Edhec pushes for greater transparency in the ETF market

The marketing of certain exchange-traded funds (ETFs) is misleading and ETF securities and lending activities should be more transparent, a report published by French academic institute Edhec-Risk has found.

“A fraction of the products sold to the general public in Europe and competing investment vehicles typically do not benefit from the same level of protection as that provided by the Ucits framework,” an EDHEC-Risk Institute study noted.

It added that “massive marketing and media relations campaigns implemented by some ETF providers in an effort to promote counterparty-risk-based distinctions between physical and synthetic replication ETFs are misleading.”

The institute said investors should pay more attention to factors determining the effective mitigation of counterparty risk, including the level of collateralisation, the quality of the assets performing the economic role of collateral and the ability of the fund to enforce its rights against collateral in the case of default by the counterparty.

Transparency should not be restricted to the problems posed by counterparty risk and its mitigation, it added, but should include disclosure of the revenues and costs from ancillary activities such as securities lending.

The institute concluded that regulators should provide better guidelines on what constitutes an index. “It is curious that while most ETFs are passive investment vehicles tracking indices, there is no standardisation or mandatory information on tracking error risk today in the European regulations,” it noted.

“Regulators should give a legal definition of what constitutes an index and decide on the transparency and auditability requirements of indexes, which remain the main drivers of the financial risks assumed by ETFs,” Edhec-Risk concluded.

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