SFC to permit some high risk ETFs

Added 11th February 2016

Hong Kong's regulator has announced plans to allow a limited range of leveraged and inverse products, which are effectively higher risk exchange traded funds, to be sold to the public.

SFC to permit some high risk ETFs

The Securities and Futures Commission, in a circular sent out last week, outlined the additional requirements these new style products would need to meet to be authorised for sale.

These included a demand that they not be marketed as ETFs, strict caps on the leverage factor used, and a requirement that they track very liquid benchmarks.

Popularity growing

The products, which typically deliver a multiple of the positive or negative daily return of the underlying benchmark, have taken off in the United States and are available in Asian markets such as Korea, Taiwan and Japan but are not yet permitted in Hong Kong.

“L&I (Leveraged and Inverse) products have become increasingly popular in overseas markets, particularly in Asia,” the SFC said.

The total global assets under management of short and leveraged exchange-traded products at the end of June 2015 was $62.8bn (£43.1bn, €56bn) according to ETF provider Boost.

Novelty structure

Leveraged products typically aim to deliver a daily return equivalent to a multiple of the underlying index return that they track.

Inverse products typically aim to deliver the opposite of the daily return of the underlying index that they track. Both products have to rebalance their portfolios, typically on a daily basis.

The US Securities and Exchange Commission said in December it would clamp down on leveraged and inverse ETFs due to fears that the use of derivatives increases the counterparty and liquidity risk.

Protection requirements

In order to protect the interests of the investing public and the integrity the market in Hong Kong, the SFC said new L&I products would have to comply with a range of additional regulations covering product structure, naming and distribution.

“L&I products that have been authorised by the SFC should not be named “ETFs”. Instead, these products must be named “Leveraged Products” or “Inverse Products”, as the case may be,” it said.

Under the proposed guidelines Leveraged Products will be subject to a maximum leverage factor of two times, while Inverse Products will be subject to a maximum leverage factor of one time, which effectively means they cannot be leveraged.

“As with conventional ETFs, we expect L&I Products to track indices with constituent securities which are sufficiently liquid and broadly based,” the SFC said.

The SFC said initially it will only accept applications for L&I products that tracked liquid and broadly based non-Hong Kong, non-Mainland foreign equity indices.

Review planned

“Given the novelty of these products in the Hong Kong market, we would like to give Hong Kong investors time to familiarise themselves with L&I products while allowing the SFC to monitor the potential investor impact,” it added.

The SFC plans to conduct a review six months after the launch of the initial batch of L&I products, to consider extending eligible indices to include liquid and broadly based Hong Kong equity indices.

While keeping the option open to add to the list of the eligible indices for L&I products, the SFC also said at this stage it had no plans to accept applications for L&I products tracking mainland Chinese indices.

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