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Regulatory burden easing for ETFs


Exchange-traded fund (ETF) promoters are more supportive of regulation than last year, according to EY's recent survey, Global ETF survey: A new era of growth and innovation.

The study is carried out annually and asks respondents in the US, Europe and Asia-Pacific their views on the ETF market place. Although respondents expect continued growth in the market, they also expressed the view that it is beginning to show increasing signs of competitiveness. As competition amongst firms intensifies there is a desire not only to pursue asset growth, but also to make ETFs work better for investors. 

In the previous survey, nearly three quarters of respondents (73 per cent) stated they felt cross-border regulation was a burden to the ETF market. This has fallen to 62 per cent in this year’s survey, with participants saying they are spending less time dealing with regulation than last year.
Respondents also said that the industry should have nothing to fear from closer scrutiny and that greater transparency may lead to improved investor confidence, which could boost growth. 

Lisa Kealy, financial services partner at EY, says: “It is encouraging to see companies feel more positive towards regulation as the legislative burden is unlikely to decrease in the short term. Greater clarity on new regulations from bodies like the European Securities and Markets Agency (ESMA) means that companies are starting to understand exactly what the regulation requires and can therefore focus their efforts in the right place.” 

Tax has remained a concern for the ETF industry over the past year. Much of this concern in Europe is focused on the impending introduction of a Financial Transaction Tax (FTT). This could be introduced as early as the start of 2015. The exact details of the tax have not been finalised. However, it is expected that the tax will increase costs, widen spreads and reduce liquidity across markets. It could also have a selective impact on funds, depending on their domiciles, trading locations and settlement venues. 

As the ETF industry grows in complexity, there are also a number of other tax-related issues that will demand more attention from firms. The management of fund-level investment taxes, such as stamp duty, is one such problem. In Europe tax reporting is also a factor as cross border regulation is very prevalent and national requirements vary significantly. 

Kealy adds: “Firms are not going to have very long to prepare for the implementation of the FTT and our survey shows that not all of them are proactively looking at how the changes will affect them. We would encourage firms to review this situation as soon as possible. Even though the tax may not be implemented as it currently stands, it is not going to go away completely.” 

Respondents cited that ensuring there is sufficient liquidity is going to be crucial for the industry to grow, particularly when it comes to attracting institutional investors. Respondents saw liquidity as being something of a virtuous circle, with more liquid funds being able to attract more assets and therefore increasing their liquidity. Lack of liquidity was felt to be the main reason why new launches fail, with 89 per cent of respondents saying a viable size for an ETF falls between USD50m and USD100m. 

The fragmented nature of the ETF market in Europe is one of the barriers to liquidity in this market. The different processes in each country means cross-border settlement in Europe can cost up to six times more than in the domestic US market. Respondents said centralised European settlement would have a “game changing” impact on the region’s markets and bring down costs for investors. The changes brought about by forthcoming regulations such as Target to Securities and Markets in Financial Instruments Directive II may provide a catalyst for this, but Europe will still be much more divided than the US. 

Kealy says: “In order to grow their businesses, ETF providers need to expand into new markets, and having sufficient liquidity will be central to this. This is particularly relevant when looking to reach institutional investors. With the European market creating barriers, providers will have to work hard to keep up with the US.” 

Respondents said that each region would see different rates of growth. The US was cited as the most developed market but will still see 15 per cent growth annually. The Asia-Pacific region is expected to see growth of between 20-30 per cent and European growth is anticipated to be between 15-20 per cent. At a regional level market share of the big three will remain stable. 

Global growth for providers will be driven by increased competition to take market share away from both their active and passive competitors, as well as the launch of new products. The study expects new products to be fewer, but more innovative and with increased success rate. The greater due diligence likely to be carried out than in previous years will ensure funds are meeting demand and offering something unique for investors. 

Participants felt new launches would become more sophisticated with focus on smart, enhanced or alternative beta ETFs. The popularity of foreign currency share classes and emerging market ETFs is also expected to increase. 

Kealy says: “The ETF industry will continue to grow rapidly over the coming years. Competition will be tough and companies will need to make sure they stand out and innovate in order to maximise opportunities and target more groups of investors. In Europe, for example, we are seeing for the first time ETFs being launched on mutual fund platforms in a move that brings them closer to retail investors.

“The growth of the ETF market needs to be built on solid foundations and there are a number of areas which firms should focus on. A structured approach to regulation and tax changes is important, as is product innovation. As an industry, there needs to be a greater focus on educating both retail and institutional investors about the benefits of ETFs to increase appetite for these products. The industry also needs to work as one in its dealings with outside parties such as the regulator, as this will give greater clout to its demands. Similarly, the creation of a professional industry body would provide a forum where companies can devise a shared approach to common issues. By working together, firms will create greater trust with investors towards ETFs which will, in turn, build appetite for these products.” 

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