ETFs May Avoid Complex Label Under MiFID

The European Securities and Markets Authority (ESMA) last week released a consultation paper with  proposed new regulatory guidelines for Europe’s exchange-traded fund market. Following the release, Paul Amery, editor of, asked ESMA’s Richard Stobo, Clément Boidard and Antonio Barattelli about the thinking behind the draft rules. Your new consultation paper (CP) on “ETFs and other UCITS issues” follows a discussion paper from last July on “ETFs and Structured UCITS”. Why the change of title?

ESMA: The change in the papers’ titles reflects a certain change of emphasis in their content. Many of those responding to the discussion paper pointed out that some of the topics we were discussing—so-called “efficient portfolio management” (EPM) techniques like securities lending, the use of total return swaps, or the disclosure requirements for index-tracking funds—were not specific to ETFs, but applied to all UCITS. So we’ve enlarged the scope of the guidelines and the title of the CP reflects that.

We’d like to stress that, in widening our scope, we haven’t relaxed the requirements we were planning to introduce for ETFs. But we’ve recognised that we needed to broaden our coverage. Could you clarify whether certain types of ETFs, such as those using swaps to replicate their indices, will be considered as “complex products” under the revised Markets in Financial Instruments Directive (MiFID), and therefore subject to restrictions on their sale to retail investors?

ESMA: This will be decided by the European Council and European Parliament, who are reviewing MiFID, and not by ESMA. One of the possible outcomes of the MiFID review is that a distinction will be introduced between certain types of UCITS (for example, complex and non-complex), but that’s still to be decided. But if MiFID does classify so-called structured UCITS as complex, is it fair to assume that synthetic ETFs will be considered as structured UCITS?

ESMA: Again, that remains to be seen. But under the current definition of a structured UCITS, it appears not. A structured UCITS is described in the Key Investor Information (KII) regulation as a fund with algorithm-based payoffs, linked to the performance of financial assets or indices. You write in the CP about the necessity for improved disclosure when a UCITS deals with an affiliated party, such as an in-house swap counterparty, lending agent or depositary. Why have you not gone the extra step and introduced more formal requirements for a separation of roles, such as that which exists in the US under the 1940 Act, which regulates investment funds?

ESMA: This is a big issue. We’re conscious of the potential impact that such a formal restriction on dealing with affiliates could have, given the existing business models in Europe. But we’re clearly raising the question of potential conflicts of interest and are making recommendations to improve transparency in this area. We’d require further debate, though, before imposing more stringent requirements on dealing with in-house entities.

Our proposed guidelines for the treatment of collateral in securities lending transactions and for total return swaps (and, specifically, the requirements for the quality and liquidity of such collateral) are designed to mitigate some of the conflicts of interest that might arise when an affiliated firm is involved in providing services for a UCITS. When it comes to disclosure, though, most of your recommendations are for mandatory disclosure of details like securities lending or derivatives counterparties, or of the type and amount of fund collateral, only on a semi-annual or annual basis. But many ETF issuers are already disclosing this information daily. Why not require more frequent disclosure?

ESMA: We wanted to make sure that the annual report included additional information of this type, but we’ve also stated in the draft guidelines that, as a matter of best practice, ETF issuers should disclose such information on their websites on a more frequent basis. We’re open to suggestions that we should increase the required frequency of disclosure.

  • Luke Handt

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