Canada: IOSCO Releases Consultation Paper

Principles for the Regulation of Exchange Traded Funds

On March 14, 2012, the Technical Committee of the International Organization of Securities Commissions (IOSCO) released a Consultation Report (the Consultation Report) entitled Principles for the Regulation of Exchange Traded Funds. The Consultation Report was prepared by the Technical Committee's Standing Committee on Investment Management (SC5) and highlights the committee members' experience and key regulatory issues regarding exchange traded funds, identifies common issues of concern and proposes a set of principles or best practices for ETF regulation. SC5, on which both the Ontario Securities Commission and Québec's Authorité des marchés financiers have staff members, acknowledges the variety of exchange-traded products available in the market, but explains that the Consultation Report is limited to exchange traded funds that are organized as collective investment schemes, commonly known as ETFs.

SC5 proposes 15 "investor protection" principles that broadly fall into four categories.

  1. ETF classification and disclosure
  2. Marketing and sale of ETF securities
  3. Structuring of ETFs
  4. Issues broader than only ETFs.

ETF CLASSIFICATION AND DISCLOSURE

The majority of SC5's proposed principles focus on ETF classification and disclosure. As ETF strategies have become more complex and innovative, SC5 suggests that steps must be taken to address possible investor confusion and to clearly identify possible investment risks. Generally, SC5 believes that ETF producers should focus on disclosure that properly identifies the risks and benefits of an investment in an ETF versus an investment in another type of collective investment product, the different strategies that may be used by ETFs (such as full replication, sampling, leveraged, inverse and other synthetic ETFs), the portfolio securities held by an ETF and the costs and expenses associated with investing in an ETF. To address these points, the Consultation Report suggests the following eight principles (we use the same numbering of the principles in this Bulletin as in the Consultation Report):

1. Regulators should encourage disclosure that helps retail investors to clearly differentiate ETFs from other ETPs (exchange traded products).

2. Regulators should seek to ensure a clear differentiation between ETFs and traditional CIS (collective investment schemes), as well as between index-based and non index-based ETFs through appropriate disclosure requirements.

3. Regulators should encourage all ETFs, in particular those that use or intend to use more complex strategies, or other complex techniques, to assess the accuracy and completeness of their disclosure, including whether the disclosure is presented in an understandable manner and whether it addresses the nature of risks associated with such strategies or techniques.

4. Regulators should consider imposing disclosure requirements with respect to the way in which an ETF will replicate the index (or the asset basket or the reference portfolio) it tracks (e.g., physically holding a sample or full basket of the securities composing the index (or the asset basket or the reference portfolio) or synthetically).

5. Regulators should consider imposing requirements regarding the transparency of an ETF's portfolio or other appropriate measures in order to provide adequate information to investors concerning the index (or the asset basket or the reference portfolio) tracked and its composition; as well as the operation of performance tracking in an understandable form.

6. Regulators should consider imposing requirements regarding the transparency of an ETF's portfolio or other appropriate measures in order to facilitate arbitrage activity in ETF shares.

7. Regulators should encourage the disclosure of fees and expenses for investing in ETFs in a way that allows investors to make informed decisions about whether they wish to invest in an ETF and thereby accept a particular level of costs.

8. Regulators should encourage disclosure requirements that would enhance the transparency of information available with respect to the material lending and borrowing of securities.

MARKETING AND SALE OF ETF SECURITIES

SC5 examined the role of intermediaries in the marketing and sale of ETFs and suggests that they have a role to play in addressing investor protection concerns related to ETFs. In particular, the Consultation Report emphasizes the importance of intermediaries assessing the suitability of ETFs for retail investors and the need for having and enforcing written strategies, processes and controls in order to ensure that a proper suitability review is undertaken. SC5 proposes the following four principles with respect to market intermediaries:

9. All sales materials and oral presentations used by intermediaries regarding ETFs should present a fair and balanced picture of both the risks and benefits of such products, and should not omit any material fact or qualification that would cause such a communication to be misleading.

10. In evaluating an intermediary's disclosure obligations, regulators should consider who has control over the information that is to be disclosed.

11. Before recommending the purchase, sale or exchange of an ETF, particularly a non-traditional ETF, an intermediary should be required to take reasonable steps to ensure that recommendation is based upon a reasonable assessment that the product is consistent with such customer's experience, knowledge, investment objectives, risk appetite and capacity for loss.

12. Intermediaries should establish a compliance function and develop appropriate internal policies and procedures that support compliance with suitability obligations when recommending any ETF.

STRUCTURING OF ETFs

The Consultation Report also addresses the conflicts of interest that may arise between an ETF manufacturer and an ETF investor. Possible conflict of interest situations include affiliated index providers, securities lending agents, designated brokers or authorized participants and derivative counterparties. SC5 focuses on synthetic ETFs and, in particular, the adequacy of risk disclosure with respect to counterparty exposure, collateral management and securities lending. SC5 proposes two principles to help address these issues:

13. Regulators should assess whether the securities laws and applicable rules of securities exchanges within their jurisdiction appropriately address potential conflicts of interests raised by ETFs.

14. Regulators should consider imposing requirements to ensure that ETFs appropriately address risks raised by counterparty exposure and collateral management.

BROADER ISSUES

In addition to the principles set out above that address many ETF-specific risks, SC5 examined some of the broader financial stability issues associated with entities and investment products. These broader issues include the risks arising on secondary markets (risk of shock transmission), the risk of abusive behaviour and the impact of that behaviour on market integrity and the risk to financial stability caused by securities lending, counterparty risks and the impact on underlying market price formation. The last principle proposed by SC5 focuses specifically on the risk of shock transmission in secondary markets, for example, the "flash crash" of May 6, 2010. In this regard, SC5 proposes the following:

15. ETF exchanges should consider adopting rules to mitigate the occurrence of liquidity shocks and transmission across correlated markets (e.g., automatic trading interruption mechanisms).

SC5 asks some specific questions and is soliciting public comments on the Consultation Report. Comments are due by June 27, 2012. A full copy of the Consultation Report is available on IOSCO's website [available here].

Given the involvement of staff of the OSC and the AMF on SC5, together with the Canadian Securities Administrators' overall commitment to supporting and fostering IOSCO principles in Canadian securities regulation, we expect that the CSA will evaluate and address the proposals set out in the Consultation Report as part of the CSA's ongoing modernization project on the rules relating to mutual funds and investment funds1. This Consultation Report can be viewed as a very timely addition to that regulatory discussion and initiative.

Footnotes

1 Please see Canadian Regulators Propose to Modernize Investment Fund Regulation Investment Management Bulletin June 2011 Borden Ladner Gervais LLP [available here].

About BLG

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Blake, Cassels & Graydon LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Blake, Cassels & Graydon LLP
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions