The Securities and Futures Commission's (SFC) move to
deregulate Hong Kong’s budding exchange-traded
funds (ETF) market is welcome, but limits on passporting have
The SFC announced its authorisation of the issuance of
leveraged and inverse ETFs in February, while setting new
requirements on the naming and trading of such products.
But counsel in Hong Kong have pointed to the continued
rigidity of the territory’s approval process for
cross-listing of ETFs, with the prospect of a new ETF regime
being relatively slim.
Because ETFs are treated as specialised schemes, full
compliance with the Hong Kong rules is required, according to
Rolfe Hayden, partner at Simmons & Simmons in Hong
Kong. "Anything that is slightly different or has already been
launched may be a struggle," he added.
"It’s quite difficult to change things but Hong
Kong regulation requires changes to be made", said Hayden.
Under Appendix I to the SFC’s Unit Trust Code
(UT), an overseas ETF may be authorised through a streamlined
recognition process… if it meets the core requirements
under the UT Code.
"It was (once) hoped that ETFs could be passported and
approved more quickly if they were already established in a
recognised ETF regime, but in practice this has not happened,"
Hayden added that investors in the territory once thought
that the US would qualify as a recognised ETF regime, but it
has never been approved by the SFC.
- The SFC’s move to deregulate Hong
Kong’s budding ETF market has received mixed
reactions, with critics citing inflexibility over
- The SFC announced its authorisation of the
issuance of leveraged and inverse ETFs in February, while
setting new requirements on the naming and trading of such
- But counsel in Hong Kong have pointed to the
continued rigidity of the territory’s approval
process for cross-listing of ETFs, with the prospect of a new
ETF regime being relatively slim.
Brokerage regulators and fund managers, such as BlackRock in
the US, flagged the potential risks associated with inverse and
leveraged ETFs, suggesting that they could "blow up" the entire
According to a December study by the Securities and Exchange
Commission, nearly four percent of funds in the US have
received exposure exceeding 150% of net assets.
While US regulators have raised concern about the
suitability of these products for retail investors, they have
gained traction in major Asian economies such as Japan and
Japan’s Next Funds Nikkei 225 Leveraged Index
ETF, driven by a shift among domestic investors away from a
volatile stock market, raked in 177.4 billion yen ($1.5
billion) in the first weeks of January.
"The SFC’s caution is understandable but there
has been a growing feeling among ETF providers that Hong Kong
was missing out on something which was doing very well in other
markets," said Hayden.
The SFC’s cautious approach to the products was
reflected in its plan announced last December to impose a 150%
cap on the leverage an investor can derive from the trading of
derivatives. The was in tandem of a similar proposal issued by
the Securities and Exchange Commission following warnings from
key industry players about the danger of exposing the EFT
market to these leveraged products.
"The SFC has taken a cautious approach and not only is the
ratio restricted but it has restricted the markets that these
ETFs may be invested," said
Taylor Hui, partner at Deacons in Hong Kong.
"The SFC has taken a
"They put them into the category of a hedging tool or a
trading tool rather than a long-term investment," he added.
In addition to the statutory cap, the SFC has imposed a
maximum leverage factor of two times on all leveraged products,
while limiting all underlying tracking indices to those
"The major possible concern has been around naming in that
you are not allowed to include "ETF" in the name of these
products," said Hayden.
But some in the ETF industry have been surprised by the
SFC’s move to introduce these leveraged products,
while stressing the need for tight regulation of trading in the
leveraged ETF market.
"To introduce something that is synthetic, or in some
respect, more aggressive in the synthetic spectrum was a bit of
a surprise," said
Mark Shipman, partner at Clifford Chance in Hong Kong.
Shipman added that, while it is a positive development
reflecting the SFC’s willingness to cater to
market needs, a number of risk warnings that need to be added
to these products; that they should be clearly categorised as
products intended for hedging purposes and not for long term
investment by sophisticated investors who are well-informed of
ETFs: creator of risk or choice
HK ETF managers urged to comply promptly to new rules