Exchange Traded Funds ("ETFs") 

The ETF market has been growing significantly over the past few years and incoming cash-flows can be observed regularly. These are the main factors supporting the strong confidence of the major service providers that ETFs will be a product of the future.

A hybrid product that evolved over time

"ETFs are typically open-end index funds that provide daily portfolio transparency, and which are listed and traded on exchanges like stocks(...) Similar to index mutual funds, ETFs represent a portfolio of securities that typically track specific indexes. Comparable to stocks, they can be bought and sold on an exchange throughout the trading day." (according to BlackRock - ETF Landscape Global Handbook Q2 2011). 

Traditionally, ETFs have been index replicating funds. The replication of the performance of the index is achieved either through a direct replication (direct investment in the basket of shares that is representative of the underlying index), or by indirect / synthetic replication (the ETF will enter into a derivative transaction with one or more counterparties to achieve the performance of such index).  ETFs that physically replicate indices derive an important part of their revenues through securities lending activities.

Product innovation in the ETF industry has led to the development of a variety of ETF types including leveraged and inverse leveraged strategies. 


Reasons for growth


  • Strong investment inflows by investors attracted by low fees and greater transparency.
  • Retail and institutional investors increasing their investments in ETFs to gain cost-effective and direct exposure to hard commodities such as gold, oil, natural gas and copper and to gain access to hedge fund-like strategies.
  • High-frequency traders increasingly focusing on costs and, consequently, ETFs.


Listing versus domicile


 ETFs are not necessarily domiciled in the country where they are listed.


  • Luxembourg is considered to be the number one domicile in Europe with over 20% of ETFs domiciled in the country. On the basis of total assets under management Luxembourg ranks second behind Ireland.
  • When it comes to listing, the picture is quite different: Germany, France, the UK and Switzerland share over 90% of ETF listings in Europe.


Recent developments


In Europe most ETFs are UCITS funds (and hence have to comply with the UCITS regulation) and in the US most are registered as investment companies under the 1940 Act (same as mutual funds).

ESMA’s guidelines ref. ESMA/2012/474 introduce a definition of what kind of UCITS are UCITS ETFs as well as specific guidelines such as those to differentiate these funds from other UCITS.

Additional guidelines are introduced with regards to efficient portfolio management techniques (EPM) such as securities lending, repo and reverse repo transactions, and in particular with respect to collateral received, qualitative and quantitative criteria are introduced that amend certain provisions of the existing Guidelines on Risk Measurement and Calculation of Global Exposure and Counterparty Risk for UCITS (Ref. CESR/10-788). These new requirements are applicable to all UCITS (and not just ETFs) using EPM techniques. The guidelines also introduce a number of additional disclosure requirements deriving from the above key changes.


The Following definitions were introduced by the ESMA guidelines: 


 Actively-managed UCITS ETF 


 “An actively-managed UCITS ETF is a UCITS ETF, the manager of which has discretion over the composition of its portfolio, subject to the stated investment objectives and policies (as opposed to a UCITS ETF which tracks an index and does not have such discretion). An actively-managed UCITS ETF generally tries to outperform an index.”

 UCITS ETF                            

“A UCITS ETF is a UCITS at least one unit or share class of which is traded throughout the day on at least one regulated market or Multilateral Trading Facility with at least one market maker which takes action to ensure that the stock exchange value of its units or shares does not significantly vary from its net asset value and where applicable its Indicative Net Asset Value. “ Further clarifications may be required as to whether these requirements are to be interrelated at the share class level rather than the umbrella level.

 Index-tracking UCITS

 A UCITS the strategy of which is to replicate or track the performances of an index or indices e.g. through synthetic or physical replication.

 Index-tracking leveraged UCITS

 A UCITS the strategy of which is to have a leveraged exposure to an index or exposure to a leveraged index.


These guidelines will apply from two months after their publication on ESMA’s website. Transitional provisions are set out in section XIV of Annex III of the ESMA document. In the meantime, the industry is likely to express the need for further clarifications or definitions with regards to these guidelines. In addition, EPM techniques are likely to be subject to additional regulatory requirements as a further consultation on the treatment of repo and reverse repo arrangements with a deadline for respondents to reply by 25 September 2012 is included in Annex IV of the ESMA document.

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