Exchange traded funds have become an important investment tool in the industry but they do not have special legislation when it come to regulations. In 2008 the SEC proposed ETF-targeted legislation, but after the credit crisis and subsequent market meltdown it was placed on the back burner.
“It is clear that ETFs are here to stay and, going forward, will be an increasingly important segment of the investment industry. Therefore, it makes sense for exchange-traded products to have their own dedicated rules and regulations. As it stands today, the major industry regulators, such as the Securities and Exchange Commission, still don’t have a dedicated ETF division,” John Gabriel, Morningstar ETF Strategist, said. [Why ETF Assets Could Explode in the Second Half of 2012]
To date, investment legislation is anchored by the investment acts put together in 1933, 1934 and 1940, so-called Depression-era legislation that is governing digital age technology and investing, Gabriel reported from the recent Morningstar ETF conference. There is an entire exemption and manufacture process that providers must adhere to before bringing a product to market.
Two ETF executives agreed on the importance of providing incentives to market makers. The market makers are key to effective trade execution and keeping spreads tight, and these traits can help an ETF gain traction with investors. [How ETF Assets Could Break into 401(k) Plans]
“You can’t manufacture demand for a product,” said John Hyland, chief investment officer at U.S. Commodity Funds. But that doesn’t mean that some newer products don’t have solid merit or shouldn’t exist, Morningstar’s Gabriel wrote.
The three main characteristics that the ETF industry strives for is to be cheaper, faster and reliable. Most of the time, it is only viable to achieve 2 of those 3 traits at a time. For example, recent regulations such as Reg NMS in 2005, for example, have led to cheaper and faster markets for investors. But, as a result, they became less reliable.
As the dependence on technology becomes heavier and providers begin to replace people with computers, the need for updated rules and regulations will be urgent. There will need to be updated safeguards in place to protect investors. Since ETFs are readily available to retail investors and more areas of the market are accessible, ETFs should have more updated structures and regulations in place. [Regulatory Concerns Hamper European ETF Growth]
Tisha Guerrero contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.