A proposal by a cabal of dominant ETF issuers that calls on exchanges to adopt a new naming convention for exchange-traded products has prompted a backlash from smaller, innovative rivals who claim the move is anti-competitive.
A group of dominant asset managers is attempting to commandeer the ETF label.
The proposal
The self-styled ‘industry coalition’, which consists of asset management heavyweights BlackRock, Vanguard, State Street Global Advisors, Invesco, Charles Schwab, and Fidelity, issued a letter to Cboe, Nasdaq, and NYSE, asking them to implement a taxonomy that it believes “more accurately reflects the complexities, risks, and structural features inherent in different types of ETPs”.
The coalition proposes that the exchanges’ data feeds reflect a new naming system with defined rules to separate ETPs into one of four categories: exchange-traded funds (ETFs), exchange-traded notes (ETNs), exchange-traded commodities (ETCs), and exchange-traded instruments (ETIs).
Specifically, the firms want ETFs to be the exclusive domain of funds registered under the 1940 Investment Company Act that have normal creation/redemption activity and provide unleveraged positive exposure to an underlying index.
According to the group, three-quarters (77%) of the roughly 2,400 US-listed ETPs would fall into this category and would cover nearly 96% of the country’s $3.65 trillion in ETP AUM.
The approximately 550 remaining ETPs would be allotted to the remaining categories. ETNs would largely maintain their existing designation; however, the new convention would see any vehicle providing commodities exposure being classified as an ETC, while everything else (including a wide range of inverse and leveraged products) would take on the ETI moniker.
“At its core, this effort is about increasing transparency for investors,” said Samara Cohen, co-Head of iShares Global Markets and Investments at BlackRock. “One of the benefits of ETPs is the breadth of access they offer to the world’s investment markets. However, the presence of multiple product structures can be confusing and through this initiative we want to introduce a shared language to help investors know what they own.”
Anna Paglia, Head of Legal, US ETFs at Invesco, added, “As the ETP industry continues to mature, the classification and categorization of the ETP product structure should mature as well, ensuring that investors have a clear view of the differentiation between an ETF, and other structures like ETNs, ETCs and ETIs.”
Rory Tobin, Global Head of SPDR ETF Business at State Street Global Advisors, said, “Investors have embraced the transparency proposition offered by ETFs in that it enhanced their ability to make better-informed investment decisions. As the ETP industry has grown, and new and innovative structures have emerged, a robust industry categorization system is required, providing investors with a toolkit to better inform their decision-making as to the risk characteristics inherent in different ETP structures.”
This is not the first time that the firms, which collectively manage approximately 90% of US-listed ETP assets under management, have pushed this agenda, having previously petitioned the US Securities and Exchange Commission (SEC) to act upon the matter.
When the SEC approved Rule 6c-11 (known as the ‘ETF Rule’) in 2019 to help support future growth by allowing ETFs that met certain conditions to launch without seeking exemptive relief, many hoped the Commission would include changes to the ETP taxonomy. The SEC did not include an ETP classification scheme as part of the final ETF Rule, however, but instead encouraged market participants to continue engaging with their investors and each other to find a solution.
The latest attempt to adopt a new naming convention comes at a strategic time when some leveraged ETPs have come under renewed criticism. A few of the most highly leveraged products were recently forced to close after their value sank to zero during the heightened volatility caused by the Covid-19 sell-off.
The fightback
The proposal has drawn sharp criticism from smaller and specialist ETF issuers who have accused the coalition of anti-competitive behaviour by lobbying for a system that secures their own dominance. Instead of enhancing transparency, these critics argue that the new, convoluted naming convention would confuse investors and stifle innovation.
Innovator Capital Management is one such firm pushing back as its flagship products, among others, stand to lose the ETF designation if the new convention is adopted. The Innovator S&P 500 Buffer ETFs utilize options to provide US equity exposure while limiting downside risk. The suite, which has proven popular with investors seeking in-built equity risk management, gathered over $500m in net inflows during the Covid-19 market rout in February and March.
According to Bruce Bond, Innovator’s CEO, the coalition is trying to monopolize the ‘ETF brand’ for themselves.
“This is yet another example of how the biggest firms representing 90% of US ETF assets are trying to stifle the very innovation that made the ETF industry what it is. With this ETP taxonomy proposal, the members of the ‘coalition’ are just seeking to build deeper and wider moats and taller walls, which not only disadvantages smaller, innovative ETF issuers that are pushing the industry forward, it hurts the end investor.
“The SEC already turned down this flawed, self-serving proposal. The continued efforts to lobby the exchanges after the decision from the SEC suggests that this group thinks they are more powerful than their own regulators. This very move by a group of the largest asset managers reflects the dangers of concentration that regulatory bodies have voiced discomfort with.
“In the last two decades, ETFs have thrived on transparency, innovation and lower costs. As a result, fees have come down on actively managed mutual funds, loads have become less rare, hedge funds’ alpha strategies have been turned into smart beta strategies, and defined-outcome strategies – once only available to the ultra-wealthy – now exist in a much more efficient, affordable, and accessible wrapper. The common current here is that the investor has always benefited. This latest behaviour by the largest ETF providers shames that tradition and opens the door to more confusion.”
Direxion, a leading provider of leveraged and inverse ETFs, would see almost its entire product suite reclassified as ETIs under the new classification scheme.
Rob Nestor, President of Direxion, says his firm has a long track record on investor education and will always support efforts to improve understanding but argues that these changes are not necessary, arguing that there is no evidence of any misunderstanding that needs to be cleared up or clarified.
“Direxion Leverage & Inverse ETFs are “ETFs” in every sense of the designation as 1940 Act regulated funds that are exchange-traded. We believe our products already have an established category as ‘L&I ETFs’ that is understood, so we are concerned a change to “ETI” after decades may only serve to confuse rather than clarify.”
Condescending
Regardless of the merits or not of the coalition’s proposal, being told by powerful issuers that they need help to know what they own, or that a change of a single letter will better inform their decision-making, will no doubt rile many investors. Investors in the Direxion Daily S&P 500 Bull 3X Shares ETF (SPXL US) probably already have a hunch that it might be leveraged. And if they don’t, well, changing the “F” to an “I” isn’t likely to help.