February 1, 2013 7:19 pm

No respite in regulation from Esma

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Exchange traded fund providers may be mistaken if they think regulation of their sector is in the rear view mirror.

Last year, the European Securities and Markets Authority (Esma) gave ETFs, as one market participant put it, a “good 10-year check-up” by issuing rules on disclosure, product identifiers and securities lending. The guidelines came after concerns that the authority would separate complex ETFs from the rest of the Ucits crowd. It did not happen, but Esma’s intervention was only the first manifestation of regulators’ concerns.

In Brussels, home of the European Commission, and in Strasbourg, where the European parliament sits, some policy makers are eager to make sure that complex ETFs do not pose a threat to investors.

Sven Giegold, a German Green MEP, is one of them. He says: “It is unfortunate that Europe has not done more to regulate [ETFs] in the interest of consumers. A key reason for this is the diversity of products, which make a one-size-fits-all regulation impossible.

“But the mills of Europe grind slowly but surely.”

In the case of ETFs, the mills are to be found at the commission, which has started work on the so-called Ucits VI and could test the industry’s lobbying efforts to a higher degree.

In a consultation paper on Ucits published in July, the department of commissioner Michel Barnier called Esma’s guidelines on ETFs an important “first response” to the issues posed by complex portfolio management techniques.

Brussels has yet to make formal proposals, but it has raised the possibility of a review of eligible assets, which could close the door to complex Ucits funds, including some ETFs. In its consultation it expressed concerns over a potential lack of liquidity in secondary markets for ETFs.

Among ETF providers, the sentiment is, perhaps inevitably, that the Ucits framework is strong enough to protect investors.

Townsend Lansing, head of regulatory affairs at ETF Securities, says: “Ucits need to be flexible to deal with investors who want a bit more leverage or diversified risk in their portfolios.”

Boost ETP, which offers short and leveraged ETFs, believes the response to the issue of complexity is education. The firm has devised a test that advisers can use to measure their knowledge of complex financial matters.

“There needs to be far more education for retail investors. Irrespective of which ETFs you talk about, investors are still very immature,” says Hector McNeil, co-chief executive.

The firm also argues that existing suitability requirements are sufficient to protect clients from investments they cannot understand. It adds there are enough safeguards to allow products such as its triple leverage ETFs to be available to retail investors.

Alan Miller, chief investment officer at SCM Private, adds: “Look at ETFs in a comparative way and you’ll see ETF standards are miles, miles higher than in other types of investment funds.”

ETFs score better on transparency and disclosure, compared to funds, he says. “The key is whether funds are properly marketed to investors. They need to be given proper information.”

Other providers agree. “We believe that there should be specific labelling on products. If there is an inversed strategy, it should be very clear, so that people understand when they use Ucits key investor information documents or go on financial websites,” says Joe Linhares, head of Europe, the Middle East and Africa at iShares.

“However, ETFs have had a check-up from Esma, and the result is that they are very well regulated and the products are sound.”

It remains to be seen what the commission decides, but the industry warns that any regulatory initiative will have to take into account the dangers posed to the Ucits label.

Jean-Baptiste de Franssu, former European Fund and Asset Management Association president and chairman of Incipit, an advisory firm, believes that ETFs are reflective of a wider problem with the approach taken to regulate funds.

Asked whether it would be a good idea to create complex Ucits, he says: “The theory is good but it would be very difficult in practice.

“Reviewing eligible assets would ultimately be less damaging than breaking up Ucits in two.”

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