Special Report – ETF Roundtable
IPA’s ETF Roundtable was held in Hong Kong and featured: Chee-Ping Yap - MD and Fund Services Head Asia Pacific at Citi Transaction Services Marco Montanari - Head of Passive Asset Investment, Asia Pacific at Deutsche Bank Frank Henze, MD of SPDR ETFs – Asia Pacific, State Street Global Advisors
How do you perceive that the ETF market has developed in Asia during the last 20 years?
CPY: Singapore has the most number of ETFs but they tend to be very small. Hong Kong has a handful of ETFs that have been successful but, for various reasons, there hasn’t been one stand out market in Asia. Regulators have been taking an extremely conservative approach. Also people are replicating products that are already out there.
MM: The US had its first ETF in 1996, and today its ETF market is 10 times the size of Asia. There are two key reasons. Firstly in Asia there is no common regulatory framework, whereas in Europe there are UCITS, so what happens is that for providers like ourselves it is relatively easy to, say, create an ETF in Luxembourg and cross list it throughout main European markets. That makes it much easier to increase the number of products. In Hong Kong there are 105 ETFs. In Germany there are more than 1000. Secondly, Asia has been too open to ETFs listed offshore, mainly in the US, but also in Europe. European investors never really bought ETFs that were listed elsewhere. Historically, Asian investors have been too accustomed to buying offshore and that’s delayed the growth of the market. The products that have done best in Asia are those with local underlyings, such as China A shares.
Now, the markets in Asia that have the biggest potential for ETFs are probably China and India because they are such closed markets.
FH: The ETF market in Asia has taken a very positive development in Asia since the launch of the Tracker Fund of Hong Kong (TraHK) as the first Asian ETF in 1999. We measure this by the general knowledge about ETFs by investors and by the growing market segment investing in ETFs. The TraHK was launched primarily for a retail audience which has been augmented in recent years by institutional investors, asset managers, insurance and private banks. The breadth and depth of the clients investing in ETFs has grown tremendously and is a testament to the success of ETFs in Asia.
Do you think that the new RQFII regulations in China will allow greater opportunities for ETFs and foreigners wanting to invest in those?
MM: It’s a historical moment. This opening up of the Chinese market gives a lot of opportunity to create products linked to China underlyings. We have a China product listed in Hong Kong and it proved difficult to list in Europe because of quota availability. This change will allow us to list in Europe as it is easier to satisfy demand.
CPY: In the next few years there should be much more China ETF demand coming in via Hong Kong, and we know that the supply of new products is going to increase. We have a number of clients looking into how to link such China-themed products into other investor markets.
A further new development will be to allow China and Hong Kong to cross-list ETFs and that may happen before the end of this year. That will be a gigantic milestone.
FH: The Asian ETF market is driven by events that allow ETF to advance into new segments and reach new frontiers. In that light, the introduction of RQFII regulation has grown the ETF market in Asia and the changes to the regulation will further grow the assets held in local ETFs. As far as foreign investors are concerned we believe that a significant expansion of the RQFII ETF assets will be accompanied by new client groups investing in these products, especially regional investors as well as foreign investors from Europe and the US. Access to China is a more pressing issue now than in the past and the RQFII quota expansion will help providing investors with choice in products and investment managers managing these products.
In Asia, what is the balance between institutional versus retail interest in ETFs?
MM: Our experience is that in Asia, over 80% of the ETF investors are institutions. In the US it is split 50-50 between institutional and retail.
This is because ETFs don’t pay distribution fees, and we know that to reach retail investors, you need to pay a network of distributors. In Asia we still have a commission-based system and not the kind of fee-based system as the US employs. Distributors need to be incentivised with a distribution fee and that’s not how ETFs work when used by insurance companies, hedge funds and sovereign wealth funds to implement a view in a cost efficient way.
CPY: With the exception of Japan, which also has the big securities houses like Nikko and Nomura, distribution elsewhere is dominated by banks and they lack an incentive to promote ETFs in the way of fees and commissions.
