© Bloomberg

Latest news on ETFs

Visit our ETF Hub to find out more and to explore our in-depth data and comparison tools

Single-stock ETFs should change their names, an advisory group to the Securities and Exchange Commission said.

Single-stock ETFs, leveraged ETFs and other non-traditional ETFs, which were allowed to be created under streamlined rules created by the 2019 ETF rule, are “functionally not the same product” as traditional ETFs, according to the agency’s Investor Advisory Committee.

“The commission should therefore establish a clearer naming convention around different types of [exchange traded products],” the committee has written in draft recommendations that were set to be passed to the SEC.

Single-stock ETFs invest in only one security directly or through the options markets. Registered investment companies cannot provide leverage directly, so such funds that offer leverage — sometimes up to five-times leverage — do so through the options market.

This article was previously published by Ignites, a title owned by the FT Group.

AXS launched the first single-stock ETFs last July to include leveraged funds with exposure to nine stocks, including Tesla, Salesforce, ConocoPhillips, Nvidia and PayPal.

Since then, four asset managers have successfully launched a total of 29 single-stock ETFs, according to ETF.com.

Such funds tended to “run afoul of the general spirit of ETFs”, members of the IAC said in a December meeting. They do not offer a diverse basket of securities, can be highly leveraged and risky, are generally higher in fees than traditional ETFs, and can serve as a way for retail investors to access leverage without margin or options trading permission.

These types of non-traditional ETFs also could create investor confusion about how the products’ operations, risks and returns differ from those of traditional ETFs, the IAC concluded.

As of January 2023, retail investors made up 92 per cent of single-stock ETFs’ investor base, the IAC noted.

“The lack of a clearer naming convention around exchange traded products, which include single-stock ETFs, leveraged ETFs, and other exchange traded notes (ETNs), has led to investor confusion and unnecessary loss of capital from self-directed investors failing to understand the payouts and risks, due in part to their close association with more standard, diversified products,” the recommendations stated. Therefore, the committee argued, they should not be allowed to be called exchange traded, lest they be confused with more plain vanilla ETFs.

Another SEC committee, the fixed-income market structure advisory committee, in 2018 also recommended limiting which products can use the ETF title. This recommendation was premature and could confuse investors even more, State Street Global Advisors wrote in a 2019 comment letter.

Changing the name of single-stock ETFs and other exchange traded notes and products may also serve other policy goals, such as separating them from index ETFs for the purposes of insider trading screens, the IAC noted. Members of Congress might be using thematic ETFs to skirt conflict-of-interest and insider trading disclosures, the Financial Times reported last month.

More concentrated ETFs can serve as alternative instruments for insider trading, Vinay Patel, a professor at the University of Technology Sydney, noted. “Any way you can [get] exposure to an underlying stock provides a way for an insider to make money,” Patel said. “These single-stock ETFs . . . there’s definitely an avenue where an insider could profit from them.”

Meanwhile, the SEC had yet to approve a single-stock ETF that tracks a non-US-registered foreign security, noted Ryan Charles, a principal at Kelley Hunt & Charles.

Charles worked for Kelly Intelligence, whose application for 11 single-stock ETFs were rejected by the SEC in September, he said. The SEC was concerned that the foreign securities underlying the single-stock ETFs did not have American securities disclosures, and so the single-stock ETFs would act as an effective workaround from having to register with American exchanges or utilising an American Depository Receipt, Charles said.

With a new name, single-stock ETFs might be treated differently by policymakers and organisations than broad-based, traditional index ETFs, the IAC argued.

The SEC last year proposed reforms to its Names Rule that would broaden the scope of strategies governed by the rule. The IAC still needed to determine how, if at all, their recommendation for name changes for such non-traditional ETFs would fit within the SEC’s current or proposed Names Rule, said Andrew Park, senior policy analyst at Americans for Financial Reform and a member of the SEC’s Investment Advisory Committee.

The IAC was not interested in amending the 2019 ETF rule, which standardised the way most ETFs launch, Park noted. That rule “has vastly improved the issuance process and lowered the costs for the entire ETF industry” because most ETFs no longer have to apply for exemptive relief prior to launching, the report said.

The IAC considered recommending to the SEC that in order for an ETF to qualify as such, it needed a minimum number of securities, Park said. But the committee ultimately rejected that approach because they couldn’t determine the right minimum threshold.

Latest news on ETFs

Visit the ETF Hub to find out more and to explore our in-depth data and comparison tools helping you to understand everything from performance to ESG ratings

The recommendation of requiring a minimum number of holdings to qualify as an ETF would also effectively make single-stock ETFs illegal, Park noted. “We decided that recommendation was going to be a distraction,” Park said. “Effectively, the genie is out of the bottle on this.”

Instead, the SEC should continue to crack down on the products with more enforcement of existing securities laws, the IAC recommended.

Other regulators have warned that financial advisers themselves might not understand the products’ risks.

Last month, the SEC ordered a small adviser to pay $1mn for holding leveraged ETFs for clients improperly.

The SEC should also crack down on sales practices of single-stock ETFs, the IAC recommended, adding that ETF issuers should be required to disclose performance against their reference assets and the SEC and Finra should require such visual disclosures at the point of sale.

“There’s a difference between losing money because you made a bad trade and losing money because you didn’t know how the product worked,” Park said.

Copyright The Financial Times Limited 2024. All rights reserved.
Reuse this content (opens in new window) CommentsJump to comments section

Follow the topics in this article