The Central Bank of Ireland (the "Central Bank") published its Feedback Statement on DP6 – Exchange Traded Funds on 14 September 2018 following consideration of feedback received from the exchange traded funds ("ETFs") industry to its 2017 discussion paper ("DP6") on ETFs and subsequent engagement with selected stakeholders.
The Feedback Statement sought to address a number of key themes including: portfolio disclosure, direct redemption, ETF dealing arrangements, share class dealing arrangements, listed and unlisted shares classes, conflicts of interest, counterparty exposure, synthetic ETFs, active investment strategies, ETF liquidity, informational efficiency of underlying securities, ETF provider support, European-centric analysis and ETF specific considerations in the context of European market harmonisation.
As anticipated in our previous ETF update, the Central Bank has clarified its position on the following matters which we believe will be of particular importance:
- The concept of the co-existence of ETF and non-ETF share classes in a single fund structure;
- Related share class liquidity features; and
- Portfolio transparency requirements.
ETF and non-ETF Share Classes
Industry feedback contributed significantly to the Central Bank's understanding of ETFs and challenged its pre-existing views. This has resulted in a welcome development in that the Central Bank has indicated that ETF providers will be able to structure ETF and non-ETF share classes within a single fund. While operationally possible, until now it has not been permitted by the Central Bank and a number of other regulatory bodies due to some potential investor protection issues.
ETF providers will be able to avail of this structure subject to compliance with certain requirements which seek to safeguard investors. Cognisant that this structure may give rise to investor confusion, the Central Bank will develop guidance on appropriate disclosure requirements to apply for both types of classes.
Share Class Liquidity Features
On related share class liquidity features, following consideration of alternative approaches, the Central Bank has confirmed it will permit different liquidity features for share classes within the same ETF such that hedged and unhedged share classes will be able to have different dealing deadlines, in the same way that is currently permitted for in-kind and cash share classes.
Against the backdrop of much debate on how to identify the optimal way to achieve the right level of transparency in relation to active ETFs, advocates seeking flexibility in relation to transparency obligations that would facilitate the launch of active ETFs have had their hopes dashed as the Central Bank has shied away from relaxing its portfolio disclosure requirements.
Current disclosure and transparency requirements for active ETFs will remain unchanged such that Central Bank will continue to require daily portfolio disclosure to the public in the context of the authorisation of ETFs.
Acknowledging the different disclosure requirements on ETF portfolio transparency across the EU, the Central Bank has however committed to consider this further and to continued engagements with European and international regulatory forums.
As regulator of the largest European centre for ETFs, the Central Bank intends to utilise the feedback received to further contribute to the broader international regulatory agenda for ETF development at global and European level including the International Organisation of Securities Commission's recently launched ETF work stream. In particular, the Central Bank envisages that this feedback will enlighten its further engagement on:
- Investor centric matters to facilitate a better understanding of the characteristics of ETFs and the related potential risks associated with investment in this product. The range of potential issues identified within this topic includes (a) whether investor expectations are managed appropriately, (b) the suitability of more complex ETF strategies for retail investors, (c) investor recourse and related operational challenges, (d) investor awareness in relation to ETF related costs, (e) issues related to the usefulness of portfolio disclosure to investors and (f) the effectiveness of other disclosures (such as the iNAV); and
- Structural characteristics of the broader ETF market including (a) the selection and monitoring of authorised participants, (b) the role of index providers and how these are monitored, (c) managing potential conflicts of interest between parties, (d) risk transmission between primary and secondary markets and (e) the potential challenges of market fragmentation where ETFs are listed and traded on multiple exchanges.