A coalition of some of the world’s biggest asset managers, including BlackRock and State Street Global Advisors, are proposing a new classification system to more clearly differentiate among types of exchange-traded products.
The new nomenclature would distinguish between traditional ETFs from structures that use leverage or invest primarily in commodities or in senior, unsecured, unsubordinated debt securities issued by an underwriting bank.
The leveraged product would be called an ETI, for exchange-traded instrument; the commodities investment pool an ETC, for exchange-traded commodity, and the debt product, an ETN, or exchange-traded note.
“At its core, this effort is about increasing transparency for investors,” said Samara Cohen, co-head of iShares Global Markets and Investments at BlackRock, in a statement. “We want to introduce a shared language to help investors know what they own.”
The coalition, which also includes Vanguard, Charles Schwab Investment Management, Fidelity Investments and Invesco, has sent identical letters to the Cboe, Nasdaq and NYSE asking them to implement the change. Coalition members account for more than 90% of the U.S. ETP market.
After noting the collapse in the price of 3x leverage long crude-oil linked exchange-traded notes in April and the 90%-plus loss in inverse VIX ETPs in February 2018, the letter argued that “certain ETPs have greater embedded market and structural risks and more complexity than others” and should be more clearly identified and categorized.
All three exchanges in separate statements from spokespeople said they welcomed an industrywide discussion about the proposed new classification structure.
Industry analysts, however, are not enthusiastic about the proposal, though they support the idea of more transparency for investors, especially for leveraged and ETFs.
“While I agree with the spirit of the industry’s coalition, I take issue with the specifics,” writes Ben Johnson, director of global exchange-traded fund research for Morningstar. The ETI label, for example, would not only include inverse and leveraged ETFs but ETPs that provide additional income, limit their upside and downside and “don’t serve to be grouped with them,” Johnson explained.
One example of that group is the Defined Outcome ETFs from Innovator ETFs, which “in many ways are safer equity plays than what biggest ETF issuers offer with index-tracking funds,” says Bruce Bond, the CEO of Innovator ETFs. Its S&P 500 Buffer ETF (BAUG) was down 4.1% year-to-date through May 12, compared to a 11% drop for IVV, the iShares S&P 500 index ETF, noted Todd Rosenbluth, director of ETF and mutual fund research at CFRA.
“The planned classification efforts will add, not remove, confusion with additional jargon, and not help investors understand that what is inside their portfolios drives future returns,” wrote Rosenbluth in the note.
There are also questions about who would enforce such new categorization since the proposal doesn’t envision any regulatory oversight by the Financial Industry Regulatory Authority or Securities and Exchange Commission, which passed on something like the proposed categorization when it adopted its new ETF rule, which took effect late last year.
“This feels a lot like ‘taxation with representation,’ writes Dave Nadig, chief investment officer and director of research at ETF Trends, noting that the top ETF issuers pushing the proposal control about 90% of the ETF market.
“There is not no evidence this will serve any purpose other than solidify the position of the largest providers,” said Robert Nestor, president of Direxion, which sponsors about 100 ETFs, 80% of them leveraged for either long or short positions.
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