Those who want to see exchange-traded funds less heavily regulated in Hong Kong will welcome a paper from the city’s Financial Services Development Council (FSDC) urging regulators to take a more open-minded approach.

The government-backed agency’s paper, published yesterday, addresses concerns among some in Hong Kong’s financial community that the city is being left behind as a centre for trading of ETFs.

In its revision of fund authorisation procedures this month, the Securities and Futures Commission (SFC) appeared to marginalise ETFs that do not fall into the ‘plain vanilla’ category. The regulator plans to fast-track approvals of ‘standard’ products. It will take longer to process ‘non-standard’ ETFs, such as smart-beta, leveraged or inverse products.

But Laura Cha, chairman of the FSDC, said in the paper: “Hong Kong is well positioned to support a thriving ETF market. The cross-border cooperation between mainland China and Hong Kong opens up major opportunities for the ETF industry in the two places.

“However, Hong Kong’s leadership position within Asia has been overtaken by Tokyo and Shanghai, as they have introduced more innovative products. Action must be taken to enhance the competitiveness of Hong Kong's ETF platform.”

Key FSDC recommendations include improving ETF education, promoting the use of ETFs on the Mandatory Provident Fund platform and broadening the ETF product range by way of ETF cross-listings.

The report did not provide any convincing solutions on the distribution issue that has been a major impediment to ETF sales growth in Hong Kong, apart from suggesting it can be overcome by introducing non-traditional distribution platforms. But it did highlight the need for the regulators such as the SFC and the Mandatory Provident Fund Schemes Authority to “provide an optimal regulatory environment for ETF investors”.

There are around 130 ETFs listed in Hong Kong with a broad range of local and overseas underlying assets in various classes. But Japan, Korea and most recently Taiwan have seen ETFs traction through product innovation such as smart-beta, leveraged and inverse structures.

The inclusion of ETFs in the mutual recognition of funds (MRF) scheme between China and Hong Kong is seen as a catalyst for the growth of ETFs listed in Hong Kong. Even more of a potential “game changer”, said the FSDC, would be to include ETFs as investible securities under the Shanghai‐Hong Kong Stock Connect scheme for southbound (China-to-Hong Kong) investment.

If ETFs were included in the Stock Connect schemes, many mainland Chinese investors would invest in Hong Kong‐listed ETFs, as they cannot buy ETFs in other overseas markets directly, said the paper.

However, the FSDC argued that the ETF market in Hong Kong lacked the infrastructure to nurture local talent to compete with international asset managers in the city. Only 12 of the 130 ETFs listed in Hong Kong are managed by local issuers that do not belong to subsidiaries of a foreign or Chinese asset manager.

"The regulators should consider initiatives to encourage local asset managers to put effort and resources in developing their ETF businesses and creating innovative products for local and overseas investors," said the paper.