Crowded Field
A slew of new rules could emerge from the Commodity Futures Trading Commission, the Nasdaq and the New York Stock Exchange in coming years. The exchanges are currently floating market maker and indicative pricing (a nonbinding price for a security) proposals, which would first have to pass muster with the SEC before becoming established rules.
“If pricing or liquidity incentives eventually became regulation, advisors would get greater liquidity and higher spreads, which helps lower the overall cost of the ETF for shareholders and clients,” Hamman said. “Indicative pricing gives advisors a tool for better execution, but those services are not free. The benefit could result in higher listing expenses, which would increase the price of the fund.”
Meanwhile, the SEC is considering a number of cloaking technologies that would limit transparency by preventing daily disclosure of ETF holdings. For example, Eaton Vance has an application on file with the SEC seeking approval for its cloaking technology that would be used for ETFs.
"New regulation will require greater collaboration from various regulatory agencies and the exchanges. If and when that happens, the environment will be even more investor friendly than it is today,” Johnson said. "It's not to say the environment we exist in now isn't investor friendly, it's just that it could be more so if ETF regulation were simpler to understand, transparent and coherent."
Elsewhere on the regulatory front, ETFs fall under the umbrella of Finra’s expanded suitability rules rolled out last year. They require a broker-dealer or their associated persons to have a “reasonable basis” to believe a recommended transaction is suitable for the customer based on information obtained through “reasonable diligence” to understand a customer’s investment profile.
“In coming years, you may see more enforcement, compliance reviews and monitoring which will require financial advisors to do more due diligence and better understand the risks associated with ETFs in order to avoid regulatory action and any private cause of action where an individual investor brings an arbitration claim to the Finra forum because an advisor sold an unsuitable ETF,” said Dev Modi, an attorney with Lyon, Glassman, Leites & Modi LLC in Florham Park, N.J. “Advisors will want to be more closely aligned with their internal compliance and legal departments.”