Sky's the limit

Sky's the limit

Asia Asset Management 18th Anniversary Special - Extract.
Deborah Fuhr

Future bodes well for ETFs/ETPs in Asia Pacific ex-Japan

Although there are still questions on when and how it will be developed and implemented, the greatest perceived opportunity in the Asia Pacific ex-Japan region for many asset managers and exchange traded fund (ETF) providers is the development of the mutual recognition regime with China. On my last visit to Hong Kong on September 23, after a 20-hour delay while we all waited for typhoon Usagi to pass over Hong Kong, a number of people expressed a view that an ETF(s) might be the first product to be offered via the mutual recognition scheme.

Hong Kong will continue to benefit from asset managers and ETF providers deciding that they should develop locally domiciled products in Hong Kong to be able to take advantage of the mutual recognition scheme with China when it is implemented.

In order to contemplate the future of ETFs and exchange traded products (ETPs) industry in Asia Pacific (ex-Japan), we first need to consider and review the environment within which they currently operate. Asia Pacific ex-Japan is in the most fragmented region of the world when we consider the different regulatory and tax regimes, ability for foreigners to invest freely into various countries in the region and for local investors to invest outside of their home country, currencies, languages, investor profiles, product preferences, providers and distribution models.

The challenge for investors, product providers and exchanges is that the fragmentation described above is compounded by the fact that today unlike Europe there is not currently a pan-Asian mutual fund/ETF passporting regime. Within the region there are a number of initiatives between smaller subsets of countries working on passporting regimes.

Twenty percent of the ETFs/ETPs listed in the region are cross-listings from Europe and the United States. Many investors in the region trade ETFs/ETPs listed in the US and Europe as the primary listing in the US or Europe is perceived to be more liquid – which as we know the real liquidity of an ETF is the underlying portfolio of securities. Developing and growing secondary trading in cross-listed ETFs has been and will continue to be a challenge.

Industry breakdown
At the end of 3Q 2013, the global ETF/ETP industry had 4,982 ETFs/ETPs, with 10,019 listings, assets of US$2.22 trillion – a new record high – from 212 providers on 57 exchanges. Europe, which has many similar challenges to Asia ex-Japan from a tax and regulatory, currencies, language, and distribution models, benefits from the UCITS regime which allows UCITS funds and UCITS ETFs to be easily passported across Europe as well into Asia ex-Japan and Latin America.

The European ETF/ETP industry, which started in 2000 – a year after the first ETF launch in Asia ex-Japan in 1999, ten years after the first ETF in Canada in 1990, and seven years after the first ETF was listed in the United States – had 1,971 ETFs/ ETPs, with 6,167 listings, assets of $390 billion or 17.5% of the global assets, from 48 providers on 23 exchanges in 20 countries at the end of Q3 2013.

The Asia Pacific (ex-Japan) ETF/ETP industry had 481 ETFs/ETPs, with 605 listings, assets of $91 billion or just 4.1% of the global assets invested in ETFs and ETPs, from 94 providers on 14 exchanges in 11 countries. The result of the fragmentation is that Asia Pacific ex-Japan has nearly double the number of providers serving nearly half as many countries as in Europe with a significantly smaller pool of overall assets $91 billion versus US$ 390 billion in Europe.

While in Hong Kong a number of people commenting on the initiatives being discussed to create various passporting regimes within Asia Pacific ex-Japan region, many people feel that the smaller initiatives will eventually develop, merge and consolidate into one pan Asia Pacific ex-Japan passporting regime. If this change happens it would potentially allow significant cost savings for providers who would like to be able to offer ETFs in multiple countries in the region from one main domicile.

Many also expect the UK Retail Distribution Review “RDR” regulatory change, which banned the payment of commission or distribution fees to independent financial advisors, to eventually be enacted in a number of Asian countries. As ETFs do not pay distribution fees this type of change would encourage the use of ETFs by financial advisors and end retail investors.

Some of the challenges of investing directly in some of the markets in Asia Pacific ex-Japan are overcome by using ETFs. Investors will continue to adopt ETFs to access markets or assets classes that would otherwise be difficult or impossible to attain. Many emerging markets, for example, require investors to have foreign investor status, a local bank account and a local custodian, amongst other requirements. By using ETFs, which trade and settle like any other share on an exchange, investors seeking access to obscure markets no longer require special status or accounts. And, because of the breadth and depth of benchmarks and asset classes covered, small minimum investment requirements, liquidity, transparency, and efficient cost structures, ETFs have become valued tools for multi-asset class investors implementing a variety of asset allocation models.

One of the key challenges for the continued growth in the use of ETFs within all channels across the region is the need for investor education. Institutional investors tend to initially try ETFs and ETPs to equitise cash or as a transition tool, from there they then most typically embrace them as tactical and strategic investments where both the size of the investment and time horizon grows.

Drivers of growth:

  • Product features: easy to use; liquid; transparent; cost efficient access.
  • Growth in indexing.
  • Access to markets and asset classes that were otherwise not easily available.
  • Growth in new products: new asset classes; new market segments; new benchmarks; and actively managed ETFs.
  • Expansion to new markets with local products, registrations and crosslistings.
  • Growth in users: institutional; financial advisors and retail.
  • Growth in ways products are used: multi-asset.

In conclusion, we believe the future looks attractive for the ETF/ETP industry in Asia Pacific ex-Japan.