ESMA earns strong credentials thanks to its convincing approach concerning ETF regulation

Abstract

Exchange traded fund (ETF) regulation was brought on the agenda of the European Securities and Markets Authority (ESMA) less than six months after its creation. On this occasion, the new authority demonstrated a strong commitment to maintaining the unity of the Undertakings for Collective Investment in Transferable Securities (UCITS) legal framework. The Guidelines on ETFs and other UCITS issues published in late 2012 did not create any specific regulation for ETFs. They regulate the use of the name ETF by UCITS, thus creating a UCITS ETF brand which brings clarity to investors. Moreover, ESMA quickly stated its neutrality concerning the two replication techniques used in the ETF world and recognised that physical ETFs and synthetic ETFs bore equivalent risks. In focusing its analysis on collateral diversification and counterparty risk, ESMA broadened the debate to the whole sector of UCITS funds. In particular, the Guidelines regulate securities lending at the European level, a practice which was formerly subject to various provisions in several member-state regulations. Finally, ESMA set out criteria that should be respected by financial indices in which UCITS invest. By doing so, the authority will prompt some ETFs indexed on strategy indices or ‘smart beta’ indices to qualify themselves as ‘actively managed ETFs’. In the meantime, the narrowed definition of a market index in the European regulation will block any attempt by alternative managers to misuse UCITS rules by exploiting their loopholes.