Streetwise

Canada's ETFs safer than U.S. and Europe's

The Globe and Mail

(Shapiso/© Lee Phek Thong, all rights reserved)

Global regulators are starting to crack their whips on exchange traded funds, but the Canadian industry isn’t very worried.

While global oversight of ETFs is evolving, are detailed here, the focus is on tightening the leash for sophisticated ETFs that employ derivatives and counterparties. Here in Canada, many of these issues have already been addressed because our regulatory documents govern such problems.

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“We are very fortunate in this country that the regulations that are in place, while they may not have contemplated ETFs when they were being devised... actually cover the various types of ETFs [today]very well,” said Howard Atkinson of Horizons ETFs. More specifically, Canadian ETFs typically fall under National Instruments 81-102 and 81-104, which govern mutual funds as well as derivatives and commodities.

South of the border, on the other hand, commodities ETFs are governed by the Securities Act of 1933, so they are treated like typical securities, and that’s created all kinds of problems.

Whereas U.S. and European regulators are now looking for ways to ensure that the collateral that underpins these risky ETFs is legitimate, and that their counterparties are kept separate from the ETF providers, Canada is already ahead of the curve.

Here, the rules for a swap-based ETF, such as the Horizons S&P/TSX 60 Index , dictate a 10 per cent maximum exposure to one counterparty, and the counterparty must have at least an ‘A’ credit rating.

And Horizons, Mr. Atkinson points out, uses 100 per cent cash as its collateral. That differs very much from some scary situations in Europe, where small-cap Japanese stocks may be used as collateral. If the market goes belly up, who knows what their value will be.

Because Canadian ETFs are already governed by stricter rules, Mr. Atkinson reiterates that they really aren’t that much different from mutual funds from a risk standpoint. As he pointed out, mutual funds used to be plain vanilla investments, but they too evolved over time and allowed investors to do things such as effectively short the market. It simply took time to educate investors on the riskier strategies.

Plus, he said that Canadian ETF providers work together on regulatory issues. “It’s fairly collegial,” he said. “As much as it can be,” considering that they are still in competition with each other.

As for the proposal by BlackRock to only classify plain vanilla ETFs – the ones that track basic equity indices – as ETFs, and to call the more sophisticated products something else, Mr. Atkinson said you can’t call the riskier products another name because they are still exchange-traded funds. “It’s hard to redefine an industry after the fact,” he said.

Though he acknowledges that more investor education is needed for the more complex ETFs, Mr. Atkinson said that investors must also make sure they are aware of what they are investing in.

“I would encourage you to invoke the Buffet rule and not invest in something that you don’t understand,” he said.