The US Securities and Exchange Commission’s (SEC) decision to approve non-transparent ETFs for the first time this week is a watershed moment for the industry.
Since 2008, the US regulator has been rejecting applications for ETFs that do not require the asset manager to reveal its holdings daily however, Precidian Investments was the first provider to see its non-transparent active ETF range approved on Monday, having been declined twice already over the past five years.
The decision will be being closely monitored by other regulators. Last September, the Central Bank of Ireland pushed back on changing the rules around daily disclosure in its Discussion Paper 6 – Exchange Traded Funds as the rule provided “clarity” to market participants and enabled investors to monitor the underlying holdings.
At the time, the Irish regulator admitted some industry players were in favour of a more “nuanced” approach to the disclosure rules with asset managers providing the full portfolio to authorised participants (APs), instead of the whole market, in order to enable them to maintain tight spreads.
The rule change is widely expected to bring a whole host of asset managers to the ETF table. Hector McNeil, co-founder and co-CEO of Europe’s white label platform HANetf, said he has been in discussions with over 50 asset managers who will only enter the ETF space once non-transparent products are allowed.
The reason for this is asset managers do not want to reveal their secret sauce to the market as this would leave them exposed to front running and would destroy the value of their investment strategy.
Furthermore, from an investor’s perspective, if they are paying higher fees to get exposure to an asset class through an active ETF, then they will not want their asset manager’s secret advantage exposed to the market.
This is why the majority of active ETFs have primarily been in fixed income (72%) as the opaqueness of the market makes it difficult to front-run their trades.
However, the industry is divided on whether daily disclosure should be a requirement with one camp arguing it is the logical next step that will encourage more players to market while others question whether a move away from transparency at this moment would help.
One of the unique selling points since ETFs were launched is the transparency they provide to investors. This could be the start of a slippery slope as investors can longer look under the bonnet of their investments.
As James McManus, head of ETF research at Nutmeg, comments: “Rarely, if ever, has a reduction in the transparency of a market or product benefitted end investors.”
