ETF Securities welcomes the Financial Stability Board's (FSB) paper on 'Potential financial stability issues arising from recent trends in Exchange Traded Funds (ETFs)' , published on 12th April 2011 and supports the need for further transparency.
ETF Securities believes it is important for investors to understand that there are various forms of exchange traded products (ETPs) which tend to be loosely defined as "ETFs". ETF Securities specialises in ETPs, which include exchange-traded funds (ETFs) and exchange-traded commodities (ETCs). The ETP industry needs to educate investors and be clearer on the labeling of various ETPs. ETF Securities is engaging with other ETP providers on this objective in order to have set standard definitions for the European ETP industry.
ETF Securities would like to make the following observations around key concerns highlighted in the FSB's paper. As the FSB's paper focuses on ETFs, ETF Securities will be referring specifically to the ETF range under its ETF Exchange (ETFX) platform which is subject to the requirements and safeguards of the European UCITS regime.
Quality and transparency of collateral
ETF Securities agrees that the quality and transparency of collateral is an important factor for all potential investors to be aware of. When investing in ETFs, potential investors should be aware of any additional layers of risk which may be imparted by an ETF issuer's model and of where title to an ETF's collateral ultimately lies. The FSB appropriately highlights the operational risks associated with the lending of securities in the context of some physically-replicated ETFs. For example, potential investors should be aware of the credit rating of the party that such collateral securities are lent to as well as the process for calling the collateral back when required (especially where securities have been subject to lending more than once along a chain). In the context of swap-backed ETFs, ETF Securities also supports the FSB's encouragement to potential investors to scrutinize and to carry out due diligence over the collateral selection process, including its credit quality, liquidity, valuation practices and haircut determination. The quality of collateral held in relation to ETFX's products is already subject to an eligible collateral schedule which sets out stringent guidelines as to what is acceptable and which are more conservative than the current UCITS requirements (as set out on the ETF Securities website). In the coming weeks, ETFX will be publishing a list of all collateral held independently by Bank of New York Mellon on its website in order to increase transparency to investors.
In general, ETF Securities believes that collateral should not be used for the benefit of an ETF issuer where it may jeopardise the security of the collateral.
Multi-Swap Counterparty
ETF Securities supports the FSB's view on the conflict of interests and risks associated with in-house products where the swap provider and ETF issuer are all a single party. ETF Securities is an independent product issuer supported by high quality counterparties which are regularly monitored with respect to their credit risk. The ETFX model promotes minimal risk correlation between issuer and swap provider in the event of default.
The ETF industry has grown considerably in recent years and, as the FSB mentioned in its paper, the ETF industry has seen a growth rate of 40% year-on-year over the past 10 years, dwarfing the rate of mutual funds and equity markets. As the industry continues to innovate and grow, it's essential to ensure investors are equipped with as much information as possible about products so that they understand what they are buying and the risks associated with such products. Issuers should also continue to evolve its business in order to promote the quality and transparency of ETFs. ETF Securities also encourages that, for unsophisticated or retail investors, they should seek independent investment advice so that they are fully informed on their investments.
