Asian ETFs thrust into the spotlight

Exchange-traded funds have once more been thrust into the spotlight by the arrest earlier this month in London of Kweku Adoboli, an ETF trader at UBS, who allegedly hid his $2.3 billion in losses using fake positions. But what of Asian ETFs?
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Exchange-traded funds (ETFs) have once more been thrust into the spotlight by the arrest earlier this month in London of Kweku Adoboli, an ETF trader at UBS, who allegedly hid his $2.3 billion in losses using fake positions. With the variety of ETFs and size of the market having grown in Asia in recent years, the question of how well the products are understood and whether they require more regulation is now on the table in the region.

Much of the criticism that has followed the trouble at UBS has been focused on synthetic ETFs, where, in order to reduce costs, a portion of the fund is based on a derivative of the underlying assets, rather than buying the assets themselves.

“ETFs based on synthetic replication can mirror the performance of an index without having to own the actual securities, which can be advantageous when it is difficult or expensive to trade in certain markets or sectors,” says Bernardus Roelofs, global head of ETF sales trading at Flow Traders in Singapore. “This can lead to lower tracking error.”

Defenders of synthetic ETFs also point out that only a small portion of the fund, usually 10%, is composed of derivatives, while critics claim that even full replication ETFs have increased risk because the fund providers lend out the underlying assets.

“An ETF is a fund like any other fund. But they are much more transparent than many other kinds of funds. There are daily sheets published of the composition and most issuers of synthetic products also show detailed information on collateral and swap exposure,” says Roelofs.

“Transparency is important not just for ETFs, but for every product in the asset management industry.”

“More and more asset managers are using ETFs, allowing them to get easy market access in all kind of markets and asset classes and by optimising their portfolio performance,” says Roelofs, citing easy access to commodities via ETFs as an example.

Andrew Freyre-Sanders, global head of client electronic execution at RBS, points out that access to Asia's emerging markets are driving ETF growth in the region.

“ETFs are there to provide liquid, clean access to markets and they've done well when they've delivered access to something you can't otherwise easily get,” says Freyre-Sanders.

“In Asia, the two hot markets are India and China. India is an ID market and China is one of the trickiest markets out there to get direct exposure to,” continues Freyre-Sanders. “Clearly, ETFs have provided great liquid ways in and out of those two markets.”

The Asian ETF market remains much more fragmented than in Europe, with each territory having its own rules and regulations, according to Roelofs, who says that such an environment “creates its own challenges”.

Freyre-Sanders points out that regulations around ETFs have already been tightened in Asia, and doesn't see it as a future problem for the market. Roelofs also believes ETF growth in Asia will continue, while both of them believe the issue of buy-side investors not understanding the products is overblown.

“ETFs have expanded and evolved into a lot of different kinds of products since they were created all those years ago, and maybe mass-market knowledge hasn't grown along with that,” says Freyre-Sanders. “But the people I know who trade ETFs are knowledgeable and comfortable with the products they're dealing in.”

Nevertheless, he concedes the complex nature of some parts of the products can be a challenge for investors.

“For a non-active user of ETFs, whether they are fully aware of the exact mechanics of the posting and collateral, you could argue they may not be as clear,” he says.

For his part, Roelofs says he relishes the spotlight being thrown on ETFs, “It's positive when there are criticisms, because then you have to explain the product.”

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