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Taiwan’s Financial Supervisory Commission has announced plans to crack down on exchange traded funds’ use of so-called earnings equalisation mechanisms that are used to shore up existing investors’ dividends.
Such ETFs set aside a portion of invested funds, often from newer subscribers, to mitigate the dilution of the percentage paid out in dividends due to existing investors in the ETF. The regulator instead wants to ensure that such payouts should largely come from “dividends and bond yield”.
The FSC has received complaints from investors of high-dividend ETFs, including criticism around the proportion of dividends paid out by the earnings equalisation mechanism being too high, Kao Ching-ping, deputy director of the regulator’s Securities and Futures Bureau, said in a press conference on August 31.
Kao said the regulator would like ETFs to go “back to basics” when determining dividend payouts by clarifying the principles of the use of the earnings equalisation mechanism.
“[Dividend payouts] should be based on the dividends and bond yield, instead of paying by earnings equalisation mechanism,” she said.
Kao said the FSC would strengthen its management regarding the earnings equalisation mechanism by setting out clear rules on the use of such mechanisms for dividend payout, and to strengthen the disclosure of relevant information.
The Taiwan Stock Exchange had earlier drafted the initial regulation framework around paying out dividends with the earnings equalisation mechanism, but the FSC believes there is “still room for more detailed regulations” and has asked the Taiwanese bourse and Securities Investment Trust and Consulting Association to further discuss the regulations, according to Kao.
Among 146 Taiwan ETFs with income distributions, 23 have introduced an earnings equalisation mechanism, including the market’s largest high-dividend ETFs, according to the FSC.
The products have helped fuel growing interest in Taiwan’s ETF industry with many investors rushing to buy them in August in order to gain access to dividends paid in mid-September.
Newly launched high-yield ETFs have switched from annual dividend payouts to semi-annual or even monthly dividend payouts, aiming to attract more investors.
Many of the market’s largest high-dividend ETFs have introduced the earnings equalisation mechanism, including the Cathay MSCI Taiwan ESG Sustainability High Dividend Yield ETF, which had more than a million shareholders at the end of August.
Yuanta Funds, one of the largest local ETF issuers, recently published an article explaining the earnings equalisation mechanism on the Taiwan Stock Exchange’s newly launched ETFortune platform in August.
If an ETF with NT$10bn ($311mn) in assets receives NT$500mn in dividends, the cash dividend rate for the next month might be, for example, 5 per cent, Yuanta explained.
In a situation where that ETF records a large amount of subscriptions before the dividend cut-off date, and its assets increase to NT$50bn, the cash dividend rate for that NT$500mn of dividends would be diluted from 5 per cent to 1 per cent.
With the earnings equalisation mechanism, however, the ETF would take NT$2bn out of the new investors’ invested funds to bring the distributable dividend to NT$2.5bn and maintain the cash dividend rate at 5 per cent.
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Liu Tsung Sheng, chair of the Securities Investment Trust and Consulting Association, argued that the earnings equalisation mechanism was a good thing for asset managers, however, because it “prevents new investors’ funds from diluting the returns of existing investors”.
The issue is that the intense competition between fund houses in launching high-dividend ETFs has caused an escalation in dividend rates where new products have to offer higher dividend rates in order to attract investors, Liu said.
“If the first high-dividend ETF offers a 6 per cent dividend rate, the latecomers will have to offer 8 per cent or even 12 per cent. This is the situation right now,” he said.
“What the regulator is worried about is that when everyone is making a fuss about the level of dividend rate, the source of the dividend may be misused or manipulated,” he explained, adding that the key concern of the regulator is to avoid misleading investors in terms of the source of dividend.
*Ignites Asia is a news service published by FT Specialist for professionals working in the asset management industry. Trials and subscriptions are available at ignitesasia.com.