Regulator warns on ETPs’ conflict of interest risks
Investment advisers must monitor conflicts of interest associated with collateral, trading and indices when advising on exchange-traded products, the FSA has said.
The warning came in a five-page factsheet for investment advisers on ETPs, which was published on the regulator’s website.
The City watchdog said conflicts may arise between the ETP and third parties when the fees obtained for the arrangement of securities lending are shared between the stock lending specialist and the ETP.
The guidance said: “Where third parties are affiliated to the ETP provider, the freedom to choose unaffiliated parties may be affected.”
It also warned that if the authorised participant, who contributes to the price of the shares, is part of the same parent company as the ETP provider, the company may also have the incentive to restrict the number of competing firms.
Investment advisers are also urged to look out for indices created specifically for an ETP and to investigate what its components are.
The guidance said: “If the institution that creates the index is affiliated to the ETP provider, it may have an incentive to select the individual constituents of the index to optimise its own revenues, rather than that of the investor.”
The document said: “These parties’ interests may not be the same as those of the investor. In some cases, ETP providers may be affiliated - that is, part of the same company - to the parties providing these services to the ETP, which can increase the potential for conflicts of interest. Many ETPs are managed electronically, not by a dedicated fund manager. Therefore, the ETP provider may not be able to effectively challenge potentially conflicted parties.”
Nick Lincoln, director of Hertfordshire-based Values to Vision Financial Planning, said: “The FSA seems to have a real bee in its bonnet about stock lending in particular.
“Stock lending has been practised by firms such as iShares for years with no issue.
“Plain vanilla ETFs are as straightforward as index-tracking Oeics and I just do not see what the fuss is about.
“Derivative and swap-based ETFs/ ETPs are a different subject and I would not touch them with a bargepole, however. I feel the FSA should focus more on these than the former.”
ETFs were put under the spotlight in 2011 after reports by the FSA, the Bank of England and the Financial Stability Board. The regulators warned about synthetic ETFs that use derivatives to replicate indices or price movements.
The City watchdog said conflicts may arise between the ETP and third parties when the fees obtained for the arrangement of securities lending are shared between the stock lending specialist and the ETP.
The guidance said: “Where third parties are affiliated to the ETP provider, the freedom to choose unaffiliated parties may be affected.”