The white paper, named The stars are aligning for Hong Kong’s ETF market, highlights how the market benefits from good governance and a sound legal framework.
Investors benefit from no capital gains tax, no income tax on dividends and no stamp duty tax on ETFs. From August 2020, stamp duty on purchases and sales of underlying shares for the creation and redemption of Hong Kong-listed ETFs will also be waived.
In the first quarter of 2020, on-exchange ETF trading volumes increased by 47% as markets reacted to the implication of the global spread of coronavirus, according to Euroclear.
The report says the Hong Kong Exchange aspires to be Asia’s hub for international ETF trading, yet the range of locally listed ETFs is limited.
Jackie Choy, director of exchange-traded fund research, Asia at Morningstar, said in the report that the domestic investors would struggle to build a global portfolio.
He added: “There are a lot of Chinese equity products of different kinds. In fixed income, the exposure is largely to Asian and some Chinese indices.”
An important factor for UCITS ETFs Euroclear highlights is the use of on-screen optics. The liquidity for UCITS ETFs bears little relationship to what might be shown on-screen, says the firm.
This is because market makers can trade on multiple platforms or even go back to the ETF issuers and carry out the process of creation and redemption. Therefore, an ETF is at least as liquid as the underlying assets it tracks.
Roeland Pot, managing director at Flow Traders, Hong Kong, said in the report: “A decent size on-screen to demonstrate liquidity and minimise spread is something the institutions look at even though they will be able to get competitive spreads from market-makers when trading OTC.”
In Asian markets, investment managers generally cannot invest more than 10% or 20% of the volume traded or market turnover in any one day. However, this does not mean an ETF is not tradable because it has not traded yet because the market makers can utilise the creation and redemption mechanism, says Marco Montanari, head of global product platform, APAC at DWS.
To increase on-exchange trading, the Hong Kong Exchange is introducing new measures to tighten spreads, improve visibility of liquidity and reinforce the competitiveness of the market making function. On-screen trading enables investors to better see the liquidity of an ETF and encourages more to invest, according to the exchange.
Furthermore, the exchange has also introduced a new market maker programme which commits its 25 registered ETF market makers to make continuous quotes, bringing the Hong Kong market to more international standards.
One downside for Hong Kong’s ETF market is its regulatory stance towards Europe-domiciled issuers distributing products. The report says a European ETF issuer could have to spend between six and 12 months registering its funds for retail distribution in Hong Kong and this can be a costly process.
The international issuers have to get the Securities and Futures Commission’s (SFC) approval for any minor changes to their UCITS ETFs which take several months. Euroclear says this deters asset managers because they can already be selling these products to Asian investors without the SFC’s additional oversight.
Issuers have to comply with their domestic regulators as well as the SFC to cross-list their ETFs. For this to be worthwhile, Abdelhamid Bizid, head of iShares products and global markets at BlackRock, said in the report that the Hong Kong market needs to attract more small players like wealth managers and retail investors.
The report highlights that the SFC is relaxing some of these strict hurdles for issuers trying to enter the market. International master ETFs do not need to obtain an authorisation to start trading in Hong Kong if they meet certain credentials.
These include having at least $1bn assets under management, a five-year track record and its engagement in securities financing transactions should not exceed 50% of its total net asset value unless there are comparable safeguards and disclosures.
Another issue that remains prominent for issuers is a lack of incentive for financial advisors to invest using ETFs over mutual funds. This is because retrocession – finders fees from asset managers to advisors – is still permitted in Hong Kong while it is banned in the UK, Australia and the Netherlands.
Choy concludes by saying that “retrocession is the biggest hurdle to the more widespread use of ETFs”.
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