ETF after-hours trading faces delay over pricing risks

South Korea’s plan to introduce after-hours trading for exchange-traded funds could be delayed, as asset managers warn that gaps in pricing and liquidity infrastructure could cause ETF prices to diverge sharply from their underlying value.

The Korea Exchange met asset managers and securities firms Monday to discuss whether to include ETFs in the after-hours market, financial industry sources said Tuesday. Asset managers broadly opposed the proposed launch date, arguing that the system is not ready.

“Sept. 14 may be too soon, and asset managers are concerned about taking on the risk,” an asset management official said. “The industry is already under intense scrutiny over single-stock leveraged products. If something goes wrong in after-hours trading, asset managers could become the target of criticism.”

At the center of their concerns are two market mechanisms that would be unavailable after regular trading: real-time pricing of some derivatives held by ETFs and the creation and redemption of ETF units. Without those mechanisms, industry officials warn, market makers could struggle to keep ETF prices aligned with the value of their underlying assets.

The risk is already visible during regular trading. In July, when market volatility intensified, there were 864 cases in which ETF prices deviated from their underlying value.

The discrepancy could widen after hours because some derivatives tracked or held by ETFs would not trade during that session. Liquidity providers use prices from both stocks and derivatives to calculate quotes and keep ETF prices close to their indicative net asset value, or iNAV.

“An ETF’s iNAV should be calculated using all the assets it holds,” the official said. “If stocks are trading while derivatives are not, the iNAV becomes incomplete and less reliable.”

The inability to create or redeem ETF units poses another risk.

If heavy buying exhausts a liquidity provider’s inventory during regular trading, it can create new ETF units to meet demand. That mechanism would not operate in the after-hours market.

“If a major announcement triggers 5 billion won or 10 billion won ($3.53 million or $ 7.1 million) in sudden buying, the liquidity provider’s inventory could be completely depleted,” the official said. “Normally, additional ETF units could be created to supply the market, but that would not be possible.”

The shortage could push an ETF to its daily price limit even if its underlying assets make no comparable move.

The KRX has asked liquidity providers to maintain bid-ask spreads for ETFs whose managers opt into after-hours trading. Industry participants say that obligation could expose liquidity providers to greater losses because they would have to continue quoting prices without being able to adjust supply through creation and redemption.

Asset managers also cite additional staffing and operating costs, as well as the risk of reputational damage if prices become distorted.

“Would ordinary investors be able to distinguish after-hours trading from the regular market?” another industry official said. “They would probably see it simply as an extension of regular trading. If a major disclosure or strong earnings report is released after the close, buying could become heavily one-sided, creating sharp volatility.”

Smaller asset managers are waiting to see whether major firms participate. The industry could conduct another survey once the largest managers make their positions clear, according to an official at a smaller firm.

“Most of us do not want to participate,” the official said. “But if a major asset manager joins, smaller firms may have little choice but to follow.”

The final decision on whether and when to allow after-hours ETF trading is expected to require consultation with the Financial Services Commission rather than being made by the KRX alone.

“Nothing has been decided yet,” an FSC official said. “We will review the views of the Korea Exchange and asset managers before making a final decision.”