The Shanghai Stock Exchange (SSE) is striving to spur growth in its exchange-traded funds market by allowing several ETF managers to track the same index concurrently.

Up until now ETF providers have enjoyed index exclusivity. By scrapping the regulation, the exchange is seeking to implement a market-orientated system to improve index efficiency.

“The deregulation aims to drive healthy competition among FMCs and sustainable growth of the ETF market,” says David Xu, managing director of passive investment at HuaAn FMC. “On the one side FMCs want the chance to manage ETFs tracking major indices, and on the other, the stock exchange needs more FMCs to participate and grow the market.”

According to SSE guidance, the day a fund manager applies to run an ETF the exchange will announce the details on its website; other ETF providers can then apply to track the same index within 15 working days.

The exchange will issue a “no-objection letter” if the number of applicants doesn't exceed a prescribed limit, which according to one Beijing-based manager will be three to begin with.

If more than three apply, the SSE will call on an expert panel to assess the applicants' credentials against certain criteria, including the estimated AUM of the ETF in two years' time (if listed), total AUM of the ETF provider and their track record of managing ETFs.

The exchange says appraisal by a panel is designed to prevent liquidity being diluted by an excessive number of ETFs tracking the same index.

Once ETFs are approved and listed, if there is further demand the exchange says it will accept subsequent applications for new ETFs to track the same index at a time it deems appropriate.

Shanghai and Shenzhen boast 43 ETFs with combined AUM of Rmb120 billion ($18.8 billion) as at the end of June, although this is heavily concentrated at the top end. There are only four ETFs with AUM above Rmb10 billion: China AMC SSE50, E Fund SZSE100, Huatai Pinebridge CSI300 and Harvest CSI300. The smallest – Guotai SZSE SME300 Growth ETF – had just Rmb55million.

The Beijing-based manager expects the SSE’s move to drive further concentration around ETFs tracking the major indices. He notes the market is at an early stage of development and there are only 300,000 ETF investors nationwide.

"Many are not familiar with smaller ETFs tracking sector-specific indices, let alone sophisticated strategies such as using ETFs to capture sector rotation,” he says.

He suggests the new regulation will give FMCs greater flexibility to launch new ETFs, although he also concedes that there are already a lot of small ETFs in the market.

"The operational costs are high, but the margins are low," he adds. "It's hard to make profits from these small funds. It may be worth considering giving FMCs the option to delist illiquid and unpopular ETFs.”