LONDON Exchange traded funds must disclose whether they lend out securities and give greater detail on the collateral they hold, the European Union's market watchdog (ESMA) proposed on Monday.
ESMA released new draft rules aimed at addressing concerns about the complexity and counterparty risks involved although it delayed a decision about proposals on the sale of ETFs to retail investors that would divide products based on their complexity.
ETFs - funds tracking baskets of shares, bonds or commodities that are traded like stocks - have become increasingly popular among retail investors seeking cheap access to indices without having to buy the underlying securities.
Some ETFs lend some of the shares out for a fee while holding other assets as collateral.
"The aim of these guidelines is to enhance investor protection and limit the risk of certain practices by strengthening, in particular, the standards applicable to collateral received in the context of activities such as securities lending," Steven Maijoor, Chair of the European Securities and Markets Authority (ESMA) said in a statement.
Under the new proposals, ESMA would require funds to disclose in prospectuses if they make use of securities lending, along with specific criteria and disclosure requirements about the quality and diversification of collateral posted.
COMPLEX OR NOT?
For synthetic ETFs, which use derivatives to generate index returns, ESMA will apply the same rules on collateral management as for securities lending.
In October, Laurence Fink, CEO of BlackRock (BLK.N), the world's largest asset manager and owner of ETF provider iShares, called on U.S. lawmakers to ban synthetic funds from calling themselves exchange-traded funds, arguing they are too "opaque."
ESMA proposed that all ETFs should be labeled, requiring the use of an "identifier" and is seeking feedback on provisions for an adequate level of protection of retail investors dealing on the secondary market.
The watchdog said concerns remained about the sale of complex products to retail investors but there were no firm proposals yet on whether to divide ETF products into "complex" and "non-complex" groups or whether the sale of derivative-based synthetic ETFs to retail investors should be restricted.
"ESMA will await the outcome of the negotiations on the revised MiFID and stands ready to provide any further input on this point at the appropriate stage," it said in the consultation paper.
By the third quarter of 2010, the global ETF sector managed $1.2 trillion of assets, after growing at an average annual rate of 40 per cent in the past decade, data from the Financial Stability Board shows.
The industry now has until March 30 to respond to the guidelines before they are finalized for adoption in the second quarter of the year.
As part of an overhaul of pan-European regulation, the Markets in Financial Instruments Directive (MiFID) is seeking to introduce a new classification of "complex" Undertakings for Collective Investment in Transferable Securities (UCITS) which allow financial institutions to sell funds into any European Union country after approval from a single member state.
This will include structured products and more complex exchange-traded funds that are wrapped inside a UCITS fund and will mean providers will have to apply appropriate safeguards when selling complex UCITS.
(Reporting by Anjuli Davies, Editing by Sinead Cruise and Jodie Ginsberg)