After much anticipation, the European Securities and Markets Authority (ESMA) has published draft guidelines on the future regulatory framework of UCITS ETFs.

Steven Maijoor: “The aim of these guidelines is to enhance investor protection and limit the risk of certain practices”.

The guidelines come after repeated concerns have been raised about the transparency and suitability of certain exchange-traded products, most notably relating to synthetic products and securities lending, following dramatic growth of the ETF industry over the past few years

In seeking to address these concerns, the European financial regulator’s proposed guidelines cover both synthetic and physical UCITS ETFs and detail the obligations to come for UCITS ETFs, index-tracking UCITS, efficient portfolio management techniques, total return swaps, and strategy and active indices for UCITS.

For UCITS ETFs, ESMA proposes the obligatory use of an identifier – or label – for all funds that fall within the scope of the harmonised definition.

In addition, the guidelines say that investors should be provided with more information when a UCITS ETF does not track an index and is actively managed. Furthermore, the requirements on eligibility of such indices should be tightened.

Concerning index-tracking UCITS, the guidelines call for additional disclosure requirements on such issues as the index to be tracked and the method of replication and the tracking error.

With regard to securities lending, ESMA proposes that collateral posted to mitigate counterparty risk should conform to a set standard, while recommending that the diversification and haircut criteria be strengthened.

Expanding on concerns previously expressed by the regulator about the increasing number of complex products sold to retail investors – what it refers to as the ‘retailisation’ of complex products – ESMA reiterates the need to confront these issues and hints at future regulatory responses.

While ESMA does not object to the use of total return swaps – indeed they are used systematically outside of ETFs in, for example, fixed income funds to manage duration and interest rate risk – ESMA does envisage additional obligations with respect to the collateral to be provided.

Other proposals include placing an obligation on UCITS ETFs to facilitate the ability of investors to redeem their shares, whether in the secondary market or directly with the ETF provider.

Commenting on the guidelines, Steven Maijoor, ESMA Chair, said:

“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.

“Moreover, the proposed guidelines improve the quality of the information provided to investors to allow them to make informed investment decisions. Furthermore, the draft guidelines help address concerns arising from the increase in the number of complex products sold to retail investors”