Canadian Securities Administrators Propose New "ETF Facts" Documents to be Delivered to Investors Post-Trade.
On June 18, 2015, the Canadian Securities Administrators (the CSA) published for comment proposed rule amendments that introduce a requirement for exchange-traded funds (ETFs) to prepare and file specified “ETF Facts” documents, in addition to the ETF’s prospectus. Under the proposed rule amendments dealers will be required to deliver the applicable ETF Facts document to investors within two days of any trade in an ETF. The proposed rule amendments are to National Instrument 41-101 General Prospectus Requirements and Companion Policy 41-101CP, as well as other related instruments, and create a proposed new disclosure form 41-101F4 Information Required in an ETF Facts Document.
The comment period for the proposals ends on September 16, 2015.
The proposed rule amendments have long been promised by the CSA as a necessary follow-on to their “point of sale” disclosure project for mutual funds. And although the CSA may have successfully achieved a harmonized marriage of the disclosure rules for mutual funds and ETFs, there are some significant elements of disconnect, particularly around delivery of the documents to investors.
Relationship Status between ETF and Mutual Fund Rules – “It’s Complicated”
The proposed ETF disclosure and delivery requirements are intended to mirror the developments in point of sale disclosure that have been introduced for conventional mutual funds, as well as codify regulatory exemptions that were granted to certain ETF managers and dealers in the fall of 2013. The proposed rule amendments will bring the summary disclosure documents for ETFs largely in line with the Fund Facts for conventional mutual funds, with some notable disclosure differences, but do not achieve a harmonized marriage of the delivery requirements for the two types of funds.
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Disclosure in ETF Facts –Something Borrowed
Fund Facts and ETF Facts have the same purpose – they are intended to highlight the key information that is important for investors to consider when they make an investment. The CSA used the Fund Facts form set out in Form 81-101F3 as a starting point in developing the ETF Facts. This is obvious from reviewing the sample ETF Facts document included with the proposed amendment publication. ETF Facts look very similar to Fund Facts in lay-out, and many of the disclosure requirements are substantially similar, including details on what the ETF invests in (“Top 10 Investments” and “Investment Mix” disclosure), performance disclosure (year-by-year, best and worst 3-month and average returns), suitability disclosure and fund expense disclosure. Interestingly, the CSA have included disclosure on trailing commissions that is substantially borrowed from the Fund Facts form; however, unlike conventional mutual funds, trailing commissions are paid only in respect of a small number of ETFs.
The ETF Facts will also include a section on the risk rating of the ETF. Currently, ETF managers are not required to rate and disclose the risk rating of their ETFs in the prospectus or the existing summary documents. Under the proposed amendments this disclosure must be in both the prospectus and the ETF Facts. The CSA explain that they are still working on developing a new risk classification for mutual funds, with proposed rules expected to be published for comment by the end of the year1. We hope that the CSA will align the publication of any final rules on risk classification methodology with any final rules on the proposed amendments, so that ETF managers will be able to adopt the CSA’s fund risk classification methodology at its implementation, rather than having to change methodologies and disclosure of same after the first ETF Facts are prepared and filed.
Disclosure in ETF Facts — Something New
The ETF Facts provide for some additional ETF-specific information that isn’t included in the Fund Facts form or the current ETF summary documents. Most of these additional requirements are intended to highlight that ETFs, unlike conventional mutual funds, are traded on an exchange. For example, the CSA propose the inclusion of additional disclosure on ETF pricing information over a 12 month period ending within 60 days of the date of the ETF Facts, such as the market price, net asset value (NAV), average bid-ask spread and average premium/discount to NAV. Prescribed disclosure on the significance of the difference between the market price and the NAV and a description on the impact of premium/discount of market price to NAV will also be required. It will be interesting to see the comments the CSA receive on this section of the proposed ETF Facts, as it is not clear whether this information will be meaningful or useful to investors. Other ETF‑specific content will include average daily volume and number of days traded over a 12 month period, which is intended to provide investors with information about the liquidity of their investment.
