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BBH comments on the Central Bank of Ireland’s ETF regulatory changes

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The Central Bank of Ireland (CBI) has published a Feedback Statement in relation to ETFs giving its response to the Central Bank’s Discussion Paper 6 – Exchange Traded Funds (DP6), which was published in May 2017.

CBI writes that it focused on ETFs to ensure that this fund type and any inherent risks are understood. 

“Ireland is the largest European centre for ETFs and these are the fastest growing type of investment fund globally. The global ETF market continues to see significant growth in assets under management (AUM). AUM was circa US USD4.6 trillion at the end of 2017.

“The Central Bank undertook this initiative in order to highlight areas where further regulatory consideration and discussion is warranted. The responses received to DP6 provided a good insight into the design features, dealing mechanisms and operating models that exist in the global ETF environment today, and what implications these may have for ETFs, particularly in stressed market conditions. This feedback will inform the Central Bank’s approach in the ongoing debates in European and international policy forums.

“New regulatory outcomes for Irish ETFs include: different dealing times will be permitted for hedged and unhedged share classes within the same ETF; Investment funds can establish both listed and unlisted share classes within a single fund structure, subject to disclosure requirements; and there will be no change in the requirement to have daily portfolio disclosure at this time.”

Gerry Cross, Director of Policy and Risk, says: “This exercise has been extremely useful to further the debate, both domestically and internationally, in relation to ETFs. We regard the publication of this feedback statement as a continuation of this discussion and not the conclusion of our work. We remain firmly of the view that where regulatory change is needed, it is most effective when implemented on a consistent basis. This is why we will continue to actively contribute and collaborate within Europe and at IOSCO, seeking progress on the issues identified as part of DP6.”

Commenting on the Central Bank’s report, the ETF team at Brown Brothers Harriman writes that following the release of guidance, sponsors can expect that the CBI will accept submissions that permit the establishment of listed and unlisted share classes within the same UCITS sub fund.

The team writes that Vanguard has had success with this in the US where they obtained a patent and subsequently launched US ETFs as a share class of a mutual fund.

BBH writes: “The CBI’s guidance regarding this structure brings them in sync with the Luxembourg regulator (CSSF), who have already approved several ETF share class structures. The change could make it easier and more cost effective for asset managers to enter the ETF market by launching an ETF share class within their existing UCITS platform. 

“In choosing this route, they may find benefits from enhanced speed to market, reduced launch costs, and the ability to leverage existing performance history. An added benefit is they will be able to access more distribution platforms sooner because they hit certain requirements, such as AUM minimums.”

BBH writes that shareholders will benefit as they will be able to choose which structure they buy (mutual fund or ETF) to access a particular investment strategy.

“We welcome this development,” says Nick King, Head of ETFs at Fidelity International. “Allowing listed and non-listed share classes has the benefit of allowing investors to choose how they wish to deal with the fund, either directly with the fund at a specific point in time or through a broker at any point during the trading day.”

BBH writes that while this is clearly an area of potential innovation for the industry, asset managers will need to carefully consider product suitability for the structure and assess the impact on fund operations and tax structure.

Commenting on the Central Bank’s revised policy on allowing different dealing cut-off times for hedged and unhedged share classes, BBh writes that this revised policy decision will benefit both primary and secondary market trading. 

BBH writes that in the primary market, providing an extended order window for the unhedged share class will allow more intraday liquidity for authorised participants (APs) and market makers. 

“As a result, this will indirectly benefit shareholders who buy in the secondary market because APs/market makers will be able to more effectively hedge their risk which translates into tighter spreads for secondary market shareholders. We expect that sponsors will react by setting earlier deadlines for hedged classes allowing the execution of the hedge FX closer to the fixing time of the benchmark while allowing later deadlines for the unhedged classes.”

BBH believes that this change gives greater clarity to the market and will lead to greater efficiency in the ETF creation and redemption process.

The firm comments that when it comes to portfolio transparency, the requirement remains for sponsors to publicly disclose details of the portfolio holdings on a daily basis.

“The SEC included a similar requirement in their recent proposed ETF regulation (Rule 6c-11). The continuation of the transparency requirement is most pertinent for active ETFs where sponsors have raised concerns regarding the daily disclosure of holdings namely, front running and release of intellectual property.

“The CBI has left the door open for further engagement on this issue and will ‘continue to consider the matter’. In their statement, they discuss different options available in meeting portfolio disclosure, such as release of the portfolio holdings to a limited number of APs or provide proxy portfolio information only to the public.

“Sponsors, who have waited to launch ETFs with the hope that CBI would ease their portfolio transparency requirements, must now weigh their concerns of daily disclosure versus losing out on attracting assets as more asset managers enter the ETF market,” BBH writes.

Looking forward, BBH writes that the CBI is expected to release a guidance document regarding listed and unlisted share classes and different dealing deadlines in the coming weeks. 

“Following the guidance, ETF sponsors will be able to make submissions to the CBI for consideration. We expect sponsors will react quickly to these policy decisions which will promote a more diverse product range which could ultimately benefit shareholders.

“The feedback statement touched on many other topics, including public disclosure of APs and remuneration, direct redemptions, risk due to multiple counterparties, and ETF liquidity. The CBI will continue to review many of these themes and will also engage with the European and international regulatory forums, however they did not identify a specific timeline for next steps,” BBH concludes.

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