We have experimented with an advisory fee model, and are looking into that. Our pilot scheme in Taiwan was successful and we may move that into Hong Kong and Singapore this year. If the big banks start to change their model, then the local banks may change theirs’ too.
FH: The Asian ETF market started very heavily focussed on retain investors with the launch of TraHK in 1999. Since then, the vast majority in asset growth in local Asian ETFs as well as Asian asset flows into US and European ETFs has been institutional. In summary, we believe that the balance of current ETF asset originating out of Asia are heavily skewed towards institutional investors which include asset managers, insurance and private bank clients.
Do investors feel less attached and less emotional though to an ETF (than they might about a gold bar under their bed)?
That’s a philosophical question. I’ve never seen a study that concludes firmly that an ETF makes the markets more volatile as a result of that mentality. If you are to blame an ETF for market volatility, it is no more than you can for other funds, futures and swaps.
CPY: In Asian markets, regulators tend not to be comfortable about futures within ETF’s, so that means that the only commodity which seems to work here is gold. So there is a lack of diversification. We are working with the Hong Kong regulator to get them to approve a futures based ETF. If allowed to do that, then you will see more commodity ETFs, more inflation-related products, food ETFs and so on.
MM: ETF’s manage only 10% of the global assets compared to those managed by funds. At the end of the day, ETFs are of course funds as well, but they are listed. So I ask myself why there is so much attention paid to ETFs and less for other funds. An ETF has a continuous listing, it invests throughout the trading day, and that may actually help to smooth out volatility.
What other new products do you foresee?
CPY: A lot more fixed income products, perhaps focusing on the exotic currencies, such as the RMB. There should be more access products for China and India, more broader-based commodity strategies, such as copper, silver and other metals. I see demand for those products in China, if listed in Hong Kong.
Real estate could be structured into an ETF, perhaps by investing into REITS. Can direct property be creatively factored in? It’s still early dates for that.
MM: It depends if you can trade and hedge the underlying in real time. We already see some of these innovative products in Europe, but only a few banks can handle them.
I agree fixed income is the next step. Until now Asian bonds have not been as liquid as bonds elsewhere. Now that is changing. Asian bond funds have already been successful, and more Asian countries have been receiving investment grade ratings for their bonds. All this helps with regulatory issues. Asian fixed income should appeal to investors globally.
FH: The ETF market asset in Asia is heavily driven by national exchange benchmarks like the HSI in Hong Kong, Topix and Nikkei 225 in Japan, CSI 300 in China, etc. as they offer better opportunities to build liquidity in these ETFs. This is mainly a function of greater availability of trading tools on these indices and index arbitrage opportunities between the various instruments (e.g. between funds and futures). As the market matures, we expect asset allocation tools to come to market. Currently, these ETFs are mainly bought in the US and with greater local buying of ETFs we believe that locally domiciled ETF used for asset allocation will become more popular.
What has hindered the progress of ETFs in Asia, and what problems still remain to be overcome in future?
MM: The problems are the lack of common regulation, the fact that Asian investors still buy ETFs offshore. There is a strong local bias due to familiarity. Ninety-nine percent of ETF volumes in Hong Kong are linked to either Chinese or Hong Kong underlyings.
CPY: There’re a lot of regulators in the region still taking a very conservative view – on subjects such as futures ETFs, products that have been around elsewhere for a long time. Korea has approved a few of them, but not in either Hong Kong or Singapore.
The second challenge is getting retail to participate. After Lehman’s failure and its effect on Lehman structured products, retail investors like to use the big banks as a middleman, and so it will be difficult for ETFs until the banks are more willing to promote them.
We recently engaged a University in Hong Kong to send a small group of students to approach various banks across Hong Kong for market research purposes. Ninety-nine percent of them said that the banks actively sought to push them away from ETF investment. They recommended mutual funds instead.
MM: People sometimes say that ETFs aren’t liquid because they don’t trade a lot. This is a big misconception, because actually, the liquidity doesn’t depend on how much the ETF trades, but on the liquidity of the underlying assets.
