Enhancing portfolio versatility and liquidity with ETFs

How ETFs are facilitating secure access to virtual assets

HKEX is the first exchange in Asia to introduce both spot VA ETFs and L&I products. These products reflect the growing acceptance within the financial industry of virtual assets such as Bitcoin, which currently has a market cap of over $2.5 trillion globally. VA ETFs offer investors access to this space by making virtual assets more accessible and mitigating risks and challenges.

The SFC has taken a phased approach, initially allowing only VA futures ETFs to launch in December 2022. The regulator last year put in place a framework for VA ETFs which allows trades in Bitcoin and Ether and has several advantages over direct investments in virtual assets. Mesnard-Sense said, “It is akin to trading stocks, involving a broker on a recognised stock exchange.” Like stocks, VA ETFs use a traditional settlement cycle which means that investors have visibility on when they will receive proceedings from their sales. Besides, fees and commissions are comparable to those charged for other ETFs, a positive contrast to potentially lower levels of transparency in direct virtual asset trading.

Several measures are in place to address security concerns. According to the guidelines from the SFC, issuers of virtual asset ETFs must have a good track record of regulatory compliance and at least one staff member with experience in managing virtual assets. Participating dealers and custodians of these assets also require appropriate licenses. Custodians are expected to hold a majority of the physical virtual assets in cold wallets to provide greater security from hackers, and to insure against potential losses.

In addition to a comprehensive regulated ETF ecosystem, several other factors make HK-based ETFs attractive. Mesnard-Sense said, “They are tradable during Asian hours, and in multiple currencies — US dollars, RMB and Hong Kong dollars. Furthermore, their robust liquidity is supported by an extensive network of market makers in Hong Kong.”

VA ETPs have been received enthusiastically with active trading and a significant surge in market cap to over HK$3.7 billion ($478.6 million), indicating strong potential for future growth.

Why active ETFs are gaining ground

There has also been a global surge in active ETFs which combine the benefits of traditional ETFs with active management. Globally, active ETFs accounted for over 20% of the total ETF fund flow as of April 2024, and approximately 7% of the total ETF AUM. Global flows into active ETFs have experienced substantial growth, surpassing $180 billion in 2023. Data from research firm ETFGI reveals that assets invested in actively managed ETFs increased from $161 billion in 2019 to $740 billion in 2023.

In APAC, net inflows into active ETFs have reached almost $9.2 billion in 2023 — a YoY increase of 220%.

Hong Kong is no exception — the asset size of Hong Kong-listed active ETFs reached HK$10.8 billion ($1.4 billion), marking a robust growth of 26% since the end of 2023. Their average daily turnover (ADT) has also surged substantially by more than 240% to HK$55.4 million ($7.1 million) during the same period. The active ETF market in Hong Kong has been further expanded with the launch of the first covered call ETFs in February this year, bringing the total of active ETFs to 26.

Active ETFs are also part of the boom in thematic ETFs which provide access to industries such as EVs, semiconductors, AI, virtual assets, and biotech. Many of these industries have generated significant interest among retail investors, as well as asset allocators looking for tactical investments.

With their ability to generate alpha, boost tactical allocations, aid in ESG investing, and competitive total cost of ownership, active ETFs are outpacing the overall ETF industry growth, growing at 48% according to data from SPDR Americas research.

The ETF market is poised to continue its growth trajectory

Besides placing itself at the vanguard of innovative and diverse product offerings, the Hong Kong ETF market is also a cost-effective option due to the prevailing tax regime. Mesnard-Sense said, “In many markets, the application and consequences of capital gains tax or withholding tax may be unclear to investors. Hong Kong’s simple tax regime could prove to be an advantage.” For instance, waiver on stamp duty for Hong Kong-listed ETFs enable market makers to reduce their creation / redemption cost by up to 10 bps. HKEX has also created a tax calculator in collaboration with Ernst & Young which factors in investor locations and the jurisdictions of the investments to accurately estimate after-tax returns.

Another factor boosting ETFs in Hong Kong is the recent expansion of eligibility criteria for ETFs within Stock Connect: a mutual market access program which allows global and regional investors to trade Mainland China shares listed in Shanghai and Shenzhen (Northbound trading); and gives investors in the Mainland access to Hong Kong shares (Southbound trading).

ETFs were first incorporated into Stock Connect in July 2022 resulting in an uptick in trading activities and turnover for Hong Kong-listed ETFs and vice versa. The total ADT of Hong Kong-listed ETFs has grown from HK$9.8 billion ($1.3 billion) in July 2022 to HK$12 billion ($1.5 billion) in June 2024. Southbound ETF ADT has grown from HK$215.7 million ($27.7 million) in July 2022 to HK$1 billion ($128.2 million) in June 2024.

More recently, an expansion was announced for eligible ETFs under the Stock Connect programme, featuring a lower threshold for average daily AUM, plus a reduced proportion requirement for Mainland-listed, Hong Kong-listed, as well as Stock Connect-eligible stocks. Under the extended eligibility criteria, six Hong Kong-listed ETFs have been newly added to Southbound trading of Stock Connect and 85 new ETFs in the Northbound trading of Stock Connect, taking the total number of eligible ETFs to 241. The enhancement allows Mainland Chinese investors to diversify their portfolios by including access to secondary listed companies in Hong Kong and cost-efficient trading due to waiver of stamp duty for both buying and selling Southbound ETFs. Global investors too now have more choice when it comes to opportunities in China.

The expansion will foster product innovation within the ecosystem in both Hong Kong and Mainland China, supporting Hong Kong’s continued development as the leading ETF marketplace in Asia. The responsiveness of the regulators and the sheer depth and width of opportunities ensure that the surge in ETFs will continue in the years to come.

For more information, please visit HKEX ETP website.