Synthetic ETFs to overcome hostile environment
Recent approvals of synthetic exchange-traded funds (ETFs) in
Hong Kong will fuel rising interest, but market and regulatory fragmentation
mean Asia is unlikely to reach the levels of issuance seen in Europe in the
A report released
last week by Boston-based Celent titled ‘Synthetic exchange-traded funds in Asia-Pacific: A
losing battle?’ points out that the synthetic variety make up a far smaller
portion of the overall ETF market compared to Europe, and suggests significant
growth may be hard to achieve.
“The notion that the Asian development in ETFs is 10
years behind that of the US or Europe, implies that Asia will be equally
developed in 10 years’ time. But I don’t see it like that because of the
inherent structural difficulties,” says Joseph Ho, head of ETFs for
Asia-Pacific at Credit Suisse.
Ho points out that the fragmentation of Asia’s financial
markets is “something of a mismatch” with ETFs. “As a high-volume business you
need economies of scale – it’s difficult to achieve that in Asia,” he explains.
“For example, it is extremely difficult to ‘passport’ products around the
different Asian markets, unlike the case in Europe where UCITS compliance makes
Although three of Asia’s biggest markets – China, India and
Japan – have different barriers to ETFs, Ho believes growth on the cards, “but
it’s going to be uneven and slower than it has been in the US or Europe”.
Attracting retail investors to ETFs is a key factor for
“Cross-listing of ETFs from Europe is one way to add
products to the marketplace but it is costly. If you’re an institution, you can
go directly to source and trade the same ETFs in Europe or the US with OTC
trading support provided by large broker-dealers, so why trade them in Asia
where on screen liquidity is relatively low?” says Ho. “That’s why getting
retail investors on board is key to a successful ETF market development in
The distinctions made between ‘risky’ synthetic and ‘safe’ physical
ETFs are often misleading, according to Steve Kinoshita from the ETF sales
trading desk at market maker Flow Traders’ Singapore office.
“The risks for physical ETFs can be higher than for
synthetics so investors need to find out what the risk profile is for each
individual product. If, for example, you have a physical ETF that tracks an
illiquid basket of emerging market stocks, then if there’s a problem such as
the manager going bust, you could be left waiting for the liquidation of the
basket,” says Kinoshita. “You’re not necessarily in better shape if you’re in a
This is a view echoed by Marco Montanari, head of ETFs in Asia for Deutsche Bank.
reason for regulators to treat synthetic and physical ETFs differently because
it’s the same considerations of counterparty risk and collateralisation. And at
the moment, for example, there are no physical ETFs listed on Hong Kong,” says
now requires synthetic ETFs to have 100% collateral, and 120% for equity-based
products. But we were already complying with this before the regulations came
in and we now post the daily collateral levels on our website,” he adds.
Kinoshita suggests some Asian regulators are wary of synthetic
ETFs and don’t want to risk a crisis that brings down a bank and / or causes investors
to suffer. But he believes that India and China opening up to foreign
participants will not slow down the growth of synthetic ETFs in Asia.
“You still need to access those markets, deal with FX and
local regulations, as well as have a local trading facility – which is
cumbersome,” says Kinoshita. “As well as avoiding those issues, ETFs also allow
investors to buy baskets which are otherwise unavailable.”
It is still
too early to gauge investor reaction to the new synthetic ETFs that Deutsche Bank
launched in Hong Kong earlier this month, particularly with the upcoming
Chinese New Year holidays keeping the market quiet, according to Montanari. Still,
he sees the ETF market only heading in one direction.
a growth of 40% in the number of ETF products in Asia last year, while assets
under management were up 10%, which is significant considering the market
conditions last year. It’s still a very young market so the growth potential is
still high,” says Montanari.