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Since the launch of ETF as a new index investment product on China's securities market, the ETF shares have been declining on the Shanghai Stock Exchange (SSE) and the Shenzhen Stock Exchange. According to the SSE Innovation Lab's latest research report, the ETF premium, which can lead to arbitrage through a large subscription of ETF and thus promote the ETF scale, will not happen until the secondary market has a greater demand for ETF.
The research report points out that the ETF share decrease is due to ETF's discount trading. The ETF discount attracts investors to do arbitrage, resulting in a large redemption of ETF. The major cause of the ETF discount is the lack of liquidity and depth for ETF market. Statistics show that the market impact cost when investors directly sell the ETF far outweighs that when investors sell the redeemed stock. This shows the ETF's liquidity on the secondary market is below that of its underlying shares, which makes investors prefer selling after redemption of constituents when they need to sell the ETF or are in need of cash.
According to further analysis in the report, the underlying cause of the ETF discount and lack of liquidity, from a fundamental view, is the lack of market demand for ETF. Firstly, the undeveloped market product structure greatly limits the function of ETF. Secondly, the performance advantage of China's ETF is not obvious compared with that of active investment fund. Besides, the deficiency in ETF's operational mechanism has had a negative impact on the ETF shares change when companies conduct important actions (especially the equity division reform).
The report puts forward 6 measures to enlarge the ETF scale. First is to improve the market structure and vigorously develop financial derivatives market. Second is to introduce the margin trading and securities lending for ETF and ETF constituents as soon as possible. Third is to allow ETF to participate in new shares' allotment. Fourth is to abolish the mechanism of "cash substitution only" for subscription and redemption of ETF and adopt the mechanism of "optional cash substitution" when relevant stocks are under trading suspension. Fifth is to promote the pooled creation mechanism to facilitate small and medium sized investors' ETF subscription. Sixth is to work out after-hours basket trading, with a securities code for the ETF constituents' portfolio, and allow investors to conduct basket trading of the ETF constituents' portfolio according to the code.
