Selena Li, Samuel Shen

SHANGHAI/HONG Kong – As delisting threats threaten the market of $37B for China-focused ETFs (exchange-traded funds), global index-tracking managers are pushing their index providers into Hong Kong-traded counterparts.

Washington wants complete access, which Beijing has so far declined to grant, to these audit papers. Chinese American Depositary Receipts will (ADRs), be removed from the market by 2024 if there is no solution. This could potentially cause a major blow to ETFs that have large ADR exposure.

Brendan Ahern (CIO) of Krane Funds Advisors said that they have engaged with all index providers to discuss the potential risks of ADR delisting. The company manages China-focused ETFs based upon CSI and MSCI indices.

He said that passive ETF managers would like their index providers transition from ADRs into the HK share classes to avoid tracking errors. This refers to the undesirable performance gap between ETFs and indexes.

He said, “Index providers move at different speeds.”

ETF managers, such as CSOP Asset Management or Samsung (KS-) Asset Management, stated that they also encouraged their index providers and to exchange Chinese ADRs for Hong Kong-traded equivalents.

Some smaller index companies, such as China Securities Index Co, said they have started the switching but the likes of S&P Dow Jones Indices and MSCI are more cautious, citing the need for further clarity around Sino-U.S. audit talks, and concerns over relatively low liquidity levels in Hong Kong.

Many active managers are free from index tracking requirements and have either disposed of ADRs or moved to Hong Kong shares.

TRACKING ERRORS

ADR exposure of the S&P New China Sector Index ETF, run by CSOP, has decreased to 6% from over 30% a year ago after discussions between the Hong Kong-based asset manager and its index provider, portfolio manager Wang Yi said.

China Securities Index, a Chinese index publisher, started prioritising Hong Kong-listed stock inclusions in its CSI Overseas China Internet Index.

KraneShares manages the $6 billion ETF that tracks this index, as well as many index funds.

Other people are still waiting.

China has proposed rules to allow U.S. regulators the ability to access audit work papers of Chinese companies. This is Beijing’s attempt to make a deal that will keep Chinese ADRs on record.

Mike Shiao (Invesco’s Asia-ex-Japan chief investment officer) stated that the U.S. overhang on Chinese-listed companies had been “partially” lifted, however Invesco which has an ETF invested heavily in ADRs would still monitor the U.S. responses.

S&P Dow Jones declined comment on potential changes to methodologies, while MSCI and Russell also declined comment.

The KraneShares CSI China Internet ETF stated last month, underscoring the impatience of some investors that it aimed at fully transitioning to Hong Kong shares within the next months.

Can an ETF be converted to an index provider without the need for an index provider?” KraneShares’ Ahern confirmed that the ETF could be converted without an index provider, even though this would lead to tracking errors. He said, “Obviously it would be better to have tracking error than holding a stock during a delisting.”