19.2 Regulation And Structure Of Exchange-traded Funds

The Regulation And Structure Of Exchange-Traded Funds

1 | Explain the Regulatory Requirements and Different Legal Structures of ETFs

Exchange-traded funds (ETFs) are popular investment vehicles that combine the features of mutual funds and stocks. They are regulated under either of two national instruments in Canada, depending on their structure. Understanding the regulatory requirements and different legal structures of ETFs is crucial for financial professionals and investors alike.

Types of ETFs Structures and Their Regulatory Requirements

There are two primary legal structures under which ETFs operate:

1. Corporate Class ETFs
2. Trust Class ETFs

1. Corporate Class ETFs

Corporate Class ETFs are established as classes of shares within a mutual fund corporation. These funds are regulated by the National Instrument 81-102 ( extit{NI 81-102}):

• Key Features:

  • They can provide tax-efficient distributions through the corporation.
  • They have the ability to offer capital gains reduction benefits when structured correctly.

• Regulatory Compliance:

  • Corporate Class ETFs must comply with the legal and taxation standards stipulated in NI 81-102.
  • They are subject to fiduciary standards and periodic financial disclosures.
  • Investment restrictions and governance outlines are dictated by the Instrument.

2. Trust Class ETFs

Trust Class ETFs are structured as investment trusts, the most frequent form for ETFs. They are governed by National Instrument 81-107 ( extit{NI 81-107}):

• Key Features:

  • Beneficiaries hold the units of the ETF.
  • The trustee is responsible for managing the trust’s assets in favor of the unit-holders.
  • They can facilitate efficient distribution of income and capital gains.

• Regulatory Compliance:

  • Trust Class ETFs must adhere to guidelines set by NI 81-107, concerning investment policies and operating standards.
  • Regulations including disclosure, mutual funds restrictions, and operational attributes are administered by NI 81-107.

Frequently Asked Questions (FAQs)

Q1: What is an Exchange-Traded Fund (ETF)?

A: An ETF is a type of investment fund that is traded on stock exchanges and holds a collection of assets such as stocks, bonds, or commodities.

Q2: How are ETFs different from mutual funds?

A: ETFs are traded on exchanges like stocks, while mutual funds are bought and sold based on their net asset value (NAV) at the end of the trading day. ETFs typically have lower expense ratios than mutual funds.

Q3: What are the advantages of investing in ETFs?

A: ETFs offer advantages such as liquidity, tax efficiency, low expense ratios, and diversification.

Glossary

• National Instrument 81-102 (NI 81-102): A regulatory framework for mutual funds and ETFs, governing their operations, disclosure, and investor interactions.
• National Instrument 81-107 (NI 81-107): A regulatory framework targeted at mutual funds organized as investment trusts, covering governance and operational criteria.
• NAV (Net Asset Value): The value of one share of the Fund, computed as total assets minus total liabilities divided by outstanding shares.
• Unit-holder: An investor who owns units of a mutual fund or ETF.
• Fiduciary Standards: Legal obligations of fidelity and care owed by trustees or fund managers to the beneficiaries or investors.

Key Takeaways

• ETFs are structured as either Corporate Class or Trust Class funds, each governed by distinct National Instruments in Canada.
• Both structures have unique regulatory compliance requirements involving sufficient disclosure, investment limitations, and fiduciary responsibilities.
• Understanding the structure and regulation of ETFs helps investors make informed decisions to meet their financial goals.

Diagram: ETF Structure Overview

    graph TB
	    A[Exchange-Traded Funds] --> B[Corporate Class ETFs]
	    A --> C[Trust Class ETFs]
	    B --> D[Regulated by NI 81-102]
	    C --> E[Regulated by NI 81-107]
	    D --> F[Tax-efficient distributions and capital gains]
	    E --> G[Efficient distribution of income and capital gains]

In this section

• 19.2.1 Mutual Fund Trusts And Mutual Fund Corporations
  Learn about the structures, regulations, and key differences between mutual fund trusts and mutual fund corporations in Canada, including their governance under National Instrument (NI) 81-102.
• 19.2.2 General Disclosure Requirements For Exchange-traded Funds
  A comprehensive guide on the general disclosure requirements for exchange-traded funds (ETFs) as set out in NI 41-101, including detailed insights into the ETF Facts document, the creation and redemption process, and various ETF types and risks.