As the popularity of exchange traded funds (ETFs) continues to soar, global regulators are reconsidering how they strike the balance between managing ETF risk without hampering innovation.
Speaking on a panel at the FSC’s recent ETF Forum in Sydney, Robert Taylor, Chair of the International Organization of Securities Commissions (IOSCO), said the “exponential growth” of ETFs was one major reason for regulators to review their approach, as well as “the liquidity concerns that the central bankers have about the fixed income securities market”.
Updating IOSCO’s principles for ETF regulation
IOSCO represents securities regulators around the world, including the Australian Securities & Investments Commission. In 2013, IOSCO issued its Principles for the Regulation of Exchange Traded Funds. These focused on better transparency for investors around the products, as well as how conflicts of interest differ with ETFs.
Speaking at the FSC’s ETF Forum, Cian Murphy, Head of Function - Markets Policy Division, Central Bank of Ireland (CBI) said: “We do think some elements of the 2013 principles might need to be updated, but we certainly don't think there's fundamental reform [required].”
Murphy and his CBI colleagues have been reviewing ETFs in relation to investment protection and financial stability. “We looked quite a lot at the dealing arrangements, the arbitrage mechanism, and the liquidity aspects,” said Murphy. “We all know how complex the ecosystem is around ETFs, and we came up with about three or four [risks] that, we thought, were inherent in the product.”
The CBI’s work is contributing to IOSCO’s broader review of ETF regulation. Taylor explained this is a collaborative process focusing on disclosure as well as “the responsibility of the product producers to actually manage their product appropriately. We haven’t come to our conclusions yet, because there’s a lot more work we’re trying to do around the liquidity components. We’re looking to 2020 before we actually have a final version of it.”
ETF regulation in Australia
The FSC Forum panel also included a local perspective on ETF regulation, provided by Rhys Bollen, Senior Executive Leader - Investment Managers at the Australian Securities & Investments Commission. “For the most part, I probably wouldn't single out ETFs as a separate line of work for us,” he said. “ETFs are still a somewhat smaller part of our market than they are in some of the bigger jurisdictions.”
Bollen said active and passive ETFs were not yet being treated differently from a risk perspective. He said that liquidity and the best interests of customers are a major focus for ASIC, but not solely in relation to ETFs. The same applies for issues around the suitability of products, he said.
In Europe, Murphy said that suitability is a larger focus when ETF products become more complex. And Taylor added that disclosure was an important part of suitability and that an IOSCO committee was taking a closer look at distribution-related issues.
In the current era of fintechs, robo-advice and other technology disruptors, the panel was asked how regulators were anticipating future risks around ETFs.
Taylor said he was cognisant that regulation and compliance can sometimes delay innovators from introducing new products into the market. However, he offset that by saying, “The bigger issue is: How do we go from an industry where we've been very focused on the behaviours of people within the decision-making chain, to people who aren't actually in the regulatory net.”
Taylor singled out entrepreneurs and innovators who seek to make money quickly and then exit a business. In these cases, he argued: “You're not actually as focused on customer outcomes, or what is a good governance structure for your company”.
As for Australia, Bollen added: “Things like robo-advice are likely to become a big part of our market. There's a small amount of change at the moment and, in the advice area, a number of firms are moving out or rethinking that part of the business. Probably, for some of them, robo-advice can be part of that. If an algorithm looks at all the products out there, and recommends a simple low cost product, that doesn't sound like a bad thing to me.”
On a broader level, Taylor said regulators were still coming to terms with how dynamic innovations were changing the financial landscape. “We're seeing the impact of technology [such as social media] in our lives, but we've never really thought through what that would mean in terms of either government oversight or regulatory oversight.
“I'm not really comfortable yet that we, as regulators, know how best to cope with these changes. At IOSCO, I can tell you we spend a huge amount of time talking about this and we're still not certain where this is actually going to lead ourselves.”