LONDON, June 24 Global securities regulators
published a framework for further regulation of the $1.9
trillion Exchange Traded Funds (ETFs) market on Monday, seeking
to make ETFs more consumer friendly as their index-based
investment strategies grow in popularity.
The Madrid-based umbrella group International Organisation
of Securities Commissions (IOSCO) wants national regulators to
encourage more disclosure to help investors differentiate
between the growing range of exchange-traded products and the
specific risks of each ETF type.
ETFs track baskets of shares, bonds or commodities and can
be traded in real time via an exchange unlike other mutual
funds, which can only be traded once daily. Most ETFs offer to
replicate the returns of a given index, without having to buy
all its individual constituents.
ETFs attracted $243 billion in new money in 2012, compared
with $161 billion a year earlier, data from independent research
firm ETFGI shows, demonstrating the increasing demand for ETFs
among investors looking for low-cost and liquid investments.
Among its top recommendations for regulation, IOSCO has
asked watchdogs to consider imposing rules to force ETF
managers to be more transparent about the counterparty risks
raised by their securities lending activities.
Many funds lend out the shares they own to short-sellers
like hedge funds in exchange for collateral and a fee. The extra
revenue earned can improve slim profit margins for the fund
manager, which can in turn keep costs low for investors.
Short-sellers make money by borrowing, and then selling,
stocks they believe are poised to fall in value. If they have
bet correctly, they can buy back the stock later at a lower
price, return it to the lender and pocket the difference.
But critics argue that ETF investors are not reaping the
full financial rewards of securities lending and are broadly
unaware that they are liable to cover any losses, if the
borrower defaults and fails to return the stock as agreed.
IOSCO has also encouraged improved disclosure of fees and
expenses for investing in ETFs to complement enhanced
transparency on securities lending.
If the ETF portfolio is modelled on an index, IOSCO has also
called for standardised disclosure on the manner in which the
fund will track that index, both in terms of composition and
This recommendation reflects concerns of a potential
conflict of interest between operators and ETF investors,
particularly if index providers who compile custom-built indices
for a particular ETF are affiliated with the ETF provider.
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