Despite operating under a regulatory framework that was built for mutual funds, ETFs are rapidly outpacing the growth of their traditional rivals. Now, the Canadian Securities Administrators (CSA) is contemplating a set of bespoke rules for the sector that may underpin its future growth and innovation.
In mid-June, the CSA published a consultation paper on ETF regulation, which contemplates introducing a series of rule changes driven by the unique structure of ETFs. Currently, ETFs are generally regulated under rules that were originally crafted for mutual funds — a situation that was adequate when the ETF industry was still relatively small, and largely limited to passive, index-tracking products. However, as the industry has evolved, expanded and diversified, the current framework risks falling short of what’s needed.
In response, the CSA is now proposing to introduce new requirements for ETFs that would formalize certain existing practices, enhance disclosure in several areas and take steps to ensure that investors are adequately protected by the rules regarding ETF trading.
“We believe that a regulatory framework tailored to the unique ETF structure can enhance investor protection, promote investor confidence in ETFs and foster competition,” the CSA said in its paper.
That sentiment has been echoed by the industry.
In its submission to the regulators’ consultation, investment dealer trade group, the Canadian Independent Finance and Innovation Counsel Inc. (CIFIC), called the initiative “both timely and necessary given the rapid growth and evolving complexity of the Canadian ETF landscape.”
It also comes in the wake of recent guidance from the International Organization of Securities Commissions, outlining best practices for adopting international standards in the ETF sector.
In the CSA’s consultation, regulators focused on the fundamental differences in how ETFs operate, and are traded, compared with mutual funds — with a view to identifying potential gaps in the current framework and opportunities for improving those rules.
In particular, they zeroed in on the fact that, unlike mutual funds, ETFs trade on the secondary market. They offer investors continuous liquidity, alongside the primary market — where market makers are involved in creating and redeeming ETF units, and arbitraging discrepancies between an ETF’s trading price and the value of its underlying assets. This arbitrage function ensures that the ETF’s market price doesn’t stray too far from the price for its portfolio holdings, while also generating revenues for the traders that fulfill that function.
To assess how well this is working in the real world, the Ontario Securities Commission (OSC) undertook an empirical study of trading in ETFs over a four-year period, from January 2019 to the end of 2023. It focused on secondary market liquidity and the efficacy of the ETF arbitrage mechanism.
That research, which was published alongside the CSA’s consultation paper in mid-June, found that most ETFs were relatively liquid, and exhibited only narrow deviations between their trading prices and their net asset value (NAV) under normal market conditions. However, it also noted that these deviations soared when the financial markets were under stress in early 2020 due to the onset of the Covid pandemic. The research also found that thinly traded ETFs, which are typically smaller and less liquid, tend to see larger discrepancies between their trading prices and their NAVs.
Additionally, the OSC’s research found some statistical evidence that funds with a larger number of market makers (authorized participants) experienced smaller deviations from their NAVs. Meanwhile, ETFs’ portfolio disclosure practices didn’t appear to have any impact on their secondary market liquidity or their NAV deviation.
These findings support some of the CSA’s current thinking on regulatory reform for the ETF sector. Specifically, the CSA is proposing to require that ETFs adopt, and adhere to, written policies and procedures that govern the creation and redemption of units. Under its proposal, ETFs would also be required to use at least two market makers that must be treated equally by fund managers, and would be required to disclose their contracts with their market makers.
The regulators are also calling for greater disclosure to investors about the performance of ETFs’ arbitrage mechanisms (the deviations between ETFs’ trading prices and their NAVs); and proposing standards for fund managers to oversee their ETFs’ arbitrage performance and liquidity in the secondary market. And, while they are proposing that ETFs be required to adopt policies for disclosing information about their portfolios, they aren’t seeking to mandate public portfolio disclosure.
So far, the feedback received by the CSA to its proposals has been relatively limited. While the consultation paper was published for a longer-than-usual 120-day comment period, the CSA pushed back its initial deadline from mid-October to the end of the month, giving the industry more time to consider the nuanced policy issues at hand.
That said, the responses that regulators have received are generally supportive of the CSA’s direction. For instance, in its submission, the Independent Financial Brokers of Canada (IFB) said it supports the CSA’s efforts to enhance disclosure by ETFs about their trading metrics.
“The new requirements should help [reps] explain the true costs of ETFs beyond the MER,” it said. The IFB believes that would be beneficial for investors.
The group also said that it doesn’t see any negative consequences for reps from the CSA’s proposals, but it called on the regulators to provide guidance for reps on explaining the proposed ETF trading disclosures to investors.
Industry concerns
In its submission, the CIFIC said that investment dealers are particularly supportive of the proposal that ETFs be required to work with more than one market maker. Dealers have reported instances of ETFs only using affiliated firms as their market makers, and rejecting requests from independent dealers to fulfill that role.
“We believe that formalizing a requirement for multiple, independent [market makers] would promote transparency, enhance market efficiency and better align with the CSA’s stated investor protection goals,” it said in its submission.
However, it also pushed back on the suggestion that the contracts between ETFs and their market makers should be disclosed in a fund’s prospectus, arguing that this could inadvertently expose dealers to elevated legal risks.
The CIFIC also disagreed with the CSA on another issue — whether ETFs should be required to publish their NAV throughout the trading day.
In their paper, the regulators rejected the idea of requiring funds to provide an intraday NAV that’s calculated based on the real-time prices of their underlying assets. While the CSA acknowledged that a so-called iNAV could provide useful information to retail investors, and may help facilitate arbitrage, it also worried that the metric could be misleading too.
“We are concerned that an iNAV could be considered to represent the current value of an ETF even though underlying markets have moved, creating confusion for investors,” the CSA said in its consultation.
And, as market makers haven’t needed an iNAV to carry out their arbitrage trading in the past, it concluded that requiring ETFs to publish an iNAV isn’t necessary.
However, the CIFIC suggested that investment dealers are in favour of an iNAV requirement — which, it said, would enhance market transparency and efficiency.
“Requiring the dissemination of iNAV at regular intervals, ideally every 15 seconds as in the United States, would level the playing field, enhance price transparency and support more efficient market functioning,” it argued.
Single-stock ETFs, which were approved during the consultation period, pose added compliance challenges. Those are being addressed by the Canadian Investment Regulatory Organization when it comes to the application of market volatility controls. It recently adopted new procedures for imposing trading halts on single-stock ETFs and other foreign instruments that Canadian issuers, dealers and exchanges can’t easily track.
The CSA’s initial consultation starts the Canadian ETF industry down the road to rules that are tailored to this increasingly important segment of the investment business — with a view to fostering both confidence and competition in the sector.
This article appears in the November 2025 issue of Investment Executive. Read the digital edition or read the articles online.