What non-transparent ETFs could mean for Canada

Novel structure for active ETF strategies approved in the U.S. could have implications for Canadian industry

What non-transparent ETFs could mean for Canada

Canada’s active ETF issuers have long held an advantage over their counterparts in the U.S., thanks in no small part to a difference in regulation. But with a novel fund structure gaining approval south of the border, is the playing field set to shift?

In a recent interview with Wealth Professional, Evolve ETFs President and CEO Raj Lala explained the regulatory quirk that’s enabled Canadian active ETF managers to gain a comparative edge.

“In Canada, we have something called selective disclosure: we provide transparency to market makers, but we don’t have to provide full daily transparency to the end investor,” Lala said. “I applaud the OSC for being forward-thinking about that policy.”

Canadian ETF portfolio managers are able to disclose their investment holdings on a quarterly basis; in contrast, those in the U.S. must disclose their holdings daily. That has made active managers in the States hesitant to offer their strategies in an ETF format, as its transparent nature makes it prone to front-running and copycat funds.

Partly because of the relative protection of their underlying strategies, active mandates have been able to play a more significant role in Canada’s ETF space.

“I think the active space in Canada is definitely punching above its weight relative to the U.S. For example, about 40% of all flows into Canada-listed fixed-income ETFs in the last year have gone into actively managed strategies,” Lala said. “It appears that advisors recognize what a big difference a good portfolio manager can make on a risk-adjusted basis for certain asset classes.”

Of course, that balance could shift in the near future. In a newly published commentary, Carol Derk, Sarah Gardiner, and Sienne Lau of Borden Ladner Gervais (BLG) noted several changes relating to ETF regulation in the U.S. — including the Securities and Exchange Commission’s (SEC) approval of an actively managed, non-transparent ETF.

Under the Precidian Investments’ ActiveShares ETF structure, funds have the ability to disclose their daily holdings only to “authorized participant representatives” who will be responsible for exchanging baskets of the underlying assets to create or redeem shares of the ETF. Public disclosures of holdings, meanwhile, will be done just once every quarter with a 60-day delay.

“This approval has prompted a number of other applications to the SEC to permit the offering of ETF products under a non-transparent or semi-transparent, actively managed structure,” the experts from BLG said in their commentary. “As these structures are approved and launched, we expect the ETF market in the U.S. to see a larger share of active ETF mandates, which could have both positive and negative implications for the Canadian ETF industry.”

A potential positive effect, they said, would be a decreased likelihood for the OSC to pursue new policies that would increase the transparency of active ETFs. However, the Canadian active space could also become relatively less appealing to global active managers, as the U.S. market offers a larger investor pool as well as potential protection through a semi-transparent or non-transparent ETF structure.

“Hopefully, U.S. ETF operators will be incentivized to bring their actively managed ETFs to Canada if processes can be streamlined and made efficient, thereby bringing more innovative investment products and strategies to Canadian investors,” BLG’s experts said.


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