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FSA highlights exchange traded product risks

The FSA has set out the risks investment advisers need to consider when deciding whether or not to recommend exchange traded products.

The regulator has published a factsheet for investment advisers which outlines key features, investment strategies and the potential for conflicts of interest in exchange traded products.

The FSA notes somes aspects of the factsheet may change as a result of a consultation on exchange traded products published by European regulator the European Securities and Markets Authority in January.

The factsheet says advisers should consider whether an exchange traded product is structured as a fund or as a debt security.

In the case of exchange traded funds, advisers should ensure whether the ETF complies with the Ucits directive on requirements such as a set level of portfolio diversification, that assets are appropriately segregated, and be aware of the restrictions on the types of assets the fund can buy.

Advisers should know whether the exhange traded product lends out the underlying securities it invests in, or whether a synethetic swap-based investment strategy is used instead.

The FSA has also highlighted potential for conflicts of interest in exchange traded products.

The regulator says because many exchange traded products are managed electronically, the provider not may be able to challenge potentially conflicted parties.

Some exchange traded product providers may also be part of the same company, which the FSA also says increases the potential for conflicts of interest.

One conflict of interest could be the exchange traded provider being provided with low quality assets by the party borrowing securities or the swap provider to reduce costs.

Where the index being tracked is created especially for an exchange traded product, thr provider creating that index can be affiliated to the exchange traded product provider.

The FSA says there may be an incentive in this case to select the index on the basis of maximising its own revenues, rather than that of the investor.



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There are 6 comments at the moment, we would love to hear your opinion too.

  1. Let me get this right, the FSA are warning us that it may be dangerous but then again no according to Europe or perhaps even more dangerous? May be ,perhaps,could be, what a waste of salaries. Can someone please clarify? Not you Nic!

  2. I think what they are trying to say is, ” Don’t advise on stuff you don’t understand.”

  3. What theyare saying is the assets underpinning the ETF could be rubbish and to avoid consumer detriment and another FSCS levy, have a proper look under the bonnet and be certain you are comfortable its right for your clients.

  4. Yet another investment falling within the RIP definition which the FSA is clearly unhappy about if it is actually used.
    Is there any chance that the FSA will review its directive that the whole range of RIPs must be considered and understood by IFA firms?
    I think we all know the answer but I thought I’d ask.

  5. There is actually a lot of sense in this factsheet, as it highlights the complexity of ETPs and the need for effective due diligence.

    However, it misses the opportunity to correct some of the rather dubious scare stories about ETFs that emerged last year, and which were no doubt encouraged by some of the active fund houses. ETP, just like OEIC, is a term that can cover a wide range of fund strategies and risk levels. It would have been helpful if the factsheet highlighted the types of fund that are lower risk, as well as examples of good practice.

    It would be very sad if this factsheet deterred advisers from considering ‘vanilla’ ETFs, whether physical or synthetic, that offer more than sufficient protection in respect of the collerateral and swap-lending concerns.

    It should, of course, be remembered that ETPs are not allowing in employing swap-based replication or stock lending. In fact, many absolute and other managed funds employ these techniques and should be subject to the same due diligence prior to recommendation.

  6. Paul Willan’s last para says it all in a Nutshell.


    Most Active fund managers employ these techniques as part of the day to day management of their funds.

    Remember Key Data and all the adviser’s who did not look closely enough at the small print in the product info.

    ETF’s are used in Cautious rated, balanced rated and aggressively rated funds lets not forget that if you have not figured this out and it does not meet your clients capacity for loss then you/the IFA will be blamed.

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