Since our alert in June 2011 (see http://www.mofo.com/files/Uploads/Images/110607-Structured-Thoughts.pdf) concerning the regulatory scrutiny focused on ETFs, the focus has only intensified. In Europe, a number of regulators have continued to look closely at ETFs. In July 2011, ESMA, the European Securities and Markets Authority, published a discussion paper addressing regulatory and policy guidelines for ETFs and other packaged products. European regulators have focused on concerns related to the complexity of certain of these products, as well as related suitability issues. Many have focused on the use of derivatives or commodities futures by ETFs. Others have focused on market structure or systemic issues that may result from the growth of this market and the development in Europe of the synthetic ETF market. Many of the discussions of ETFs refer more broadly to exchange-traded products and create some potential confusion for investors in distinguishing between ETFs and ETNs. In the United States, there have been a number of Congressional hearings to address market structure issues, and several of these have touched on ETFs. In mid-October, Eileen Rominger, Director of the Division of Investment Management at the SEC, provided testimony on ETFs. Rominger distinguished ETFs from ETNs and helpfully noted the differences as follows:
Exchange traded notes or “ETNs,” which, unlike interests in ETFs, generally are unsecured debt securities issued by public companies, in most cases by bank holding companies or investment banks. ETNs also are exchange-traded securities that can provide the investor with investment exposure to certain market benchmarks or strategies. As ETNs are debt obligations of the issuer of the security, the ETN does not provide the investor with any ownership interest in the referenced security or securities in the referenced index. In addition, an investor in an ETN is exposed both to the market risk of the linked securities or index of securities and the credit risk of the issuer. ETNs do not share the same fund-like or trust-like structure as do other ETPs, and are not registered or regulated as investment companies under the 1940 Act.
However, other participants in the Congressional hearings referred more generally to “exchange-traded products” and seemed to lump ETNs in with ETFs, despite the important differences between these products—especially when considered in light of their impact on trading. We will continue to provide regular updates as regulators move from discussion papers to regulatory action.