The Australian Securities and Investments Commission (ASIC) has released Report 282 Regulation of exchange traded funds which explains its position on various regulatory aspects of exchange traded funds (ETFs) and outlines the key areas it will focus on as the rapidly growing ETF market continues to develop in Australia.
What you need to know
- ASIC has looked at the current ETF regulatory framework in Australia and is satisfied that it would comply with the proposed principles for ETF regulation that have been released by International Organisation of Securities Commissions (IOSCO) for consultation
- ASIC has identified key regulatory issues and risks that it will be focusing on and how it will address those issues and risks in consultation with the ETF industry
- The report also provides a useful background overview of the operation of ETFs in the Australian market
Who does this impact?
The report is for stakeholders in the ETF industry, in particular ETF product issuers and any investors or users of ETFs, including fund managers market participants involved in ETF market making activities and financial advisers.
According to ASX data, there is approximately A$4.2 billion invested in the Australian ETF market as at 2012. While Australia's ETF market is immature compared to the United States and European markets in terms of its size and product diversity, it has been growing rapidly over the past 2-3 years and continues to do so. As this growth occurs, ASIC will be carefully monitoring the regulatory landscape to ensure that retail investors (who make up a relatively large proportion of ETF investors in Australia compared to the United States and European ETF markets) are sufficiently educated and protected.
ASIC has been consulting with and conducting surveillance on ETF providers to gauge which areas are potentially problematic in the regulation of the ETF market. Current areas of particular interest to ASIC appear to be price transparency, liquidity and synthetic ETFs. ASIC appears to be satisfied that the current regulatory framework for ETFs is suitable for the ETF products currently on offer in Australia, including the recently introduced fixed interest ETFs.
ASIC's role in regulating ETFs
ASIC undertakes the following regulatory functions:
- consulting with ASX on proposed refinements and amendments to the AQUA rules
- providing informal feedback on draft PDSs for ETFs before the ETF units are approved by ASX for quotation
- considering applications by ETF issuers for case-by-case relief from certain Corporations Act 2001 (Cth) (Corporations Act) provisions
- remaining in contact with overseas regulators about ETFs
- conducting surveillance at the offices of responsible entities of ETFs using its powers under s601FF of the Corporations Act
- educating retail investors through its MoneySmart website.
ASIC has outlined the limited case-by-case relief it has provided to responsible entities of ETFs in the report. This includes relief allowing responsible entities of ETFs to treat members unequally by limiting the provision of certain information about the assets in the portfolio to authorised participants and market makers, on the condition that the responsible entities:
- publish this information as at the end of the previous trading day; and
- intend to provide an estimate of net asset value (NAV) during the trading day at intervals not exceeding 15 minutes.
One of the matters ASIC is currently considering is how the periodic statement provisions of the Corporations Act apply to ETFs.
Proposed IOSCO principles for regulation of ETFs
IOSCO recently issued a consultation paper setting out proposed principles for regulation of ETFs. ASIC considers that the regulation of ETFs in Australia is in line with these proposed IOSCO principles.
ASIC's key areas of focus
The views that ASIC has expressed in the report about what ASIC considers to be the key regulatory issues and risks in the ETF market have been summarised below. These matters are relevant to ETF product issuers' operational arrangements and product development activities.
Structured products and synthetic ETFs
To ensure that investors are not misled, ASIC has generally required the use of naming conventions in order to distinguish synthetic ETFs and structured products by including at the end of the product name the words '(synthetic)' and '(structured product)' respectively. This enables investors to distinguish these types of products from other standard ETF products (which ASIC considers involve less risk for investors than synthetic ETFs and structured products). In the future, the development of new products may give rise to more naming conventions.
Although ASIC has no immediate concerns regarding the activities of authorised participants and market makers leading to a lack of general liquidity, ASIC will continue to focus on market liquidity and the prevailing spread for each ETF. ASIC will also pay particular attention to the liquidity of the underlying assets of ETFs, including for emerging equity market-referenced ETFs.
As ETFs are traded on a secondary market, ASIC is aware that it is likely that many retail investors do not access product disclosure statements (PDSs) and may therefore have inadequate risk awareness. ASIC intends to discuss with ASX, major stockbrokers and ETF issuers how effective disclosure might be provided as part of the ordering process on the market, such as an electronic pop-up box which is used by brokers for certain partly paid instruments. If problems emerge about the extent of retail use of unsuitable ETFs, ASIC may consider requiring advice about suitability as a precondition to investment by retail investors.
The report also identifies certain areas of risk that ASIC expects to see disclosed in the PDS where that risk is relevant to the ETF. These include:
- potential exposure to currency risk and foreign taxes in ETFs which provide international exposure
- lower liquidity in underlying assets such as small companies, certain commodities and emerging markets
- material information about the rules governing the inclusion and weighting of index securities where index providers and the ETF issuer are associated with one another
- where part of the ETF portfolio is invested in derivatives, the risks and benefits of using derivatives, and the procedures and processes used to address risks.
ASIC has noted that the price of a number of ETF trades during the 10:00–10:30 am period has deviated substantially from NAV and the previous day's close. This is due to wide ask-bid spreads and thin volumes as market makers are reluctant to price ETFs until trading in all securities in the relevant index opens. ASIC is monitoring the situation, has had discussions with market participants through whom the orders were placed and is considering further action which, if warranted, may include compliance action.
ASIC considers that publication of an estimate of current NAV (iNAV) assists accurate price discovery. ASIC found that most ETF issuers provide iNAV on their websites to support confidence in their product. However, the publication of correct NAV before commencement of trading on the following day is also important and warrants particular attention by responsible entities of ETFs. This may be the subject of future ASIC surveillance activity.
The following types of ETFs are not yet present in the Australian market and will be considered by ASIC if and when they emerge in the Australian market:
- inverse ETFs
- leveraged ETFs
- ETFs using funded swaps to achieve index replication.
Minter Ellison and ETFs
Minter Ellison has significant depth of experience and expertise in the emerging Australian ETF market. We have acted as legal adviser to a number of Australian ETF providers across a range of ETF types. We have been, and continue to be, at the forefront in working together with our clients, ASIC and the ASX to identify and resolve key regulatory challenges that the Australian regulatory regime presents for ETFs.
ASIC Media Release 12-57MR