As firms continue to expand into exchange-traded funds provision in Asia, a growing number are also withdrawing from this business in the region, as a widely tipped shakeout gains momentum*. And more look set to do so, particularly as regulatory scrutiny of ETFs with relatively low AUM and trading volumes is increasing.
Following moves to delist by firms such as HSBC this year and Lyxor in early 2012, providers are becoming more inclined to follow suit, say multiple sources in Hong Kong, and some are actively discussing the prospect of doing so. (However, the resolution to delist was not passed at an HSBC EGM on October 4, so the ETFs are still being run.)
Potentially adding momentum to this trend, the International Organization of Securities Commissions (Iosco) has been talking to regulators in Asia – notably Hong Kong and Singapore – about the potential for delisting smaller ETFs, say sources.
Iosco’s role is to set best practices for regulators around the world, so it doesn’t have the power to require anything of individual watchdogs. But in suggesting minimum requirements for asset size or liquidity, it is effectively acting as a lobbyist, presenting the idea for consideration.
A spokesperson for Iosco said she had heard the organisation was talking about closing ETFs in Asia but that it was “highly unlikely” it would discuss the prospect of fund closures, adding that the group would not pressure exchanges.
Hong Kong’s Securities and Futures Commission and the Monetary Authority of Singapore (MAS), both members of Iosco, declined to comment on whether there has been discussion about pressing funds to delist. MAS noted that it has no minimum-size requirement for ETFs and that commercial pressures encourage closures.
Iosco would like to see minimum standards implemented worldwide, says one source familiar with the talks, but ETFs are used far more heavily in Europe and the US than in Asia.
There are a number of issues in respect of smaller ETFs. They usually have higher expense ratios, wider bid-ask spreads and potentially higher tracking error. They can also be burdensome for market-makers that have pledged to provide liquidity for them, especially when there is very little day-to-day volume. Moreover, there is heavy overcrowding in Asian ETFs. More than half the listings in Hong Kong focus exclusively on companies in China or Hong Kong.
“At this stage [regulators are] not putting any pressure on the market,” says the unnamed source. “Floating the idea is a very subtle message saying ‘Maybe you want to do something about it, because we may do something about it if you don’t.’”
The source says there had been specific discussion among regulators in Asia about how to deal with small funds and whether to introduce minimum sizes or trading-volume standards, something the regulators are keen to see handled through Iosco as a platform.
Even if they eventually do not establish explicit minimums, they plan to put pressure on providers of small funds by asking them more questions about the operation of the funds, the source adds.
Minimum standards of asset diversification, liquidity and counterparty risk management are “important features that all ETF products should have”, confirms one Iosco committee member who contributed to the commission’s principles on ETFs. He did not want to be identified because Iosco had not taken an official stance on the issue of delisting.
The committee member, who co-drafted Iosco’s ETF report, agrees that Iosco’s principles would indirectly require minimums in terms of liquidity and fund holdings, but says national or regional regulators should work out the fine print of how those are implemented.
“There is clearly no appetite at the Iosco level to look at de-listings, for which national exchange rules I understand would apply,” he says.
An Iosco spokesperson remarked that the committee member was merely stating his personal opinion.
Asia would be by far the most heavily affected region if any measures along these lines were introduced. In Hong Kong, 70% – or 85 – of the 121 listed exchange-traded products have less than $100 million in assets, commonly seen as the minimum threshold if a product is to be profitable – and 30 of those are tiny, with less than $10 million in AUM.
In Singapore, only seven fall under $10 million, but 43 have less than $100 million in assets. That’s close to half (44%) of the 97 listings.
Even Asia’s biggest stock and ETF market would be challenged. Japan has 38 ETFs with less than $10 million, more than one quarter of the 144 listings.
Joseph Sullivan, chief executive of US asset manager Legg Mason, sums up the views of many in the industry. Asked whether his firm would enter the index or exchange-traded funds business, he answered in the negative. This is a market that Sullivan sees as "an oligopoly; pretty much game, set and match already”.
The firm has, however, has considered actively managed ETFs and continues to do so. "But will this be a cornerstone of our business?” says Sullivan. “I'm not sure.”
*An extended feature on consolidation in the ETF industry will appear in the November issue of AsianInvestor magazine.