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ETFs May Avoid Complex Label
By Paul Amery | 06 February, 2012 In the section of the CP devoted to the trading of ETFs, you suggest that issuers should include a risk warning about the possibility of investors buying or selling their funds at a significant premium or discount to net asset value. How concerned are you about the secondary market liquidity of ETFs? And what can you do if you see funds persistently trading with wide spreads or with inadequate market maker support?

ESMA: These liquidity risks are mitigated, to some extent, by the existence of the iNAV as a measure of intraday value, and also by the rules of stock exchanges which, for example, can prevent execution of a trade at a level too far away from the iNAV. There are also contractual arrangements between market makers and stock exchanges to ensure that funds are tradeable at levels that reflect fair value.

But we are also seeking the views of stakeholders on whether there should be additional contractual arrangements between issuers and market makers, and also on whether issuers should offer investors the option to redeem their units directly. The idea is to put the onus on the issuer of the ETF to ensure that investors can redeem when they want to.

As far as possible interventions or sanctions for inadequate liquidity provision are concerned, this is a matter for national regulators rather than for ESMA, although we could issue some further guidelines in this area. In the section of the CP on strategy indices, you write that non-disclosure of index information would mean that the index would not be eligible to be tracked by an ETF, for example via a swap. Am I correct in assuming that you’ve had some concerns about the levels of disclosure being offered by some providers of proprietary indices, for example those that embed an investment strategy?

ESMA: That’s right. The overarching principle for such strategy indices is that an investor should be able to replicate the index’s performance. We’ve indeed been concerned that some investors have been able to buy exposure to very complex strategies via such indices. As we write in the CP, we received feedback from some index firms to the effect that the disclosure of proprietary information could jeopardise their businesses, but we’ve taken the position that full disclosure of index information is a necessary requirement. What do you mean by full disclosure—the index methodology and the full list of constituents on a real-time basis?

ESMA: We’d regard the publication of the full index methodology as necessary, but we’d permit the publication of constituents and their weightings with a certain delay. EDHEC-Risk has already responded to your CP, saying that “it is almost impossible, at reasonable cost, to procure the historical composition of indices and to check both the accuracy of the implementation of the ground rules and the index performance”. So have you gone far enough?

ESMA: A firm providing strategy indices should provide information on its indices’ historical performance and composition, and many providers already do this. In our guidelines we’ve suggested that index firms should publish this information after each rebalancing, on a retrospective basis. What’s the timetable for the introduction of the new rules?

ESMA: The current consultation period ends on March 30 and we plan to publish the final guidelines by June. Your current regulatory initiative involves only ETFs. Are you looking at other exchange-traded products as well?

ESMA: Yes. We feel that we’re taking a step forward with this CP in setting new requirements for UCITS ETFs, but in due course we’d like to look at other products like notes and certificates as well, many of which provide similar, index-tracking exposures. This will require a cross-sectoral initiative, probably at the level of the European Commission. So that process is not entirely in our hands, but we haven’t forgotten about it.


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