More than a year in the making, the Central Bank of Ireland (CBI) today issued revised exchange-traded fund (ETF) policy decisions in the form of the “CBI Feedback Statement.” This is the latest course in a process the CBI started in 2017 with their discussion paper on ETFs, but it is only an appetizer as the ETF story continues to unfold. The much-anticipated statement provides the ingredients to increase efficiency and product innovation in the rapidly growing ETF market.
While ETFs have experienced widespread adoption, evidenced by a ten-year global CAGR of 18.9%, they largely exist without specific regulatory framework. ETFs are governed by legacy policies built for mutual funds that do not account for ETF product nuances. European ETFs are governed by two sets of regulations: UCITS, which govern funds, and MiFID, which govern exchange-traded instruments. In June, the US Securities and Exchange Commission (SEC) proposed a new rule set for US ETFs and Hong Kong regulator SFC is conducting their own review of ETFs to permit certain strategies.
Ireland is the largest ETF domicile in Europe and the CBI is playing a leading role in driving the ETF debate in areas that will shape policy on a global stage. The CBI outlined their thinking regarding several themes, the most important being: portfolio transparency, listed and unlisted share classes, and different dealing deadlines for hedged and unhedged share classes. These are hotly debated topics, and the industry has been keenly awaiting the CBI’s response. Here’s what global asset managers need to know:
Blending Share Classes
The CBI indicated a change in their policy on the co-mingling of listed (ETFs) and unlisted (mutual funds) share classes in a single fund structure. Following the release of guidance, sponsors can expect that the CBI will accept submissions that permit the establishment of listed and unlisted share classes within the same UCITS sub fund. Vanguard has had success with this in the US – they obtained a patent and subsequently launched US ETFs as a share class of a mutual fund.
The CBI’s guidance regarding this structure brings them in sync with the Luxembourg regulator (CSSF), who have already approved several ETF share class structures. The change could make it easier and more cost effective for asset managers to enter the ETF market by launching an ETF share class within their existing UCITS platform. In choosing this route, they may find benefits from enhanced speed to market, reduced launch costs, and the ability to leverage existing performance history. An added benefit is they will be able to access more distribution platforms sooner because they hit certain requirements, such as AUM minimums. Shareholders will benefit as they will be able to choose which structure they buy (mutual fund or ETF) to access a particular investment strategy.
“We welcome this development,” said Nick King, Head of ETFs at Fidelity International. “Allowing listed and non-listed share classes has the benefit of allowing investors to choose how they wish to deal with the fund, either directly with the fund at a specific point in time or through a broker at any point during the trading day.”
While this is clearly an area of potential innovation for the industry, asset managers will need to carefully consider product suitability for the structure and assess the impact on fund operations and tax structure.
Hedged or Unhedged: Dealing Deadlines Made to Order
The industry along with the CBI has also been investigating the need to allow different dealing cut-off times for hedged and unhedged share classes and the CBI will permit this in the new policy.
This revised policy decision will benefit both primary and secondary market trading. In the primary market, providing an extended order window for the unhedged share class will allow more intraday liquidity for authorized participants (APs) and market makers. As a result, this will indirectly benefit shareholders who buy in the secondary market because APs/market makers will be able to more effectively hedge their risk which translates into tighter spreads for secondary market shareholders. We expect that sponsors will react by setting earlier deadlines for hedged classes allowing the execution of the hedge FX closer to the fixing time of the benchmark while allowing later deadlines for the unhedged classes.
This change gives greater clarity to the market and will lead to greater efficiency in the ETF creation and redemption process.
Not on the Menu
When it comes to portfolio transparency, the requirement remains for sponsors to publicly disclose details of the portfolio holdings on a daily basis. The SEC included a similar requirement in their recent proposed ETF regulation (Rule 6c-11). The continuation of the transparency requirement is most pertinent for active ETFs where sponsors have raised concerns regarding the daily disclosure of holdings namely, front running and release of intellectual property.
The CBI has left the door open for further engagement on this issue and will “continue to consider the matter.” In their statement, they discuss different options available in meeting portfolio disclosure, such as release of the portfolio holdings to a limited number of APs or provide proxy portfolio information only to the public.
Sponsors, who have waited to launch ETFs with the hope that CBI would ease their portfolio transparency requirements, must now weigh their concerns of daily disclosure versus losing out on attracting assets as more asset managers enter the ETF market.
For the Next Course
The CBI is expected to release a guidance document regarding listed and unlisted share classes and different dealing deadlines in the coming weeks. Following the guidance, ETF sponsors will be able to make submissions to the CBI for consideration. We expect sponsors will react quickly to these policy decisions which will promote a more diverse product range which could ultimately benefit shareholders.
The feedback statement touched on many other topics, including public disclosure of APs and remuneration, direct redemptions, risk due to multiple counterparties, and ETF liquidity. The CBI will continue to review many of these themes and will also engage with the European and international regulatory forums, however they did not identify a specific timeline for next steps.