The Asia-Pacific (APAC) region is now firmly fixated on the minds of global asset managers as a target market and for good reason. Out of the region’s unprecedented economic boom has emerged an upwardly mobile and dynamic urban middle class. In China alone, nearly 400 million people – or one third of the population – are defined as being middle class,1 while investable assets in the country are projected to reach USD31.8 trillion by 2021. 2 Throughout APAC, there is also a flourishing HNWI (high-net-worth-individual) population more substantial than North America, worth around USD21.6 trillion.3 APAC retail investors are already very enthusiastic buyers of UCITS mutual funds, but the question remains as to whether there are viable opportunities for UCITS ETFs (exchange traded funds) as well.

    The APAC ETF landscape

    Assets invested in APAC domiciled ETFs have experienced strong growth over the last three years. According to ETF consultancy firm ETFGI, assets under management (AUM) in APAC ETFs stood at USD589 billion in June 2019, having more than doubled in size from December 2015 when industry-wide AUM was at USD249 billion. Of this, the majority of the region’s assets (USD352 billion) reside in ETFs domiciled in Japan, fuelled by the massive ETF purchase programme by the country’s Central Bank.4 Despite the impressive AuM growth, APAC ETFs still only account for 10.7 per cent of the global USD5.49 trillion in ETF assets. Nonetheless, a large percentage of the world’s ETFs are located in APAC. Of the 6,736 ETFs listed worldwide, 1,466 (21.8 per cent) are domiciled in APAC5 owing to the fragmented nature of the region’s markets and their relative development, at least when benchmarked against the US.

    New types of ETF products are finding favour across APAC too. Fixed income ETFs – having accumulated sizeable investor inflows globally – are now becoming increasingly popular in the region due to their liquidity, transparency and risk diversification. 6 Taiwan’s fixed income ETF market has amassed more than USD16 billion 7, overtaking South Korea on an AuM basis.8 Taiwan’s fixed income ETF market, which tracks mostly US treasuries and China policy financial debt, 9emerged more by regulatory quirk than design. Its genesis can be traced back to when Taiwan’s regulators imposed strict limits on domestic financial institutions’ foreign investments, but did not apply any restrictions on locally listed foreign fixed income ETFs. 10 Consequentially, Taiwan’s fixed income ETF market ballooned, with experts now predicting it could potentially grow to USD40 billion by the end of 2020.11

    Hong Kong – in particular – has also tried to position itself as a regional ETF leader. The Securities and Futures Commission (SFC) gave approval for the listing of inverse and leveraged ETFs three years ago, while earlier this year, it permitted the first ever inverse leveraged ETF to trade on the Hong Kong stock exchange. 12More recently, the SFC gave the seal of regulatory approval to actively managed ETFs after updating its Code on Unit Trusts and Mutual Funds, becoming the third market in the region (after Australia and South Korea) to permit trading in these assets. 13 While most investors are using ETFs to acquire returns or hedge risk, others are utilising them to collateralise their synthetic trades.

    Notwithstanding this progress, there are some headwinds impeding APAC investors from allocating into ETFs. In addition to their historic predisposition towards equities and property, the playing field for distributing ETFs is uneven. A number of major markets including Hong Kong do not have a fee-based distribution model, so distributors – who are often retail or private banks – have limited incentive to sell ETFs to clients, meaning there is a heavy bias instead towards structured products and mutual funds.14 While some markets such as Australia have prohibited retrocessions, the SFC in Hong Kong is hesitant to do so due to fears about an advice gap potentially opening up.15 However, it is possible local regulators could shift their position and replicate EU legislation (i.e. UK’s Retail Distribution Review [RDR], Markets in Financial Instruments Directive II [MiFID II]) banning inducements, a development that would help invigorate the ETF market in the region.

    A growing number of European UCITS ETF issuers are increasingly looking to tap into the burgeoning APAC investor market, especially in jurisdictions where other UCITS products are already purchased widely by local allocators.

    New ETF distribution channels within APAC

    Efforts to stimulate wider cross-border distribution of funds (including ETFs) in APAC have been in the works for several years now. The ASEAN CIS (Collective Investment Scheme) – which covers Malaysia, Singapore and Thailand – went live in 2014, although it took another three years before the Singapore Exchange (SGX) authorised the listing of the scheme’s first ETF, a product issued by Thailand’s One Asset Management. 16The Asia Region Funds Passport (ARFP) is also currently being implemented but, to date, only five countries (Australia, Japan, South Korea, New Zealand and Thailand) are participating in the initiative.17 However, several core economies – namely China, India and Indonesia – currently impose restrictions on foreign asset managers targeting local investors, although some of these constraints are gradually being lifted.

