Leveraged, inverse ETFs imminent in Hong Kong

Hong Kong’s first leveraged and inverse exchange-traded funds are expected to be authorised early in 2016, while the local securities regulator has reiterated its concerns about these types of product. 

AsianInvestor understands that ETFs are being readied for approval and the first one could be given the green light soon.

Germany’s Commerzbank, which is the market-maker for around two-thirds of Hong Kong-listed ETFs, is readying its local set-up to accommodate a client going through the approvals process with the Securities and Futures Commission. The likely timing of the authorisation and launch is uncertain, because the SFC has made it clear that complex products of this type would not be fast-tracked under new fund submission rules.

Roberto Vila, Commerzbank’s global head of equity markets and commodities, said he expected the first leveraged ETF to be available for listing inside six months. He told AsianInvestor: “We have been approached to see if we would be willing to act as market-maker for a leveraged product. We don’t know that the fund has the go-ahead from the SFC yet, but it will be great to be partnering on a new product segment.”

Leveraged ETFs use derivatives to boost returns of an index over a short period, typically one day, and are not designed for use over an extended period. Inverse ETFs do the same for investors who want to short an index. 

These products have proved popular in other parts of the region, notably Japan and Korea. While they are designed to boost returns for day traders, they can also mean big losses if the trade goes in the opposite direction. Hence they are viewed as speculative, so Hong Kong regulators are taking a cautious view. 

An SFC spokesman said the regulator generally welcomed product innovation and works to promote choice, but was primarily concerned about investor protection and maintaining market integrity.  “Leveraged and inverse ETFs are designed as trading tools for short-term market timing or hedging purposes,” he told AsianInvestor. “These products may not be suitable for long-term investments.”

The spokesman added: “We will adopt a cautious approach to consider the introduction of leveraged and inverse ETFs in Hong Kong, and ensure that investor protection and systemic risk concerns associated with these products are adequately addressed.”

Julie Kerr, Hong Kong-based director of Asia-Pacific financial services at consultancy EY, said: “There appears to be significant investor demand for these funds.” She added that there were several leveraged ETFs in the regulatory pipeline in Hong Kong, and the first was expected to be launched “very soon”.

Rob Hughes, Nasdaq’s head of global indexes in New York, said: “We'd love to see leveraged and inverse ETFs in Hong Kong, so that investors can accentuate a particular view or position. It’s hard to ignore how successful these products have been in other parts of the region.”

However, an October EY survey suggested that fund issuers felt that not all Asian regulators fully understood the structure and behaviour of products such as inverse and leveraged ETFs. “The ETF industry needs to ensure that it engages with regulators in a consistent way over potential areas of misunderstanding”, said the report.

Some argue that Hong Kong's regulators are being over-cautious in their approach to ETFs. The city's government-backed Financial Services Development Council has suggested that Hong Kong was being overtaken by other markets in Asia as an ETF hub, as reported.

As well as its market-making and product structuring activities – principally in Hong Kong, Singapore and Thailand – Commerzbank is also partnering Asian institutions that are moving into Europe. The first result of this was the tie-up in March this year with China Construction Bank (CCB) for the first Ucits ETF domiciled in the UK. CCB International handled the investment management for the RQFII money market ETF, while Commerzbank looked after the structuring and market-making.

The China connection has another dimension in that Commerzbank was also involved in the first two ETFs to be issued on the new China Europe International Exchange (CEINEX), launched last week in Frankfurt. The CCBI RQFII Money Market ETF is being cross-listed on the CEINEX as well as London. The other listing is the Bank of China International Commerzbank Shanghai Stock Exchange 50 A Share Index Units ETF.

Thorsten Heidt, Asia head of equity markets and commodities at Commerzbank in Hong Kong, said the bank viewed Asia as a manufacturing base for its structured products in the region. It has been building a market-making business for commodity and equity-linked ETFs in the region using its technology hub to market make third-party products, both OTC and exchange-traded.