05 December 2011

Advice on ESMA’s public consultation on UCITS exchange traded funds in the European Union

The Group generally agrees with the concerns raised by ESMA in its Consultation Paper, which relate mainly to the fact that ETFs have become increasingly complex, and may raise significant issues both in respect to investor protection and to systemic risk. In respect to the prevention and mitigation of the risks that may arise from ETFs, while the whole Group agrees that greater disclosures are required, the majority of the Group members believes that, in addition to these disclosure requirements, regulators should adopt a more interventionist approach. The Group also believes it necessary to avoid any type of regulatory arbitrage, by subjecting all UCITS products and exchange-traded products to similar rules.

The Group generally supports the recommendations made by ESMA, and agrees that:

• UCITS ETFs should use an identifier in their titles, fund rules, Key Investor Document, prospectus and marketing material;
• investors should be provided with sufficient details to understand the index tracking policy used;
• there is a need for greater disclosures in respect to synthetic ETFs, notably in relation to underlying exposure, counterparty(ies) and the portfolio fund, as well as for stricter requirements in respect to the quality of the collateral, in the form of quantitative requirements on the quality (notably the liquidity) of the collateral, over-collateralisation requirements in specific circumstances, the regulators (and potentially ESMA) being responsible for regularly controlling the quality of the collateral. In addition, risks of conflicts of interests should be limited by prohibiting entities from the same group from acting at the same time as the ETF provider and the derivative counterparty;
• securities lending should be made more transparent to investors, should be forbidden in respect to the collateral received in exchange for the swap in the case of synthetic ETFs, and the lending agent must be required to indemnify the UCITS when a counterparty defaults for all types of ETFs (synthetic and physical);
• actively-managed UCITS ETFs should be subject to greater disclosure requirements;
• it is necessary to specify, in the product title of leveraged UCITS ETFs, that they constitute leveraged ETFs, as well as the level of leverage;
• greater protection of secondary investors would be achieved by informing investors of their redemption rights, the ETF manager being made responsible for paying the difference between the collateral and the index underlying the swap if a counterparty defaults;
• total return swaps and strategy indices need to be better regulated.

Full consultation

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