As the market for exchange traded funds continues to grow and evolve, advisors distributing these products can expect to see increased regulatory oversight, lawyers and industry experts said on Wednesday.
At the Exchange Traded Forum in Toronto, hosted by Radius Financial Education, Ronald Landry, executive director of ETF services and relationship management at CIBC Mellon, said that as ETFs become more prevalent, regulators are focused on investor protection.
“The regulators really do want to start putting a lot of pressure on investor protection, and they’re going to start coming down hard when they feel they feel that the investor isn’t truly being protected,” said Landry.
To protect ETF investors, he said the securities commissions want to make sure that both investors and advisors understand the products that they’re buying and selling.
“If you don’t understand the product you want to advise your clients on,” he said, “it’s a recipe for disaster.”
International securities regulators are similarly focused on protecting investors, and are looking to advisors to help fulfill this role, according to Carol Derk, partner, securities and capital markets at Borden Ladner Gervais LLP. She said the International Organization of Securities Commissions recently issued a set of principles on the regulation of ETFs, including four principles specifically targeted at financial advisors.
“Those four principles really focus on making sure that you understand the product, and that it’s suitable for the client,” Derk said.
Advisors should act in accordance with those principles, Derk said, by ensuring they’re providing comprehensive product disclosure that presents a fair and balanced picture of the risks and benefits of ETFs; and by ensuring that any recommendation for a client to purchase an ETF is made based on a reasonable assessment of the ETF, in the context of the client’s investment knowledge, objectives and risk tolerance.
“Clearly, you’ve got to know your client, and you’ve got to understand the product,” Derk said.
Transparency is key theme in the regulation of ETFs, especially as increasingly complex ETFs emerge, according to Paritosh Gambhir, senior manager in the Canadian asset management practice at KPMG LLP. He said product manufacturers face a responsibility to be completely transparent about the structure of the product, including whether it provides direct or synthetic exposure to the underlying assets, whether the exposure is leveraged or inverse, the correlation between the ETF and the underlying index or asset class, and other factors.
But he said advisors also face a responsibility to help clients understand how the product works, and the risks associated with it.
“Transparency,” Gambhir said, “is getting more and more scrutiny now as we go along.”
The prospect of more rules is of concern to the ETF industry, particularly because products in this space are known for their low fees, which could rise if the regulatory burden grows.
“Increased regulation often results in increased fees, so that’s a concern,” said Landry.