The Korea Exchange is reviewing adjustments to the premium rate management standards for the exchange-traded fund (ETF) market to enhance its integrity. However, voices from the asset management industry and liquidity providers (LPs) are calling for consideration of the structural differences between domestic and foreign ETFs.
Industry experts warn that applying a uniform standard without accounting for the time lag in the real-time estimated net asset value (iNAV) based on foreign underlying assets could lead to adverse effects, such as dampening market-making activities.
According to financial investment industry sources on June 30, the Korea Exchange has recently prepared a proposal for improving ETF premium rate management and is gathering feedback from asset management firms and securities companies. It is reported that the proposal suggests tightening the LP closing premium rate standard from 3% to 2% for domestic ETFs and from 6% to 3% for foreign ETFs. This move comes in response to a surge in cases of exceeding the premium rate disclosure following the introduction of single-stock leveraged products and increased market volatility, prompting financial authorities and the exchange to take notice.
However, practitioners in the financial investment sector point out that the iNAV calculation logic for domestic and foreign ETFs is fundamentally different.
For domestic ETFs, the real-time prices of underlying assets during regular trading hours are directly reflected in the iNAV. In contrast, foreign ETFs are calculated based on the previous day's index return (closing price), with certain real-time variables like exchange rates excluded due to time lag. This leads to a fundamental difference in the meaning of the premium rate calculated based on the closing price (3:30 PM) between domestic and foreign ETFs, according to industry consensus.
Notably, while the domestic market is open, the U.S. S&P 500 and Nasdaq futures markets are continuously active. As U.S. pre-market trading variables come into play during local morning hours, the actual value of foreign underlying assets fluctuates throughout the trading day.
Consequently, securities firm LPs continuously adjust their quotes to reflect real-time movements in futures for investor protection and accurate market pricing. For instance, if U.S. futures surge by 5% during the trading day, LPs will adjust their ETF quotes accordingly.
The issue lies in the fact that the iNAV benchmark for foreign ETFs remains fixed at the previous day's closing price within the exchange's system. As LPs accurately reflect the volatility of foreign markets in their quotes, a misleading phenomenon occurs where the premium rate is recorded as widening under the exchange's iNAV calculation logic.
A representative from a major securities firm LP stated, "Foreign ETFs are managed based on the closing price due to the time lag, but during trading hours, we must continuously price them based on night futures and real-time volatility. If we standardize the threshold to 3% when volatility increases and the premium widens, it becomes physically challenging for LPs to comply, raising the likelihood of losses or leading to a more passive approach to quote submissions."
Another securities firm representative added, "Whether to unify based on the closing price or how much to reflect U.S. over-the-counter variables presents inherent challenges in the logic, making it difficult to arrive at a clear answer systemically. Due to these practical limitations, there is a strong sentiment of discomfort among practitioners at major securities firms regarding the new guidelines."
Some experts suggest that trust in the market's self-regulatory capabilities should take precedence over regulatory pressure through guidelines. An ETF representative from an asset management firm noted, "Information on premium rates and correlation coefficients is already being disclosed in real-time to investors through home trading systems (HTS). Products that do not manage premium rates effectively will naturally lose investor trust and be sidelined by market economic logic. Relying solely on regulatory measures could hinder product diversity and lead to negative consequences."
In response to these concerns, the Korea Exchange stated, "The proposed improvements are not yet finalized, and specific directions are still under discussion."
* This article has been translated by AI.
Copyright ⓒ Aju Press All rights reserved.