Financial advisors who offer exchange- traded funds (ETFs) probably will have to start providing investors with the same type of disclosure for those products as is required for mutual funds. And like that older initiative, known as Fund Facts (FF), much work will be required to co-ordinate the new requirements for ETFs with the reporting regime of the second phase of the client relationship model (CRM2). The ETF Facts initiative will start with two-day post-trade disclosure, albeit not for a few more years.
The new initiative has been hailed by the ETF industry. “I don’t think there is any great concern,” says Pat Dunwoody, executive director of the Canadian ETF Association in Toronto. “It’s not a surprise,” she adds, noting that most ETF manufacturers have been operating under a prospectus exemption that allows them to deliver a summary disclosure document within two days of a sale.
The Canadian Securities Administrators (CSA) has proposed that the investment industry create a standard ETF Facts document and post it on the relevant websites.
Ralf Hensel, general counsel, corporate secretary and vice president of policy with the Investment Funds Institute of Canada in Toronto, welcomes the ETF Facts proposals issued by the CSA in June. “We think they are a very good first step,” Hensel says. “The idea of greater consistency in the regime between mutual funds and ETFs is a very good thing.”
The CSA proposal also will create a new delivery regime. Buy-side dealers who receive an order to purchase ETFs must deliver ETF Facts to the investor within two days following the purchase. Failure to do so means the investor can sue for damages or rescind the transaction. The delivery can be electronic, by post, by fax or in person.
Darin Renton, lawyer with Stikeman Elliott LLP in Toronto, predicts that ETF Facts will become a critical document: “People will use that as a sales document.”
The CSA’s proposal states: “The introduction of ETF Facts will help provide investors with access to key information about an ETF, in language they can easily understand,” will improve the “consistency with which disclosure is provided to investors” and create “a more consistent disclosure framework between conventional mutual funds and ETFs.”
Like the FF, the changes in store for ETF Facts are very prescriptive, lawyers say, and mandate the type of information that needs to be disclosed. ETF Facts is to be two pages, double-sided, and written in plain language. The document must disclose key information relevant to investors, including risks, past performance and costs.
Because ETFs are bought and sold through an exchange, the CSA also proposes that information relating to market price, the bid/ask spread and the premium or discount of market price to net asset value (NAV) ratio be discussed.
The CSA has created a template, which has been tested in focus groups, similar to the preparations for the FF. This research revealed that investors do not understand that ETFs have a market price and a NAV. Focus group testing also revealed that investors want to know about any trailer fees.
Notes Dunwoody: “It really is a whole new way of speaking about absolute costs.” She predicts that advisors may find explaining the meaning of such terms as the bid/ask spread to clients difficult.
Michael Bunn, securities lawyer with Norton Rose Fulbright Canada LLP in Toronto, predicts a move to point-of-sale disclosure may be coming for ETFs. “[The CSA] hasn’t closed the door on moving to a point-of-sale regime for ETFs in the future,” he says. “They just haven’t got there yet.”
Bunn says there are a few wrinkles applicable to ETFs that do not apply to mutual funds. For example, ETFs trade on an exchange and the price fluctuates during the day. “Regulators need to consider those points if they do move to a point-of-sale regime for ETFs,” he says.
Carolyn Shaw-Rimmington, manager of public affairs with the Ontario Securities Commission, notes that the FF was deployed in stages: “Using a staged approach also allows us to continue to consider the applicability of pre-sale delivery in the ETF context.” She adds that there are some “mechanical differences” between the way mutual funds and ETFs are purchased. “We need to consider further whether those nuances merit different approaches in terms of the timing of delivery.”
In addition, the CSA’s proposal creates a new delivery obligation for buy-side dealers, says Shaw-Rimmington: “Traditionally, dealers have had the obligation to deliver prospectuses when they act on the sell side. We recognize that this is an entirely new obligation for the buy side, and we anticipate that there may be some implementation issues related to this shift in approach, particularly for dealers that are not currently captured by the exemptive relief that is in place.”
For manufacturers of ETFs, the challenge, Bunn says, will be in the application of a risk rating, which is a new requirement. Some highly leveraged ETFs, or those that allow short sales, can lose a lot of money quickly and are suitable only for certain types of investors, Bunn adds. He notes that dealers have to make sure that financial advisors are comfortable with the contents of ETF Facts and must guide advisors when it comes to issues of suitability.
Renton notes that the timeline for rollout of the ETF Facts initiative in its entirety is likely to be 2018: “People are going to have a good long time to adjust. It will give people time to get used to it.”
Hensel adds that the ETF segment of the industry can look to the mutual fund segment for guidance. “They have the advantage that we’ve gone first,” he says. His advice is simple: “It’s always in the details.” He urges the ETF industry to embrace ETF Facts: “It’s good for the investor.”
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