Synthetic ETFs Expected to Shrink After H.K. Regulations

It’s very interesting that as soon as a government regulator wants to increase transparency in synthetic ETFs the market is expected to shrink.

Forty-four percent to be exact, according to Celent, a Boston-based financial research and consulting firm. The Hong Kong market for synthetic ETFs will drop to $4.5 billion by 2014 from $8 billion last year, says Anshuman Jaswal, a financial-services analyst at Celent, if new regulations to increase transparency and protect investors are strongly enforced by the city’s Securities and Futures Commission. That’s a pretty huge drop for these ETFs, which produce returns through derivative contracts rather than through underlying securities. The obviously implication here is the counterparties involved in the derivative contracts don’t want to be knownd and that once you must protect investors these things can’t make money.

“Societe Generale’s Lyxor Asset Management plans to delist all 12 of its Hong Kong-listed synthetic ETFs in March, “ says Bloomberg, quoting Lyxor’s head of ETF distribution in Asia, Herman Chen, who added the decision was not a reaction to the new regulations. Maybe, but the timing seems awfully suspect.

Singapore, meanwhile, is expected to pick up the slack. Over the next two years, its market for synthetic ETFs is expected to grow to $5.5 billion from $1 billion, says Jaswal. Bloomberg reports synthetic funds make up 11% of Asia’s $100 billion ETF market, with 70 ETF listings in Hong Kong and 44 in Singapore.

“It is possible that trading volumes are insufficient to make Lyxor’s ETFs cost-effective in light of the new measures,” Celent said a report. The big not fully explained is why will trading volumes drop so precipitously? Is it because once investors get a load of what’s inside these things they won’t want to go anywhere near them?

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