BlackRock Inc., which controls 42% of the exchange-traded-fund market, is calling on the industry and regulators to raise the bar in terms of both transparency and regulatory oversight.
While the report issued by the company today includes five areas of recommended reform,
BlackRock has placed particular emphasis on a reduction in the use of synthetic strategies that don't hold the underlying investments.
The reliance on derivatives and futures contracts to replicate the exposure of an index or asset class introduces risks associated with “mis-tracking as well as counterparty risks,” according to Jennifer Grancio, managing director and head of BlackRock's iShares U.S. distribution.
. She acknowledged that as the ETF industry has expanded and now includes more than 1,300 ETFs and more than $1 trillion under management, there are some strategies that would be difficult, if not impossible, to employ without the use of synthetic strategies.
In the commodity space, for example, it would be impractical for a fund manager to own the physical commodities represented by many ETFs, which is why gold and silver ETFs are among the few exceptions in terms of holding the underlying assets.
RELATED ITEM ETFs with the biggest net outflows
Ms. Grancio said of the more than 460 iShares funds, globally, “only a handful” use synthetic strategies.” And of those, she added, “we are undertaking a review” of whether it would be possible to start holding the underlying assets.
“We believe, where possible, holding the physical securities is preferred,” she said. “And where that is not possible, we are moving to the highest level of collaterization and disclosure.”
Morningstar Inc. ETF analyst Robert Goldsborough praised BlackRock for “showing some leadership in the ETF space.”
Although he acknowledged that any standards set out would mean that “everyone in the industry has to agree on this.”
Mr. Goldsborough was particularly supportive of the recommendation related to fees.
While ETFs already are considered to be among the least expensive and most transparent packaged retail products, BlackRock believes that transparency should extend all the way up the food chain to include counterparties and all revenue associated with the products.
Mr. Goldsborough said the fee disclosure recommendation follows along the lines of an existing Morningstar analysis of estimated holding costs of ETFs.
“For a long time we've felt that investors should have a better understanding of the costs, and uniform global stands is a great idea and long overdue,” he said.
While most ETF providers already post expense ratios on website, BlackRock is recommending uniform global standards to help investors determine which additional fees and expenses are included or excluded.
“ETFs were structured a lot differently in 1990s than the ones coming out today,” Mr. Goldsborough said. “I think there is definitely some investor confusion out there.”
In addition to uniform fee disclosure, BlackRock also is recommending clear labeling of product structure and objectives, frequent and timely disclosure of all holdings, standards for diversifying counterparites, and uniform trade reporting for all equity trades.
In light of the rapid expansion and growing popularity of ETFs since their introduction in 1989, some kind of global standards makes sense to Ryan Issakainen, an ETF strategist at First Trust Advisors LP
“I think the ETF providers have been pretty good at being clear in the literature and letting people know what they should expect,” he said. “But investors need to know how some of these ETFs achieve the strategy.”
