HONG KONG (Reuters) - China has been looking at allowing Western firms such as Citadel Securities and Jane Street to act as market makers in its rapidly growing exchange-traded fund (ETF) sector, two people with direct knowledge of the matter said.

Over the last two years, Chinese authorities have issued more licences and encouraged the development of domestic market makers. But international market makers are more experienced in providing liquidity to ETFs and the move would boost trading efficiency and lower costs, the people said, declining to be identified due to the sensitivity of the matter.

The sources cautioned, however, that the escalating trade war with U.S. that has seen China saddled with tariffs of 145% this year could delay Beijing's official green light for U.S. firms.

ETF market makers serve as liquidity providers, offering continuous bid and ask quotes for ETF shares which allow investors to trade the products efficiently and at lower cost. Licenced market makers in China enjoy lower fees and less restrictions in trading.

Billionaire Ken Griffin's Citadel Securities and Jane Street, two of the largest market-making firms in the U.S., as well as Amsterdam-headquartered Optiver may be the first to benefit when the market is opened up, according to one of the people and a third source.

Citadel Securities applied in January to set up its own securities broker unit in China.

The China Securities Regulatory Commission, Citadel Securities and Jane Street did not respond to Reuters requests for comment. Optiver declined to comment.

China's ETF sector has expanded 134% over the past two years to be worth $510 billion, driven by strong inflows from state capital that has propped up the stock market. It is now the second-largest ETF market in the Asia Pacific region after Japan's, which is worth $620 billion.

Foreign financial firms have in recent years been granted wider access to China's domestic securities, funds and insurance sectors.

Even so, many foreign firms have trimmed headcount in mainland China and pared back expansion plans, concerned about slow growth for the world's second-biggest economy and the rise in geopolitical tensions.

Last year, firms doing so included Fidelity International, Morgan Stanley and Legal & General.