(Bloomberg) -- China’s fast-growing $157 billion market for exchange-traded funds will be directly accessible to overseas investors from Friday, at least four years since the plan was first hatched.
Four so-called “feeder” ETFs will begin trading in Shenzhen and Hong Kong, the first batch in a project aimed at connecting the two markets. The Shenzhen funds will track the Hang Seng China Enterprises Index and the S&P New China Sectors Index, while the Hong Kong-listed ETFs will follow the benchmark CSI 300 Index and a gauge of China’s 5G companies.
The investment vehicles, popular with retail traders around the world because they’re among the cheapest way to trade an index, will collect capital locally and settle trades across the border. Some 900 million yuan ($135 million) of funds has been gathered in a pre-sale of the ICBC CSOP S&P New China Sectors ETF, said Melody He, managing director at provider CSOP Asset Management Ltd.
Regulators in Hong Kong have been mulling broadening trading links with mainland China to include ETFs since at least 2016. The plan was delayed partly due to complex clearing and settlement issues. At $40 billion, Hong Kong’s ETF market is smaller than the mainland’s even though its first fund was launched five years before China’s in 1999. ETFs in China nearly doubled in value in the first half of this year.
“This is the very start of ETF connectivity,” said Bloomberg Intelligence analyst Sharnie Wong.
While there are ETFs in Hong Kong, London or New York following China’s onshore equity market, the tracking error can be as high as 15%, partly due to limits on foreign ownership. The feeder ETFs can better replicate mainland benchmarks because their providers are local and won’t be subject to caps. Overseas investors are currently permitted to own no more than 30% in yuan-denominated shares.
Unlike other major stock markets in the U.S. or Japan, China -- the world’s second largest -- isn’t overrun by ETFs. Individual investors haven’t caught on to the products even though costs can be a lot lower than with mutual funds, partly due to little demand for individual stock research.
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ETFs can be traded in real time and in the U.S. are growing increasingly complex and diverse since the first one came about in 1993. China’s first ETF was launched by China Asset Management Co. in 2004. They only started to gain traction in China after MSCI Inc. added yuan-denominated shares to its benchmarks in 2018.
Cross-border trading of ETFs between Hong Kong and mainland China will take time to grow, said Wong, adding that the experience of the stock connect scheme launched in 2014 between both sides could be instructive.
“It could take six years for northbound trading to contribute 5% to mainland China’s ETF turnover, assuming participation of international investors in ETFs is similar to that of A-shares,” she said.
“It may take only two years for southbound trading to contribute 5% to Hong Kong’s ETF turnover, if mainland investors appetite for Hong Kong listed ETFs is similar to that of stocks.”
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