Issuers of exchange traded products (ETPs) should be aware of the key recommendations contained in ASIC’s Report 583, which sets out its comprehensive review of ETPs gleaned from stakeholder data over the period 1 January 2016 to 30 September 2017 as well as trading data from ASIC’s market surveillance system for the period 2014 – 2017. These key recommendations are likely to inform ASIC’s regulatory approach to ETPs going forward.

The Australian Securities and Investments Commission (ASIC) released a report on 2 August 2018 detailing its key findings and recommendations in relation to two types of ETPs:

  • passively managed exchange traded funds (ETFs) with an investment objective to track an index or benchmark; and
  • ‘active ETFs’ that are actively managed to outperform a benchmark or achieve an absolute return objective,

for the purpose of testing whether the Australian ETP market is functioning well and delivering on promises to investors (REP 583). ETPs are growing in popularity with retail investors and self-managed super funds because of their accessibility, perceived low cost, transparency, intraday liquidity, diversification benefits and ability to provide exposure to new asset classes.

Some Key Recommendations for Issuers

While ASIC’s review found that the Australian ETP market is generally functioning well and delivering on promises to investors, it outlined a number of key recommendations for issuers, briefly summarised below:

Issue Recommendation
Indicative Net Asset Values (iNAV) For issuers of ETPs holding international assets, where the primary market for the underlying assets is closed while the ETP is trading, ASIC recommends that participants consider using proxies based on derivatives markets for after-hours movements (where available) to improve accuracy of intra-day iNAV
Tracking difference and error ASIC recommends that issuers disclose both tracking difference and tracking error to investors to assist them to compare products with the same investment strategies; with ASIC noting that a number of issuers currently disclose the tracking difference and/or tracking error information on their websites at calendar month end.
Market making The low number of market makers with formal agreements with issuers for liquidity purposes in the Australian market has resulted in concentration risk and ASIC recommends that issuers consider and deal with this risk in their risk management.

Further, for issuers who use internal market making (where the issuer itself undertakes the market making directly or by instructing a market participant to act as its agent and trade on its behalf) ASIC recommends that these issuers should:

  • monitor the market making arrangements to ensure that investors are able to trade at or close to the NAV. If this cannot be reliably achieved, the issuer should consider removing the fund from quotation on the market or should ultimately consider winding up the fund;
  • carefully manage and disclose to investors the conflicts associated with internal market making;
  • ensure that profits from internal market making are disclosed separately to investors in periodic statements; and
  • ensure that profits from internal market making are excluded from the performance fee calculations, if the issuer charges a performance fee.
Spread monitoring and analysis As part of its review, ASIC observed that spreads do temporarily widen in some circumstances, meaning individual transactions may involve a higher spread than an investor may consider desirable. ASIC recommends that issuers and financial advisers better inform investors about spreads in ETPs and how these may impact on trading strategies.
Marketing, advertising material and investor education ASIC encourages issuers to ensure that any advertising is consistent with Regulatory Guide 234 (“Advertising financial products and services (including credit): Good practice guidance”) and, following the International Organization of Securities Commissions’ report, Principles for the regulation of exchange traded funds, also recommends disclosure that helps investors clearly differentiate ETFs from other ETPs.
Unsuccessful funds and quotation ASIC encourages issuers to develop:

  • strategies that may prevent a fund from being unsuccessful; and
    • policies for dealing with unsuccessful funds which may include de-quoting or winding up those funds.
Periodic Statements ASIC recommends:

  • regular disclosure of fund performance alongside the benchmark or stated investment objective in periodic statements.
  • inclusion of a written explanation about this relative performance in periodic statements.
  • separate disclosure of profits from internal market making in periodic statements to assist investors’ understanding of the performance against the benchmark/investment objective.

ASIC has noted that it will continue to engage with the ETP industry regarding the monitoring of spreads on a more regular basis, appropriate to the nature of the underlying assets, and continue to monitor the development of the ETP market and the experience of retail investors in the market. The continuing growth in ‘active ETFs’ is likely to be an ongoing area of focus for ASIC.

Issuers of ETPs are urged to consider the full terms of REP 583 carefully.

Contact Hive Legal

Contact John Malon, David Reckenberg, Rebecca Lim or Mona Sukkar at Hive Legal if you have any questions about how REP 583 may impact your financial services business in Australia.

This is for general information only and formal legal advice should be sought on matters of interest arising from this article.

John Malon, Principal

M: +61 408 272 189
E:  john.malon@hivelegal.com.au
W: www.hivelegal.com.au

David Reckenberg, Special Counsel

M: +61 411 265 284
E:  David.reckenberg@hivelegal.com.au
W: www.hivelegal.com.au

Rebecca Lim, Special Counsel

T: +61 3 8645 8400
E:  rebecca.lim@hivelegal.com.au
W: www.hivelegal.com.au

Mona Sukkar, Lawyer

M: +61 433 336 784
E:  mona.sukkar@hivelegal.com.au
W: www.hivelegal.com.au

Email: john.malon@hivelegal.com.au
Mobile: +61 408 272 189

Email: david.reckenberg@hivelegal.com.au
Mobile: +61 411 265 284

Email: rebecca.lim@hivelegal.com.au
Telephone: +61 3 8645 8400

Email: mona.sukkar@hivelegal.com.au
Mobile: +61 433 336 784