Hong Kong adjusts leveraged ETF rules amid trading boom and volatility

Hong Kong's securities regulator is introducing new measures to manage volatility in the rapidly growing market for leveraged and inverse exchange-traded products (ETPs). The Securities and Futures Commission announced Friday that issuers will have greater flexibility to adjust the leverage factor during periods of high market turbulence.

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Leveraged and inverse ETPs are funds aimed at delivering a multiple of, or the opposite of, an underlying asset's daily return using derivatives such as swaps or futures.

Under the revised rules, leveraged and inverse ETPs with "highly dynamic capacity" must adopt a flexible leverage structure. This means the leverage factor can vary daily within existing caps of two times for leveraged products and minus two times for inverse products. Issuers will gain more control to manage their products and reduce tracking difference risk during busy trading sessions by lowering the targeted leverage factor when necessary.

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Single-stock leveraged ETFs are booming in Asia as investors use them to juice bets on chipmakers such as Samsung Electronics and SK Hynix, driving massive flows that are reshaping markets, lifting volatility and worrying regulators.

Providers will also be required to publish the targeted leverage factor for the next trading day after market close each day. This aims to provide investors with daily clarity on the targeted exposure. The adjustments come amid extreme swings in leveraged and inverse ETFs, fueled by recent volatility in global tech shares. These swings have increased derivative costs and led to significant deviations from funds' targeted returns.

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The Securities and Futures Commission will now require L&I products with "highly dynamic capacity" to adopt a flexible leverage structure, under which the leverage factor may vary daily within the existing caps of 2 times for leveraged products and minus 2 times for inverse products.

One example of this volatility is CSOP Asset Management's Hong Kong-listed CSOP SK Hynix tracking product. The fund, the largest of its type globally with $6.6 billion in assets, has seen its shares drop approximately 75 percent from their peak within a single month.

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Issuers will have more room to manage their products and mitigate tracking difference risk during high-volume trading sessions by lowering the targeted leverage factor when necessary.