Review of index trackers in 2012

Nicole Bastiaansen

AFM on index trackers

Misconceptions

• AFM is a proponent of active investing

• AFM is a proponent of passive investing

• AFM is an opponent of complicated products

• AFM is an opponent of synthetically products

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Mission statement

The AFM promotes fairness and transparency within financial markets

The AFM supervises the conduct of the entire financial market sector: savings, investment, insurance and loans

Acting in the interest of client

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Acting in the interest of the client

• For example, as a product provider: – Cost-effectiveness Does the proposition offer good value

for money? – Usefulness Does the proposition meet a genuine need of

a target group? – Safety Does the proposition do what it is intended to do

in all kinds of situations, and are the results acceptable to the target group?

– Comprehensibility Is the proposition not unnecessarily complicated, and can consumers properly assess its quality and suitability?

• AFM review of index trackers (2010)• AFM Guidelines on active and passive investing in

the interest of the client (2011)– The status of academic research regarding the

results of active and passive investing (2011)• AFM review of index trackers (2012)• ESMA’s guidelines on Exchange-Traded Funds

(ETFs) and other UCITS issues (2012)

Recent studies on index trackers

ESMA Guidelines vs. AFM’s recommendation

• Both the ESMA Guidelines and the AFM’s recommendation provide more transparency and better protection for retail investors and other investors

• Both reports have a different background and goal:– The ESMA Guidelines, which emerged from the review of existing

regulations, includes broader recommendations relating to: information provision on index-tracking UCITS and UCITS ETFs, rules for UCITS that make use of OTC derivatives transactions and efficient portfolio management techniques, and criteria for UCITS that invest in financial indices.

– The AFM’s report, on the other hand, includes a number of specific recommendations that emerged from the study into the clarity of various types of index trackers that are marketed to consumers in the Netherlands.

AFM review of index trackers (2012)

• Contents report ‘Review of index trackers in 2012 ‘– The theoretical study – The product tests– Content of the testing framework – The findings – What does the AFM expect of the market?

• The report is intended to inform market participants regarding the AFM’s findings and recommendations as a result of its review.

The theoretical study: Definitions

• In this report, the term ‘index tracker’ is to be understood as an open-end listed collective investment scheme (UCITS).

• Funds with an objective other than that of following an index can also be referred to as an ETF. In this report however, reference is made exclusively to ETFs whose objective is to replicate the return of an index.

• Other Exchange Traded Products (ETPs), such as Exchange Traded Notes (ETNs), are left out of consideration.

The findings

• Comprehensibility of the product structures– Some product structure are more complex than product structure of ‘plain

vanilla’ index tracker, e.g. synthetic index trackers, leveraged trackers and/or inverse trackers and physical index trackers with optimisation or sampling.

• Comprehensibility of the information provided– Information is incomplete or difficult to find– The costs are not clear– The type of index tracker is unclear

• Performance indicators– A different and/or not clearly explained investment policy– The policy of the tracker is different from that of the index– Investment policy is too broadly formulated– No policy formulated regarding counterparty selection and collateral

• Securities lending

Main conclusions

• Index trackers can (indeed) be very simple, but not all index trackers are comprehensible to everyone

• Comprehensibility of products depend on product characteristics and target groups

• More complicated products require higher standards on the provision of information

Specific recommendations

• As a product provider of indextrackers– The AFM expects providers to only offer index trackers to consumers

that can be understood by the relevant target group.• As a distributor/investment advisor

– In the case of advisers and asset managers, the AFM expects these parties to only recommend products to consumers or include products in consumers’ investment portfolios that they sufficiently understand in order to be able to assess the suitability of the product for their customers.

– Lastly, the AFM expects the providers of execution-only services to only select products that are suitable for offering via this channel.

What’s next?

• Non-UCITS index trackers?

• Clear distinction for the retail investor between active and passive investing?

• What is the definition of an index? What criteria?