The lengthy cease-trade order affecting Emerge Canada Inc.’s 11 ETFs, coupled with prolonged radio silence during the order, led to great frustration from unitholders. Several unitholders told Investment Executive they had become more wary of ETFs and would only invest with well-known ETF manufacturers.
The situation was “a black eye on the Canadian capital markets,” said Yves Rebetez, partner with Credo Consulting Inc. in Oakville, Ont.
He and other industry players hope the ETF industry and the regulators learn from how the case played out over the past year.
Here are options for bolstering trust in the Canadian ETF industry.
Mandate more frequent updates
There is precedent for regulators to require frequent updates from issuers under a cease-trade order (CTO).
Management cease-trade orders (MCTOs) are voluntary and restrict only specific insiders and management from trading in a security. They can be issued when a reporting issuer fails to file its financial statements on time.
During an MCTO, the issuer must release biweekly default status reports disclosing any relevant changes in material information, as well as an update on how the issuer is attempting to remedy the reason for the MCTO. However, such status reports are no longer required if a CTO is issued.
Could the Ontario Securities Commission (OSC) mandate periodic updates under a CTO as well?
“The Emerge ETFs were subject to a general CTO for their failure to file specified continuous disclosure documents,” said JP Vecsi, senior public affairs specialist with the OSC, in an emailed response to that question. “A failure-to-file CTO will generally not be revoked unless the issuer has filed outstanding continuous disclosure documents. As such, there typically isn’t an update to provide until the issuer knows when it will file the missing disclosure.”
But Vecsi said the OSC made sure Emerge communicated with unitholders during the CTO.
“During our oversight of Emerge, we ensured that it kept the funds’ investors informed about the CTO and the subsequent termination of the funds through various means, including press releases, investor letters, requiring it to actively maintain [its] website with a prominent page for investor questions on the wind-up and trading restrictions, as well as monitoring whether it was responding to investor questions,” he said.
Rebetez said he finds the disparate disclosure requirements under an MCTO and a CTO odd — particularly for ETFs, which are marketed as transparent and liquid.
“Does it make sense to have updates every two weeks in one instance and then zero updates for extended periods? That, to me, is something that should be improved upon,” he said. “Investors put their trust in you, and put money in your funds. You owe them something [other than] communicating when it suits you.”
Dan Hallett, vice-president of research and principal with HighView Financial Group in Oakville, Ont., said he likes the idea of increased communication about funds under a CTO. However, he cautioned that the regulatory burden must be considered too: “We don’t want to make everyone do something for a scenario that happens so rarely,” he said, referring to putting a family of ETFs under a prolonged CTO.
Improve independent review committees
A fund’s independent review committee (IRC) reviews conflicts of interest referred by the manager. Reports filed between 2020 and 2023 from the IRC for the 11 Emerge ETFs didn’t indicate referrals regarding the receivables, nor related discussions. Following the CTO, industry experts we spoke to explained that IRCs’ mandates are quite narrow.
Regulators are now asking IRCs to widen their scope.
Last week, the OSC and the Autorité des marchés financiers (AMF) called on fund managers to “take a broad view of what constitutes a ‘conflict of interest matter’ and to err on the side of caution to refer an actual or perceived conflict of interest to the IRC.”
The regulators also stressed that fund managers should be prepared to identify new operational conflicts.
“The increasing complexity of investment fund management regulation and operations makes it appropriate for the [fund manager] to have an ongoing and specific focus on the identification of new conflicts of interest and to refer those to the IRC for its recommendation or approval,” the OSC and AMF said in their guidance.
Vecsi told Investment Executive the IRC review was not influenced by any firm or situation.
Support smaller ETFs, players
Karl Cheong, an investor and former ETF industry executive in Toronto, said thinly traded ETFs are at a disadvantage since their prices do not necessarily reflect the true value of a fund’s underlying securities.
“The [Canadian Securities Administrators] and ETF community need a solution for end-of-day valuations to ensure consistency and reflect true values; [otherwise] investors and advisors [may be] hesitant to purchase from a smaller provider with lower volumes,” he said.
Rebetez suggested the ETF industry could go further and create a compensation fund that makes up for losses experienced by investors if an ETF manager unexpectedly closes.
“I think an industry-wide initiative would be worthwhile as opposed to putting it all on the shoulders of new entrants,” he said. “It’s for the good of the industry and the good of the broader public.”
Cheong said he supports incentives for entrepreneurs looking to start new ventures within the financial services industry. Nonetheless, anyone looking to start an ETF firm needs sufficient capital to both satisfy regulatory requirements and to sustain their planned funds through multiple years, he said.
“When you’re stress-testing your business case, if you’re going to make a bet on thematic funds that tend to be very cyclical, you should know in advance the capital to set aside for that,” Cheong said. “You don’t want to run out of capital as soon as performance starts to wane and investors flee your funds.”
Furthermore, “for entrepreneurs who are entering the [ETF] space, they have to ensure above all else that investor capital is not at risk or in a situation where they cannot access it, especially in the ETF industry where we’re known for liquidity,” he said. “We’re not the private debt market.”
Cheong said someone running an ETF firm has not only a fiduciary duty to their unitholders and investors but also a duty to operate responsibly so as not to harm confidence in Canada’s 34-year-old ETF industry.
“For the end investor, all we have is their trust and their willingness to buy our products,” he said.
Read our latest analysis of the Emerge ETFs situation, and see our full coverage of the issue over the past year.