Asia’s booming ETF markets – the next innovation frontier

The rising popularity of exchange traded funds (ETFs) over the last decade represents a global shift towards investment solutions that were initially designed as passive and are now trending into active management.

Asia is part of this trend, as the region’s investors become increasingly aware of the benefits of this ETF asset class – namely, diversified exposure to an economy, sector, or investment theme; lower fees compared to actively managed products, and better tracking of the underlying assets in a simple tradable format on an exchange.

The total assets under management held by ETFs in Asia ex-Japan rose to USD499 billion as of September 2022 from just USD 126 billion at the end of 2016, representing a compound annual growth rate of 28%¹. The number of ETFs in the region has also quadrupled over the same period to 2,330.

In Hong Kong, 11 new ETFs were listed on Hong Kong Exchanges and Clearing (HKEX) in the first ten months of 2023.

In terms of the product mix, ETFs that have equities as the underlying take the lion’s share of the market, accounting for 83% of regional AUM², while fixed income products are a smaller, but expanding segment of the market. Within the equity ETFs, investors have a greater choice of products than ever before.

The ETFs on offer in Asia range from products that offer broad exposure to a market’s main benchmark, such as the S&P 500 or the Hang Seng Index, to funds that provide fine-tuned thematic access to the trends that will drive growth over the coming decades – such as Artificial Intelligence (AI) in China or global clean energy.

ETFs are also establishing a presence in new and emerging asset classes, with the recent arrival of products that are linked to the value of virtual and digital assets, such as cryptocurrencies. In 2022, Hong Kong became the first market in Asia to offer virtual asset ETFs³, with the Hong Kong stock exchange now home to products that track Bitcoin and Ether futures.

In addition to standard passive funds, actively managed ETFs are also growing in institutional acceptance and mainstream popularity in Asia. These ETFs have the potential to capture the similar benefits of an actively managed fund, while offering the scale and trading flexibility of an exchange-traded security. These products also present new and interesting opportunities for asset managers to expand their platform and enhance their client outreach.

A broad range of regulatory and market infrastructure developments have supported the growth of ETFs by allowing issuers to design a greater range of products connecting investors to new markets.

The master-feeder structure is already utilised in Asia, which allows the cross-listing of an ETF among different markets. In this set up, “feeder” funds listed in one market’s exchange invest their assets into a “master” fund on another market’s exchange. The result is that investors in the feeder fund gain access to the master fund within the comfort of their home market’s infrastructure.

In 2019, the Securities and Future Commission of Hong Kong streamlined requirements for eligible ETFs to adopt the master-feeder structure⁴. Issuers were quick to take advantage of the new rules, and in 2020, cross-listed products were launched that link Hong Kong’s exchange to mainland China’s stock markets in Shanghai and Shenzhen. More recently, there are cross-listed ETFs connecting Shenzhen and Singapore^5.

A related development that further enhanced connectivity between onshore and offshore China was the addition of ETFs to the eligible securities of Stock Connect in 2022, commonly known as “ETF Connect”, providing alternative access for ETF issuers and investors.

More than one year since the expansion, ETFs have proved popular on both northbound and southbound channels of Stock Connect. As of July, there were 131 northbound products average daily turnover of RMB 483 million (USD 67 million), and although there are only six ETFs available on southbound, the level of trading is very high, HKD 4.3 billion ADT (USD 550 million)⁶, with onshore investors particularly interested in Hong Kong-listed ETFs that provide exposure to Chinese technology companies with an offshore listing.

Beyond Hong Kong, other major financial centres are exploring links with China’s onshore ETF market. In May, the Shanghai Stock Exchange and Singapore Exchange (SGX Group) signed a memorandum on ETF connectivity between ASEAN and China⁷. News reports suggest that a similar link could be launched between China and the Middle East⁸.

While Asia's ETF ecosystem is becoming more mature with better connectivity across markets and product range, the growing trend is for Asian investors to increase allocation to ETFs created in the region. This is to take advantage of regional expertise, support in the same time zone, and in some cases, more favourable taxation and regulatory frameworks. Participants have an imperative to improve the market microstructure and enable flows to ensure economies of scale and benefits in the ETF ecosystem.

As an ETF pioneer, and in line with its longstanding commitment to Asia, HSBC has played a significant role in developing the asset class in the region and in encouraging market participants to strengthen the product microstructure.

In ESG for example, asset managers are harnessing HSBC’s product and thought leadership to use ETFs to seamlessly integrate ESG sustainability frameworks, such as clean energy and climate transition, into their investment mandate. HSBC has been partnering with Hong Kong fund providers to implement ESG index transition.

“HSBC’s success is driven by a strong global network, top institutional talent, healthy fund flows, and deep understanding of ETF regulatory and operational complexities,” said Hazel Lai, Head of Sales, Greater China and Korea, Asset Owners and Managers, Securities Services, HSBC.

This experience and focus is marked by a string of market firsts for HSBC in the ETF space – such as bringing to market the first Smart Beta ETF and the first futures-based and money market ETF in Hong Kong. Another accolade includes The Asset naming HSBC as Asia’s Best ETF Custodian 2022⁹, while the Hong Kong Exchanges and Clearing (HKEX) ranked HSBC as the top trustee, and among the top three market makers in 2021¹⁰.

HSBC has streamlined its “one-stop” solution to offer the full range of services: covering ETF creation and redemption, trustee and custodian services, seed investment, market maker functions, synthetic access, and hedging solutions. ETF investors have also benefited from HSBC’s ability to source ample liquidity, ensuring that they can execute their investment strategy or trade large volumes, in a cost-efficient manner.

“Asia’s ETF ecosystem has come of age, both in scale and sophistication. Investors are taking advantage of the flexibility and greater liquidity of ETFs to make these funds a dynamic component of their overall portfolio,” said Sharon Cheng, Head of Equity Solutions Sales, Asia Pacific, HSBC. It is such continued innovation has also helped Hong Kong strengthen its position as a regional hub for ETFs.

Another sign of Hong Kong’s rise as a regional ETF hub came in November, CSOP Asset Management announced the launch of its Saudi ETF on the Hong Kong exchange, and emphasised the role of its ETF partner, HSBC. This is a milestone that allows Asian investors greater access to the Saudi capital markets and promotes two-way capital flow as part of the Belt and Road Initiative.

By continuing to produce market-leading services to Asia’s ETF ecosystem, HSBC will remain a pioneering force in this increasingly important asset class: “The focus will be to continue to drive Asia’s ETF market to greater heights and stay at the forefront of product innovation to deliver the greatest value to our investors,” said Michael Chandler, Global Co-Head of Equity Sales and Securities Financing Sales, HSBC.