For index-tracking ETFs, the ETF Facts will disclose the name and nature of the ETF’s benchmark index in the “What does this ETF invest in?” section. However, the ETF Facts do not permit disclosure of the performance of an ETF’s benchmark index. Currently, some ETFs disclose the year-by-year returns and average returns of the benchmark index that the ETF tracks to allow investors to get a sense of how closely the ETF tracks the performance of the benchmark index.
The CSA have also included more prescriptive requirements for what the ETF Facts should disclose in situations where the typical disclosure does not neatly fit the features of the particular ETF. For example, in the section disclosing the past performance of the ETF, the CSA have provided for alternative disclosure for new ETFs or ETFs that have not been distributed under a prospectus for 12 months. This prescribed disclosure is not provided for in the mutual funds Fund Facts form and some managers have adopted their own forms of disclosure where the prescribed disclosure does not fit. Having a consistent approach for ETF Facts will be useful.
Finally, the CSA propose to highlight the risks of certain types of ETFs, including those that track a multiple of the daily performance of a benchmark index, those that track the inverse performance of a benchmark index and those that are commodity pools. The ETF Facts form includes warning language for these types of products that must be displayed prominently as one of the first items in the ETF Facts document.
ETF Investor Rights – something old, but also new
The various rights of rescission and rights associated with misrepresentations have not been modified for ETFs, but will apply to ETFs in respect of ETF Facts in ways that are similar to Fund Facts for mutual funds.
Investors that do not receive the ETF Facts within the prescribed timing will have the right to seek damages or rescind their purchase in the same ways as apply to mutual funds. However, the proposed amendments do not extend to ETF investors the right of withdrawal within two days of purchase that is provided to conventional mutual fund investors (generally investing under a specified amount). This difference may not be intuitive to retail investors, and a comparison of the disclosure in the Fund Facts and the ETF Facts does not provide investors with much help in drawing out this distinction. ETF purchasers will, however, have the same statutory rights of rescission or action that apply with respect to the prospectus for misrepresentations in the ETF Facts, since the ETF Facts will be incorporated by reference into the prospectus. Further, in some jurisdictions, investors will continue to have a right of rescission associated with the delivery of the trade confirmation and may have a right of action for civil liability for misrepresentations in secondary market disclosure.
Delivery of ETF Facts — A Disconnect
The proposed amendments will require a dealer which has received a purchase order for an ETF to deliver or send to the purchaser the most recently filed ETF Facts within two business days after the purchase (unless the dealer has previously done so). This requirement differs from the Fund Facts delivery requirement that will come into force May 30, 2016, which provides that a dealer must deliver the most recently filed Fund Facts to a mutual fund investor before the dealer accepts an instruction for purchase, unless a narrow set of exceptions apply. Curiously, while the CSA explain the differences between ETFs and conventional mutual funds that lead to some of the differences in the form of summary disclosure documents prescribed, they do not provide further details on the rationale for the differing delivery requirement. This has the potential to be operationally complicated for dealers who distribute both mutual funds and ETF and we expect that commenters will request that the CSA justify this difference before publishing a final rule.
Transition Period — Something New
The CSA have signalled that they will be working towards publishing final rule amendments by early 2016, with the requirements coming into force three months after the publication date. ETF managers will then be permitted to file ETF Facts beginning 9 months after the publication of the final rule, and all ETF managers must file ETF Facts within 23 months of publication of the final rule. With the proposed ETF Facts transition, the CSA appear (commendably) to be doing their best to avoid the administrative difficulties experienced by mutual funds with 2014’s “Stage 2” requirements to refile Fund Facts in the new form by a specific date (not connected with annual prospectus renewals). Although it is still open for comment, this transition period appears to provide ETF managers with enough time to transition their existing summary documents to the new ETF Facts without the need to file ETF Facts between the annual prospectus renewal. Dealers will be required to deliver ETF Facts to purchasers beginning 2 years after the publication of the final rule, which appears to be more generous timing than what was put in place in respect of mutual funds.
It will be important to comment on the proposed amendments before the expiry of the comment period on September 16, 2015, in particular, to comment on the length of the transition period and whether the proposed timelines allow sufficient time for the transition for both ETF managers and dealers.