ETF industry braces itself for transparency push

By Lionel Laurent

PARIS (Reuters) - Top heavyweights from the $1.3 trillion exchange-traded fund (ETF) industry are bracing themselves for a shift in how their fast-growing but relatively opaque products are marketed, distributed and regulated.

During a three-hour hearing in Paris on Monday, executives from ETF providers like BlackRock <BLK.N>, Societe Generale <SOGN.PA> unit Lyxor and Natixis <CNAT.PA> unit Ossiam picked apart the European Securities and Markets Authority's (ESMA) recent proposals to make ETFs more transparent and ultimately less risky for investors.

But despite some pushback on details such as how ETFs should be labeled, what information should be disclosed and how their risk levels might be controlled, some executives acknowledged the broad push toward more transparency was inevitable.

ETFs are mutual funds traded like a stock and are popular because of their cheap fees. Although regulatory concerns have been brewing for months, they have most recently been caught up in alleged rogue trades that triggered $2.3 billion losses at Swiss bank UBS <UBSN.VX> <UBS.N>.

UBS has alleged a trader on its ETF desk in London had racked up the losses through unauthorized, speculative futures transactions which were hedged with fictitious ETF trades.

The hearing took place in the wake of a consultation by ESMA, launched in July, on what it sees as inadequate regulation of listed complex ETFs sold under the EU-approved UCITS mutual funds framework.

Regulators worry about what they see as potential systemic risks from the complex structured and synthetic or leveraged varieties which use derivatives like futures and options rather than a stock or commodity, as their underlying security.

Complex ETFs now make up half the market in Europe and regulators worry they leave investors with open ended exposures.

ESMA's representatives expressed concerns about the recent growth spurt of ETFs and whether there was enough disclosure and transparency to allow retail investors to really understand the product.

"If the investor is not able to understand they need an advisor to buy the product," said ESMA's Nicoletta Giusto. "They have to be able to understand what they buy."

ESMA is looking at possible curbs on sales of complex ETFs to small investors. Its chairman, Steven Maijoor, said in July the emphasis would be on giving investors more information about risks, though curbs could not be ruled out.

However, several executives at the hearing cried foul over what they saw as excessive demands for transparency and disclosure on the composition of ETFs. One PriceWaterhouseCoopers representative told the hearing: "If you get down to a daily, single-position transparency, then this will be the death of this product."

The European Fund and Asset Management Association (EFAMA) told ESMA's consultation there is generally no need for ETF-specific regulation as the EU framework provides for a "very high level of investor protection."

UK consumer lobby group Which? disagreed.

"With regard to concerns about exchange traded funds, UK consumers could be purchasing a financial product manufactured in Luxembourg or Ireland, managed from Paris and listed in London, with potential exposure to swap counterparties located elsewhere," Which? said in its submission to ESMA.

"This means that it is vital that action is taken at a European level to control the risks from these products," the consumer association added.

The Financial Stability Board of global regulators is studying complex ETFs and the European Systemic Risk Board urged caution on their distribution.

Britain's Financial Services Authority has questioned whether synthetic ETFs are suitable for small investors.

(Additional reporting by Huw Jones, editing by Bernard Orr)