China Asset Management (ChinaAMC) and the Shanghai Stock Exchange have been given the green light by regulators to introduce the country's first exchange-traded fund, which will track the bourse's SHSE 50 Index of the most capitalized stocks.
State Street Global Advisors is serving as ChinaAMC's advisor for the product. China AMC and Shanghai exchange officials could not provide a timetable for actually launching the fund, but this is the first time the China Securities Regulatory Commission has authorized an ETF.
SSgA and other market players have promoted the idea of an ETF as one means of helping China sell state-owned shares in listed companies without disrupting the equity markets, as Hong Kong did with shares purchased in the 1997 financial crisis. As the overhang of state-owned shares is among the biggest challenges to capital markets reform, the introduction of ETFs could prove to be an important step.
It is not clear, however, how efficiently this ETF will work in the absence of a futures market. In the United States, Hong Kong and other places, market participants arbitrage between the ETF's net asset value and futures against the underlying index. Although ETFs are comprised of stocks from the index, there are often discrepancies that can send the ETF's NAV out of whack with the index's value without arbitrage against futures to maintain discipline.
To get around this problem, the first ETF is being based around the most liquid stocks on the Shanghai market. "In the future, as the market gains more capacity, the listed large-cap stocks will be more concentrated, and the SHSE 50 Index will reflect the market more closely," says Li Zhongxiang, director of international business development at ChinaAMC in Beijing. "Moreover, the constituent stocks of the SHSE 50 are blue chips with sound performance and good risk and income characteristics, which will assist subscription and redemptions, making this more acceptable to investors."
SSgA officials could not be reached by press time.
Whether the CSRC decides to authorize more ETFs is unclear. Market players have long expected a "listed open fund" product - sort of an ETF lite - to appear on the Shenzhen Stock Exchange, and a number of fund managers have been competing to introduce that product, including Boshi Fund Management, which has a partnership with SSgA rival BGI.
Xinhua FTSE, S&P Citic Securities and Dow Jones also sponsor various A-share stock indices that could back up future ETFs, including ones that span both the Shanghai and the Shenzhen markets. Presumably the CSRC will want to see how this first one fares before allowing others.
"Once this ETF is introduced there will be no regulatory obstacle to new products," says Wayne Chen Zhizuo, deputy director of international business development at the exchange. "You would need CSRC approval to launch a new product, just like any other mutual fund."
ChinaAMC was the first local house to launch an 'optimized' index fund, five years ago. Until now all mutual funds have had rules such as the requirement they hold at least 20% in bonds, so there are no true equity index funds, but the idea has gained currency over the past year.
The Shanghai exchange has been researching the ETF concept for several years with a variety of fund houses, including ChinaAMC, which began explorations in 1992. Last year the firm beat more than 10 rivals to become the exchange's main partner in developing ETFs, says Li.
Separately, ChinaAMC has begun selling its fifth open-ended mutual fund, the Large-Cap Select Fund, via Bank of China, China Construction Bank, Bank of Communications, Guotai Junan Securities, United Securities and another 20 securities firms.
