The market for exchange traded funds in Asia is still in its relative infancy but tax benefits in holding them in European-domiciled UCITS fund structures is boosting business, says iShares.

The market for exchange-traded funds in Asia is still in its relative infancy but tax benefits in holding them in European-domiciled UCITS fund structures is boosting business, says iShares.

iShares, the world’s biggest brand for ETFs and part of BlackRock, points to a wrinkle in global tax treatments of funds. The tax difference gives ETFs held in European-domiciled UCITS structures a compelling advantage in the eyes of investors in centres such as Hong Kong and Singapore. UCITS funds are designed to be bought and sold across European Union borders and they are winning increasing numbers of fans outside the EU bloc as well.

An investor from Hong Kong or Singapore - these jurisdictions have no tax treaty with the US – is subject to the 30 per cent withholding tax on distributions from a US-listed fund holding US exposures. However, if the same investor holds a UCITS fund, such as one domiciled in Dublin, with the same exposure, he or she will not be forced to pay such taxes, although the fund itself will have paid a 15 per cent withholding tax. In short, the tax rate is half of what a US fund involves, iShares says.

When compounded over time, such a tax difference can add considerably to long-term gains.

“The benefits of UCITS funds are quite evident now,” Jane Leung, head of Asia-Pacific, iShares, said with magnificent understatement during an interview with this publication.

And she has reason to be confident that the picture is rosy. In the year so far, there have been strong inflows from Asian clients into ETFs using the UCITS structure, at more than $1 billion against $132 million for the whole of 2012. iShares reports inflows overall from private banks into its UCITs ETFs in 2014 (particularly against a decline in 2013). In the first half of the year, Asian private banks bought European equity, broad emerging market and APAC exposures through these UCITS-structured ETFs.

The situation over differing tax on distributions explains why the US, with its worldwide system of tax – recently expanded via its FATCA legislation – is arguably driving investor flows into the arms of non-US registered vehicles if there are significant post-tax gains to be won.

The ETF market in Asia is still in a relatively “baby” stage compared with those of the US and Asia, but awareness is growing, she said. Wealth managers use these funds as core holdings, and for tactical asset allocation, as well as to enter otherwise-hard-to-enter markets, said Leung.

The arena for ETFs hasn’t been without some wobbles. In the aftermath of the 2008 financial crisis, there were concerns that some of these vehicles, such as “synthetic ETFs”, could be vulnerable to counterparty risk. Synthetic ETFs typically replicate returns from an index via swaps. However, Leung said that clients and advisors are becoming better informed.

Leung spends a good deal of her time talking to regulators and other institutions about the market and how it should involve; her work includes plenty of time talking to wealth managers, for example. ETFs are useful, she said, for tactical asset allocation and for investors who want to get into a market that would be otherwise difficult to penetrate.

As the head of iShares, Asia-Pacific, Leung is responsible for the iShares business across Asia, including both distribution and management of iShares products and offices in Japan, Australia, Hong Kong, Singapore, and Taiwan. Before she took on this post, she was head of BlackRock's Asia Pacific Index Equity team and was responsible for portfolio management activities across the region. Leung has served the firm since 2001, including her years with Barclays Global Investors, which merged with BlackRock in 2009. A veteran of the index world, she is also a member of the FTSE Asia Pacific Index Committee and the China Securities Index Advisory Committee. In short, her experience is global – and that gives her an insight into how ETFs can appeal in an up-and-coming region such as Asia.

iShares argues that private banks offering discretionary funds in Asia like to do so in a UCITS form, which is why these structures are liked when it comes to holding exchange traded funds. European ETFs are also getting better known: last year, 98 European ETFs had assets under management of more than $1 billion, a rise of 51 per cent from July 2013.