ETF Expansion Assessed

Exchange-traded funds will continue to attract money, but the expansion of the ETF ecosystem poses a risk to the industrys rapid growth by providing more areas for regulators to scrutinize.

That was an assessment offered at the 2018 ETFs Global Markets Roundtable, which was held May 15th in New York.

The first ETF in the U.S. launched in 1993. It took time for institutional investors to warm up to the investment vehicles, but the past decade has seen U.S. ETF assets surge about sevenfold to $3.4 trillion as of year-end 2017, according to industry data.

ETFs are now mainstream and time-tested as a way for investors to efficiently take positions, across multiple asset classes, sectors and strategies.

But the rapid expansion means more fiduciaries, portfolios, structures, and technologies — each of which may present their own interest to regulators — are involved in ETFs.

Dan Draper, managing director of global ETFs for PowerShares by Invesco, cited robo-advisory as an example. What potential regulations in that area will affect ETFs? he asked.

Doug Cifu, CEO of electronic market maker Virtu Financial, said the ETF proliferation will continue, but also cited regulation as a potential damping factor.

Regulators would be well-served to focus on education and suitability of ETFs for end-user investors, but it would be best if they stayed away from structural and trading aspects of the market, according to Cifu.

The best regulation is no regulation, he said. Whenever they get involved with trying to slow things down or speed them up, they screw it up.

Financial Industry Regulatory Authority Rule 5250, which prohibits ETF issuers from making payments to market makers, came up for discussion. Paying market makers is allowed in Europe, and Cifu said there is no principled reason why it shouldnt exist in the U.S., Cifu said.

Allowing payments to market makers could expand the ETF market, and boost all market makers including Jane Street, Citadel Securities and Susquehanna. As long as payments are made transparently and with full disclosure, such a system would be beneficial, Cifu argued.

Europes ETF market was about $800 billion as of year-end 2017. That number should rise as liquidity and transparency improves under MiFID II, Cifu said. Elsewhere, Cifu noted Asia overall is relatively underpenetrated, but there is some strength in Australia, Hong Kong and Japan. Brazil is also poised for ETF growth.