The International Organization of Securities Commissions (IOSCO) has published its final report on principles for the regulation of exchange-traded funds (ETFs).
IOSCO has published nine principles for the regulation of ETFs.
The report contains nine principles intended to guide the regulation of ETFs and foster industry best practices in relation to these products.
Investor interest in ETFs has increased worldwide as evidenced by the sharp increase in funds invested in these types of products. Assets managed under ETF structures totalled around $2 trillion at end January 2013, representing roughly 7% of the global mutual fund market.
This dynamic growth in ETFs has gradually attracted the attention of regulators, concerned about the potential impact of ETFs on investors and on the broader marketplace, as the industry has continued to evolve through diversification and the launch of new innovative products.
Already in the course of 2008-2009, IOSCO began to look more closely at the rise of ETFs, helping to launch a debate, both within and outside the regulatory community (i.e., involving asset managers, investors, and other multilateral institutions), on ways for regulators to address the specificities of these products, while also seeking to address their potential risks.
Numerous consultations among IOSCO’s member regulators and their repeated engagements with representatives of the global ETF industry have led to the report. As such, it reflects a shared consensus within the regulatory community as to how the regulation of ETFs should be approached.
Taking into account the comments expressed during the consultation process, IOSCO has focused its final recommendations on features that are specific to ETFs. The principles address ETFs that are organised as Collective Investment Schemes (CIS) and do not apply to other, non-CIS, exchange-traded products (ETPs).
The first section of the report concerns ETF classification and relevant disclosures for investors, including principles intended to clearly differentiate ETFs from other non-CIS ETPs, as well as from other CIS. Important in this regard is that investors are able to appreciate both the similarities and differences of ETFs with other competing products, as well as the way ETFs achieve their investment objective and the quality of their performance typically vis-à-vis a reference index.
Further principles encourage the disclosure of related fees and expenses, including the eventual impact of securities lending on these, as well as complete, accurate and understandable disclosure to address the types of risks investors may be exposed to particularly through ETFs using complex strategies that may involve the use of leverage (or reverse leverage).
The second part of the report addresses concerns tied to the structuring of ETFs as such, including the management of potential inherent conflicts of interest and of counterparty risks arising from the two main types of replication methods: physical and synthetic. IOSCO encourages regulators to consider imposing requirements to ensure that ETFs appropriately address risks raised by counterparty exposure and collateral management.
A concluding section addresses ETFs in a broader market context, underscoring the importance of intermediaries’ disclosure and conduct requirements (particularly in terms of product suitability) and referring to other work that may be relevant.
The principles are as follows:
Principle 1 – Regulators should encourage disclosure that helps investors to clearly differentiate ETFs from other ETPs.
Principle 2 – Regulators should seek to ensure a clear differentiation between ETFs and other CIS, as well as appropriate disclosure for index-based and non index-based ETFs.
Principle 3 – Regulators should require appropriate disclosure with respect to the manner in which an index-based ETF will track the index it references.
Principle 4 – Regulators should consider imposing requirements regarding the transparency of an ETF’s portfolio and/or other appropriate measures in order to provide adequate information concerning: i) any index referenced and its composition; and ii) the operation of performance tracking.
Principle 5 – Regulators should encourage the disclosure of fees and expenses for investing in ETFs in a way that allows investors to make informed decisions about whether they wish to invest in an ETF and thereby accept a particular level of costs.
Principle 6 – Regulators should encourage disclosure requirements that would enhance the transparency of information available with respect to the material lending and borrowing of securities (e.g., on related costs).
Principle 7 – Regulators should encourage all ETFs, in particular those that use or intend to use more complex investment strategies to assess the accuracy and completeness of their disclosure, including whether the disclosure is presented in an understandable manner and whether it addresses the nature of risks associated with the ETFs’ strategies.
Principle 8 – Regulators should assess whether the securities laws and applicable rules of securities exchanges within their jurisdiction appropriately address potential conflicts of interests raised by ETFs.
Principle 9 – Regulators should consider imposing requirements to ensure that ETFs appropriately address risks raised by counterparty exposure and collateral management.