16 July 2012

AFG's response to the IOSCO’s consultation report on Principles for the Regulation of Exchange Traded Funds

AFG believes that is not appropriate to regulate specifically ETFs, to the extent that they are only CISs. AFG may however understand that IOSCO looks at regulating what is really specific in ETFs, for example market-making and everything that relates to the secondary market. It would therefore be inefficient and incoherent to regulate specifically ETFs as regards such issues. It seems to AFG that regulations are better when they have a broader and general application.

AFG therefore suggests that IOSCO:

• either restricts these guidelines to what is specifically linked to ETFs: principle 1, 2, 6, 13 and 16;
• or makes clear that these guidelines do not concern specifically ETFs but all CISs, except the few principles that are ETF-specific.

Distinction between “traditional” and “non-traditional” ETFs

AFG believes the distinction established between “traditional” and “non-traditional” ETFs including all synthetic ETFs, without any distinction within the second category (between vanilla indices and leveraged/inverse strategies), should be reconsidered. It seems there is a strong confusion between “traditional” (“physical ETFs”) and the “non-traditional” (“synthetic ETFs”), suggesting that synthetic ETFs (no matter the investment strategies of the ETFs) are highly speculative and risky. This is totally misleading. All European ETFs are UCITS funds. Amongst those UCITS ETFs, only a small proportion of synthetic ETFs are based on complex strategies such as leveraged or short strategies. It seems that this confusion relies on a certain degree of “US bias” in the analysis and the comparison of ETFs linked to US historical structuring techniques.

Thus, AFG would like IOSCO not to make the traditional/non-traditional distinction in the way it does in the paper (implicitly US type physical ETFs versus European type synthetic ETFs), but rather to base it on the fund’s objective (vanilla index ETFs versus leveraged/short ETFs).

Also, a clear distinction should be made between synthetic UCITS ETFs and synthetic US ETFs: they do not have the same investment strategies and therefore the same risks. Another distinction should also be made between European ETFs (that are not actively-managed ETFs until now) and US ETFs that can be active funds.

In Europe, UCITS ETFs are highly regulated products and are amongst the most transparent type of funds by the means of regulation combined with voluntary practices in the European environment which is highly competitive.

In this respect, AFG more than welcomes the general approach of the consultation which is to avoid any discrimination against what the consultation has named “non-traditional” ETFs. Such discrimination would not make sense because physical replication and synthetic replication ETFs are identical in terms of risks, and so-called "synthetic replication" does not use a technique which is more "complex" than securities lending.

Such a distinction is all the more surprising if one considers that the market event of May 2010 which raised concerns about the link between ETFs and systemic risk did not involve UCITS ETFs (such as synthetic/“swap-based” ETFs) but rather US ETFs structured with physical replication. At this stage, it is worth remembering that after its first consultation on ETFs as of April 2011, the FSB did not retain ETFs within its main areas of scrutiny for the systemic risk.

Conflicts of interest

The report points out various sources of conflict of interests that do not exist, especially under the European UCITS framework.

ETFs proposed definition lacks the replication objective

AFG's members feel that less place is given to European ETFs and to UCITS CIS. For example, UCITS ETFs are defined before all as index tracking funds. No reference to this aspect is made in Box 1. In Europe, the vast majority of ETFs are index-based and thus they have an objective of replication. AFG believes that the definition which is given (related particularly to the secondary market specificities) should be amended to specify the replication objective.

Regulatory approach vs best practices

On a more general plan, AFG believes it should be distinguished between best practices and regulatory issues. Not all best practices are meant to be carved in stone through mandatory regulation.

Full response

© AFG - Association Française de la Gestion financière