The widely anticipated introduction of exchange-traded funds (ETFs) based on Hong Kong-listed stocks by mainland bourses may usher in a new era of financial integration between the two sides.

Mainland regulators have recently given ETFs a green light. China Securities Regulatory Commission Director-General for International Affairs Tong Daochi said late last month in a Shanghai forum that mainland exchanges will soon launch ETFs based on Hong Kong stocks.

The move, combined with the latest revisions on the Clearing Agreement for yuan in Hong Kong, marks a new phase of development of yuan-denominated business in Hong Kong.

ETFs are investment funds that track the price movements of underlying assets. They trade like ordinary stocks and are widely regarded as cost-efficient.

Financial institutions have been active in launching mainland-related ETFs on the local stock exchange.

According to figures from the Securities and Futures Commission (SFC), as of June 30, there were 21 ETFs listed on the Hong Kong stock exchange that track the price movements of A-Share indices. While mainland-related ETFs are increasingly popular in the city, there have been no Hong Kong-based ETFs listed on mainland bourses.

The proposal to list Hong Kong-based ETFs on mainland bourses is consistent with underlying principles of the 7th supplementary agreement of the Closer Economic Partnership Arrangement (CEPA), signed in late May between the Hong Kong SAR and the Central Government. Under the agreement, both sides will deepen cooperation in financial services and product development by allowing Hong Kong-related ETFs to be traded on mainland stock exchanges.

"This will create one more additional channel for mainland retail investors to invest in local (Hong Kong) equities so that it can help inject capital into the local stock market. If the capital sizes of the ETFs are large enough and the market response is good, it can foster more similar ETF products to be launched on the mainland bourses," said Simon Luk, a director at Capital Focus Asset Management.

He added that the introduction of ETFs based on Hong Kong stocks on the mainland might spur demand for local stocks and enhance transaction volumes of the local equity market.

However, Luk cautioned that the current valuation of the A-share market is lower than the H-share market because the A-share market has seen a greater correction than the H-Share market recently This may curb demand for Hong Kong-based ETFs for the time being.

The Shanghai Composite Index has plummeted 18.8 percent this year while the Hang Seng Index has lost only 0.88 percent over the same period. A-shares are now trading at 12 times their forecast earnings while H-shares are trading at 16 times of theirs.

Luk also cautioned that market volatility in the local stock market may increase because of the buying and selling moves by the ETF fund managers.

According to the latest statistics of the SFC, the average daily turnover of ETFs hovered around $252 million in the first two quarters this year and the total asset value of these ETFs amounts to $67.78 billion. These two figures have registered a year-to-year growth of 12.5 percent and 30.9 percent, respectively.

China Daily

(HK Edition 08/07/2010 page2)