The Central Bank of Ireland’s recent ETF discussion paper may herald a new era of regulatory change for the industry.
In April, global ETF assets topped $4 trillion—up from $700 billion just a decade ago.¹ The effect this rapid surge in ETFs will have on the future of asset management has been hotly debated in the industry. Interestingly enough, despite the rapid growth of ETFs, there is no specific regulatory framework for ETFs. This is certainly the case in the world’s two largest ETF markets —Europe and the US. The US ETF market is governed by a mosaic of exemptions rather than a uniform rule set. In Europe, ETFs are governed by two sets of regulations: The UCITS rules, which govern funds, and the MiFID rules, which govern exchange-traded instruments.
Regulators Take Notice
This regulatory gap has not gone unnoticed by policymakers, and there is a growing sense that it might be time to revisit the regulatory framework for ETFs. Before she resigned, SEC (Securities and Exchange Commission) Chair Mary Jo White acknowledged that the US situation was suboptimal and that it was time to review the issue. Most recently, on 15 May the CBI (Central Bank of Ireland) entered the international regulatory conversation around ETFs when it published a discussion paper to highlight the distinctive features of ETFs both in Europe and a globally. While the discussion paper does not propose any new rules, it is significant because, with nearly $300 billion in ETFs, Ireland is the largest ETF domicile in Europe and the second largest ETF domicile in the world.
The discussion paper is wide-ranging and examines a number of topics, which are framed under three broad themes: investor expectations, liquidity, and the increasing popularity of ETFs. The CBI also addresses issues with specific types of ETFs, such as leveraged, inverse, synthetic, and active ETFs.
The CBI is particularly curious as to why active ETFs have had relatively slower adoption in Europe. One suggestion is that the disclosure rules may be dissuading managers from launching active ETFs. In the paper, the CBI suggests that “alternative approaches to full portfolio transparency” could encourage more asset managers to launch active ETFs. Some of the suggested alternatives include the use of a proxy for the active ETF’s portfolio or full transparency to a limited number of associated participants, who act as market makers for the ETFs. This will be of interest to many active managers who would like to take advantage of the popularity of ETFs but have been hesitant due to the daily portfolio disclosure that ETFs require.
Who Will Take the Lead?
It will be interesting to see who takes the lead in the international discussion. As the leading ETF domicile, the US should be leading the policy discussion. However, with the regime change at the SEC, it’s unclear if this will be a priority. There have been signs that the SEC will be more focused on capital formation and reviving the IPO market. Additionally, the Trump administration has indicated that the US may pull away from international regulatory cooperation.
European regulators may take the lead in shaping the international ETF policy debate, as they have done with other recently adopted US rules, such as swing pricing, redemption gates, and dealing commission bans.
Change on the Horizon
As the growth of the ETF industry seems set to continue unabated, the spotlight from global policymakers will only grow stronger. Many in the industry would welcome a set of uniform rules, which would help ensure a level playing field for all participants. This is particularly true in the US, where some asset managers have broader exemptions than others. While it will not happen overnight, regulatory change for ETFs is on the horizon; past experience tells us that often regulatory change comes slowly at first—and then all of a sudden. The industry should take the opportunity to proactively work with policymakers to help shape the regulatory framework. Otherwise one may be forced upon it.
¹ETFGI, as of 30 April 2017