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Asset Management / Wealth Management
Gearing up for ETF connect
Although it is not yet known whether only locally-domiciled ETFs will be allowed to participate in the ETF Connect, many fund managers are playing it safe by domiciling products in Hong Kong
Bayani S Cruz 18 Apr 2018

TO further open up its exchange-traded funds (ETFs) market to the world, China is looking to launch an ETF trading link with Hong Kong. The strong growth in the volume of these financial products, and the success of cross-border access schemes between the mainland and Hong Kong, particularly the Stock Connect, have added to the excitement around ETF Connect – a proposed cross-border scheme exclusively for ETFs.

While, the China Securities Regulatory Commission (CSRC) has given no indication as to how the ETF Connect will look like in terms of structure and products, the general expectation is that the ETF Connect will be launched in the second half of this year.

There are suggestions, particularly from the Hong Kong Investment Funds Association (HKIFA), the powerful lobby group for the fund management industry, that the ETF Connect should follow the Stock Connect model.

If this happens, it would mean that the ETF Connect would have no limits on the purchase of ETFs although the total trading volume may be subject to a daily quota. Under the HKIFA proposal, the quota for the ETF Connect should also be separate from the aggregated quota of the Stock Connect.

In any case, the only thing that is clear so far is that the ETF Connect will allow investors in Hong Kong to access Shanghai and Shenzhen-listed ETFs, and mainland investors can trade Hong Kong ETFs.

For ETF providers, the impending launch of the ETF Connect means they have to be ready with their products as soon as the cross-border access scheme is launched.

In Hong Kong, one particular issue is whether the ETF Connect will require only locally domiciled or Hong Kong-listed ETFs to qualify for the scheme. Although this issue is not yet resolved ETF providers, particularly the offshore fund managers, are already thinking of preparing their products so they will be ready the moment the ETF Connect is launched.

As of April 13 2018, there are 107 ETFs listed in the Hong Kong Exchange. There are also 27 leveraged and inverse (L&I) products. In addition, 34 ETFs have been delisted in 2017.

“Because the ETF Connect will hopefully be launched before the end of this year, a number of foreign fund managers are already thinking about listing and launching an ETF in Hong Kong,” says Eva Chan, partner at Simmons & Simmons, a law firm which has worked on 80% of the ETFs listed in Hong Kong. Chan, herself, has 15 years of experience working on fund services particularly ETFs.

According to Chan, the process of listing an ETF actually begins the moment an ETF sponsor goes to a law firm like Simmons & Simmons and provides information on the investment strategy and structure of the ETF. The lawyers will then offer the ETF sponsor their legal opinion.

“We will consider it and check against whether it will comply with the current provisions under the SFC (Securities and Futures Commission) Code on Unit Trust and Mutual Funds. For innovative products, we always advise clients to have a preliminary meeting with the SFC to discuss the unique features of the product first. For this, we’ll assist them by preparing a document, listing out the issues and exemption requests that may be sought in order to seek the authorization of the SFC, and setting out the rationale, justification and proposal in seeking a waiver,” Chan says.

Once the SFC is happy with the structure, investment strategy, underlying assets, and other salient features of the ETF, the ETF manager can formally submit the application. In preparing the submission they get help from legal experts.

“We will assist them by preparing the draft offering document, which is usually the most heavily negotiated document. The negotiations usually focused on disclosure, for example, like what is the underlying index, and if there are any related risk factors,” Chan says.

The negotiations usually involved a few rounds of comments as well as back and forth between the ETF manager with their lawyers and the SFC.

“When you get the stock exchange listing approval then you go back to the SFC to submit the finalized offering document and other required documents, and then it’s complete. When the ETF’s name is listed on the SFC website then you know it has been granted the final authorization by the SFC,” Chan says.

"The ETF Connect has not yet been launched so we don’t know yet whether a Hong Kong domicile will be required for an ETF to qualify for the ETF Connect. Nevertheless, many fund managers, just to play it safe, are deciding they might as well domicile the product in Hong Kong,” Chan adds.

 

This article is an abbreviated version of Gearing up for ETF Connect published in the April print edition of The Asset and available on The Asset Plus.

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