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Cross-border schemes and technology key to Asia’s ETF market liquidity
Important initiatives are being implemented across the region to enhance cross-border access to exchange-traded funds (ETFs) in Asia, a market that Tradeweb’s platform continues to support through its technology offering.
Regulatory fragmentation is often a starting point for conversations on where ETF trading, as well as broader investment flows, may be heading in Asia. In spite of that and the challenges related to a year dominated by the pandemic, Asian financial markets have continued to thrive, with new initiatives set to help further facilitate liquidity and boost trading volumes in the ETF space.
From a regulatory point of view, the Asia Region Funds Passport (ARFP), an initiative led by the Asia-Pacific Economic Cooperation (APEC), could be a turning point. The scheme aims to attract and retain finance within the region to foster its economic growth, while strengthening the investment management industry.
Five countries, namely Australia, Japan, New Zealand, South Korea, and Thailand, signed a Memorandum of Understanding to participate in the ARFP, which has been live since early 2019. Other countries considering entry to the scheme include India, Indonesia, the Philippines, Singapore, and Vietnam, whose addition would greatly expand the scheme’s coverage of the region.
Even under the ARFP, however, rules for the trading of foreign ETFs listed in each member country remain varied, with some like Japan imposing little burden on the sale of foreign ETFs in the domestic market, while others requiring stricter oversight, like Australia.
ETFs constitute a large and growing segment of the market both locally and globally, as testified by the year-over-year increase of 74.2% in global ETF activity on Tradeweb in October this year. The firm already offers institutional investors the ability to trade over 500 ETFs listed on exchanges in Hong Kong, Singapore, and Tokyo. Some of these markets have reached substantial size. Hong Kong has 130 ETFs listed on its exchange, trading nearly US$900mm a day, and with assets under management of around US$40bn as of the end of September.
The launch of the Hong Kong-Mainland ETF Cross-listing Scheme, with its first funds listed in both Shenzhen and Hong Kong, at the end of October, will further facilitate liquidity in this market, by pooling previously segregated groups of investors and by greatly expanding investors’ access to the funds.
An expansion of the latter scheme, for example, could be of enormous importance, given China’s fast rising ETF AUMs. Assets in those funds grew 64% year-on-year in 2018. In 2019, non-money market ETFs AUM rose nearly 50% on the previous year to US$81.6bn. The trend continued, albeit more slowly given the pandemic’s impact, in the first half of the year, both in terms of AUM growth and new ETF launches.
The importance of technology allowing investors to optimize their execution process was very much on show this year, when the occasional sell-offs put pressure on market liquidity. Even so, ETFs held up better than other investment products, according to industry participants, in particular for fixed income ETFs compared to their underlying bonds.
That being said, liquidity has vast growth potential in the region. Even though on-screen liquidity can seem thin at times, the Tradeweb request-for-quote (RFQ) system allows for better price discovery for the larger trades than would otherwise be possible for investors. There is also room for exchange-driven initiatives to boost liquidity, not just for single stocks but also for ETFs.
Meanwhile, the regional integration initiatives discussed above will also help by growing the number of market makers in Asia, with Tradeweb currently offering access to 33 liquidity providers globally, seven of which are in the APAC region. In markets where there are still not as many arbitrage participants, a larger number of market makers will provide a substantial boost to the market.
However, the view that the Asian ETF market lacks liquidity is also at times a reflection of investors’ incomplete understanding of the product, in particular of their creation and redemption mechanism. In fact, investors can still access an ETF even when it has a small daily average volume through a liquidity provider that can assemble the underlying basket of the ETF. As a result, the liquidity of the ETFs will be at least as much as their underlying markets.
The same goes for the outstanding number of shares of an ETF which, unlike traditional equities, can rapidly expand when new orders come in, growing the overall number of shares available for the instrument. Overall, one of the keys to an efficient ETF trading system is the ability to trade not just ETFs across venues, but also the underlying securities.
As the appeal of ETFs continues to grow, institutional electronic marketplaces can only help improve the current trading infrastructure. For example, Tradeweb has been offering dealer axes and streams for some time. What they do is to highlight prices or indications from market makers to buy or sell specific instruments, allowing investors to leverage the information when requesting quotes from dealers.
Tradeweb also plans to expand key features of the platform to Asia, such as the ability to use pre-trade information, which is embedded in the trade ticket, to make more informed trading decisions, including historical data on the past performance of dealers. This in turn assists institutions with demonstrating best execution, a requirement that has been significantly strengthened over the last few years, and in more than just one jurisdiction.
In a constantly evolving ETF market landscape, the role of technology in helping to unlock liquidity for investors is becoming increasingly important. Electronic trading leverages innovative functionality and trading protocols to spur greater adoption of ETFs, while simultaneously enhancing transparency and efficiency for investors in an automated, compliant workflow.