Exchange-traded funds are forecasted to comprise one-third of managed money by 2018. This expansion is expected to provide financial advisors an opportunity to grow their practice, but could bring with it increased regulation, examination and standards.
"As more and more ETF products flood the market, regulators are creating more specialists and examiners who focus on ETFs and ETF managers," said Jeff Montgomery, who worked with financial advisors at NFP for eight years before acquiring Innealta Capital in 2009. "Financial advisors can expect to see new rules and new standards around ETFs, ETF portfolios and ETF financial advice over the next five years.”
Most ETFs are registered under the Investment Company Act of 1940 and defer to specific provisions of the ‘40 Act as they pertain to open-end funds. That could change as more companies launch ETFs.
“I believe that the current structure is an effective one,” said Robert Kurucza, a partner in the investment funds practice at the law firm Goodwin Procter in Washington D.C. “However, as ETFs continue to proliferate and new product permutations are introduced, if issues or abuses develop we could see a much less benign regulatory approach. But we will only see incremental tweaking changes in the current regulatory scheme for ETFs in the future.”
Fast Growth
Assets in ETFs increased from $102 billion in 2002 to $1.3 trillion in 2012, representing a 29.3 percent compound annual growth rate, according to Cerulli Associates. In a report, Cerulli noted that the continued maturation of this market has increased competition among established ETF sponsors and driven new sponsors to enter the space.
Part of the process in launching a new ETF is applying for exemptive relief when several of the customary features of an ETF are not consistent with the requirements of the ‘40 Act. Exemptive relief application is filed with the Securities and Exchange Commission’s Division of Investment Management.
“The biggest regulatory change I expect in five years is sponsors will be able to offer ETFs without requiring exemptive relief,” said Noah Hamman, CEO of AdvisorShares, a firm that exclusively offers actively managed ETFs. “As a result, advisors will gain more choices because there will be more ETFs competing on the market. When exemptive relief is no longer needed, it will be easier to build and launch your own ETF. So advisors may even create their own ETFs.”
In 2008, the SEC proposed new rules that would simplify the process of bringing ETFs to market and permit institutions to invest in ETFs to a greater extent. However, the rules have yet to become regulation.
“It’s a slow process but my hope is that are moving towards stand-alone regulation that is specific to ETFs,” said Ben Johnson, Morningstar’s director of passive funds research. “Currently, ETFs have been shoehorned into depression-era regulations in the form of the ‘40 Act. There’s a need to move towards regulation that is uniform, comprehensive and ETF specific.”