CPY: For the banks’ attitude to change, the business model has to change. Right now, they say ETFs are risky, and those younger investors we talked about should not invest in risky products. Other banks decline to provide help on ETFs as they say that branch staff don’t have the Type 4 SFC securities advisory licenses, and that is in fact a valid point. To employ an advisory model, staff skills would need to be upgraded to provide advice. Till then it is difficult. Citi has introduced a pilot advisory scheme in Taiwan whereby the advisory team is kept separate from the mutual fund team. The next challenge is to replicate that in Hong Kong and Singapore.
FH: The Asian ETF market has been hindered by a couple of factors when compared to larger markets like the US or Europe. The main aspects are currencies and regulation fragment the markets into national markets, limiting scale and drive costs. Other aspects are the traditionally lower exchange volumes in Asia and the availability of trading tools for arbitrage and hedging which have so far not allowed the ETF market to branch out into asset classes which are more difficult to hedge and trade. The third factor is that ETFs are currently only used for a subset of applications ETFs can be used for. We undertook a study last year which showed that ETFs are primarily used in asset allocation and that flow applications like cash equitisation or the building of liquidity sleeves are not yet as popular than elsewhere. Lastly, particularly in the US a thriving fee for service financial advisor market has driven the uptake of ETFs in the retail space. As Asian retail distribution of financial products is dominated by banks and includes high product commission, the retail space has not grown like in other markets.
What positive features will drive ETFs in Asia?
MM: The launch of products that because of know-how and liquidity, will be hard to implement elsewhere. For example, China A shares, Asian fixed income, RMB-linked products. These products are much better listed in Asia, and done by Asian institutions because of their knowledge.
CPY: A greater convergence of Asian markets, although that may be somewhat wishful thinking, we won’t have that UCITS style structure, the regulators all maintain their own different ways. There are signs that linkages are being created, such as between China Hong Kong and Taiwan, and one hopes ETFs may be one of the first products with cross-recognition between them.
Thailand also now allows feeder structures into Hong Kong ETFs. So there is a linkage there. There are gleams of these links being forged, but there are separate approaches. I say continue with those different approaches and regulations, but still find ways to link up and make ETFs accessible, perhaps via cross-listing.
MM: ETFs being passive, have to be cheap, so you need economies of scale. You can’t afford 20 different platforms, cross listings, and feeders are great ways of bringing products in. In Indonesia, you can’t cross list, or use a master feeder. But it is too expensive though to create local fund management company each time. People use ETFs in Hong Kong as 80% of the time they are UCITS. It is easy for a manager to have their platform in one place like Luxembourg or Ireland and sell everywhere.
CPY: It’s still early days for that connectivity. I visit Asian countries to talk about ETF development. It takes a lot of effort for a stock exchange to go beyond its local underlying stocks. They all seem to want to start with a nationalistic product containing their own stocks. Of course, investors there can buy their own chosen stocks.
MM: A local product, dealing in local stocks would be for just domestic investors. A foreign investor wouldn’t use it as a product. An American investor would not be allowed to invest in an offshore ETF, it would need to be approved by the SEC. It is also difficult for a European investor if it is not UCITS, also the clearing systems are not connected.
CPY: In Thailand, investors lost interest in the ETF, so the authorities realised that to revive the market they had to introduce something that investors could not buy- hence the feeder structure into gold, Chinese stocks – and that created a fair bit of success.
Indonesia was the first country to launch an ETF seven years ago, and it still has just the one ETF product.
MM: Philippines won’t allow a master feeder, and yet allowing master feeders and cross-listing is in local investor interest. It makes it cheaper and quicker for the investor. It has been tested elsewhere, so there is lower operational risk.
FH: Asia has a tremendous financial future. Asset pools are developing fast across the region, parts of the financial service industry are developing fast, e.g. wealth industry, financial solutions are increasingly required for the regions pension provision and changes from active to greater acceptance of passive investment tools are all driving the ETF business in Asia. We believe that significant growth in the ETF market in Asia still lies ahead and that positive regulatory changes will further deliver substantial growth for ETFs in Asia, particularly as they are low cost and transparent products.