Taking The Lead: Defining Transparency (SPY, DIA, IWM, VTI, QQQ)

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October 19, 2011 6:01pm NASDAQ:QQQ NYSE:DIA

Jennifer Grancio: Whether it’s the Eurozone Crisis, the most recent strikes, or even Occupy Wall Street that has gone from a sit-in to a movement, the world is demanding accountability and answers. Today’s congressional testimony about ETFs is another example, and my colleague

(and blog contributor) Noel Archard is in Washington, DC to outline our recommendations for defining and disclosing exchange traded products.

Recently, BlackRock published a paper called ETFs: A Call for Greater Transparency and Consistent Regulation. In it, we lay out recommendations for reforms in the way exchange traded products (ETPs) are labeled and reported. Although some of the recommendations are aimed at the European market, the following two are the most relevant and pressing for the United States: Clear labeling of a product’s structure and investment objectives; and frequent and timely disclosure for all holdings and financial exposures.

Clear Labeling

Since the first ETF was launched in 1989, the number of funds has grown steadily and now totals more than 2,000 products globally. But not all ETFs were created equal. The first ETFs were straightforward, tracking relatively broad benchmarks such as the S&P 500 or individual country indexes. In the past few years, however, sponsors have introduced more complex products, including so-called leveraged and inverse funds, as well as products backed principally by derivatives rather than physical holdings.

These more complex funds account for less than 10 percent of the ETF universe, yet receive nearly all of the media attention.

To reduce confusion, we are proposing a system to clearly identify the differences between products. Instead of using ETF as a catch-all phrase, we propose the following global classification system:

Frequent and Timely Disclosure

Just as you should be able to clearly understand the structure of any ETP you purchase, you should also be able to clearly understand its holdings. We are proposing that the institutions – or sponsors — that create ETPs provide a clear picture product holdings and financial exposures.

A straightforward example would be something like a fund that tracks the S&P 500 index  — those stocks would be listed in the disclosure. When it comes to more complex products, we believe sponsors need to disclose the use of derivatives, including futures, options and swaps. Products that use swaps involve counterparty risk, where collateral is posted in case a counterparty cannot fulfill its financial obligations. Information about counterparties, including their identity and relationship to the sponsor, as well as the type and value of collateral should be clearly presented to an investor.

Knowledge is Power

At the end of the day, our goal is to empower you, the investor.

We want to ensure that when a product is defined as an ETF it means that it is regulated as a publicly offered investment fund and is appropriate for a long-term retail investor. Products that are designed only for professional or short-term investors, such those that use leverage or inverse strategies, would not be permitted to use the “ETF” label.

We also want to ensure that you know what exactly it is that you are buying – whether it’s a standard ETF or one that uses complex financial instruments, like swaps, to achieve its investment goals.

Every fund at iShares has a factsheet that provides you with key information, such as a fund’s holdings and its total expense ratio. We encourage you to read these factsheets before making any investment decisions, and we encourage the industry to join us in our call for transparency by standardizing definitions and ensuring more complete disclosure.

Written By Jennifer Grancio From The iShares Blog

iShares believes in openness, transparency, and honesty. It’s how we fulfill our mission: empowering investors and investment professionals to achieve their goals. The iShares Blog furthers that commitment, by providing visitors to the Blog with market insights and analysis from some of the preeminent thought leaders at iShares.

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