Can ETFs Further International Harmony?

by on June 17, 2009

Spurred by a shift in investor preference away from traditional active management and towards passive investing, the ETF industry in the U.S. has boomed in recent years. News of new ETFs and entrants to the market are commonplace occurrences. The market for most ETFs fully liquid, with larger funds trading more than 100 million shares daily. With several issuers focusing on niche style and location markets, investors can gain exposure to nearly any desired asset through ETFs. But while investors in the U.S. and other developed countries can easily gain access to stock exchanges half a world away, many restrictions, including political conflicts, still limit ETF investing between emerging market economies. Cross-investment between China and Taiwan has been limited for decades as a result of intense conflicts over Taiwan’s political status. But in recent months tensions have begun to ease, and cross-border investments are now possible. In recent weeks, China and Taiwan have taken steps towards cross-listing exchange-traded funds, a significant step that would further align the economic interests of these traditional rivals.

From Bitter Rivals…

The relationship between Taiwan and China is incredibly complex. The controversy surrounding Taiwan’s political status relates to differing opinions as to whether Taiwan should (1) remain effectively independent as territory of the Republic of China, (2) become unified with the People’s Republic of China (what is commonly referred to as China), or (3) formally declare independence as the Republic of Taiwan. China has repeatedly stated that any declaration of independence would trigger an immediate war. As opposing factions have sought to further their agenda, China and Taiwan have have approached the bring of armed conflict on countless occasions.

…To Financial Allies?

Relations between China and Taiwan have been improving since March 2008, when Chen Shui Bian, a staunch spporter of independence, was replaced by Ma Ying Jeou. Since then, signs of easing tensions have appeared regularly. In November, the rival governments agreed to open shipping and postal routes that had been closed for more than 50 years. A month later, daily direct flights began for the first time between Beijing and Taipei. An in January, China presented two pandas with names that combine to spell “reunion” to the Taipei Zoo.

While the pandas may make for an adorable photo and local news story, the most promising sign that China and Taiwan have turned the page in their rocky relationship is occurring in the offices of financial regulators. According to a report from Taiwan’s Securities and Futures Bureau, the Financial Supervisory Commission is reviewing an application submitted by Polaris International Securities Investment Trust Company to start a feeder fund for the CSI 300 ETF listed in Hong-Kong. Such a fund, if approved, would represent the first opportunity for Taiwanese investors to buy ETFs linked to Chinese equities. The CSI 300 is a market capitalization-weighted index that tracks the performance of equities traded on the Shanghai and Shenzhen exchanges. Polaris will likely also apply to list its Taiwan 50 Index ETF in Hong Kong, furthering cross-investment that may lead to warming relations. 

The Almighty (Taiwan) Dollar

Last month, the Shanghai Stock Exchange began considering a proposal to allow Taiwan’s ETFs to trade in Shanghai. The Shanghai Exchange already encourages Taiwanese companies to list their shares in China, but further collaboration with Taiwan to promote cross-listing of other financial products, particularly ETFs, could go a long way towards ensuring peace in the region. Chinese-linked ETFs in Taiwan (and Taiwan-linked ETFs in China) would likely be extremely popular, as they would allow for greater geographical diversification through investment in familiar regions. Although limited investment opportunities exist already, ETFs would allow all classes of investors to gain exposure to neighboring economies, further aligning their economic interests and providing inventives to avoid disruptive conflicts in the future.

Direct flights and open ports are surely signs of progress, but they offer no indication that future conflicts won’t flare up. Which is why these developments could be so important in promoting peace and stability. With cross-listing of ETFs, peace gains an important ally: prosperity. As investors in Taiwan and China accumulate holdings in each others’ economies, the costs of armed clashes rise significantly, hopefully encouraging the governments to pursue diplomatic channels.