ETF providers defend themselves ahead of Esma proposals

As the ETF industry awaits Esma's proposed changes, participants continue to insist on their increased transparency and the need to move the debate forward

The dichotomy between synthetic and physical exchange-traded funds (ETFs) is simplistic and unhelpful, according to industry participants, and even regulators may now be moving beyond this distinction. This may make no difference to the European Securities and Markets Authority (Esma) when it passes its long-awaited judgement on ETFs "very early 2012", however, as physical and synthetic ETFs alike may be compromised by the regulator.

The merits of physical versus synthetic methods are less important to investors than first understanding how and why to use ETFs, according to Scott Ebner, global head of ETF product development at SPDR, who was speaking at a roundtable debate in London in December.

The decision about whether to opt for a synthetic or physical ETF should take place at the point when investors undertake product due diligence to determine which ETF best suits their investment needs, he said. "A lot of questions have been asked about ETFs, which has in turn created a lot of misinformation and negative news," said Ebner.

"Unfortunately, this misinformation has overshadowed the true virtues of ETFs and the reasons behind their tremendous growth rates."

This was echoed by Thierry Francq, secretary general of the French regulatory body, Autorité des Marches Financiers (AMF), at a panel discussion organised by ETF provider Ossiam in Paris in December, which brought together ETF industry participants to discuss ETFs in the context of the Ucits regulations. The topic for debate was likely spurred by discussions within Esma about whether Ucits ETFs should be classified differently from regular Ucits-compliant investments, a mooted change that could end their execution-only sale to retail investors.

"Francq mentioned that physical ETFs bear risk due to securities lending," says Isabelle Bourcier, director of business development at Ossiam in Paris. "His main question was: are the financial community in general and investors aware of those risks and capable of understanding them?" Francq called for increasing clarity with respect to securities lending and for all ETF issuers to offer an equivalent level of information on their different products and the way in which they are managed, says Bourcier.

ETF providers continue to insist they are becoming increasingly transparent about the swap arrangements that underlie synthetic ETFs. "Over the past 18 months, the European ETF industry has greatly increased transparency in relation to these collateral arrangements," says Manooj Mistry, London-based head of Deutsche Bank's ETF platform, db X-trackers.

"Today, anyone can go onto our website, choose whichever ETF they are interested in, and instantly be presented with a full breakdown of the underlying collateral, to the level of the individual security and its associated weighting in the collateral basket... we supplement the regulatory standards with our own in-house rules to ensure that, for instance, any underlying constituent security in the collateral basket meets a minimum liquidity standard, and that the collateral is highly diversified."