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ASIC lifts 'pause' on active ETF listings

Emma Rapaport  |  13 Dec 2019Text size  Decrease  Increase  |  
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Australia's corporate watchdog has lifted the six-month suspension of opaque exchange-traded funds following a review, clearing the way for new products to come to market.

ASIC conducted the review after a surge in the number of non-transparent active ETFs that decline to disclose daily portfolio holdings and make their own markets, and concerns that this lack of transparency could allow conflicts of interest to arise.

ASIC also flagged "international developments", including regulatory approval in the United States and Hong Kong of alternative frameworks for non-transparent active ETFs, as a reason for the pause.

In a statement on Wednesday, the regulator said the review "identified market integrity risks under certain internal market-making models —particularly those models where a market maker uses non-public information as part of its pricing methodology".

Internal market making occurs when a managed fund’s responsible entity acts as the market maker for its own fund on the fund’s behalf, either by submitting bids and offers itself or by engaging an agent to do it.

Firms can however take steps to manage these risks, ASIC said, including ensuring strong internal compliance and supervision controls and information barriers.

"Subject to controls, ASIC has requested that exchange market operators lift the pause on the admission of new managed funds with internal market making," the regulator said.

ASIC said it would work with with market operators and stakeholders "to ensure new funds being admitted for quotation use compliant models, and changes that are required to existing models are made as soon as possible".

ASIC upset the market in July announcing it would block the listings of new active ETFs that rely on internal market makers while it undertook a review

Since then, several active ETFs which do not use internal market makers but instead choose to disclose their full portfolios to external market makers were listed on the ASX, including one from Morningstar Investment Management.

Active ETFs make up a small part of the $60 billion Australian ETF market, but funds are growing in popularity, with around $5 billion under management, Morningstar estimates.

Samuel Morris, senior investment specialist with Fidante Partners, which operates a series of active ETFs, told Morningstar issuers will be relieved ASIC found no major flaw with the internal market-making processes.

"It's a relief to the industry that nothing majorly untoward has been found and I would assume that most if not all product issuers already had strong internal controls around non-public information," he said.

"Internal market making had been through a fairly robust process with multiple products issued."

Active ETFs combine the benefits of active fund management with the convenience of share trading. They're are managed by a team of portfolio managers who make decisions on the underlying portfolio allocation and aim to outperform an index or benchmark.

Managers behind non-transparent active ETFs say daily disclosure of the fund’s portfolio holdings gives away their intellectual property, and fear competitors could replicate their portfolio.

Managing director of active ETF provider eInvest Camilla Love told Morningstar she welcomes ASIC's decision to lift the pause, adding the recommendations resulting from the review will "only strengthen and provide greater confidence into the ETF industry".

Morris expects the conclusion of the review to encourage new active products to come to market in the coming year.

"I think there will be a backlog of products that were being contemplated before the pause that will now go ahead," he said.

"Product issuers that are in the market will probably want to see good traction with what they've already launched before they press ahead with too much new issuance. Everyone is learning how to distribute these strategies."

For those who haven't issued products yet but may be considering, Morris said this action could give them confidence to proceed.

Australian fund managers see active ETFs as a new distribution channel to seek access to the self-directed market.

ASX and ASIC have agreed the exchange will take full responsibility for the day-to-day admission process, as it does with the admission of listed companies.

is an editor for Morningstar.com.au

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