News & Insights

SFC concerned over secondary market liquidity of ETFs

The Securities and Futures Commission (SFC) issued a circular on 17 April 2020 (Circular) to managers and market makers of SFC authorised exchange traded funds (ETFs) reminding them of their responsibility to manage ETFs in the best interests of investors. The circular was prompted by the suspension of market making activities by the sole market maker of an ETF due to the quarantining of some of its trading staff.

The market making function is critical to the liquidity of ETFs, and liquidity is one of the main concerns of the SFC in the context of products sold to retail investors.

Key takeaways

An ETF manager should:

  • conduct due diligence and regular ongoing monitoring on the competence and performance of market maker(s);
  • monitor the secondary market trading and liquidity of the ETFs closely;
  • “maintain a close dialogue with each market maker” so that it can anticipate possible disruptions to the market making function;
  • manage risks attendant on the appointment of a sole market maker, including by the appointment of additional market makers or an alternate market maker which is in a position to step in promptly in the event of a suspension or interruption of the operations of the sole market maker;
  • inform the SFC immediately in the event of cessation, disruption or suspension of market making activities and inform investors; and
  • give the SFC early alerts of any untoward circumstances relating to the ETFs under its management.

An ETF market maker should:

  • ensure that its business continuity plan identifies likely scenarios involving disruptions and provides for appropriate back-up facilities and adequate personnel to maintain their market making function;
  • implement contingency measures in a timely fashion; and
  • alert the ETF manager, the SFC and The Stock Exchange of Hong Kong Limited (SEHK) immediately if it anticipates a disruption in its operations.

ETF managers should satisfy themselves through appropriate due diligence that market makers which they appoint are adequately resourced to discharge their function and that they have appropriate contingency plans in place to manage the risk of interruption of their operations. This obligation applies on appointment and during the life of the appointment, so regular monitoring is necessary.

The SFC reminds ETF managers to familiarise themselves and comply with the listing requirements of including the procedures for the publication of announcements or notices on the SEHK’s website such as the publication windows cut-off times, so that they can ensure that information affecting secondary market trading is disclosed in a timely manner.

The Circular requires the market maker of an ETF to alert the ETF manager, the SFC and the SEHK if it experiences or foresees that it will experience any operational difficulties or disruptions that may affect the proper discharge of its market making functions. ETF market makers which are themselves listed (whether in Hong Kong or overseas) need to consider whether such information amounts to price sensitive non-public information relating to the market maker itself, in which case provision of such information could potentially trigger a requirement for the market maker to disclose the information on the exchange where the market maker is listed. 

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