Guidelines for Regulating Index Tracking Exchange Traded Funds

The SFC today publishes new Guidelines for Regulating Index Tracking Exchange Traded Funds (ETFs) under the Code on Unit Trusts and Mutual Funds and a related Consultation Conclusions Paper. The ETF Guidelines are gazetted today and become effective immediately.

The ETF Guidelines set out the regulatory requirements for the authorisation of index tracking exchange traded funds that are offered to the public in Hong Kong. The Guidelines form part of Chapter 8.6 of the Code on Unit Trusts and Mutual Funds and will be incorporated into the Code as Appendix I.

Background

The SFC issued a Consultation Paper on the draft ETF Guidelines on 18 March 2003 for an initial consultation period of four weeks. At the request of market participants and industry practitioners, the consultation was extended by two weeks and ended on 2 May 2003.

A total of 12 responses comprising comments from fund management companies, professional bodies and other market participants were received. The respondents in general supported the initiative to revise the Code to provide a regulatory framework that is conducive to the development of ETFs in Hong Kong.

Key aspects of the ETF Guidelines

The SFC believes that the ETF Guidelines should be formulated to have the flexibility to adapt to the rapidly evolving nature of ETFs. In addition, in view of how ETF markets have developed overseas and the relatively transparent nature of ETFs, the SFC considers it appropriate to adopt a principles-based approach towards regulating ETFs. In order to promote a meaningful development for the ETF market in Hong Kong, the ETF Guidelines now set up a regulatory framework that provides:

• Streamlined requirements on investment restrictions and risk disclosure requirements for all SFC authorised ETFs;
• Suitable disclosure of trading information for ETFs; and
• Streamlined recognition of overseas ETFs that meet the core requirements for authorised funds under the Code and are governed by a regulatory framework that has comparable or similar regulatory principles on ETFs as those in the ETF Guidelines.

Streamlined investment restrictions and risk disclosure requirements for all SFC authorised ETFs:

The ETF Guidelines now provide general relief to relax certain investment restrictions and prescriptive risk warning requirements in Chapter 8.6 for both local ETFs and overseas ETFs authorised by the SFC. For example, ETFs that are adopting representative sampling strategy are no longer required to adhere strictly to the investment restrictions laid down for unlisted index funds in the Code.

Suitable disclosure of trading information for ETFs:

The ETF Guidelines lay down the basic disclosure requirements for all ETFs authorised by the SFC that are also listed or traded on Hong Kong Exchanges and Clearing Limited (HKEx), such as real time or near-real time disclosure of their last closing net asset value (NAV), estimated NAV and notices for suspension and resumption of trading. At the same time, overseas ETFs that are authorised but not listed or traded on HKEx are encouraged to make disclosure of their overseas trading information.

Trading information and the offering documentation or product description document of ETFs may be published via the Internet.

Streamlined recognition of overseas ETFs regulated in an Acceptable ETF Regime:

The ETF Guidelines have introduced the concept of "Acceptable ETF Regime" to facilitate the recognition of overseas ETFs that are regulated in a regime sharing similar regulatory principles as those in the Code:

• Depending on the specific product type and the way an ETF is governed in its home jurisdiction, an overseas ETF that seeks authorisation from the SFC may be deemed to have complied with the Code requirements such as investment restrictions and strategies of an ETF, acceptability of the index underlying an ETF and its documentation requirements such as the constitutive documents and the product disclosure documents.

• Further, the ETF Guidelines do not make it a mandatory condition that all overseas ETFs must be cross-listed or cross-traded on HKEx.

The ETF Guidelines have also converted some of the previously proposed prescriptive disclosure requirements into recommended best practices which are as follows:

• ETFs are recommended but not mandated to publish and distribute their Key Features Summary. The ETF Guidelines lay down a set of recommended disclosure items for an ETF’s Key Features Summary. This Key Features Summary may be published via an ETF’s own website to facilitate public access.

• Overseas ETFs authorised by the SFC are recommended to disclose their overseas trading information on a real or near-real time basis during the overlapping trading hours of the Hong Kong and the relevant overseas market. Such trading information may be made available via such means as the ETFs consider appropriate, e.g. overseas stock exchanges’ websites or information pages supported by trading information vendors.

However, the ETF Guidelines maintain that the Code’s core operational and structural requirements such as the eligibility of managers, the safekeeping of the underlying assets of an ETF by trustees and the on-going compliance requirements with the Code are still applicable to both local and overseas ETFs that seek to be authorised by the SFC.

Alexa Lam, SFC’s Executive Director of Intermediaries and Investment Products, said: "We are aware that ETFs are generally perceived by the industry to be a relatively low-cost and transparent investment tool. In light of this, we have decided to adopt a streamlined regulatory approach for ETFs. We are confident that the ETF Guidelines achieve this objective without compromising investor protection."

"While ETFs are not new to the local market and are basically traded like stocks, investors should be aware that each ETF has its own investment objective and strategy as well as different fee structure. We are considering various options including publication of investor education materials to enhance investors’ understanding of this hybrid listed fund product," she said.

Market issues

Apart from specific comments on the draft ETF guidelines, it is worth noting that some respondents, who are key players in the international and local ETF markets, made the point that the success of an ETF market in Hong Kong depended not only on having a suitable product regulatory framework, but also on there being in place a wide range of market incentives and suitable infrastructural support. The SFC has shared these comments with relevant authorities and is seeking to work with them on related market initiatives to help develop the Hong Kong ETF market.

Mrs Lam said: "We will continue to maintain close dialogue with the industry and other regulatory bodies with an aim to facilitate the development of the ETF market in Hong Kong. It is hoped that the increase in the variety of exchange traded investment products in the Hong Kong market will help widen investors’ choice and create new business opportunities to financial services providers like fund managers and brokers. In the longer term, this may facilitate the development of Hong Kong into a regional hub for ETFs and other related derivative products."

Copies of the ETF Guidelines and the Consultation Conclusions Paper are available at the office of the SFC and on the SFC website.

Ends