Regulators Consider Ban On Retail Purchases Of Synthetic ETFs

European regulators may seek to ban or restrict purchases of synthetic (swap-based) exchange-traded funds (ETFs) by retail investors, according to Hector Sants, chief executive officer of the UK Financial Services Authority. However, from a systemic perspective, says the UK’s new financial risk supervisory body, ETFs do not merit an immediate full-scale alert.

Speaking at a press conference at the Bank of England held earlier today (Friday) to mark the release of the minutes of last week’s inaugural meeting of the UK’s interim Financial Policy Committee (FPC), Sants suggested that restrictions on the distribution of swap-based ETFs may be merited on the grounds of consumer protection.

“I think there are grounds for us to question whether synthetic ETFs are appropriate for retail investors,” said Sants.

However, he added that any new rules concerning the retail distribution of ETFs would have to be coordinated at a European level.

“Most of the banks involved in the European ETF market are located outside our [the FSA’s] immediate regulatory net,” explained Sants. “The right transmission mechanism for us to monitor the ETF market is via the European Securities and Markets Authority (ESMA), the new body responsible for the security of the financial system. We will indeed be pushing proposals through the ESMA process that the rules should be tightened, particularly when it comes to synthetic ETFs, which are our principal focus.”

According to the minutes of the June 16 interim FPC meeting, which were distributed at today’s press conference, part of the FSA’s focus will be on improving ETF-related disclosure.  Regulatory measures to this end are being coordinated globally, the FPC says.

“Over recent months, the Financial Stability Board, the Bank for International Settlements and the International Monetary Fund had all published separate reports relating to ETFs, to which the Bank of England and the FSA had contributed,” state the minutes. “In Europe, the FSA and HM Treasury were working with the European Securities and Markets Authority and other authorities to promote a strengthening of regulatory risk standards applied to ETFs, particularly concerning improved characterisation and disclosure requirements and collateral and liquidity management.”

Adair Turner, FSA chairman and the regulator’s other member, alongside Sants, on the 11-strong FPC, which will also include five staff from the Bank of England, three external members and the future chief executive of the UK’s new Financial Conduct Authority, Martin Wheatley, explained his institution’s current thinking and why it believes new restrictions on the ETF market may be necessary.

“It’s important to understand that, when it comes to ETFs, there are two broad issues we’re considering,” said Turner. “One relates to financial conduct and consumer protection—in other words, do investors in these funds adequately understand the risks—but there are also prudential risks; those risks, in other words, that are created for the banks involved in this market.”

“From a financial conduct perspective, we’ll look at a full range of possibilities, and may conclude that some categories of synthetic ETF are not appropriate for retail investors,” Turner clarified. “On the prudential side, we have to look at the ETF market very carefully and in an integrated way, with all the other complex ways that banks can create funding,” the FSA chairman concluded.

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