Market Views: How will ETF Connect impact investors?

ETF Connect, expected later this year, will allow Chinese and international investors to trade ETFs via Hong Kong. We asked four experts about the likely impact of the programme.
Market Views: How will ETF Connect impact investors?

With the ETF Connect expected to kick off by the end of 2018, Chinese investors are set to gain ready access to international exchange-traded funds (ETFs) listed in Hong Kong — while international investors will gain access to Chinese ETFs listed in Shanghai and Shenzhen.

The scheme should offer diversification benefits to investors in China, while foreign investors could use it to increase their exposure to the Chinese market, giving a boost to both the Hong Kong and Chinese ETF markets.

As of December 2017, there were 186 ETFs listed in Hong Kong from 25 managers, with assets totalling $42.9 billion, according to ETF consultancy ETFGI. China had slightly lower ETF assets of $37.9 billion from 150 ETFs.

We asked four experts what the likely impact of ETF Connect would be on mainland Chinese and international investors.

Tai Hui, chief market strategist in Asia

JP Morgan Asset Management

The ETF Connect’s success will depend on the kind of products launched. As of today, the ETF business across Asia is concentrated in a very small number of products. In Hong Kong, it’s the A-shares and tracker funds following the Hang Seng index.

So if the Connect is to do with these products, I don't think it will necessarily serve much additional purpose to investors in China. They can buy A-shares anywhere. Why Hong Kong? They can trade in Hong Kong stocks via the Stock Connect. The existing product range I don't think is going to be that appealing.

It's an important construct but, just like [with] the Shanghai-Hong Kong Stock Connect, I believe momentum in the initial phase may be slow to start.

Also, it is highly likely that the Chinese authorities will manage the flow quite carefully so as not to enable too much money to flow out of the country, especially if they believe that will place pressure on the capital flows in China.

In the broad scheme of things it's a sign that China continues to want to deepen its financial market links with the rest of the world. The ETF Connect is simply another channel that will add to the arsenal of ways in which investors can access funds and ETFs on both sides.

Yoon Ng, director

Broadridge Financial Solutions

We’re optimistic about the prospect of ETF Connect and estimate that the size of the ETF market in Hong Kong and China will grow nearly 10 times from the current $77 billion, as of Dec 2017, to $687 billion by 2025. The bulk of this growth will come from the demand of Chinese investors for overseas exposure, but we also believe that growing acceptance of ETFs will create a network effect that will help expand product range and, in turn, help bolster demand.

We’ve identified five drivers of ETF growth which has led to the phenomenal growth we’ve witnessed in the US (and recently spread to Europe). These include diversification of clientele, growing fee awareness, regulatory support, broadening ETF applications, and the expansion of product strategies. Of these five drivers, we identified regulatory support to be the weakest pillar in Asia due to the lack of a robust fee-based distribution model. More needs to be done in this space to really spur retail adoption, but ETF Connect could play a significant role in encouraging the shift.

There are certain issues still to be ironed out with the ETF Connect, such as the discrepancy in settlement days: Hong Kong operates on a T+2 model whereas China operates on a T+1 model. The ETF Connect has still not finalised this detail but suggestions are they can potentially follow the precedence set by Stock Connect.

Another issue is whether the eligibility criteria for ETF Connect will follow that of Stock Connect or Mutual Fund Recognition (MRF). This will affect whether qualifying ETFs need to satisfy criteria like fund size, track record, investor composition (MRF only), or daily trading quota (Stock Connect).

David Quah, co-managing director of quantitative investment solutions

Value Partners

Through Hong Kong-listed ETFs, mainland Chinese investors can conveniently access international equity markets if such ETFs are allowed under the ETF Connect.

On the other hand, for Hong Kong and international investors ETF Connect provides another avenue to access the ETFs in the mainland China market.

The connectivity will be a major impetus to encourage Hong Kong-based managers to launch more ETFs, catering to the demand from mainland investors and vice versa.

The combined assets under management of ETFs in Hong Kong and mainland China provides the critical mass to launch many more underlying assets. This is encouraging and may help to grow the ETF industry in both markets (as well as how it competes globally), while 27 ETFs were delisted in 2017.

We expect the ETF Connect to launch late this year. However, the criteria for inclusion are not known yet. Having more clarity on the inclusion criteria will help Hong Kong and global ETF issuers to better prepare for the eventual ETF Connect.

It is possible not all ETFs domiciled and listed in Hong Kong will be eligible for inclusion. For example, there may be a requirement in terms of market capitalisation, the type of underlying asset classes or strategy (i.e. leveraged and inverse, futures-based, derivatives-based, actively managed) or type of securities, etc. The impact is that it causes uncertainties in ETF issuers’ business/product strategy.

Ray Chan, head of SPDR ETFs in Hong Kong

State Street Global Advisors

The much anticipated ETF Connect will be an inflection point in the growth of the ETF industry for China and Hong Kong, widening the access for mainland investors to invest offshore and for Hong Kong-based investors to buy mainland-listed ETFs. This development will potentially drive greater interest in new product launches in the ETF space, as new providers and products come to the Hong Kong market to take advantage of this opportunity.

We also believe that well-established ETFs in Hong Kong with demonstrated scale, track record, and liquidity will be best positioned to capture the [expected] southbound [capital] flow. Meanwhile, international investors seeking to increase their exposure to the Chinese onshore market via Hong Kong may find the ETF Connect as perhaps the most convenient and cost-efficient way to do so. In a single ETF trade via the ETF Connect, investors can gain direct and instant access to the China onshore markets to invest in their desired asset classes.

Overall, the ETF Connect will be key to help drive further developments across the ETF ecosystem in both Hong Kong and the Chinese mainland that will benefit investors over the long term.

These contributions have been edited for clarity.

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