Index Futures and Equity Swaps (also known as CFDs) are products that give similar exposure to ETFs. While ETFs are not yet as widely used as the other two products, around a third of the larger firms are using them today with a significant increase in adoption over the last two years. Equity swaps can be used for purposes of hedging protection, access, “equitisation” and leverage; that most ETFs are useful only for access and “equitisation” may be limiting their adoption. However, in the US, ETFs are traded at fine spreads and can enable a better appreciation of transaction costs which may be attractive to asset managers.
Key points of the session:
- Retail investors need access to NAV-based prices for retail volumes to develop.
- Market fragmentation might initially be a threat to volumes but cross-listed ETFs could be unaffected.
- Direct market access could eventually make ETF-domicile irrelevant.
Speakers:
- Adam Sussmann [MOD] -Moderator – Head of Research, TABB Group
- David Mann [DM] – Director, iShares Capital Markets, Asia Pacific BlackRock
- Jackson Loi [JL] – Investment consultant, Towers Watson
- T.K. Yap [TY] – Executive Director, OCBC
- Frank H Lin [FL] -Head of International Business Division, Polaris Securities Investment Trust Company
In the US, retail investors make up about 50% of the ETF market. Is the Asian retail investor involved in ETFs yet?
FL – In Taiwan the retail side is responsible for around 60% of volume but tends not to hold long-term positions. Having market-makers in ETFs has promoted liquidity in the market.
TY – Most of the trades in Singapore are professional, not retail; ETFs have not yet caught on with retail investors. This is possibly due to a misconception: liquidity is viewed as being the dealt volumes whereas it really should be defined by the bid and offered volumes. Investor education for retail has been lacking.
How should one proceed that?
DM – The net asset value (NAV) of a fund is the holdings of the fund divided by the shares outstanding. An investor could note that the spread is 75 pips wide and be concerned that the spread will have to be crossed to get a fill. The reality is that there are both participating dealers (PDs) and market-makers actively pricing what they think that basket is worth; this will generally be around NAV. A PD is a bank that can effect a creation or redemption against a fund. For example, one could deliver a basket of securities to a PD and get back units of ETF. NAV-based prices from participating dealers must be got onto the screen so that retail will see that they can trade without paying an exorbitant spread.
TY –There are some issuers that choose to make sure that all trading in their issuance, even if it’s dark or primary, is shown as a print in the marketplace. Such prices are often in the middle of the bid/offer spread.
What are the challenges for proprietary firms setting up in Taiwan?
FL – In order to become a market-maker in Taiwan a securities firm first needs a subsidiary office there. Even global players lacking a physical base in Taiwan find it difficult to enter the market. In the appointment of a market-maker an asset manager will obviously prefer a PD that actively participates in the creation and redemption of ETFs on a regular basis.
Some Asian markets have tight regulations or even restrictions against short-selling. How do liquidity providers deal with that situation? Aren’t such restrictions keeping ETF spreads, under such jurisdictions, artificially wide?
FL – In Taiwan, the regulator requires asset managers to disclose their indicated NAV every 15 seconds. Investors can access the websites of these asset managers to see the indicated NAV of a fund’s underlying stocks and can, of course, compare this to the spot price. As regards short-selling, there’s no uptick rule for any stock in the Taiwan Top 50 and the Mid-Cap 100 so they can be sold.
DM – Obviously an ETF is more complicated than a simple stock but not all securities and lending desks understand that an ETF can be treated as good collateral. We see some PDs very active in ETF lending giving investors access to short-selling.
FL –And it should be noted that the lending of the stocks underlying an ETF can enhance the yield of the ETF itself.
JL – But ETFs can contain some counterparty risks, typically from securities lending, for which investors may not be adequately compensated.
DM – Counterparty exposures from how an ETF is constructed are definitely an issue; issuers work continuously to ensure investors are precisely aware of what they are buying.
What sort of impact are the changes in market structure and technology going to have on the ETF market?
TY – The more venues, the more opportunities there are for investors. But it will take time fully to understand the emerging fragmentation. In the early stages, there is a risk that fragmentation will negatively impact volumes. A lot of ETFs are cross-listed so a key thing is how much cross-trading will come through in cross-listed ETFs.
DM – I think the changes will be positive; in ETFs we frequently use the word ‘transparency’, baskets are published and NAVs are readily available online. If you can take that NAV and apply it to more sophisticated algorithms, working with, not just the market-makers but say Chi-East, we can get a closer-spread market developed.
Are ETFs cross-listed in order to satisfy the demand for ETFs across different markets? Does cross-listing have an impact on liquidity?
FL – The Taiwan market is quite closed off for listed off-shore products and it was only recently that foreign ETFs were allowed to be listed in Taiwan. The three cross-listed ETFs are HSBC’s Hang Seng H-Share and a China ETF and, launched by Polaris, the Wise CSI 300; there has been a high participation, particularly from those wanting to access the ‘China fever’ theme.
DM – Some investors will want a locally domiciled product and others won’t care whether it’s domiciled or cross-listed
Regarding overall demand for ETFs – where in the region do you see this growing the most?
JL – I think Hong Kong has a long-term advantage over China. The Chinese market is still at a very early stage and growth will be step-like as regulations change: the launches that we saw in China recently could only be traded on a closed-end fund basis, there was a lack of market-making mechanism, and the foreign exchange restrictions in China only allow monthly repatriations of capital.
TY – With direct market access (DMA), ETFs can be looked at as more of a product class, regardless of where they are listed: DMA levels the field.
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