As exchange-traded funds (ETFs) steadily increase in popularity across Asia-Pacific and buck the worldwide trend to see a rise in trading in 2012, the region is ripe with potential for firms willing to innovate.
Hong Kong market poised for rash of new RMB-denominated ETFs, says BNY Mellon
Rex Wong, Managing Director within BNY Mellon’s Asia Asset Servicing business, a leading fund administrator with some US$266 billion in ETF assets under administration, discusses the outlook for ETFs and why he expects to see accelerated development of ETFs in Hong Kong, giving investors more targeted exposure to industry sectors, asset classes and investment strategies.
“The primary structural factors underpinning the growth of ETFs in Hong Kong are coming into place quickly. Foremost among them is the opening of China’s Renminbi (RMB) Qualified Foreign Institutional Investor (RQFII) to non-Chinese asset managers. The creation of RMB-denominated ETFs will accelerate as regulators allow global fund managers into the market, bringing their expertise in structuring specialty financial products.
“We expect developments on these fronts to spur the creation of a range of investment styles and options of China-focused ETFs in Hong Kong that will ultimately match the diversity of options that we see today in other ETF markets, catering to both institutional as well as retail interests.
“The most likely ETFs to emerge in the short-term are specialized equity funds, such as those comprising equities of a particular industry sector or geographic region, and fixed income ETFs. In the medium term, there is scope for a range of more exotic or niche products, such as real estate sector and commodity ETFs built around precious metals.
“The most important factor to promote more RMB-denominated ETFs is a more inclusive RQFII program. Recipients of RQFII licences have been the primary sponsors of exchange-traded products that invest directly in China’s capital markets.
“The number of RQFII licenses is highly likely to rise after the recent decision by the China Securities Regulatory Commission to extend RQFII eligibility to non-Chinese asset managers, including Hong Kong-based subsidiaries of global fund houses. Based on conversations we’ve had, we expect the fund management industry to respond to the opening of China’s securities market and give a boost to Hong Kong’s ETF industry. It’s possible, for example, that a Hong Kong unit of an American or European fund house will get RQFII credentials by year’s end.
“Another important factor driving ETF creation is the development of indices around which asset managers can structure new funds. With the recent launch of the CESC Cross Border Index Series by the China Exchanges Services Company, a joint venture between the stock exchanges in Shanghai, Shenzhen and Hong Kong financial institutions will be able to construct RMB-denominated ETFs to give investors exposure to a regional basket of equities.
“Another likely innovation is sector-based ETFs that invest in a basket of Chinese equities from a specific industry sector, such as technology or industrial companies. These would offer investors concentrated exposure to industries they believe are poised to outpace broader market growth.
Developing Hong Kong’s ETF infrastructure
“The growing sophistication of the ETF market in Hong Kong will put new demands on custody and asset servicing companies. The complexity of ETF structures and securities in which they invest will require more advanced systems for creating and tracking the value of ‘ETF baskets,’ calculating changes to the baskets based on market movements and managing the flow of securities between custodians and asset holders to make sure that the representation of each security in the basket corresponds to its weight in the index. Hong Kong’s administrators, custodians and asset servicing firms will have to grow in sophistication in order to keep pace with the demands of this new market.
ETFs beyond 2013
“While the near-term trends are encouraging for the future of RMB ETFs, the range of ETF’s tracking China’s securities markets will not reach full potential until regulators further loosen restrictions on the amount of RMB that foreign asset managers can raise and invest in the A-share market.
“Continued liberalization of RQFII program will allow greater investment into China from global financial institutions that are growing more comfortable using ETFs. This includes public and private pension plans, insurance companies, global asset managers and securities firms.
“The current level of foreign investment in China’s securities market remains extremely low by global standards. Foreign investors collectively hold approximately 1.5% of Chinese securities, compared to over 20% on average for other foreign markets. Given investors’ interest in China and the continued growth of its economy, this disparity should correct over time.”