    Even though the ETF Connect bridge between Hong Kong and China was put on hold, regulators do still want to create a channel to facilitate simplified cross-border distribution and listings of ETFs. According to Broadridge, ETF growth in China and Hong Kong will be far greater than anywhere else in APAC, eventually accounting for 19 per cent and 18 per cent respectively of regional ETF assets by 2025. 18Experts are rather bullish on the region’s prospects as a whole, with Broadridge estimating local ETFs’ AuM could reach USD1.9 trillion by 2025.19 In short, there is huge scope for global ETF providers to increase their footprint in APAC.

    The opportunity for European ETF issuers

    A growing number of European UCITS ETF issuers are increasingly looking to tap into the burgeoning APAC investor market, especially in jurisdictions where other UCITS products are already purchased widely by local allocators. In May 2019, Euroclear, the international central securities depository (ICSD) and Hong Kong Exchanges and Clearing Limited (HKEX) announced they would collaborate in order to help enhance the distribution networks for European ETFs across APAC. 20 Under this framework, HKEX will become the first APAC stock exchange to adopt the ICSD ETF settlement model, 21 allowing trades to settle in one place 22 thereby helping investors to obtain improved settlement efficiencies and a reduction in costs and risks. 23 The challenge, however, for some European issuers, will be to identify products, such as fixed income ETFs, which offer greater choice and liquidity than the competitive APAC products.

    Conclusion

    The surge in regional institutional flows into ETFs – especially fixed income products – is also partly ascribed to issuer efforts to educate investors about the benefits of ETFs, 24 including their liquidity and value for money relative to more expensive mutual funds. However, the motivation for distributors to sell ETFs is simply not there. If local regulators were to transition towards a paid-for investment advice model, local demand for ETFs would grow dramatically, in what could prove to be very lucrative for global asset managers.

     

    1 South China Morning Post (October 12, 2018) The question mark hanging over China’s 400 million strong middle class
    2 Boston Consulting Group (December 2017) China Wealth 2017: The way ahead after a golden decade
    3 Capgemini – World Wealth Report 2019
    4 Financial Times (April 1, 2019) BOJ’s dominance over ETFs raises concern on distorting influence
    5 www.ETFGI.com 30 June 2019 ETF statistics
    6 ETF Stream (November 15, 2018) Taiwan’s fixed income ETF market now the largest in Asia
    7 ETF Stream (November 15, 2018) Taiwan’s fixed income ETF market now the largest in Asia
    8 ETF Stream (November 15, 2018) Taiwan’s fixed income ETF market now the largest in Asia
    9 ETF Stream (November 15, 2018) Taiwan’s fixed income ETF market now the largest in Asia
    10 Fund Selector Asia (April 18, 2019) Taiwan regulatory boost to bond ETFs
    11 Fund Selector Asia (April 18, 2019) Taiwan regulatory boost to bond ETFs
    12 ETF Strategy (June 19, 2019) Hong Kong welcomes its first actively managed ETF
    13 ETF Strategy (June 19, 2019) Hong Kong welcomes its first actively managed ETF
    14 Fund Selector Asia (October 10, 2018) Why investors snub ETFs in Asia?
    15 Fund Selector Asia (October 10, 2018) Why investors snub ETFs in Asia?
    16 Fund Selector Asia (April 18, 2017) First ETF approved under the ASEAN CIS
    17 Regulation Asia (November 12, 2018) Asia Region Funds Passport: What you need to know.
    18 Fund Selector Asia (March 13, 2018) APAC ETF Assets to quadruple by 2025
    19 Broadridge – APAC ETF assets estimated to reach USUSD1.9 T by 2025
    20 Euroclear (May 7, 2019) HKEX selects Euroclear’s international ETF structure
    21 Euroclear (May 7, 2019) HKEX selects Euroclear’s international ETF structure
    22 Reuters (May 7, 2019) Hong Kong exchange, Euroclear launch ETF tie up
    23 Euroclear (May 7, 2019) HKEX selects Euroclear’s international ETF structure
    24 Fund Selector Asia (October 10, 2018) Why investors snub ETFs in Asia?
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