Why Canadian regulators should bolster ETF investor protection

Kenmar president Ken Kivenko supports the CSA review of ETF regulations

Why Canadian regulators should bolster ETF investor protection
Steve Randall

The growing popularity of – and myths surrounding – investment in exchange-traded funds in Canada demands strong regulation to protect investors says a prominent wealth professional.

Kemar Associates president Ken Kivenko has written a letter in support of the CSA’s review of ETF regulation and calls for “regulators to adopt policies and regulation to assure that ETF’s (and other structured products) are designed to meet the needs of target markets.”

With ETFs continuing to build on positive flows, as mutual funds post net redemptions, the CSA announced in August that it will assess whether the current regulations applicable to ETFs remain appropriate, including the unique features of the funds such as secondary market trading, creation and redemption of ETF units by authorized dealers, and the arbitrage mechanism that acts to keep the market price of an ETF close to the underlying value of its portfolio.

Kivenko notes that regulation of ETFs was not a priority until recently, but some securities regulators are concerned that investor protections such as disclosure requirements are not sufficient for more complex products.

He says that investors may be unaware of how to use ETFs or the risks associated with ETF investing, especially for the ‘exotic’ ETFs that may appear a more attractive option than mutual funds.  These risks have increased along with complexity.

“Most Canadians believe an ETF purchases all the securities within it in proportion to an index. Things are clearly more complex than that as evidenced by the increasing use of derivatives, futures contracts and swaps, the rise of actively- managed ETF’s and complex strategies involving leveraged and inverse ETFs,” Kivenko wrote in his letter.

Research conducted by Kenmar found that investors’ main concerns about ETFs include:

  • fund nomenclature
  • investment strategy clarity
  • risk disclosure
  • costs/fees and their disclosure
  • liquidity
  • bid-ask spreads
  • taxation  

What should be reviewed?

The Kenmar president says there are several key areas of regulation that should form the basis of the CSA review:

  • financial system risk
  • corporate democracy - Should ETF regulation provide flow through rights so

investors can vote their beneficial shares?

  • Impact on society – due to the large share of ownership in Canadian companies held by large asset managers such as BlackRock and Vanguard
  • governance
  • product design
  • portfolio transparency
  • education
  • marketing and sales practice rules
  • greenwashing
  • disclosures
  • embedded commissions
  • DSC ETFs
  • options on ETFs
  • use of AI
  • taxation
  • impact of total cost reporting
  • performance reporting

Regulatory framework

Kivenko notes that the UK financial regulator, the Financial Conduct Authority (FCA), has developed a regulatory framework for complex structured products.

This includes requiring that products have a “reasonable prospect of delivering economic value to customers in the target market. Firms must be able to determine and evidence this via robust stress testing as part of the product approval process.”

Kivenko says that the CSA review should show why similar robust regulatory requirements would not be in the best interests of Canadian investors.

He also says that client complaint information received by Dealers and OBSI should be used in formulating regulatory policy.

“Looking beyond CSA ETF product regulations, informed investment advice and guidance are essential for enhanced investor protection. Registrants who provide advice on the more complex ETF’s, including crypto assets, should be trained in their complexity and risks,” he concluded in his letter.

Recently, Prerna Mathews, VP ETF Product and Strategy at Mackenzie Investments, gave her view of ETF regulation in Canada, acknowledging that while it is “functional” there is room for improvement.