ETP risks laid out in FSA document

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 (ETFs), 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, the 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.