale to create a viable market. We need more unique products. But education of investors is the most important thing.

“For institutional investors,  the challenge is how can we make the product more attractive to them. Otherwise it will take a long time for them to embrace the market.”

He added that the market needs to work together to create a common benchmark system.

Eric Chen, senior vice president at the Taiwan Stock Exchange agrees: “We can be optimistic for ETFs; the potential in China is huge once we can have foreign firms provide ETFs and when the QFII program is more effective. There will be A share ETFs selling in Taiwan very soon. Regulatory issues are being solved, so we hope to add 30-50 ETFs in the foreseeable future.”

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