Industry Updates

Taiwan clamps down on ETF regulatory arbitrage

Felix Xu

a city with a tall tower

  • Taiwan's fixed income ETF market has grown 900% the past 12 months

  • Insurance companies dodging foreign investment restrictions have driven the growth

  • Regulators, growing wary, are starting to clamp down

Taiwan’s regulator Financial Supervisory Commission (FSC) and the island state’s asset management industry body Securities Investment Trust and Consulting Association (STICA) have been taking steps to control the liquidity of local ETF market in the wake of excessive flows into local fixed income products.

Fixed income ETF market underwent a staggering 900% annual growth in total AUM last year to reach a record NT$400 billion (US$12.9 billion), driven by the massive inflows from local insurance companies.

Insurance capital is the major driving force in the market. More Taiwanese insurers are seeking to park their inflating insurance assets in fixed income ETFs for multiple reasons.

The ETFs allow insurers to reallocate their portfolio to bonds in a cost effective way under the current volatile market condition. Also, the yields of the ETFs’ underlying bonds are relatively high compared to equities.

Figures from the over-the-counter Gre Tai Securities Market indicate that average return of overall fixed income ETFs was about 5.12% in the first quarter this year.

Nevertheless, the major reason for insurers to invest in the ETFs is that they can use ETF for a regulation dodge, and circumvent the 45% upper overseas investment limit.

Over 97% of fixed income ETFs were controlled by local life insurers as of March. Some new fixed income ETFs are even fully invested by one or two insurers during their initial public offerings (IPO).

There were 51 fixed income ETFs listed in Taiwan as of March, while 15 top local life insurers such as Cathay Life and Fubon Life have committed over NT$500 billion in 47 of the funds.

The imbalance has raised financial regulators’ alarm with a concern that the overconcentration may lead to serious market liquidity risks.

In late March, the FSC and the SITCA launched some measures for ETF managers and market practitioners in a move to diversify the client base for their fixed income ETFs, broaden their ETF line-up, as well as improve their product liquidities.

Under the new rules, an ETF manager is not allowed to sell over 50% of its new ETF to an individual institutional investor, and the institutional holding is required to go further down from 50% to 30% in six months from the ETF IPO.

The authorities also require all ETFs should be traded through market makers to ensure sufficient market liquidity and price efficiency.

ETF managers who infringe the rules will be fined or banned from issuing such products in future, according to the authorities.

The fixed income ETF market boom has also partly reshaped the industry. Although Yuanta Securities Investment Trust Co (Yuanta SITC) remains the top in the market in terms of total ETF AUM, its leading position has been threatened by some rivals in the fixed income ETF space.

According to Taiwan’s fund website CMoney, fixed income ETF AUM of Capital Investment Trust Co and ETF manager Cathay Securities Investment Trust Co has overtaken Yuanta SITC to reach NT$142 billion and NT$138 billion as of April respectively, representing 22.7% and 22.1% market shares. Meanwhile, Yuanta SITC had NT$112.6 billion of fixed income ETF AUM, or 17.9% market share.

Despite the regulatory clampdown, the new listing activities remain very active this year. As of March, the FSC has received nine fixed income ETF listing applications from managers including Yuanta SITC, Capital SITC and CTBC Investment.

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