ESMA Consults On Future Regulation Of Exchange-Traded Funds And Structured UCITS

On 22 July 2011, the European Securities and Markets Authority ("ESMA") issued a discussion paper setting out policy orientations on guidelines for UCITS exchange-traded funds ("ETFs") and structured UCITS. Following the entry into force of the broader investment freedoms for UCITS under UCITS III and their further extension in the Eligible Assets Directive (2007/16/EC), UCITS have been used as vehicles to implement a variety of strategies previously unavailable to them. ESMA is examining the impact that such innovation may have on investor protection and market integrity, particularly as UCITS products are not intended to be complex. ESMA is of the view that the current regulatory regime does not take sufficient account of the specific features and risks associated with UCITS which are ETFs or structured funds and is concerned that particularly complex products, which may be difficult for retail investors to understand and evaluate, may be made available to them. ESMA is therefore considering introducing measures which would mitigate these perceived risks.

ESMA raises a number of questions in the discussion paper in relation to whether there ought to be limitations on the distribution of exchange traded and structured UCITS to retail investors, or whether warnings ought to be issued to investors in respect of such products. ESMA has identified the following topics in respect of which it believes that guidelines should be developed and on which feedback is sought:


Use of an Identifier

ETFs should use an identifier, in their name and in their fund rules, prospectus and marketing material, which identifies them as an ETF.

Tracking Issues

The prospectus of ETFs which track the performance of an index or other assets should contain a clear and comprehensive description of the underlying asset which it proposes to track and the mechanism by which it will gain exposure to it, ie whether the asset will be tracked synthetically or physically.

Synthetic ETFs

The prospectus of ETFs which track underlying assets synthetically should at a minimum include information on the underlying asset, the type of collateral which may be received from counterparties, the risk of counterparty default and the effect of such an eventuality on investors' returns.

Securities Lending Activities

ESMA suggests that collateral received by ETFs in respect of securities lending activities should comply with the criteria for OTC transactions set out in CESR's Guidelines...

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