Explainer: How does HK’s Tracker Fund avoid being caught between US sanctions and doing its job?

20-Jan-2021 Intellasia | South China Morning Post | 6:02 AM Print This Post

The Tracker Fund, the largest exchange-traded-fund (ETF) in Hong Kong, was in the spotlight last week after its manager State Street Global Advisors Asia made a dramatic U-turn over whether it should comply with US sanctions against Chinese stocks in its portfolio.

The reversal, matching a similar on-off-on flip-flop by the New York Stock Exchange, underscores how global financial institutions are struggling to keep up with the flurry of executive orders issued in the twilight of Donald Trump’s presidency against Chinese companies.

Millions of retail investors and institutional funds who invest in the Tracker Fund have been affected by the sanction. Here’s how:

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What is the Tracker Fund?

Established on November 11, 1999, the Tracker Fund, known simply as TraHK, was set up by the Hong Kong Monetary Authority (HKMA) to dispose of the city government’s equity holdings accumulated in a two-week, HK$118 billion (US$15.2 billion) intervention to prop up stock prices during the 1998 Asian Financial Crisis. At its launch, the portfolio’s value had risen by 69 per cent.

An estimated 184,000 retail investors bought TraHK during its HK$33.3 billion initial public offering, the largest sale in Asia excluding Japan in 1999. Combined with additional sales between 1999 and 2002, the government sold HK$140.4 billion of TraHK to the public, keeping HK$51.3 billion as long-term investments for the Exchange Fund, as the city’s reserve is called.

The fund, with HK$105 billion of assets under management, is popular with retail investors and many of the 4.5 million members of Hong Kong’s Mandatory Provident Fund (MPF) because it is easy and cheap to trade, with a portfolio that tracks the city’s benchmark Hang Seng Index. Twelve MPF funds offer TraHK as an investment choice.

Who manages the Tracker Fund?

Boston-based State Street was selected in 1999 by the HKMA and its consultant Watson Wyatt to manage TraHK, beating the shortlisted bidders Barclays, Hang Seng Bank and Jardine Fleming. The Standard & Poor’s 500 Index depositary receipts (SPDRs), which inspired the creation of TraHK, was also managed in the US by State Street.

As a passive manager, State Street does not pick stocks, but must ensure that the portfolio tracks any changes among the 52 constituents of the Hang Seng Index, subject to quarterly reviews by the compiler of the benchmark.

State Street Global Advisor Asia has been the Tracker Fund’s manager since 1999 while State Street Bank & Trust Company is the trustee.

How was Trump’s executive order a problem for TraHK?

While TraHK is a Hong Kong fund, State Street’s parent is a Boston-based firm which must follow US laws and regulations.

State Street declared on January 11 that TraHK cannot buy the shares of any sanctioned firms according to Trump’s November 12 executive order barring Americans from transacting in shares of companies deemed to be linked to China’s military. Trump’s order named 35 Chinese companies, including three constituents of the Hang Seng IndexChina Mobile, China Unicom and China National Offshore Oil Corporation (Cnooc)with 4.27 per cent in combined weighting on the benchmark. The sanction list subsequently grew to 44 companies after the US added nine stocks including the smartphone maker Xiaomi, with 4.75 per cent weighting on the Hang Seng.

“The whole purpose of the Tracker Fund is to track the Hang Seng Index. If the manager cannot track the index, then the manager is no longer fit for duty,” the HKMA’s former chief executive Joseph Yam Chi-kwong, and the creator of the Tracker Fund, said in a statement to South China Morning Post.

State Street, in a January 13 stock exchange filing on the resumption of its investments in US-sanctioned stocks, pointed out that TraHK is no longer suitable for US investors. The company declined to comment for this article.

Does State Street’s U-turn solve all problems?

The damage has been done. Up to 5 per cent of TraHK units were redeemed last week, according to stock exchange data.

“Will they change their mind a second time, like the New York Stock Exchange?” askedc shareholder activist David Webb, who called for changing the manager on webb-site.com.

HKMA and the six-member Tracker Fund Supervisory Committee indicated they would keep a close watch over the matter. State Street’s statements had created “unnecessary market uncertainties,” a spokesman of HKMA said on January 13.

Several major MPF providers, including Bank Consortium Trust, BOCI-Prudential and Bank of East Asia, also called on the monetary regulator to ensure Tracker Fund does not divert from the city’s stock benchmark.

“If the Tracker Fund cannot track the Hang Seng Index, some MPF funds which follow [it] may potentially create large tracking errors and be unable their objective,” said BEA Union Investment’s chief executive Eleanor Wan.

Can Tracker Fund change its manager to avoid being caught in the middle?

Based on the nature of Trump’s executive order, changing the TraHK manager to a non-US entity can allow the fund to invest in any company without having to follow US sanctions, said Stephen Chan, a partner at the law firm Dechert.

There are three ways to change TraHK’s manager, according to its prospectus:

1. The manager can opt for voluntary retirement with three months’ written notice;

2. The six-member supervisory committee, whose chair is appointed by the HKMA, can replace the manager “for good and sufficient reason” where the change “is desirable in the interests of unit holders”; and

3. The manager may be removed if more than 50 per cent of TraHK unit holders vote for removal.

The chair of the Tracker Fund’s supervisory committee is George Hongchoy, executive director and chief executive of Link Asset Management.

“TraHK Supervisory Committee will continue to monitor the situation and ensure that the manager and the trustee continue to manage and administer TraHK in accordance with the terms of TraHK’s trust deed with a view to safeguarding unit holders’ interest,” the committee said in a statement, without saying if it had pressed State Street to make its U-turn.

What are the challenges of changing the manager?

The key challenge is to find a new manager. TraHK’s prospectus said any potential new manager must be acceptable by the Securities and Futures Commission (SFC) and the Supervisory Committee. The TraHK manager must be incorporated in Hong Kong and licensed by the SFC.

If the purpose is to get around US sanctions, then the manager needs to be a non-US entity, which limits the potential candidates for replacement.

The cost for administering the Tracker Fund stands at 0.1 per cent, or about HK$104 million per year at the portfolio’s current size. While a new manager may be available to take up the challenge, the job may not be acceptable at such cost.

TraHK rose by 0.5 per cent to HK$28.78 on Friday.



Category: Hong Kong

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