The Investor Advisory Committee (IAC), an arm of the Securities and Exchange Commission (SEC), is urging a rebranding for single-stock ETFs and other non-traditional exchange traded products (ETPs).
According to the committee, the current naming conventions have led to significant investor confusion, primarily because these products function differently from traditional ETFs.
Divergent from traditional ETFs
Single-stock ETFs, which invest directly in one security or via options markets, and leveraged ETFs, which can offer leverage up to five times through the options market, came into existence following streamlined regulations instituted by the ETF rule in 2019.
However, these products have deviated from the norm, triggering concerns among the IAC members. These products have been critiqued for being risky, often bearing higher fees than traditional ETFs, and enabling retail investors to access leverage without needing margin or options trading permissions.
These types of ETFs have also led to confusion among investors about the operational differences, risks, and returns compared to traditional ETFs. In January 2023, it was observed that 92% of single-stock ETFs’ investor base consisted of retail investors.
Consequently, the IAC has emphasized the need for a clearer naming convention to help investors understand the specific nature and risks associated with different ETF products.
The IAC believes that changing the name of single-stock ETFs and other ETPs would not only reduce investor confusion but also contribute to other policy objectives. It could help segregate them from index ETFs for insider trading screens.
There are concerns that members of Congress might be utilizing thematic ETFs to bypass conflict-of-interest and insider trading disclosures.
Furthermore, more concentrated ETFs could potentially serve as alternative tools for insider trading. Vinay Patel, a professor at the University of Technology Sydney, posits that single-stock ETFs could provide an avenue for insiders to profit.
Another aspect to consider is the SEC’s reluctance to approve a single-stock ETF that tracks non-US-registered foreign securities.
Concerns revolve around the underlying foreign securities of these ETFs not having American securities disclosures, making these ETFs a workaround from having to register with American exchanges or using an American Depository Receipt.
Proposed reforms and the way forward
Last year, the SEC proposed reforms to broaden the scope of its Names Rule. The IAC is still deliberating how their recommendation for name changes for non-traditional ETFs would align with the SEC’s current or proposed Names Rule.
The IAC does not intend to amend the 2019 ETF rule, which standardized the way most ETFs launch and improved the issuance process while reducing costs for the entire ETF industry. Instead, they suggest that the SEC should intensify its enforcement of existing securities laws.
In addition, the IAC recommended the SEC crack down on sales practices of single-stock ETFs. It suggested that ETF issuers should disclose performance against their reference assets and that the SEC and Finra require visual disclosures at the point of sale.
The proposal of this rebranding doesn’t merely signify a change of names. It could pave the way for greater clarity and understanding among investors and potentially address policy goals related to insider trading.
The road ahead appears to be steeped in enforcing existing laws and refining sales practices, ensuring a safer and more transparent investment environment for all.